Bond Valuation:

Bond:
Bond is a debt instrument used to raise debt capital. The holders of the bond are
the creditor of the company. It is a fixed income security and the company has to
pay bond interest even if the company incurred loss. The bond interest is tax
deductible expense.

Difference between Share and Bond :

A zero-coupon bond is a debt security that does not pay interest but instead trades at a deep
discount, rendering a profit at maturity, when the bond is redeemed for its full face value.
From the view point of valuation, the bonds are categorized in to two types :

1) Zero Coupon Bond

2) Coupon Bond

Zero Coupon Bond:

A zero-coupon bond is a debt security that does not pay interest but instead
trades at a deep discount. At the maturity face value is given. The difference
between Face value and the purchase price is the benefits in investing in zero
coupon bond.

Coupon Bond:
The coupon bond is a bond which has a coupon interest is payable at a
regular interval and at maturity face value is given. The difference between
Face value including coupon payments and the purchase price is the benefits
in investing in coupon bond.
.
Valuation of Zero-Coupon Bond:

FV
Vzc = --------- Here, Vzc = Value of Zero Coupon Bond
n
(1 + r)
FV= Face Value

r= discount rate/cost of capital/required rate of

return/interest rate

n= No. of years
Ex-1:

Determine the value of zero Coupon bond which has face value of Tk.1000.00 having
maturity period of 3 years and the required rate of return of investors is 10%?

1000
Vzc = -------- = Tk.751.31 (Intrinsic Value)
(1.1)3

Ex-2:

Refer to the problem given above.

a) If the Market value of the Bond is Tk.760.00 , whether the bond is undervalued or
overvalued , the bond should be purchased or sold?
b) If the Market value of the Bond is Tk.740.00 , whether the bond is undervalued or
overvalued , the bond should be purchased or sold?

Decision Criteria:

If the Market Value > Intrinsic Value , the asset is overvalued , it should to sold

If the Market Value < Intrinsic Value , the asset is undervalued , it should to purchased.

If the Market Value = Intrinsic Value , Indifference position, other factors required to take decision.

Ans:

a) The bond is overvalued, it should be sold ( it should not be purchased)

b) The bond is Undervalued, it should be purchased ( it should not be sold)

Valuation of Coupon Bond;

VC = PV of Coupon Payment + PV of Face Value
Here, P /VC = Valuation of Coupon Bond

C= Coupon payment

i/r = discount rate/cost of capital/required rate of return/interest rate

M/FV = Maturity Value or Face Value

N= No. of Years

Ex-1: ) A 15% coupon bond having face value of Tk.5000.00 with maturity period of 2 years
and the coupon interest is payable yearly. The required rate of return of investors is 10%.
Find the value of Bond?

Solution:
Coupon Payment Per Year = Tk.750.00 ( 5000X15%)
Method-1:
750 750 5000
VC = (----------------- + --------------------] + ----------------------

(1+.1)1 (1+.1)2 (1+.1)2

----------------------------- -------------------
PV of Coupon Payment PV of Face value/Maturity Payment
VC = (681.82 + 619.83 ) + 4132.23

VC = 5, 433.88

Method-2: By using PV table

Year CIF( Cash PVIF @10% PV= (2X3)

 (1) Inflow) (2)
(3)
1 750 0.90909 681.82
2 750 0.82645 619.85
2 (FV) 5000 0.82645 4132.25
Total 5,433.91
Method-3: By using annuity table
Annuity Table can be used when the following two condition satisfied:
1) Cash flow same
2) Interval Same

Annuity Formula:
1
P= C X ( 1- ---------- )
(1+r)n
----------
r
Here, P = Valuation of Coupon Bond

C= Coupon payment

r = discount rate/cost of capital/required rate of return/interest rate

N= No. of Years

VC = (Coupon payment per year X PVIFA 10%, 2 years) + Face value/ Maturity value X PVIF 10%, 2 years

= (750 X 1.7355) + (5000 X 0.82645) = 5,433.88

1
P= C X ( 1- ---------- )
(1+r)n
----------
r
Ex-2: ) Refer to the EX-1, if the coupon payment is paid half yearly, then what will be the
value of Bond.
Coupon Interest = 750 per year , half yearly = 750/2=375
No. year = 2 X 2= 4
Rate = 10%/2=5%
Year CIF( Cash PVIF @5% PV= (2X3)
(1) Inflow) (2) (3)
1 375 0.95238 357.1425
2 375 0.90703 340.1363
3 375 0.86384 323.94
4 375 0.8227 308.5125
4 5000 0.8227 4113.5
Total 5443.231

EX-3: Refer to the problem above,

If The bond is presently selling in the market at Tk.4200. Should the bond be bought or sold?

The bond should be purchased because MV<IV