Bond Valuation:

Company requires funding for their investment which can be obtained from broadly
two sources.

1. Equity
2. Debt

From equity investors expect a variable income from investment made. Example is
dividend income.

From debt investors expect a fixed income from investment made. Example is
interest. Debt includes debentures, bonds.

Based on their cash flows patterns bonds can be classified into four types:

1. Plain bonds
2. Annuity bonds
3. Perpetual bonds
4. Zero coupon bonds

1. Plain bonds:
This bond pays coupon for n years and redeemed at face value after n years.

2.Annuity bonds:
This bond pays only coupon for n years. These coupons are instalments which
compensate face value and outstanding coupon.

3.Perpetual bonds:
This bond pays coupon for ever.

4.Zero coupon bonds:

This bond does not pay any coupon but pays only maturity value in the nth year.

Value of a bond:

Value of a bond is the present value of the future cash flows discounted at a required
rate of return. Future cash flows include coupon amount and face value of the bond.

Value of the bond depends on the following factors:

1. Coupon rate
2. Yield to maturity
3. Years to maturity

In the market bond can be trade at par, discount, or at premium.

Par value:
Par value means current value of the bond will be equal to redeemable value of the
bond.

When yield to maturity is equal to Coupon rate, bond will trade at par in the market.

Discount bond:
Discount bond means current value is less than the redeemable value of the bond.

When yield to maturity is greater than coupon rate, bond will trade at discount in the
market.

Premium bond:
Premium bond means current value is greater than the redeemable value of the bond.

When yield to maturity is less than coupon rate, bond will trade at discount in the
market.
Illustrations: 1

Gandi Ltd issued 8% annual coupon bonds for a period of 10 years, at yield to
maturity of 8%. Face value of the bond is $1,000. Calculate the value of bond. Based
on the price you calculate, is the bond a par, premium or discount bond?

Solution:

Calculate the value of the bond using excel as follows:

Therefore, the current price of the bond is $1,000.

As the current price of the bond ($1000) is equal to the face value or redeemable
value of the bond ($1,000), bond is trading at par.

Alternative method using formula:

Therefore, the current price of the bond is $1,000.

As the current price of the bond ($1000) is equal to the face value or redeemable
value of the bond ($1,000), bond is trading at par.

Alternative method using Financial Calculator:

I/Y = rate = 8%
NPER = Number of years = 10
PMT = Coupon = -$80
FV = Face value = -$1,000

CPT = PV = Present value = ?

Therefore, the current price of the bond is $1,000.

As the current price of the bond ($1000) is equal to the face value or redeemable
value of the bond ($1,000), bond is trading at par.

Illustrations: 2

Gandi Ltd issued 8% annual coupon bonds for a period of 10 years, at yield to
maturity of 9%. Face value of the bond is $1,000. Calculate the value of bond. Based
on the price you calculate, is the bond a par, premium or discount bond?

Solution:

Calculate the value of the bond using excel as follows:

Therefore, the current price of the bond is $935.82. (Rounded to two decimals)
As the current price of the bond ($935.82) is less than the face value or redeemable
value of the bond ($1,000), bond is trading at discount.

Alternative method using formula:

Therefore, the current price of the bond is $935.82. (Rounded to two decimals)

As the current price of the bond ($935.28) is less than the face value or redeemable
value of the bond ($1,000), bond is trading at discount.

Alternative method using Financial Calculator:

I/Y = rate = 9%
NPER = Number of years = 10
PMT = Coupon = -$80
FV = Face value = -$1,000

CPT = PV = Present value = ?

Therefore, the current price of the bond is $935.82. (Rounded to two decimals)

As the current price of the bond ($935.28) is less than the face value or redeemable
value of the bond ($1,000), bond is trading at discount.

Illustrations: 3

Gandi Ltd issued 8% annual coupon bonds for a period of 10 years, at yield to
maturity of 7%. Face value of the bond is $1,000. Calculate the value of bond. Based
on the price you calculate, is the bond a par, premium or discount bond?

Solution:

Calculate the value of the bond using excel as follows:

Therefore, the current price of the bond is $1,070.24. (Rounded to two decimals)

As the current price of the bond ($1,070.24) is greater than the face value or
redeemable value of the bond ($1,000), bond is trading at premium.

Alternative method using formula:

Therefore, the current price of the bond is $1,070.24. (Rounded to two decimals)

As the current price of the bond ($1,070.24) is greater than the face value or
redeemable value of the bond ($1,000), bond is trading at premium.
Alternative method using Financial Calculator:

I/Y = rate = 7%
NPER = Number of years = 10
PMT = Coupon = -$80
FV = Face value = -$1,000

CPT = PV = Present value = ?

Therefore, the current price of the bond is $1,070.24. (Rounded to two decimals)

As the current price of the bond ($1,070.24) is greater than the face value or
redeemable value of the bond ($1,000), bond is trading at premium.

The relationship between the bond price and Yield to maturity is inverse.

The bond price will increase, when Yield to maturity is decreased.

The bond price will decrease, when Yield to maturity is increased.

Yield to maturity:
Yield to maturity is the return earned by the bond holder, if holds the bond till
maturity.

Illustration 4:

Baba Ltd. Issued 8% coupon bonds issued at a price of $950 for its new project with a
maturity period of 10 years. Assume the face value of the bond is $1,000. Calculate
the Yield to maturity of the bond.

Solution:

For exact Yield to maturity use Excel:

Therefore, the yield to maturity is 8.77%. (Rounded to two decimals)

For approximate answer use formulas:

Therefore, the yield to maturity is 8.72%. (Rounded to two decimals)

Alternative method using Financial Calculator:

NPER = Number of years = 10

PMT = Coupon = $80
PV = Present value = -950
FV = Face value = $1,000

CPT = I/Y = Rate =?

Therefore, the yield to maturity of the bond is 8.77%. (Rounded to two decimals)
Yield to call:

Return earned by the investor, if holds bond till the call date. Call date is the any date
before the maturity date of the bond.

Illustration 5:

Baba Ltd. Issued 8% coupon bonds issued at a price of $950 for its new project with a
maturity period of 10 years. Assume the face value of the bond is $1,000 and bond
can be called in 5 years at price of $1,050. Calculate the Yield to Call of the bond.

Solution:

For exact Yield to call use Excel:

Therefore, the yield to call is 10.14%. (Rounded to two decimals)

For approximate yield to call use formulas:

Therefore, the yield to call is 9.76%. (Rounded to two decimals)

Alternative method using Financial Calculator:

NPER = Number of years = 5

PMT = Coupon = $80
PV = Present value = -950
FV = Face value = $1,050

CPT = I/Y = Rate =?

Therefore, the yield to call of the bond is 9.76%. (Rounded to two decimals)