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Bond Valuation

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Bond Valuation
A Bond is a security that pays a stated
amount of interest to the
invester,period after period, until it is
finally retired by the issuing company. A
bond has a face value, it almost
always has a stated maturity, which is
the time when the company is obligated
to pay the bondholder the face value of
the instrument. Finally, the coupon
rate or the nominal annual rate of
interest, is stated on the bond’s face.
Bond Valuation
 Bond-A long-term debt instrument issued by a
corporation or government.
 Face value- The stated value of an asset.
 Coupon Rate- The stated rate of interest on a
bond, the annual interest payment divided by
the bond’s face value.
 Maturity Period-Bonds have a maturity period
of 1-10 years, sometimes they have a longer
maturity. At the time of maturity the par (face)
value plus perhaps a nominal premium is
payable to the bond holder.
Strategic role of Bond in
 Portfolio management can be viewed as
a two level process (Macro, Micro).
 Bonds served as a kind of anchor to the
winds of adversity.
 Bond returns are less than stock
returns, bond investment involves less
 Total risk of a portfolio may be thought
of as the individual risk of each
investment and its correlation to move
relative to each other.
Types of Bonds
 Government Securities
 Treasury Bills
 Zero Coupon Bonds
 Junk Bonds
Government Securities
 These are debt instruments issued by
the RBI on behalf of the Govt of India
and are known as G.secs or Gilts, it
carries full backing of the central govt
and is also known as Sovereign debts.
 Once issued they can be traded in
secondary markets.
 The major participants are banks and
financial institution, mutual funds,
insurance co, primary dealers, provident
funds, trusts & individuals.
Treasury Bills
Zero Coupon Bonds

 A bond that pays no interest but

sells at a deep discount from its
face value, it provides
compensation to investors in the
form of price appreciation.
Junk Bonds
 The rate of interest is high
compared to the market, as the
rate of interest is high risk is high.
 No certainty about its redemption
payment of the bond.
 Credit rating is very low.
Credit Rating
 Bond investment agencies
evaluate the quality of bonds and
rank them in categories according
to relative probability of default.
 For Investors- Simplifies the task of
assessing risk.
 Rating Agencies- 1) Moody’s
Investors service. 2) Standard &
Poor corp.
How rating is done?
 Moody’s Investor’s Services
Aaa Best Quality
Aa High grade
A Higher medium grade
Baa Lower medium grade
Ba Possess speculative element
B Generally lack characteristics of
desirable investment
Moody’s Investor’s
Caa Poor standing may be in default
Ca Speculative to a high degree,
often in default
C Lowest grade
Standard & Poor’s Corp.
AAA Highest grade
AA High grade
A Upper medium grade
BBB Medium grade
BB Lower medium grade
B Speculative
CCC-CC Outright speculation
C Reserved for income bonds
DDD-D In default,with rating indicating
relative salvage value
Other Factors
 Small issues & those placed
privately are generally not rated.
 Sometimes the 2 agencies differ in
their evaluation & classification.
 The rating is altered only when
agencies deem that sufficient
charges have occurred.
Pricing of Bond
 Clean Price = Face Value + Capital
 Dirty Price = Clean Price +
Accrued Interest
 Eg: 7.46 % 901 2017 is quoted at
clean price Rs.112.50,FV Rs.100
Int payment date-28th Aug 2001
Settlement date-11th Jan 2002.
Pricing of Bond
 Accured Interest =
Rate of int *no.of days since last
int payment date/360
=7.46 * 133 / 360
Hence Dirty Price = 112.50 + 2.76
= 115.26
Yield Curve
 The plot of the yield on various debt
instrument against the time of maturity
is known as yield curve.
 Under normal circumstances-
Longer the maturity-high risk-high
(Government securities/Gilts)
Shorter maturity-low risk-low return
(Treasury Bills)
Help an investor to make a
 An investor can make a choice
between buying a long-term
instrument or buying a short-term
instrument and rolling will be at
the time of reinvestment.
Bond Return
 These are the tools by which the
performance of a bond can be
 The commonly emlpoyeed yield
measures are : Current Yield, Yield
to Maturity, Yield to Call.
Current Yield
 The current yield relates the
annual dollar coupon interest to
the market price.
Current Yield = I/P
I = Annual Interest
P = Current market price
Eg of Current Yield(1)
 A bond paying Rs.10 p.a interest
currently selling at Rs.80
Current Yield = 10/80=0.125 or 12.5%
Current Yield > Rate of coupon
That is bond is selling at a discount.
Eg of Current Yield(2)
 A bond Paying Rs.10 p.a interest
currently selling at Rs.120.
Current Yield = 10/120=8.33%

Current Yield < Rate of Coupon
That is Bond is selling at premium.
Eg of Current Yield(3)
 A bond paying Rs.10 p.a interest
currently selling at Rs.100.
Current Yield = 10/100=10%

Current Yield = Rate of Coupon
That is Bond selling at Par.
Yield To Maturity
 The expected rate of return on a
bond if bought at its current
market price & held till maturity.
Yield to Call
 Redemption before maturity
 Usually at Premium
 Yield to call is often compared with
Yield to Maturity.