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determinant of bond

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A long-term debt instrument in which a borrower agrees to make payments of principal and interest, on specific dates, to the bond holders. Bonds are issued when companies want to borrow smaller amounts of money from numerous lenders. Buying a bond means you are lending out your money

Sample of Bond

bond

Firm A

Capital

Bondholders

Receive interest payments until the term ends

Bond Characteristics

Formula

Present Value of Bond = Present value annuity of interest payments + Present value of principal repayment

or

Present Value of Bond

= I (PVA) + P (PV)

k%n k%n

I and k should be devided by 2 or 4 n should times 2 or 4

I K

= Interest payment / coupon payment = Market interest rate / required rate of return on the bond

N

P

= Principal Payment / Par or maturity value Usually RM 1000

EXAMPLE

Assume that you purchased a bond with 15 years remaining to maturity with 15% coupon rate. The interest payment is paid annually and also assume that par value is RM 1000. If the required rate of return on bonds of this risk and maturity is 15%, what will the bond sell for?

Value of Bond

= I (PVA) + P (PV)

k%n

15%, 15

k%n

15%, 15

= 877.05 + 123 = RM 1000.05 ~ RM 1000

METHOD 2 CALCULATOR

CPT

PV

INPUTS

15 N

15 I/Y PV

-1000

150 PMT

1000 FV

OUTPUT

CONT.

Assume that you purchased a bond with 15 years remaining to maturity with 15% coupon rate. The interest payment is paid annually and also assume that par value is RM 1000. If the required rate of return on bonds of this risk and maturity is 15%, what will the bond sell for?

What would be the bonds value after one year if the required rate of return were down to 10% or up to 20% respectively?

EQUATION 1

Value of Bond = 150 (PVA) + 1000 (PV)

10%, 14 10%, 14

EQUATION 2

Value of Bond = 150 (PVA) + 1000 (PV)

20%, 14 10%, 14

CPT

PV

INPUTS

14 N

10 I/Y PV

-1368.33

150 PMT

1000 FV

OUTPUT

CPT

PV

INPUTS

14 N

20 I/Y PV

-769.47

150 PMT

1000 FV

OUTPUT

EXERCISE 1

Mr. Azmin purchased a bond with 10 years remaining to maturity with 10% coupon rate. The interest payment is paid annually and also assume that par value is RM 1000. If the required rate of return on bonds of this risk and maturity is 10%, what will the bond sell for?

= 10% (1000)

K = 10% N = 10

= RM 1000

METHOD 1 : FORMULA

Value of Bond

= 10% (1000) (PVA) + 1000 (PV)

10%, 10 10%10

CPT

PV

INPUTS

10 N

10 I/Y PV

-1000

100 PMT

1000 FV

OUTPUT

Mr. Azmi purchased a bond with 10 years remaining to maturity with 10% coupon rate. The interest payment is paid annually and also assume that par value is RM 1000. If the required rate of return on bonds of this risk and maturity is 10%, what will the bond sell for?

What would be the bonds value after two years if the required rate of return were down to 5% or up to 15% respectively?

I

= 10% (1000)

K = 5%

N =8 P

= RM 1000

5%, 8 5%, 8

Value of Bond = 10% (1000) (PVA) + 1000 (PV) = 100 (6.4632) + 1000 (0.6768) = 646.32 + 676.80

I

= 10% (1000)

K = 5% N =8 P

INPUTS

= RM 1000

8 N 5 I/Y PV

-1323.16

100 PMT

1000 FV

OUTPUT

I

= 10% (1000)

K = 15%

N =8 P

= RM 1000

15%, 8 51%, 8

Value of Bond = 10% (1000) (PVA) + 1000 (PV) = 100 (4.4873) + 1000 (0.3269) = 448.73 + 326.90

I

= 10% (1000)

K = 15% N =8 P

INPUTS

= RM 1000

8 N 15 I/Y PV

-775.63

100 PMT

1000 FV

OUTPUT

INTEPRETATION

Sell at Par Value Sell at Premium Sell at Discount

I=K 10% = 10%

Whenever the required rate of return is lower than the coupon rate

I>K 10% > 5%

Whenever the required rate of return than the coupon return is higher rate I<K 10% < 15% PV Bond = RM 775.63

PV Bond = RM1000

PV Bond = RM 1323.12

YIELD-TO-MATURITY (YTM)

It is another name for : Rate of return Internal rate of return Market interest rate Discount rate of return It is the required yield expected by the investors There are 3 methods to calculate the YTM:Trial and Error YTM formula Calculator

Example: You were offered a 10yr, 15% coupon rate, RM1000 par value bond at a price of RM960. What rate of interest would you have earn if you have bought this bond and held it to maturity? Solution:

Value of Bond = I (P V A k%n ) + P (P V k%n) 960 = 15% (1000) (P V A k% 10 ) + 1000 (PV k% 10)

1. Type of bond: Discount Bond 2. Features: Market yield (market interest) is greater than Coupon rate. 3. k > I

Begin searching with k = 15% (because the value of I = 15%) and higher than 15%. So now we assume the value of k as 15% and 16%. At k = 15%, Bond Price = RM999.85 At k = 16%, Bond Price = RM951.95

k = 15%

RM999.85

k=?

RM960

k = 16

RM951.95

YTM FORMULA

I+ YTM = M- Value of Bond N

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