Bon valuation

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Bon valuation

Attribution Non-Commercial (BY-NC)

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Debt instruments promise to pay a stipulated stream of cash flows. A bond is a debt instrument It pays periodic interest payments based on the stated (coupon) rate and return the principal at the maturity. Cash flows on a bond are fairly certain and the price of bond equals the present value of future interest payments plus the present value of the face value (which is returned at maturity). 8-1

BOND VALUATION

Bond valuation is the process of determining the fair price of a bond. As with any security, the fair value of a bond is the present value of the stream of cash flows it is expected to generate. The value of a bond is determined by discounting the bonds expected cash flows to the present using the appropriate discount rate.

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BOND VALUATION

C * F * (1 (1+R)-t + C -----------------R (1+R)t

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BOND VALUATION

Example 1

Navaratna Ltd. Issued debentures with a face value of Rs. 1000 and the maturity period is 5 years. The rate of interest payable by the company on the debenture is 10% per annum. The appropriate capitalization rate is 8%. Calculate the present value of the debentures.

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BOND VALUATION

Example 2

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BOND VALUATION

Example 3

A five year bond with a coupon payment of Rs. 11 and the maturity value of Rs. 80 is currently selling at Rs. 110. The required rate of return is 10%. Advise the investor whether to buy or not this security.

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BOND VALUATION

Example 4

A Rs.100 par value bond bearing a coupon rate of 12 percent will mature after 5 years. What is the value of bond, if the discount rate is 15%

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If the current price/value of a bond is given, together with details of coupons and redemption date, then this information can be used to compute the required rate of return or yield to maturity of the bond (YTM) Yield-to-maturity the yield an investor would receive by purchasing a bond at today's market price and holding it until its maturity date, receiving all interest coupon payments and the bond's maturity value on schedule.

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Example 1 A bond with a face value of Rs. 100 is currently available at Rs. 800. The coupon rate of interest is 9%. The bond will mature after 8 years. Calculate the yield to maturity (YTM) of the bond.

If the current purchase price is higher than the face value, r must be lower than coupon rate

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R = A + C * (B-A) ----D A - is the rate at the lower trial; B - is the rate at the higher trial;

C - is the excess of value at the lower trial than the market value/ purchase price D - is the difference between value of the lower trial and the value of higher trail 8-10

Example 2 A bond paying a coupon of 7% is redeemable in five years at par (Rs.1000 and is currently trading at Rs. 106.62. Estimate its yield (required rate of return)

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1)

2)

Example 3 Suppose you buy a Rs. 1000 face value coupon bond with a coupon rate of 10% and a maturity of 4 years If purchase price is Rs. 800, what is the yield to maturity? If purchase price is 1200, what is the yield to maturity?

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Example 4

A 5 year bond, paying 6 percent interest on the face value of Rs. 1000 and currently selling for Rs. 883.40. Calculate the yield to maturity.

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Example 5

A bond of Rs. 10000 bearing coupon rate 12% and redeemable in 8 years at par is being traded at Rs. 10, 600. Find out the yield to maturity of the bond.

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Example 6

An investor buys a 10% bond (FV=1000) for Rs. 1029 today. The remaining maturity period is 4 years. Find out the YTM

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Example 7

A five year Rs. 100 debenture of a firm can be sold for a net price of Rs. 95.90. The coupon rate of interest is 14% per annum, and the debenture will be redeemed at 5 percent premium on maturity. Compute the yield to maturity.

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Example 8

The current value of a 8% debenture, of Rs. 1000 redeemable after 5 years at par is Rs.924.28. Find out the yield to maturity or internal rate of return

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Example 9

Cannon Corporation is selling a new issue of bonds to raise money to finance its new line of yogurt products. The bonds will pay a coupon rate of 5% and will mature in 15 years. The face value of the bonds is Rs.1,000 each; interest is paid semi-annually. A) The market rate of interest is currently 6% for similar bonds. What is the fair price for an investor to pay for one of these bonds? B) The current market price is $920 for each bond. If you paid this price, what would be your yield-to-maturity?

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I = Annual Coupon Interest Payment RV = Redemption Value Bo = Market Value/ Purchase price N = Number of years

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Some bonds have a feature, referred to as a , call feature, that allows the bond issuer to buy back the bonds from the investor at a specified price the call price- during a specified period prior the bonds maturity date. A bond with this feature is referred to as callable bonds. Calculation of Yield to call is similar to yield to maturity

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Example 1: Surya Ltd has a 14% debenture with a face value of Rs. 100 that matures at par in 15 Years. The debenture is callable in 5 years at Rs. 114. It currently sells for Rs. 105. Calculate Yield to call and yield to maturity

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Example 2: Suppose the 10%, 10 Year Rs. 1000 bond is callable in 5 years at a call price of Rs. 1050. The bond is currently selling for Rs. 950. What is bonds yield to call?

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Example 3: A 7-year, $1,000 par bond has an 8% annual coupon and is currently yielding 7.5%. The bond can be called in 2 years at a call price of $1,010. What is the bond yielding, assuming it will be called (known as the yield to call)?

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Example 4: A Rs. 1000 par value bond has 7.5% coupon rate. The bond has a maturity period of 15 years. YTM is 6%.

If bond is callable after 7 years for Rs. 1075, what would be the yield to call?

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Duration is defined as the weighted average of the lengths of time until the remaining cash flows are received. Duration is the weighted average measure of a bonds life. The various time periods in which the bond generates cash flows are weighted according to the relative size of the present value of those cash flows.

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As the bondholder receives a coupon payment, the amount of the cash flow is no longer on the time line, which means it is no longer counted as a future cash flow that goes towards repaying the bondholder.

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