BOND VALUATION

BOND / DEBENTURE
• A bond or a debenture is a long term debt
instrument carrying a fixed rate of interest
which is known to investors.

• A bond is redeemable after a specified period.

 Features of a Bond or Debenture
• Face Value – Face value is called par value. A bond /
debenture is generally issued at a par value and
interest is paid on the par value.
• Interest Rate – Interest rate is fixed and known to the
bondholders / debenture holders. Interest paid on a
bond is tax deductible. The interest rate is also called
the coupon rate.
• Maturity – A bond is issued for a specified period of
time. It is repaid on maturity.
• Redemption Value – The value which a bondholder will
get on maturity is called redemption value.
• Market Value – A bond / debenture may be traded on
the stock exchange. The price at which it is currently
sold or bought is called the market value of the bond /
debenture.
Accrued interest and pricing of bonds

• All bonds are quoted ‘clean’, that is, net of

accrued interest. However when a bond is
purchased or sold, accrued interest is added
to the clean price to obtain the “gross” or
“dirty” price owed.
Accrued interest and pricing of bonds

• Suppose an investor bought a 10% coupon 89

days after the last coupon was paid for a clean
price of Rs 102. The dirty price would be:
• Clean Price 102.00
• Plus Accrued interest[(89/365) *10] 2.44
• Dirty Price 104.44
 Accrued interest : Cum div / Ex Div
• If it is purchased ex – div : the investor will not
be entitled to the imminent interest payment.
• Dirty Price = Clean Price – Accrued Interest

• If it is purchased cum div: the investor will be

entitled to the imminent interest payment.
• Dirty Price = Clean Price + Accrued Interest
 Valuation of Bonds

• Bond Value > Market price of bond

• Investor buys bond / under priced
• Bond Value < Market price of bond
• Investor will not buy bond (rather sell bond) /
over priced
• Bond Value = Market price of bond
• Investor will normally buy/fairly priced
 Perpetual Bonds
• Bonds which never mature are known as
perpetual bonds. As there is no maturity date or
terminal value, the value of the bonds would
simply be discounted value of the infinite stream
of interest flows.
• The formula used to determine the value of a
perpetual bond is:
• B0 = INT1
• kd
• If the coupon rate is less than the interest
rate, the bond will trade at less than the par
face value of Rs 100.
• If the coupon rate is more than the interest
rate, the bond will trade at more than the par
face value of Rs 100.
 Zero Coupon Bonds

• A zero coupon bond is a bond that does not

pay coupon payments and instead pays one
lump sum at maturity. The amount paid at
maturity is called the face value.
• The formula used to determine the value of a
zero coupon bond is:
• B0 = Bn / (1+r)n
• Where Bn = maturity value in period n