Bonds

• Instruments of Loans issued by Government and Corporations.

• In Pakistan Corporate bonds are called Term Finance
Certificates.
• Long Term Government Bonds are called PIBs or Pakistan
Investment Bonds in Pakistan.
• Every Bond consists of
 Face Value
 Coupon Rate or Interest rate
 Maturity or Duration
 Frequency of Coupon Payments
 Price
 Regular or Plain Vanilla Bond
• Interest payments at fixed intervals.
• Sells at discount or premium (depends on
required rate of return and coupon rate).
• Face Value is paid on Maturity with last
coupon/interest payment. Face Value + Coupon

Coupon Payments

1 2 3 4 5 6 7 8
Time periods
Price
 Bond Yield
• Yield is return earned on a bond.
• Yield or return can be higher or lower than
stated coupon rate or interest Rate.
• Yield depends on Price of Bond.
• As Price goes up, Yield goes down and vice
versa.
 Price of Bond and RRR
• Price of the Bond is inversely proportional to
Required Rate of Return or Market Interest
Rate.
• If RRR < Coupon Rate; Bond’s price will be
higher than its face value i.e., sells at a
premium.
• If RRR > Coupon Rate; Bond’s price will be
lower than its face value i.e., sells at a discount.
 Yield to Maturity (YTM)
• Yield to Maturity is the rate of return that the investor
earns if bond is held till maturity.
• All other things being equal; YTM depends on the price
paid for the bond.
• If all other factors are held constant; as price paid for the
bond increases, YTM decreases and vice versa.

• Note: YTM is not Coupon rate of the bond

• YTM is also called IRR or Internal Rate of Return of the
bond.
 Price of Regular Bond
• Price = C [(1-(1+r)-n)/r] + M/(1+r)n

Where
C = Coupon Amount
r = Periodic required rate of return
n = Total number of compounding periods
remaining till maturity
M = Face Value

• Note: The factor [(1-(1+r)-n)/r] stands for present value of

Annuity
 Example
• What is the fair price of a 5 year bond with
face value of Rs. 1,000 and annual coupon rate
of 6% (compounded semiannually) if annual
required rate of return is 7%?
Coupon Payment = 1000 x (0.06/2) = Rs. 30
Price = C [(1-(1+r)-n)/r] + M/(1+r)n
= 30 x [(1-(1+0.035)- 10)/0.035] + 1000/(1+0.035)10
= 30 x 8.317 + 1000/ 1.411
= 249.51 + 708.72
= Rs. 958.23 (Discount Price)
 Example
• What is the fair price of a 5 year bond with
face value of Rs. 1,000 and annual coupon rate
of 6% (compounded semiannually) if annual
required rate of return is 5%?
Coupon Payment = 1000 x (0.06/2) = Rs. 30
Price = C [(1-(1+r)-n)/r] + M/(1+r)n
= 30 x [(1-(1+0.025)- 10)/0.025] + 1000/(1+0.025)10
= 262.56 + 781.20
= Rs. 1043.76 (Premium Price)
 Callable Bonds
• Has the option of being redeemed by the
issuer before maturity date. Called the call
date.
• Usually pays a higher coupon rate than a
regular bond with same attributes.
• Issuer pays a premium on face value if called
before the maturity date.
 Callable Bond Valuation
• Price = C [(1-(1+r)-n)/r] + M/(1+r)n
Where
C = Coupon Amount
i = Periodic required rate of return
n = Total number of compounding periods
remaining till Call date
M = Call Value
 Example
• What is the fair price of a 5 year callable bond with face value of Rs.
1,000 and annual coupon rate of 6% (compounded semiannually) if
annual required rate of return is 7%? Bond has the option to be
called back 4 years from now at Rs. 1,100.

• C?
• M?
• n?
• r?

Note: Whenever confused in such problems, make a bond payment

structure.
 Zero Coupon Bond
• Usually short term government bonds called T-
bills or Treasury Bills.
• Pays no interest Rate
• Face Value is redeemed on maturity
• Sells on Discount i.e., sells at a price lower
than face value.
• The difference is interest earned.
 Zero Coupon Bond Price
• Price = M/(1+r)n

Where
r = Periodic required rate of return
n = Total number of compounding periods
remaining till maturity
M = Face Value

This equation is used for Zero Coupon Bonds with

Maturity of longer than a year
 Types of Assets
Financial Assets Non Financial Assets
Intangible Tangible
Investments, Advances, Loans Property, Plant, Equipment, Inventories
Provisions and Amortization Depreciation
Typically does not constitute a company’s Typically always used in company
operational area of business unless the operations.
company is a bank, insurance company or
other financial institution.
 Portfolio
• In essence a collection of investments.
• Used to diversify Risk by spreading
investments across different investments.
Expected Return of Portfolio
 Types of Risks
• Capital Risk
• Purchasing Power Risk or Inflation Risk
• Interest Rate Risk
• Maturity Risk
• Default Risk
• Prepayment Risk
• Event Risk
• Reinvestment Risk
• Exchange Rate Risk
• Liquidity Risk