BONDS AND BOND

VALUATION
FINANCIAL MARKETS
BONDS
 Also called as “Fixed Income Securities”
 Less Riskier than other Securities
 Usually Decentralized – Most secondary transactions takes place
in the OTC markets. Numerous trades/volume but not as big as
stock market transactions
 Bond Markets are not as efficient as the Stock Market. It has less
price transparency. It is less traded compared to stocks.
TYPES OF BONDS
ZERO COUPON BONDS

 At
times, corporations issue bonds that have no coupon
payments but promise a single payment at maturity.

 Theface value of a zero coupon bond is different from that of a

vanilla bond in that it includes both the interest and principal.
Corporate convertible bonds can be converted into shares of common
stock at some predetermined ratio at the discretion of the
bondholder.

For example, a $1,000 face value bond may be convertible into 100
shares of common stock. A conversion feature is valuable to
bondholders because it allows them to share in the good fortunes of
the firm if the firm’s stock price rises above a certain level.

Specifically, the bondholders profi t if they exchange their bonds for

the company’s stock when the market value of the stock they receive
exceeds the market value of the bonds.
BONDS VALUATION

 Bondvaluation is a technique for determining the

theoretical fair value of a particular bond.

 To determine how bonds are priced

 BONDS VALUATION
Bond valuation includes calculating the 
present value of a bond's future interest payments, also known as
its cash flow, and the bond's value upon maturity, also known as
its face value or par value.

Because a bond's par value and interest payments are fixed, an

investor uses bond valuation to determine what rate of return is
required for a bond investment to be worthwhile.
ELEMENTS OF A BOND

 COUPON ( NOMINAL RATE X THE FACE VALUE)

 MATURITY DATE

 FACE AMOUNT

 YIELD

 PRICE
Example:


A $1,000 U.S. corporate bonds that pays 5%
annual rate sells for $965.20 that will
mature on December 31, 2032.
TO WHAT PRICE SHOULD I BUY THIS?
Now assume that the market rate of interest rises
overnight to 8 percent. What happens to
the price of the bond? Will the bond’s price be
below, above, or at par value?
What would happen to the price of the bond if interest rates on similar
bonds declined
to 2 percent and the coupon rate remained at 5 percent?
The price would rise to $1,086.52. At this price, the
bond’s yield would be precisely 2 percent, which is the
current market yield.

The $86.52 ($1,086.52 - $1,000 = $86.52) premium adjusts

the bond’s yield to 2 percent, which is the current market
yield for similar bonds. Bonds that sell at prices above par
are called premium bonds.

Whenever a bond’s coupon rate is higher than the market

rate of interest, thebond will sell at a premium.
CONCLUSION:
 SEATWORK
1. AB Corp is issuing a 10-year bond with a coupon rate of 8 percent. The
interest rate for similar bonds is currently 6 percent. Assuming annual
payments, what is the value of the bond?

2. CBA Inc. has issued a 3-year P1,000 bond that pays a coupon of 6.10
percent. Coupon payments are made semi-annually. Given the market rate of
5.80 percent what is the market value of the bond?

3. Ten - year zero coupon bonds issued by the U.S. Treasury have a face value
of P1,000 and interest is compounded semi-annually. If similar bonds in the
market yield is 10.5 percent, what is the value of these bonds?
BOND THEOREMS

1. Bond prices are negatively related to interest rate

movements. As interest rates decline, the prices of bonds rise;
and as interest rates rise, the prices of bonds decline. As
mentioned earlier, this negative relation exists because the
coupon rate on most bonds is fixed at the time the bonds are
issued. Note that this negative relation is observed not only for
bonds but also for all other fi nancial claims that pay a fixed rate
of interest to investors.
 BOND THEOREMS

2. For a given change in interest rates, the

prices of long-term
bonds will change more than the prices of short-
term bonds.

In other words, long-term bonds have greater price volatility (risk) than
short-term bonds because, all other things being equal, long-termbonds
have greater interest rate risk than short-term bonds
BOND THEOREM

3. For a given change in interest rates, the prices

of lower-coupon bonds change more than the
prices of higher-coupon bonds.