Bond & Equity valuation

Dr.L.Goverthanan
Source – RBI Website & Books on Investment
Bonds in India
Bonds are long term debt instruments.
The issuer of the Bond owes to the holder of the bond,
1. Periodic payment of Interest
2. Repayment of principal on maturity (as per terms
of issue)
Depending on the issuer of Bonds it is classified further
into Government Bonds and Corporate Bonds.
Bonds are generally secured.
Trading is done in Market popularly known as Bond
Market / Debt Market / Credit market
Types of Bonds
• Normal Bond – Periodic Interest payment +
repayment of principal on maturity.
• Perpetual Bond- Only Interest is paid
periodically for ever.
• Zero-coupon Bond- No periodic interest
payments but on maturity face value is paid.
• Deep discount bond-No periodic interest
payments but on maturity face value is paid.
• Inflation adjusted bond- Coupon is reset
periodically based on Inflation.
• Sovereign Gold bond – Redemption at Market
value. Interest periodically paid at 2.5%
Bonds in India (…)
Government Bonds (Guaranteed by Govt.)
• Treasury Bills (T-Bills)
They are issued by GOI for 91D, 182D and 364
days.
• Long term Government Bonds
These are issued for a period ranging from 5 to
40 years.
• The Bonds issued by States are called SDLs( State
Development Loans)

• RBI manages the issue, payment of Interest and

redemption on Maturity of these G-Secs. There is
no default and hence these are called Gilt Secs.
Treasury Bills
•A Government Security (G-Sec) is a tradeable
instrument issued by the Central Government or the
State Governments.
•It acknowledges the Government’s debt obligation.
Such securities are short term (usually called treasury
bills, with original maturities of less than one year) or
long term (usually called Government bonds or dated
securities with original maturity of one year or more).
• the Central Government
• Issues both, treasury bills and bonds or dated securities

•the State Governments

• issue only bonds or dated securities, which are called
the State Development Loans (SDLs). G-Secs carry
practically no risk of default and, hence, are called risk-
free gilt-edged instruments.
Dated G-Secs (Long term Govt. Bonds)
•Dated G-Secs are securities which carry a The nomenclature of a typical dated fixed
coupon G-Sec contains the following
fixed or floating coupon (interest rate) which
features - coupon, name of the issuer,
is paid on the face value, on half-yearly basis. maturity year. For example, - 7.17% GS
Generally, the tenor of dated securities 2028 would mean:
ranges from 5 years to 40 years. Coupon : 7.17% paid on face value
Name of Issuer : Government of India
The Public Debt Office (PDO) of the Reserve
Bank of India acts as the registry / depository of Date of Issue : January 8, 2018
G-Secs and deals with the issue, interest Maturity : January 8, 2028
payment and repayment of principal at Coupon Payment : Half-yearly (July 08 and
maturity. Most of the dated securities are fixed Dates January 08) every year
coupon securities.
Minimum Amount
of issue/ sale : ₹10,000
Payment of Interest – Next wday if due date is holiday.
Repayment on maturity – Previous day if maturity falls on a ISIN – International Security Identification Number
holiday. is also given for every issue.
Treasury Bills (T-Bills)
•Debt obligations of the Government that have
maturities of one year or less are normally called • They are presently issued in three
Treasury Bills or T-Bills. Treasury Bills are short-
term obligations of the Treasury/ Government. tenors, namely, 91 day, 182 day and
They are instruments issued at a discount to the
face value and redeemed at face value. 364 day. Treasury bills are zero
•Eg.a 91 day Treasury bill of ₹100/- (face value)
may be issued at say ₹ 98.20, that is, at a coupon securities and pay no interest.
discount of say, ₹1.80 and would be redeemed at
the face value of ₹100/-. The return to the
investors is the difference between the maturity • They form an integral part of the
value or the face value (that is ₹100) and the
issue price money market.
Bond Valuation
• Current value of a Bond is nothing but sum of present value of
future benefits expected.
• This may be expressed in equation form as:
• PV of a Bond = PV of future Interest payments expected +
Face value of Bond returned on Maturity. The same can be
precisely written as
• Where C is coupon int and M is Maturity value.
Bond Valuation (contd…)
• Where C is coupon interest and M is Maturity value and
Interest is paid half yearly and i is the required return.

• In excel this can be arrived at using PV functions and also by

Price function.
• P= PV(A)+PV(Lumpsum)
Bond Valuation – Coupon types
• There are three types of coupon rate
• Zero coupon
• Fixed coupon
• Floating coupon
• Calculation of price of Zero coupon Bond
• PV = where M is the face value , N is the number of periods.
i- discount rate.
Three metrics to evaluate returns from Bond
There are three types of yields
•Coupon Yield [Nominal]
• x100

• x100
. The value of i in the below equation is called YTM.
Bond Valuation Functions in Excel
• PRICE(settlement, maturity, rate, yld, redemption, frequency, [basis])
• The PRICE function syntax has the following arguments:
• Settlement    Required. The security's settlement date. The security settlement date is the
date after the issue date when the security is traded to the buyer.
• Maturity    Required. The security's maturity date. The maturity date is the date when the
security expires.
• Rate    Required. The security's annual coupon rate.
• Yld    Required. The security's annual yield.
• Redemption    Required. The security's redemption value per $100 face value.
• Frequency    Required. The number of coupon payments per year. For annual payments,
frequency = 1; for semiannual, frequency = 2; for quarterly, frequency = 4.
• Basis    Optional. The type of day count basis to use.
Deep discount Bond
• A bond is considered Deep discount Bond if it is sold at a significantly
lower price than par value, usually at 20% or more.
Bond Valuation Functions in Excel …
• YIELD(settlement, maturity, rate, pr, redemption, frequency, [basis])
• he YIELD function syntax has the following arguments:
• Settlement    Required. The security's settlement date. The security settlement date is the
date after the issue date when the security is traded to the buyer.
• Maturity    Required. The security's maturity date. The maturity date is the date when the
security expires.
• Rate    Required. The security's annual coupon rate.
• Pr    Required. The security's price per ₹100 face value.
• Redemption    Required. The security's redemption value per ₹100 face value.
• Frequency    Required. The number of coupon payments per year. For annual payments,
frequency = 1; for semiannual, frequency = 2; for quarterly, frequency = 4.
• Basis    Optional. The type of day count basis to use.
Relationship among Bond price, Coupon
yield and YTM

• When the market price of the bond is less than the face value, i.e., the bond sells at a
discount, YTM >> coupon yield.

• When the market price of the bond is more than its face value, i.e., the bond sells at a
premium, coupon yield >> YTM.

• When the market price of the bond is equal to its face value, i.e., the bond sells at par,
YTM = coupon yield.
Risk
• Market Risk
• Reinvestment Risk
• Liquidity risk
Valuation of Equity
• Dividend Discount Model (DDM)
• …… (A)
• ……. (B)
• Substituting B in A, we get
•
• + + +…+ +
• when n->
Valuation of Equity (…)
• When Dividend is constant and paid in perpetuity

When dividend grows at a constant rate g then

Gordon Growth Model - GGM
• + + +…+
• when n->
Relationship between Bond value and yield
Bond Value Vs Yield rate

1,200 1136.00 12%

1000.00 884.83
1,000 10%
10%
800 8%
8%

Bond value

Yield rate
600 6%
6%
400 4%

200 2%

0 0%
1 2 3
Axis Title

Bond value Interest%

Calculation of yield on T-Bill (Source: RBI)
Yield function in Excel (Source: RBI )
• Spread Sheet Method using MS Excel
• In the MS Excel programme, the following function could be used for calculating the yield of
periodically coupon paying securities, given the price.
• YIELD (settlement,maturity,rate,price,redemption,frequency,basis)
• Wherein;
• Settlement is the security's settlement date. The security settlement date is the date on which the
security and funds are exchanged. Maturity is the security's maturity date. The maturity date is the
date when the security expires.
• Rate is the security's annual coupon rate.
• Price is the security's price per ₹100 face value.
• Redemption is the security's redemption value per ₹100 face value.
• Frequency is the number of coupon payments per year. (2 for Government bonds in India)
• Basis is the type of day count basis to use. (for Government bonds in India which uses 30/360
basis)
What are the day count conventions used in
calculating bond yields? (Source: RBI )
• Day count convention refers to the method used for arriving at the holding period (number of days)
of a bond to calculate the accrued interest. As the use of different day count conventions can result
in different accrued interest amounts, it is appropriate that all the participants in the market follow a
uniform day count convention.
• For example, the conventions followed in Indian market are given below.
• Bond market: The day count convention followed is 30/360, which means that irrespective of the
actual number of days in a month, the number of days in a month is taken as 30 and the number of
days in a year is taken as 360.
• Money market: The day count convention followed is actual/365, which means that the actual
number of days in a month is taken for number of days (numerator) whereas the number of days in
a year is taken as 365 days. Hence, in the case of T-Bills, which are essentially money market
instruments, money market convention is followed.
• In some countries, participants use actual/actual, some countries use actual/360 while some use
30/actual. Hence the convention changes in different countries and in different markets within the
same country (eg. Money market convention is different than the bond market convention in India).