Bond Valuation

GREG C. PENAFIEL
Pre-activity
Direction: Given the definition, jumble the letters to form the correct word.
1. It is a technique for determining the par value of a particular bond.

nod b anv o i l a u t
2. It is the rate at which interest is paid by the company to the bondholder.
p u n o o c t e r a
3. It is equal to coupon divided by market value multiplied by 100.
r u r c t n e i e d ly
4. The total amount of money being transferred into and out of a business, especially as
affecting liquidity.
s a h c w l o f
5. A special type of bond which does not pay annual interest.
o z r e n u p o o c o d n b
6. The amount for which something can be sold on a given market.
t k a e m r l u v e a
7. It is the rate of return that an investor is expected to earn on an annualized
basis expressed in % .
l e y i d ot t i r y m t u a
8. It is equal to the present value of it expected cash flows.
o n d n c p i r e
9. It is a special type of bond which does not pay annual interest.
p t s o e t i e r n s t e t r a
10. Known as the face value.
a p r l e u v a
Definition

 Bond valuation is a technique for determining the par value of a

particular bond.
 Bond valuation includes calculating the present value of the
bonds future interest payments also known as its cash flow, and
the bonds value upon maturity, also known as its face value or
par value.
 Bond valuation is less glamorous than stock valuation for two
reasons. First, the returns from investing in bonds are less
impressive and fixed. Second, bond prices fluctuates less than
equity price.
4 ways of calculating bonds returns
 Coupon Rate
 Current Yield
 Spot interest Rate
 Yield to Maturity
Five Basic Variables
 FV: par value(or face value)- usually 1000 to be paid at maturity
 PMT: annual coupon= par value x coupon rate(paid periodically to
bondholder)
 T: years to maturity
 r: required rate of return(discount rate)
 PV: PV of future cash flows(value today)
COUPON RATE:
 It is the nominal rate of interest that is fixed and printed
on the bond certificate.
 It is calculated on the face value of the bond.
 It is the rate at which interest is paid by the company to
the bondholder.
 It is payable by the company at periodical intervals of
time till maturity
Example:
A bond has a face value of Tk. 1000 with an interest rate of
return 12%.

Solution: It means that Tk. 120 will be paid by the company on

an annual basis to the bond holder till maturity.
Current Yield
 The current market price of the bond in the secondary market may differ from
the face value ( that is may be currently selling at a discount or at a premium).
 Current yield relates the annual interest receivable on a bond to its current
market price-
Current yield = x 100

where ,
C= coupon
MV= Market Value
 It thus measures the annual return accruing to a bondholder who purchase
the bond from the secondary market and sells it before maturity presumably
at a price at which he bought the bond
Example:

A bond has a face value of Tk. 1000 and a coupon rate is 12%.
It is currently selling for Tk. 800.

Solution: The current yield = 120/800 x 100 = 15%

Spot Interest Rate
 Zero coupon bond or deep discount bond is a special type of bond which
does not pay annual interest.
 Rather such bonds are issued at a discount to be redeemed at par.
 The return comes in form of the difference between the issue price and
the maturity value.

Spot Rate=(FV/MV)^(1/Years To Maturity)−1

where,
MV = Market Value
FV= Face Value
R=?
Example:

A zero coupon bond has a face value of Tk. 1000 and

maturity period of five years. It he issue price of the bond
is Tk. 519.37, what is the spot interest rate?

Solution: It is that rate of interest which makes the present

value of 1000 = 519.37. r = 0.14 or 14%
YIELD OF MATURITY
 It is the rate of return that an investor is expected to earn on an
annualized basis expressed in % terms from a bond purchased at the
current market price and held till maturity.
 It is the internal rate of return earned on a bond if held till maturity.

Yield to maturity YTH =

where,
FV = Face value
MV = Market Value
N= No. of period Holding period till maturity
Example
A bond of face value Tk. 1000 and a coupon rate of 15% is currently
available at Tk. 900. Five years remain to maturity and bond is
redeemable at par. Calculate YTM.
Solution; given that,
MV = 900
FV = 1000
C = 15% of Tk. 1000 = 150
n= 5

YTM = 0. 1789 or 17.89 %

Bond Price
Definition
 Intrinsic value of bond is equal to the present values of all future cash flows
discounted at the required rate of return.
 The value of a bond is equal to the present value of it expected cash flows.

Bond Price: = +

Where,
= Present value of bond
CF = Cash flow
FV= Face value
r= Appropriate discount rate
n = No. of years to maturity
Example
The par value of 10% debenture is Tk 1,000 with maturity is 3 years. What
would be the price by general floating formula if interest rate is 12%?

Solution:

=951.96
Try this:
1.Company Z’s 20-year 1000 par bonds have a current market price of 970 and annual
coupon rate of 9% paid semi-annually. Find its current yield.
2. The price of a bond is 736. 68, it has 16 years to maturity, a 1000 face value, and
pays an annual coupon of 100. What is the yield to maturity?
3. Consider a 1,000 zero-coupon bond that has two years until maturity. The bond is
currently valued at 925, the price at which it could be purchased today. Compute the
spot interest rate of the returns.
4. 10,000 zero coupon bonds is redeemed at par in 4 years. The average annual discount
rate is 7%. What is the price of this bond?
5. A bond has a face value of Tk. 1000 and was issued five years ago at a coupon rate of
10%. The bond had a maturity period of 10 years. If the current market interest rate is
14%, what should be the present value of the bond?