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Business Finance(MGT 232)

Lecture 9

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Bond ValuationBond ValuationBond ValuationBond Valuation

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• What is a Bond?• Types of Bond• Characteristics of Bonds• Legal Aspects of Bonds• Bond Ratings

Overview of the Last Lecture

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Bond Valuation

• Value of any asset is the present value of future cash flows expected from it.

VB = INT [1- (1+rd)⁻ⁿ]+MV(1+rd)⁻ⁿ

rd

INT = Interest Payment (Interest rate x par value)rd = Market value of interestMV = Maturity ValueN = No of Years

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Bond Valuation• In 2000 PTCL issued a bond with par value of Rs.1000 at a

coupon interest rate of 10% for 30 years. If the going interest is 10% find the value of a bond in 2012?

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Bond Valuation

Bond at Par Value: If coupon rate = rd

VB = Fv

• Premium Bond: If coupon rate > rd

VB > Fv

• Discount Bond: If coupon rate <rd

VB < Fv

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Coupon Bond Example Bond C has a Rs. 1,000 face value and provides an 8% annual

coupon for 30 years. The appropriate discount rate is 10%. What is the value of the coupon bond?

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Zero Coupon Bond Bond Z has a Rs. 1,000 face value and a 30-year life. The

appropriate discount rate is 10%. What is the value of the zero-coupon bond?

VB = MV(1+rd)⁻ⁿ

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Bond Valuation with Semiannual Compounding

Bond C has a Rs. 1,000 face value and provides an 8% semiannual coupon for 15 years. The required rate of return is 10% (annual rate). What is the value of the bond?

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Bond YieldBond Yield

Investor

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firm

Bond YieldBond Yield

Investor

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FundsFunds

firm

Investor

Bond YieldBond Yield

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FundsFunds

BondsBonds

firm

Bond YieldBond Yield

Investor

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CashCash

BondsBonds

firm

Bond YieldBond Yield

Interest Payment

Investor

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Bond Yield

• Yield to Maturity

The return earned on bonds held till maturity is defined as YTM

• Yield to Call

The return earned on bonds held till called is defined as YTC

• It is used by investors to consider different bonds and expected return

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Summary

• Bond Valuation• Zero Coupon and Coupon bond valuation• Semiannual coupon bond valuation• Bond Yield• YTM• YTC