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HRM (2012-14) Batch, XLRI Prof. Mohanty Financial Management Bond Valuation Bonds: Nomenclature 10%, 2020 GOI Security Par Value or Face Value Par Value or Face Value Redemption Value or Maturity Value Maturity Date (Term to Maturity) Coupon (coupon rate) Yield to Maturity Types of Bonds Plain Vanilla Bond Bonds with Call and Put options Convertible bonds Convertible bonds Floating rate bonds Zero-coupon bonds And many more… Next Call and Put Options A call option gives its owner the right to BUY an asset at a specific price. – Suppose, I sell you a Call option on one share of HUL. You have the right to buy the stock from me anytime in the next 1 month by paying me Rs.400. The stock is currently trading at Rs.378. A put option gives its owner the right to SELL an asset at a specific price. – Suppose, I sell you a Put option on one share of HUL. You have the right to sell the stock to me anytime in the next 1 month at Rs.400. Back Some Creatively Designed Bonds Coupon payment Is contingent on certain event. Compensates the farmers when there is bad monsoon ICICI Bank Farmers there is bad monsoon Bond Investors Pays coupons when there is good monsoon Insurance Premium Face Value of Bond Warren Buffet’s Bond Negative coupon bond Face Value of Bond = $1000 (assumed) Coupon Rate = 3% Coupon Rate = 3% Holding Charges = 3.75% You get the right to buy the share at $89585 per share Market Price on Issue Date = $77900
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bond valuatn
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HRM (2012-14) Batch, XLRI
Prof. Mohanty
Financial Management
Bond Valuation
Bonds: Nomenclature10%, 2020 GOI Security
Par Value or Face Value Par Value or Face Value
Redemption Value or Maturity Value
Maturity Date (Term to Maturity)
Coupon (coupon rate)
Yield to Maturity
Types of Bonds Plain Vanilla Bond
Bonds with Call and Put options
Convertible bonds Convertible bonds
Floating rate bonds
Zero-coupon bonds
And many more…
Next
Call and Put Options
A call option gives its owner the right to BUY an asset at a specific price. – Suppose, I sell you a Call option on one share of HUL.
You have the right to buy the stock from me anytime in the next 1 month by paying me Rs.400. The stock is currently trading at Rs.378.
A put option gives its owner the right to SELL an asset at a specific price. – Suppose, I sell you a Put option on one share of HUL. You
have the right to sell the stock to me anytime in the next 1 month at Rs.400.
Back
Some Creatively Designed Bonds
Coupon payment Is contingent on certain event.
Compensates the farmers when there is bad monsoon
ICICI Bank Farmersthere is bad monsoon
Bond Investors
Pays coupons when there is good monsoon
Insurance Premium
Face
Val
ue o
f B
ond
Warren Buffet’s Bond
Negative coupon bond
Face Value of Bond = $1000 (assumed)
Coupon Rate = 3%Coupon Rate = 3%
Holding Charges = 3.75%
You get the right to buy the share at $89585 per share
Market Price on Issue Date = $77900
HRM (2012-14) Batch, XLRI
Prof. Mohanty
Yield to Maturity ABC Limited issued 10%, 2014 bond last
year.
Government of India was borrowing at 6% last year.
Now the risk free rate of return has decreased from 6% to 5%.
Yield to Maturity
XYZ Limited issued 7%, 2014 bond three years back. At the time of issue of the bond, its rating was AAA. Now it has deteriorated to AA-. Now AA-has deteriorated to AA . Now AArated bonds are paying 9%.
Assume that the risk-free rate has not changed in between.
Determinants of YTMYTM = Risk-free rate + Default Spread
Gilt 5.54%AAA 6.69%AA+ 6.91%AA 7.18%AA- 7.50%A+ 7.75%A 8.34%A- 9.92%BBB+ 11.47%BBB 15.56%BBB- 17.38%
Yield to Maturity Meaning of YTM
Factors affecting YTM
Bond Valuation Model F = Face Value
C = Annual Coupon Payment
c= annual Coupon Rate c= annual Coupon Rate
N number of Years
Y = Required Yield
Bond Valuation Equation
NY
FC
Y
C
Y
Cice
)1(...
)1(1Pr
2
NN y
F
y
C
y
C
y
Cice
222 )1()1(
2/...
)1(
2/
)1(
2/Pr
HRM (2012-14) Batch, XLRI
Prof. Mohanty
Time Path of a Bond Consider a 12% bond maturing on 1
January 2016. Today we are on 1 January 2013. y
The bond is trading at a yield of 10% APR.
Coupons are paid annually. The next coupon is due exactly after one year.
Time Path of the Bond What will be the value of the bond on 1
January 2014 immediately after the coupon payment ifp p y– The yield is 10%
– The yield is 8%
– The yield is 12%
– The yield is 14%
Time Path of the Bond What will be the value of the bond on 1
January 2015 immediately after the coupon payment ifp p y– The yield is 10%
– The yield is 8%
– The yield is 12%
– The yield is 14%
