Bond Valuation

Bond Valuation Presented By: Jignesh Madhura Chetna

Transcript of Bond Valuation

Page 1: Bond Valuation

Bond ValuationPresented By:


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Bond ValuationA Bond is a security that pays a stated

amount of interest to the invester,period after period, until it is

finally retired by the issuing company. A bond has a face value, it almost

always has a stated maturity, which is the time when the company is obligated to pay the bondholder the face value of

the instrument. Finally, the coupon rate or the nominal annual rate of

interest, is stated on the bond’s face.

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Bond Valuation Bond-A long-term debt instrument issued by a

corporation or government. Face value- The stated value of an asset. Coupon Rate- The stated rate of interest on a

bond, the annual interest payment divided by the bond’s face value.

Maturity Period-Bonds have a maturity period of 1-10 years, sometimes they have a longer maturity. At the time of maturity the par (face) value plus perhaps a nominal premium is payable to the bond holder.

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Strategic role of Bond in Portfolio Portfolio management can be viewed as

a two level process (Macro, Micro). Bonds served as a kind of anchor to the

winds of adversity. Bond returns are less than stock returns,

bond investment involves less risk. Total risk of a portfolio may be thought of

as the individual risk of each investment and its correlation to move relative to each other.

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Types of Bonds Government Securities Treasury Bills Zero Coupon Bonds Junk Bonds

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Government Securities These are debt instruments issued by

the RBI on behalf of the Govt of India and are known as G.secs or Gilts, it carries full backing of the central govt and is also known as Sovereign debts.

Once issued they can be traded in secondary markets.

The major participants are banks and financial institution, mutual funds, insurance co, primary dealers, provident funds, trusts & individuals.

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Treasury Bills

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Zero Coupon Bonds A bond that pays no interest but

sells at a deep discount from its face value, it provides compensation to investors in the form of price appreciation.

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Junk Bonds The rate of interest is high

compared to the market, as the rate of interest is high risk is high.

No certainty about its redemption payment of the bond.

Credit rating is very low.

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Credit Rating Bond investment agencies evaluate

the quality of bonds and rank them in categories according to relative probability of default.

For Investors- Simplifies the task of assessing risk.

Rating Agencies- 1) Moody’s Investors service. 2) Standard & Poor corp.

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How rating is done? Moody’s Investor’s Services

Aaa Best QualityAa High gradeA Higher medium gradeBaa Lower medium gradeBa Possess speculative elementB Generally lack characteristics of

desirable investment

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Moody’s Investor’s ServicesCaa Poor standing may be in defaultCa Speculative to a high degree,

often in defaultC Lowest grade

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Standard & Poor’s Corp.AAA Highest gradeAA High gradeA Upper medium gradeBBB Medium gradeBB Lower medium gradeB SpeculativeCCC-CC Outright speculationC Reserved for income bondsDDD-D In default,with rating indicating relative

salvage value

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Other Factors Small issues & those placed

privately are generally not rated. Sometimes the 2 agencies differ in

their evaluation & classification. The rating is altered only when

agencies deem that sufficient charges have occurred.

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Pricing of Bond Clean Price = Face Value + Capital

Appreciation Dirty Price = Clean Price +

Accrued Interest Eg: 7.46 % 901 2017 is quoted at

clean price Rs.112.50,FV Rs.100Int payment date-28th Aug 2001Settlement date-11th Jan 2002.

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Pricing of Bond(Cont..) Accured Interest = Rate of int *no.of days since last

int payment date/360=7.46 * 133 / 360=2.76Hence Dirty Price = 112.50 + 2.76 = 115.26

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Yield Curve The plot of the yield on various debt

instrument against the time of maturity is known as yield curve.

Under normal circumstances-Longer the maturity-high risk-high return(Government securities/Gilts)Shorter maturity-low risk-low return(Treasury Bills)

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Help an investor to make a decision An investor can make a choice

between buying a long-term instrument or buying a short-term instrument and rolling will be at the time of reinvestment.

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Bond Return These are the tools by which the

performance of a bond can be evaluated.

The commonly emlpoyeed yield measures are : Current Yield, Yield to Maturity, Yield to Call.

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Current Yield The current yield relates the

annual dollar coupon interest to the market price.Current Yield = I/PI = Annual InterestP = Current market price

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Eg of Current Yield(1) A bond paying Rs.10 p.a interest

currently selling at Rs.80Current Yield = 10/80=0.125 or 12.5%Conclusion:Current Yield > Rate of couponThat is bond is selling at a discount.

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Eg of Current Yield(2) A bond Paying Rs.10 p.a interest

currently selling at Rs.120.Current Yield = 10/120=8.33%

Conclusion:Current Yield < Rate of CouponThat is Bond is selling at premium.

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Eg of Current Yield(3) A bond paying Rs.10 p.a interest

currently selling at Rs.100.Current Yield = 10/100=10%

Conclusion:Current Yield = Rate of CouponThat is Bond selling at Par.

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Yield To Maturity The expected rate of return on a

bond if bought at its current market price & held till maturity.

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Yield to Call Redemption before maturity Usually at Premium Yield to call is often compared with

Yield to Maturity.