Bond Valuation Ppt

8/19/2019 Bond Valuation Ppt

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Bond ValuationBond Valuation


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Definition of 'Bond’Definition of 'Bond’A debt investment in which an investor loans money to anA debt investment in which an investor loans money to anentity (corporate or governmental) that borrows the fundsentity (corporate or governmental) that borrows the fundsfor a defined period of time at a fixed interest rate. Bondsfor a defined period of time at a fixed interest rate. Bondsare used by companies, states and foreign governments toare used by companies, states and foreign governments tofinance a variety of projects and activities.finance a variety of projects and activities.

overnment companies and the government issue bondsovernment companies and the government issue bondsand borrow money from people or institutions. !o, public isand borrow money from people or institutions. !o, public isthe lender of money and government companies are thethe lender of money and government companies are the

borrowers. !o, a bond can again be defined as a contract borrowers. !o, a bond can again be defined as a contract

that re"uires the borrower to pay interest income to thethat re"uires the borrower to pay interest income to thelender.lender.

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A technique or determining the air valueA technique or determining the air valueo a particular bond. Bond valuationo a particular bond. Bond valuation

includes calculating the present value oincludes calculating the present value othe bond's uture interest payments, alsothe bond's uture interest payments, also

no!n as its cash "o!, and the bond'sno!n as its cash "o!, and the bond'svalue upon maturity, also no!n as itsvalue upon maturity, also no!n as its

ace value or par value..ace value or par value..

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Par or Face Value -Par or Face Value -

&he amount of money that is paid to the&he amount of money that is paid to the bondholders at maturity. 'or most bonds this bondholders at maturity. 'or most bonds thisamount is s.1, , s.# , s. * and so on.amount is s.1, , s.# , s. * and so on.+t indicates the value of the bond. i.e. the value+t indicates the value of the bond. i.e. the value

stated on bond paper.stated on bond paper.

Coupon Rate -Coupon Rate -

&he coupon rate, which is generally fixed,&he coupon rate, which is generally fixed,determines the periodic coupon or interestdetermines the periodic coupon or interest

payments. +t is expressed as a percentage of the payments. +t is expressed as a percentage of the bond s face value. +t also represents the interest cost bond s face value. +t also represents the interest costof the bond to the issuer.of the bond to the issuer.


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+!- + B/ 0!+!- + B/ 0!+nterest rate ris 23 4ariability in the return from+nterest rate ris 23 4ariability in the return fromdebt instruments to investors is caused by thedebt instruments to investors is caused by thechanges in the mar et interest rates. &his is nownchanges in the mar et interest rates. &his is nownas interest rate ris .as interest rate ris .

0efault ris 23 &he failure to pay the agreed value0efault ris 23 &he failure to pay the agreed valueof the debt instrument by the issuer in full, on timeof the debt instrument by the issuer in full, on timeare called so. +t is due to the macro economicare called so. +t is due to the macro economicfactors or firm specific factors.factors or firm specific factors.

5ar etability is 23 4ariation in returns caused by5ar etability is 23 4ariation in returns caused bydifficulty in selling bonds "uic ly without havingdifficulty in selling bonds "uic ly without havingto ma e a substantial price concession is nown asto ma e a substantial price concession is nown asmar etability ris .mar etability ris .

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7allability is 7allability is

&he uncertainity created in the investor8s return&he uncertainity created in the investor8s return by the issuer8s ability to call the bond at any time by the issuer8s ability to call the bond at any timeis nown as callability ris . 0ebt instrumentsis nown as callability ris . 0ebt instrumentsused to carry a call option. &his option providesused to carry a call option. &his option providesthe issuer the right to call bac the instrumentsthe issuer the right to call bac the instruments

by redeeming them. !ince the bond or debenture by redeeming them. !ince the bond or debenturecan be called at any time there is an uncertainitycan be called at any time there is an uncertainityregarding the maturity period. &his feature of theregarding the maturity period. &his feature of the

bond may depress the price level of the bond. bond may depress the price level of the bond.

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TIME VALUE C !CEPTTIME VALUE C !CEPT

&he time value of money is that the rupee received today&he time value of money is that the rupee received todayis more valuable than the rupee received tomorrow.is more valuable than the rupee received tomorrow.

'uture 4alue : ;resent 4alue (1(1


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B)*D $%& *B)*D $%& *

-) D+*/ 0$ +)D $%& *-) D+*/ 0$ +)D $%& *An investor buys a bond and sells itAn investor buys a bond and sells ita ter holding or a period. %he rate oa ter holding or a period. %he rate o

return in that holding period is1return in that holding period is1-0 2 0rice gain or loss during the-0 2 0rice gain or loss during theholding period 3 oupon interest rateholdi ng period 3 oupon interest rate

0rice at the beginning o the holding0rice at the beginning o the holdingperiodperiod

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4$A(& +*/ B)*D 5+$ D4$A(& +*/ B)*D 5+$ D

urrent 5ieldurrent 5ield 5ield %o 4aturity 5ield %o 4aturity 5ield %o all 5ield %o all

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& $*% 5+$ D& $*% 5+$ D

%he current 5ield relates the %he current 5ield relates theannual coupon interest to theannual coupon interest to themar et price. +t is e6pressed as7mar et price. +t is e6pressed as7

Annual interestAnnual interest urrent 5ield 2 0riceurrent 5ield 2 0rice

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$8A40 $$8A40 $

%he urrent 5ield o a 9: 5ear, 9; %he urrent 5ield o a 9: 5ear, 9;< coupon Bond !ith a 0ar value o< coupon Bond !ith a 0ar value o

s.9::: and selling or s.=>:.s.9::: and selling or s.=>:.!hat is current yield.!hat is current yield.

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urrent yield 2 =>:urrent yield 2 =>: 2 9;.?@2 9;.?@

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5+$ D %) 4A%& +%5 5+$ D %) 4A%& +%5

hen you purchase a bond, youhen you purchase a bond, youare not quoted a promised rate oare not quoted a promised rate oreturn. &sing the in ormation onreturn. &sing the in ormation onBond price, maturity date, andBond price, maturity date, andcoupon payments, you fgure outcoupon payments, you fgure out

the rate o return o ered by thethe rate o return o ered by thebond over its li e.bond over its li e.

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#ormula#ormula

vv

0 2 C93r 3 C93r ; 3 C93r n 3 C93r n0 2 C93r 3 C93r ; 3 C93r n 3 C93r n

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5+$ D %) A 5+$ D %) A

(ome bonds carry a call eature(ome bonds carry a call eaturethat entitles the issuer to callC buythat entitles the issuer to callC buybac the bond prior to the statedbac the bond prior to the statedmaturity date in accordance !ith amaturity date in accordance !ith acall schedule or such bonds. +ncall schedule or such bonds. +n

such case company can f6 ansuch case company can f6 anyeild based on mar et situationsyeild based on mar et situations

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Proof Proof ::

7 : s.# p.a., ' : s.1 , : 1.* years,7 : s.# p.a., ' : s.1 , : 1.* years, y y ::1 p.a.1 p.a.

;rice of the bond : ;rice of the bond :

'rom bond valuation model2'rom bond valuation model2

;; :: 1 >(1< . *) < 1 >(1< . *)1 >(1< . *) < 1 >(1< . *)## < 1 >< 1 >(1< . *)(1< . *) $$

; : s.11$.616; : s.11$.616

Assume that interest rates rise and letAssume that interest rates rise and let y y : # p.a.: # p.a.Cith higher interest rates, the price of the bondCith higher interest rates, the price of the bondfalls2falls2

; : s.1 .; : s.1 . 19


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%-$) $4 ;7 %-$) $4 ;7

%he longest the maturity o the %he longest the maturity o thebond, the more sensitive it is tobond, the more sensitive it is tochanges in interest rates.changes in interest rates.

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%-$) $4 E7 %-$) $4 E7

%he lo!er a bondFs coupon, the %he lo!er a bondFs coupon, themore sensitive its price !ill be tomore sensitive its price !ill be togiven changes in interest rates.given changes in interest rates.

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Bond Valuation Ppt

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