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Bond Valuation-14 Bond Valuation

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Bond Valuation-14 Bond Valuation All India Satellite Classes: CA AadityaCA Aaditya Jain Jain 011-47665500 BOND VALUATION-14 BOND VALUATION 1. INTRODUCTION/WHY BOND VALUATION? Bond valuation is the process of determining the fair price of a bond. As with any security or capital investment, the fair value of a bond is the present value of the Future cash flows it is expected to generate. Bonds or Debentures are long term loan which pay periodical interest and principal amount upon maturity. Determining the value of the bond is an application of the present value concept . 2. BASIC BOND RELATED TERM Value of Bond : The amount which the investor will pay today to purchase the bond.It is also known as Current Value Of Bond / Present Value Of Bond / Intrinsic Value Of Bond / Theoretical Value Of Bond / Equilibrium Value Of Bond Coupon Rate : The annual interest rate on a bond.It is the rate at which company pays interest. Coupon Amount: The amount of interest which is paid by the company . Amount Of Interest = Face Value Of Debenture Coupon Rate Years to Maturity : The year on which the principal amount of a bond is fully repaid is known as years to maturity Note :If the question is silent about the maturity period of any investment say preference shares , bonds , debentures etc then we will assume such investmet as irredeemable or perpetual . Yield: The rate of return required by the investor of a bond.It is also known as Yield To Maturity / Cost Of Debt / Discount Rate for debentureholder / Kd / Going Rate Of Interest /Market Interest Rate Face Value : It is also called Par Value.Interest is paid on face value.Unless otherwise stated bond is assumed to be issued at Face Value or Par Value . The par value or face value may be normally assumed to be Rs. 100 or Rs.1000 depending upon the question . Redemption Value/Maturity Value : The value which the bondholder will get on maturity is called Redemption Value.If silent bond are always assumed to be redeemed at face value . 3. VALUEAADITYA OF STRAIGHT JAIN SATELLITECOUPON BOND SFM OR CLASSEQUALASS COUPON BOND Meaning : Straight Coupon Bonds or Equal Coupon Bonds are those bonds which pay equal amount of interest upto maturity and also repay principal amount at the end of maturity period . Symbolically All India Satellite Classes: CA AadityaCA Aaditya Jain Jain 011-47665500 BOND VALUATION-15 Interest Interest Interest Face Value or Maturity Value Value of Bond (B ) .................. 0 (1 Yield)1 (1 Yield) 2 (1 Yield) n (1 Yield) n = Interest x PVAF ( Yield %, n years) + Maturity Value x PVF ( Yield %, n years) Where n = Number of Years to Maturity 4. VALUE OF ZERO COUPON BOND OR DEEP DISCOUNT BOND Meaning :Zero Coupon Bonds are those bonds on which investors are not allowed to any interest but are entitled only to repayment of principal sum on the maturity period . Face Value or Maturity Value Symbolically : Value of Bond (B0 ) = (1 Yield) n 5. VALUE OF PERPETUAL BOND OR IRREDEEMABLE BOND Meaning : These are bonds where interest payment is paid forever i.e upto infinity. Annual Interest Symbolically : Value Of Bond (B ) 0 Yield 6. VALUE OF SEMI ANNUAL INTEREST BOND Meaning : Semi Annual Interest Bonds are those bonds which pay interest semiannually . To value such bonds we have to make three changes : Annual Interest Amount Yield 1. 2. Years To Maturity 2 3. 2 2 7. VALUE OF QUARTERLY COUPON INTEREST BOND Annual Interest Amount Yield 1. 2. Years To Maturity 4 3. 4 4 8. VALUE OF MONTHLY COUPON INTEREST BOND Annual Interest Amount Yield 1. 2. Years To Maturity 12 3. 12 12 9.VALUE OF BOND WITH FLUCTUATING COUPON RATE Sometimes bonds are issued with Fluctuating Coupon Rate.It means that coupon rate may change from one year to another as per the terms of the contract or as per given in question. 10. OVERPRICED AND UNDERPRICED BONDS When Current MarketAADITYA Price and Theoretical JAIN SATELLITE Market Price i.eSFM price CLASS which weASS calculate by applying present value concept are not same we will undertake following decision : Case Valuation Decision If Currenty Market Price > Present Value Market Price Overvalued Sell If Currenty Market Price < Present Value Market Price Undervalued Buy All India Satellite Classes: CA AadityaCA Aaditya Jain Jain 011-47665500 BOND VALUATION-16 If Currenty Market Price = Present Value Market Price Correctly Valued Hold 11. SELF AMORTIZING BONDS Bonds which pay a principal amount over a period of time rather than on maturity are called Self Amortizing Bonds 12.CALLABLE BOND A Callable Bond is one when the company has an option to retire or redeem the bonds prior to the date of maturity. 13.CALL PRICE The amount of money the issuer has to pay to call a Callable Bond is known as Call Price . 14.CALL DATE The date on which bonds is called by the company prior to the date of maturity is called Call Date . 15.PUTTABLE BOND A Puttable Bond is one where the investor has an option to get the bond redeemed prior to the date of maturity 16.PUT DATE The date on which bonds is sold by the investor prior to the date of maturity is called Put Date . 17.PUT PRICE The amount of money the investor receive by selling a Bond to the company prior to the date of maturity is known as Put Price . YIELD There are number of ways to express yield which are : (i) Coupon Yield / Normal Yield (ii) Current Yield / Flat Yield (iii) Yield to Maturity / Redemption Yield / Kd / Cost Of Debt / Market Interest Rate (iv) Yield To Call ( YTC) (v) Yield To Put ( YTP) (vi)Yield To Worst (YTW) (vii) Holding Period Return (HPR) (viii) Kd Of Perpetual Bond (ix) Capiatl Gain Yield Note : If Current Market Price and Intrinsic/Fair Value are different we will take Current Market Price and not Intrinsic Value ( Present Value) for all the calculation of yield . AADITYA18. NORMALJAIN SATELLITE YIELD / COUPON SFM CLASS YIELDASS : When Yield of any bond is equal to Coupon Rate such yield is known as Normal Yield / Coupon Yield . It is possible when the bond is purchased at par value and redeemable also at par value . All India Satellite Classes: CA AadityaCA Aaditya Jain Jain 011-47665500 BOND VALUATION-17 19. CURRENT YIELD / FLAT YIELD /CURRENT INTEREST YIELD/ BASIC YIELD : I1 Current Yield = BO I1 = Interest To Be Paid at Year End 1 Note : Current Yield is always calculated on per annum basis . 20. YIELD ( Kd ) OR YIELD TO MATURITY (YTM) OR COST OF DEBT /REDEMPTION YIELD / INTERNAL RATE OF RETURN/MARKET RATE OF INTEREST/ MARKET RATE OF RETURN / PROMISED YTM / OPPORTUNITY COST OF DEBT Yield to Maturity is the overall return on the bond if it is held till maturity . Symbolically : It can be calculated by using two method : Trial n Error Method : Interest Interest Interest Face Value or Maturity Value Value of Bond (B ) .................. 0 (1 Yield)1 (1 Yield) 2 (1 Yield) n (1 Yield) n Now for finding Yield we should use IRR Technique : Lower RateNPV Difference in Rates Kd = Lower Rate + Lower Rate NPV – Higher Rate NPV Approximation Method : Maturity Value – Issue Value Interest n Kd Maturity Value Issue Value 2 21. YIELD TO CALL ( YTC ) : Call Value – B Interest o Call Years YTC Call Value Bo 2 22. YIELD TO PUT ( YTP ) : Put Value – B Interest o Put Years YTP Put Value Bo 2 AADITYA JAIN23. YIELD SATELLITE TO WORST SFM (YTW) CLASS : ASS The yield to worst is the lowest yield of yield to maturity, yield to call, yield to put, and others. Example : Given the following data calculate Yield To Worst:YTM = 10%,YTC = 7%,YTP=9% Solution:YTW = 7 % All India Satellite Classes: CA AadityaCA Aaditya Jain Jain 011-47665500 BOND VALUATION-18 24. HOLDING PERIOD RETURN (HPR): Holding Period Return (R) or Total Return I (B B ) I (B B ) = 1 1 0 or 1 1 0 or Current Interest Yield + Capital Gain Yield B0 B0 B0 Where Bo is the Price of bond as on today , and B1 is the price of the bond at the end of the holding period or Sale Price of Bond at the end of holding period . Note : The holding period is generally assumed to be of one year period unless otherwise stated . 25.CAPITAL GAIN YIELD (B B ) Capital Gain Yield = 1 0 100 B0 26. KD OF PERPETUAL BOND Annual Interest Yield or Kd Bo 27. CALCULATION OF YTM OF HALF YEARLY INTEREST PAYMENT BOND Maturity Value – Issue Value Interest per 6 months n x 2 Kd Of 6month Maturity Value Issue Value 2 Now Kd p.a = Kd for 6 month x 2 28. RELATIONSHIP BETWEEN YTM AND COUPON RATE Case Nature Of Bond Coupon Rate = YTM Par Value Bond i.e MP = Par Value Coupon Rate > YTM Premium Bond i.e MP > Par Value Coupon Rate < YTM Discount Bond i.e MP < Par Value Note : For the above relationship to be true the maturity value of the bond must be equal to face value . 29. RELATIONSHIP BETWEEN BOND VALUE AND YTM YTM and the Bond Value has inverse relationship : - If YTM increases the price or bond value will decrease - If YTM decreases the price or bond value will increase ......Other things remainingAADITYA constant JAIN SATELLITE SFM CLASSASS In other words An inverse relationship exists between bond prices and interest rates. Think of it as a see- saw relationship where one goes up whenever the other goes down and vice versa. All India Satellite Classes: CA AadityaCA Aaditya Jain Jain 011-47665500 BOND VALUATION-19 30.
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