Chapter 6 Valuation of Bonds FM1

CHAPTER 6
VALUATION OF
BONDS LEADER:
BALIGNASA, JERRON MARLOWE
MEMBERS:
REPIL, GRACIA
SALTOC, ROCHELLE MAE
MENDOZA, KYLE
PILLOGO, JENNY
BONBON, RHAINALYN
VALUATION OF BONDS
In this chapter, we will discuss the following:
Characteristics of Bonds
Parties and Bond Transactions
Valuation of Bonds
Non-Zero Coupon Bond
Zero Coupon Bond
BOND
It is a long-term debt instrument issued by
government agencies or corporations to the public
in order to raise needed funds.
It is a long-term debt instrument in which borrower
agrees to make payments of principal interest on a
specific date to the holders of the bond.
BOND MARKET
Primarily traded in the over the counter (OTC)
market
Market bonds are owned by and traded among the
large institutions
The Wall Street Journal, corporate and municipal
markets
CHARACTERISTICS OF BONDS
A. Common Characteristics:
Coupon Payment
Maturity Date
- It is the amount of interest payment
- It is the date specified in the bond on
fixed each year until maturity of the bond. It
which payment of the Face Value is to be
is calculated by multiplying the coupon
made by the issuer.
interest rate to the face value of the bond.
Face Value
Coupon Interest Rate
- It is the amount borrowed
- it is the rate stated in the bond which is
by the issuer which is to be paid
used for annual interest payment calculation.
at maturity date. It is also known
- it is also known as Stated Interest Rate or
as the par value or Maturity
Nominal Interest Rate.
value.
B. Other Characteristics:
Issued with Call Provision - It is the provision that gives right or privilege to
the issuer to redeem the bond at a certain "call price" prior to its maturity.
Bonds with call provision are also referred to as callable bonds. These callable
bonds may have a provision stating that:
A. The issuer may exercise the right to call the bond

starting from issue date, or
B. The issuer may not call until five (5) years after
issuance.
WHEN TO EXERCISE ITS RIGHTS TO CALL?
the issuer will call the bond provided that the right to call is
already exercisable, such that the call protection of the
bond expires.
WILL INVESTOR DEMAND HIGHER INTEREST RATE?

since the issuer will call the bond any time prior to its
maturity provided that the right is exercisable and the
market interest rates declines, it will be detrimental to the
long term investors who will reinvest in a lower
interest rate bond after the call made by the issuer.
C. Issued with Put Provision
- It is a provision that gives right or privilege to the
bondholder to "put back" or require the issuer to repurchase the
said bond at a certain "put price" prior to maturity. Bonds with
put provisions are called putable bond.
WHEN TO EXERCISE ITS RIGHT TO PUT BACK?

the bondholder will require the issuer to repurchase the
bond prior to its maturity provided that the right to put
back is already exercisable.
D. Issued with Convertible features
- This gives the bondholders the right or option to convert the
bond into number of shares of common stocks at a predetermined
price.
E. Issued with Warrants

- This gives the bondholder the right or option not to convert
the bond but an option to buy shares of common stock from a
company at a predetermined price.
PARTIES IN ISSUANCE OF BONDS
BONDHOLDER AND ISSUER
BONDHOLDER
-is the investor who extends

loans to the company, certain amount of
money equivalent to the value of the
bond issued.
ISSUER
- may either be the Government
or the Corporation.
The bonds issued by the government are generally
referred to as Treasury bonds or Government bonds.
The bonds issued by the corporations are known as
corporate bonds.
Default Risk - It is the risk that the issuer may not

pay its obligation. It is also known as credit risk.
Default Premium - The additional yield that the
investor of a bond requires due to credit or default
risk is embedded in such bond.
VALUATION OF BONDS
BOND VALUATION
is used to determine the fair price of the bond.
Price of the Bond

= (Present value of the bond repayment)+(Present
value of interest payments)
Bond Indenture
is a certificate that gives all details of the

original bond
Effective Rate > Stated Rate = Discount

Effective Rate < Stated Rate = Premium

FIVE Method (Bond
Pricing)
1.Convert Interes Rates and Repayment Period

2.Calculate Interest Paid
3.Calculate Present Value of Interest Payments (Annuity)
4.Calculate Present Value of Bond (Single sum)
5.Calculate Bond Price
FACTORS AFFECTING IN
VALUATION OF BONDS
1. COUPON INTEREST RATE

2. DISCOUNT RATE
3. YEARS UNTIL MATURITY OR CALL
4. FACE VALUE OF THE BOND

TWO CLASSIFICATONS
OF BONDS
1. NON-ZERO COUPON BOND

2. ZERO COUPON BOND
NON-ZERO COUPON BOND
It is a coupon paying bond with a finite life
It is the price of a bond is the sum of the present value of all
expected coupon payment plus the Present Value of the Par Value
at maturity
This equation is used to calculate Present Value of these cash inflows to

determine the Bond's Value (BV)
BV= CP + CP + ...+ CP + FV
(1+D)1 (1+D)2 (1+D)n (1+D)n
Where:
CP - Coupon Payment
FV - Face Value
n - Maturity of the Bonds
Alternatively, the Bond's Value can also be computed by getting the Present Value of the cash
inflows of interest payment and face value through the following formula:
where:
CP - Coupon Payment
CIR - Coupon Interest Rate or the Stated Rate
FV - Face Value
PV CP - Present Value of the Coupon Payment
PVFV - Present of the Face Value
PV(OA-D,n) - Present Value Factor Ordinary Annuity Payment
PV(1-D,n) - Present Value Factor of One or Single Payment
D - Discount Rate
n - number of years
Issued at a Par
- If the amount of payment could be equal to the face value of the bond.
Issued at a Premium
- If the amount could be above the face value of the bond
Issued at a Discount
- If the amount of payment could be below the face value of the bond
Example:
What is the value of a 15 year, P1000 corporate bond with stated rate of 10% per
annum?
Assume that:
A. The bond of similar quality yields 10% rate
B. The bond similar quality yields 8% rate

Scenario A: The bond yields a rate of 10% and the stated rate of 10%.
Analysis:
If the discount rate is equal to the stated rate:
The Market Value of the bond amounts to P1000 which is equal to the Face or Par Value
The Bond is issued at a par
The amount to be paid by the investor is equal to the face or par value.
Scenario B: The bond yields a rate of 8% and the stated rate of 10%
Analysis:
If the Discount Rate is lower than the stated rate:
The Market Value of the bond amounts to P1,171.19 which is above the Face of Par Value
The amount to be paid by the investor is higher than the Face or Par Value
The bond is issued at a premium

ZERO COUPON BOND
This bond has no coupon interest payment

but are usually sold below its Face Value or
issued at a discount.
The investors of this kinds of bonds receives
earnings through the appreciation or rise in
the bonds value from the discounted selling
price (price paid by the bondholder) to the
Face Value (price paid by the issuer) when
redeemed at the date of maturity.
Are bonds that do not pay interest during the life of the bonds. Instead, investors
buy zero coupon bonds at a deep discount from their face value, which is the
amount the investors will receive when the bond "matures" or comes due.
Sample Problem:
BlueBlurry Corporation issued a zero coupon bond
with 15 years until maturity and a P1000 Face value.
Determine the value of the bond if the discount
rates (required rate of return) are as follows:
A.) 8%
B.) 9%
Case A: If the discount rate or the required rate of return is 8%

BV = Bond Value FV = Face Value n = Time(years) D = Discount rate multiplied by .01
The present value factor for one or single payment at 8% discount or required rate of
return for 15 periods is 0.31524. Using the formula for valuing a Zero-Coupon Bond, the
bond can is selling at P315.24. Thus, the investor who will eventually be the bondholder
can purchase the bond at P315.24 today then wait for 15 years until maturity to receive
the amount of P1,000 which is the face value of the said bond.
Case B: If the discount rate or the required rate of return is 9%:
The present value factor for one or single payment at 9% discount or required rate of
return for 15 periods is 0.27454. Thus, the investor can purchase the bond at a value of
P274.54 today but will receive the amount of P1000 which is the face value when
maturity date comes
Thank you
for listening!
Don't hesitate to ask any questions!

Chapter 6 Valuation of Bonds FM1

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CHAPTER 6

In this chapter, we will discuss the following:

A. The issuer may exercise the right to call the bond

WILL INVESTOR DEMAND HIGHER INTEREST RATE?

WHEN TO EXERCISE ITS RIGHT TO PUT BACK?

E. Issued with Warrants

-is the investor who extends

Default Risk - It is the risk that the issuer may not

is used to determine the fair price of the bond.

Price of the Bond

is a certificate that gives all details of the

Effective Rate > Stated Rate = Discount

Effective Rate < Stated Rate = Premium

1.Convert Interes Rates and Repayment Period

1. COUPON INTEREST RATE

4. FACE VALUE OF THE BOND

1. NON-ZERO COUPON BOND

This equation is used to calculate Present Value of these cash inflows to

ZERO COUPON BOND

This bond has no coupon interest payment

Case A: If the discount rate or the required rate of return is 8%

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