Lesson 4

CH 9: Debt Valuation and Interest Rate

FIN3101/3701 Corporate Finance

Dr. Sarina Preechalert

 How to Obtain Long-Term Financing for Businesses

• Internal funds External funds

• From undistributed profits FI
• How: Borrow loans from banks
• Debt financing
FM
• How: Sell equity securities and/or
debt securities in the capital markets
• Equity financing
• Debt financing

https://amazonia.fiocruz.br/scdp/blog/story-in-italian/sources-of-finance-for-a-business.php
 Corporate Financial Manager

Roles:
1. Investing decision (Capital Budgeting)
• Long-term investment (projects)
2. Financing decision (Capital Structure)
• How to raise $
• Debt financing vs. Equity financing
3. Working capital management
• S-T management (CA, CL) for liquidity
• Cash, M/S, INV, A/R
• A/P, Accruals, S-T loans
4. Distribution policy
• Dividend vs. Share buyback
4
 Long-Term External Financing

What:
• The firm raises money by selling securities/instruments (debts
and equity) in the financial markets
– Private financial market  Private placement
– Public financial market  Public offering
 Long-Term External Financing
Private Placement
• What: Firm (issuer) raises money directly from investors
• How: By selling securities (debt and equity) directly to investors through a
private placement
• Investors: Must be accredited investors (wealthy with investment knowledge)
• EX: Bank, finance co., insurance co., BOT, mutual funds, provident fund,…
• Thailand: FI, firms with 100 MB INV, individuals with 10 MB INV

https://steemit.com/cryptocurrency/@andyjim/thai-sec-warning-in-investing-in-unauthorized-tokens-and-icos
PP
 PP

http://bh.listedcompany.com/misc/DEBENTU
RE/20120124-BH-prospectusNo01-2011-EN.pdf
EX: Bond

PP
 Prospectus

• 2017 - 2022
• R = 2.36% semi
• n = 5 yrs

PP

EX: State Owned Enterprise Bonds • file:///C:/Users/HP/Downloads/GSB222A.pdf

Type of Bond:
• Debenture
• Registered Bond
• Senior Bond
• Unsecured Bond

Ratin PP
g
 Long-Term External Financing
Public Offering
• What: Firm (issuer) raises money by selling securities (debt and equity) to
general people in the public using services of investment banker (IB)
• Issuer must be qualified and meet legal requirements by laws and SEC
Investment Banker
• What: Financial intermediaries help issuer raising capital
• How: IB performs 3 functions
• 1. Advising
• 2. Underwriting
• 3. Distributing/selling
https://steemit.com/cryptocurrency/@andyjim/thai-sec-warning-in-investing-in-unauthorized-tokens-and-icos
http://www2.fpo.go.th/S-I/Source/Article/Article83.htm
EX: Underwriting Process of IB

• https://www.slideshare.net/thtsai77/markis-capital-seminars-intro-to-investment-banking-20130926
 EX: Public Offering
• Issuer: PTTEP
• Subscription: December 3 - 6, 2012
• Agents: BBL, K, Krung Thai, SCB 14
Prospectus

PO

1999

Investment Banker (IB)

15
 EX: IB 1999 vs 2001

November 7, 2001

http:www.capital.sec.or.th
 The Securities and Exchange Commission (SEC)
Prospectus

EX: Unsecured Bond

PO

• https://market.sec.or.th/public/ipos/IPOSDE01.aspx?TransID=146410
Rating for Issuer
Rating for Bond

PO

PP
 PO vs PP: Advantages and Disadvantages
Public Offering (PO) Private Placement (PP)
Advantages: Advantages:
• Raise big amount of $ • Faster
• High liquidity • Less rules and regulations
• Cheaper
Disadvantages:
• Not much disclosure of information
• More rules and regulations
Disadvantages:
• Costly
• Raise small amount of $
• Disclosure of information • Low liquidity
• Higher cost (interest)
• More restrictive covenants
Bond Valuation
 L-T External Debt Financing
• Bank loans
• Corporate bonds
– Valuation
– Rate of return
• Coupon rate
• Current yield
• Yield to maturity
– Interest rate risk
• Type of bonds (Self reading)
 Bond (Corporate Bond/Debenture)
What:
• An agreement (L-T contract) between lenders (investors, buyers,
bondholders) and borrowers (issuers, sellers)
Returns:
• Fixed
• Periodic interest (C%)
Semiannually
• Principal (PAR)
At the maturity
Claims:
• Bondholders (lenders/investors) have higher claims than stockholders
 S
EX: Claim / Priority / Right / Privilege COGS
GP
Highest
Oper Exp
EBIT
(1) Debt holders / Bondholders / I
Banks / Creditors / Lenders EBT
T
(2) Equity holders / Stockholders
NI
Preferred Stocks (P/S) P/S Div
Common Stocks (C/S) NI to C/S
C/S Div
Lowest R/E

23
 PAR 1,000Bht

Issuing Year
Issuer Year 000
2000
Electricity Generating Authority of Thailand

Name of investors
# bond Total price paid
bought Maturity Date
May 8, 2006
INT
Yearly
Nov 8 May 8
1st 2nd

Guaranteed by Ministry of Finance

24 24
 Bonds need to be rated

Source: Tris Rating: Corporate Credit Rating 2015

https://www.trisrating.com
 TABLE 10.2 Examples of Bond Rating Categories
Moody’s S&P Fitch
Aaa AAA AAA Best quality, least credit risk
Aa1 AA+ AA+ High quality, slightly more risk than a top-rated bond
Aa2 AA AA
Aa3 AA− AA−
A1 A+ A+ Upper-medium grade, possible future credit quality difficulties
A2 A A Investment Grade Risk: Return:
A3 A− A−
Baa1 BBB+ BBB+ Medium-quality bonds
Baa2 BBB BBB
Baa3 BBB−
Ba1 BB+ BB+ Speculative issues, greater credit risk
Ba2 BB BB
Ba3 BB− BB−
B1 B+ B+ Very speculative, likelihood of future default
B2 B B
B3 B− B−
Caa CCC CCC Highly speculative, in default or high likelihood of going into default

Ca CC CC Junk Bond, High Yield Bond Risk: Return:

C C C
D DDD
DD
 EX: Rating

2016
2018

2019

PP
 Rating for Issuer
Rating for Bond

Semiannually

Institutional investors and/or high net

worth investors

PP

Bondholders’ Representatives

https://www.facebook.com/fbthaibma/
 The Securities and Exchange Commission (SEC)
Prospectus

EX: Unsecured Bond

PO

https://market.sec.or.th/public/ipos/IPOSDE01.aspx?TransID=146410
 Bond Valuation
What: The value of securities is called “intrinsic value”.
How to find value of bond (intrinsic value)?
• Find PV of all future cash flows that you will receive on your investment
• PV  need to discount all future cash flows ($C + PAR) back to T = 0
Your future cash flows ($C + PAR)
EX: C = 6.12% yearly, n = 6

Price = ? $C $C $C $C $C $C

1
$PAR
2
 0 i = 10% 1
FV
PV 
(1  i)
PV = 1000/1.1 Price= =
Price ?
$909.09 PMT=$1,000

Intrinsic Value
• What: MAX price investors are willing to pay for a security
• Best estimate true value of security, based on:
• Forecast of future cash flows (CFs)
• Estimated discount rate, INT, required rate of return (rb)
Intrinsic Value Return = rb ? EX: C = 6.12% yearly, n = 6

Price = ? 6.12% 6.12% 6.12% 6.12% 6.12% 6.12%

1
1,000
2 31
To Find the Value of Security: Intrinsic Value
Value of Security (Price) = PV of Future CFs

Intrinsic Value

32
 Value of Bond (Intrinsic Value): Formula
FIN2201 ($R)
1 (kb) + 2
Price (Vb) = $C (PVIFA rb, n) + PAR (PVIF rb, n)
• Price (Vb) = Value, price of bond now, T = 0

Price = ? $C $C $C $C $C
PVIFArb, n 1
$PAR
PVIFrb, n 2
33
 EX: C = 6.12% yearly, n = 6
Value of Bond (Intrinsic Value)

Price (Vb) = $C (PVIFA rb, n) + PAR (PVIF rb, n)

• Convert C%  $C
• Coupon Interest Payment ($C) = C% * PAR
C% = 6.12% yearly
$R = (6.12%)(1,000) = $61.2

C% = 6.12% semiannually
$R = (6.12% / 2)= 3.06%
= (3.06%)(1,000) = $30.6
34
 Value of Bond (Intrinsic Value)
1 + 2
Price (Vb) = $C (PVIFA rb, n) + PAR (PVIF rb, n)
• Convert C%  $C

• Coupon Interest Payment ($C) = C% * PAR

• Coupon Interest Rate (C%) = $C / PAR

EX: $C = $100 yearly, find C%.

C% = $100 / $1,000 = 10%

35
 Value of Bond (Intrinsic Value)
1 +
2
Price (Vb) = $C (PVIFA rb, n) + PAR (PVIF rb, n)

• PAR = Stated value, face value, principal value

• Always = $1,000
• Received at the end of the maturity

36
 Value of Bond (Intrinsic Value)
1 + 2
Price (Vb) = $C (PVIFA rb, n) + PAR (PVIF rb, n)
• rb = Required rate of return by investors on similar INV
Bond/INV with similar quality and risk

EX1: 6-year Bond A = 6.12% EX2: House 1 = 10 MB

6-year Bond B = 6% House 2 = 9.8 MB

37
 Other Terms for rb
• Kb, rb, YTM, i.
• Discount rates
• Appropriate rates
• Capitalized rate
• Opportunity costs
• Required rates of returns
 Value of Bond (Intrinsic Value)

1 + 2
Price (Vb) = $C (PVIFA rb, n) + PAR (PVIF rb, n)
• n = Maturity date
• Specific date that the PAR is repaid.

39
 EX 1: Bond Value
• A 5-year bond offers a coupon rate of 15% per year. Investor’s
required rate is 15%. Find the bond value.
How much you are willing to pay today ?

You will get these cash flows

150 150 150 150 150

Price?
1,000
Vb = $C (PVIFA rb, n) + PAR (PVIF rb, n)

40
EX 1: A 5-year bond offers a coupon rate of 15% per year. Investor’s
required rate is 15%. Vb = ?

150 150 150 150 150

? PVA = 150 (PVIFA 15%, 5)

1,000
? PVF = 1,000 (PVIF 15%, 5)

Vb = $C (PVIFA rb, n) + PAR (PVIF rb, n)

41
 EX 1: rb = 15%, C = 15%
Price = $C
150(PVIFA n) )
(PVIFArb,15%,5 + 1,000 (PVIFrb,15%,5
PAR (PVIF n) )

150 (3.3522) + 1,000 (0.4972)

1,000 = 502.83 + 497.20
$1,000 = MAX Price at rb (required return) 15%
• If you buy bond at $1,000, return = your required rate of return (rb)
(= 15%) Buy
• If MP = $900, Pb , return (> 15%) Buy
• If MP = $1,100, Pb , return (< 15%) Not Buy
(-) Relationship

Note: MP (Pb) = Market price 42

 Price (Vb) = $C (PVIFA rb,n) + PAR (PVIF rb,n)

Inverse relationship : rb vs. Vb

 rb% = (INT), Changes over time
 C% = Fixed after the bond has been issued

rb C Vb PAR
PAR 15%
--
15% =
Premium 10% 15% >
Discount 20% 15% <

43
 Price (Vb) = $C (PVIFA rb,n) + PAR (PVIF rb,n)
EX: 2
rb = 15%, C = 15%, n = 5 yrs, If 1 year has passed, n = ?
EX: rb Vb
rb =15% -- Price = 150 (PVIFA 15%,4) + 1,000 (PVIF15%,4)
1 10% 1,158
-- 1,000 = 150 (2.8550 ) + 1,000 (0.5718)
2 15% 1,000

rb =10% Price = 150 (PVIFA 10%, 4) + 1,000 (PVIF 10%, 4) 3 20% 871

1,158.49 = 150 (3.1699) + 1,000 (0.6830)

rb =20% Price = 150 (PVIFA 20%, 4) + 1,000 (PVIF 20%, 4)

870.61 = 150 (2.5887) + 1,000 (0.4823)

10% 15% 20%

44
 EX: Inverse relationship between rb and Vb

EX: rb Vb

1 10% 1,158

2 15% 1,000

3 20% 871

10% 15% 20%

 More Frequent Coupon payment
Vb =$C/m (PVIFA rb / m, n*m) + PAR (PVIF rb / m, n*m)
Need to make three adjustments:

1. Coupon Rate (C%) = C% ÷ m

2. Number of period (n) = n * m
3. rb = rb ÷ m

where m = number of period per year

46
 C = 7% semiannually, n = 7,
EX: 3
Required return = 8%, Vb=?

Coupon per period = (7% ÷ 2) * 1,000 = $35

Number of periods = 7yrs * 2 = 14
rb = 8% ÷ 2 = 4%
Vb = 35 (PVIFA 4% , 14) + 1,000 (PVIF 4% , 14)
$947.21 = 35 (10.5631) + 1,000 (0.5775)
• If you buy bond at $947.21, return = your required rate of return (rb)
(= 8%) Buy
• If MP = $900, Pb , return (> 8%) Buy

• If MP = $1,000, Pb , return (< 8%) Not Buy

47
47
 Comparing Market Price (Pb) with Intrinsic Value (Vb)
Intrinsic Value (Vb) from your calculation: $947.21

Undervalued (Underpriced) vs Overvalued (Overpriced)

Undervalued (priced) Overvalued (priced)

• Pb < Vb • Pb > Vb
• 900 < 947.21 • 1,000 > 947.21
EX: StockA (bond) price EX: StockB (bond) price
• 90 < 100 • 100 > 80
• BUY • SELL, NOT BUY
• DD A • SSB
• DDA > SSA • SSB > DDB
• PriceA: • PriceB:
https://stock2morrow.com/article-detail.php?id=439 48
Rate of Return

• Current Yield
• Yield to Maturity
 Rate of Return: Current Yield (Yc)

What:
• Annual rate of return if investors buy the bond today at the current market
price (Pb)

Formula: Current Yield (Yc) = $C / Pb

$C = Annual coupon payment $
Pb = Current bond price in the market

EX 4: Bond pays $100 coupon per year, Pb = $750, find current yield.

• Current yield = $100 / $750 = 13.3%

• So, Current yield (13.33%) > Coupon rate (10%)

50
50
 Rate of Return: Yield to Maturity (YTM)
What:
• Annual rate of return if investors buy the bond today at the current
market price (Pb) and hold the bond until the maturity

• YTM is a discount rate that makes PV of future CFs ($C + PAR) equal
the current bond price in the market (Pb) that investors buy today.

PV of future cash inflows ($C + PAR)

YTM Discount Rate
Current bond price in the market (Pb)

51
 EX 5.1: Rate of Return: Yield to Maturity (YTM)
YTM: C% = 10%, n = 5 yrs, Par = $1,000, Pb = $950 (Market price), YTM = ?
YTM
YTM==?? n Approximate Yield to Maturity (YTM)
0 1 2 3 4 5
Pb = $950 C = 100 100 100 100 100
1,000
Pb = 950
PV of Future CFs = $950

• Pb = C(PVIFArb, n) + Par(PVIFrb, n) • 100 + (1,000 – 950) / 5

(1,000 + 980) / 2
• Pb = C(PVIFAYTM, n) + Par(PVIFYTM, n)
• 950 = 100(PVIFAYTM, 5) + 1,000(PVIFYTM, 5) • 11.28%
• 950 = 100(PVIFA11.37%, 5)+ 1,000(PVIF11.37%, 5) Where
• $C = Annual coupon interest
• Pb = Current
52 market price
52
• n = Numbers of years till maturity
 EX 5.2: Rate of Return: Yield to Maturity (YTM)
C% = 10%, n = 5 years, Par = $1,000, Pb = $950 Find YTM = ?

Formula:

=RATE(nper, pmt, pv, [fv], [type], [guess])

=RATE(5, 100, -950, 1,000)

=RATE(B5, B7, B6, B2)
YTM = 11.37%

53
53
 EX 6: Rate of Return: Yield to Maturity (YTM)
C% = 15%, n = 5 years, Par = $1,000, Pb = $1,000, Find YTM = ?

Formula:

=RATE(nper, pmt, pv, [fv], [type], [guess])

=RATE(5, 150, -1,000, 1,000)
=RATE(B23, B25, B24, B20)

YTM = 15%

54
54
 EX 7: Rate of Return: Yield to Maturity (YTM)
C% = 15%, n = 4 years, Par = $1,000, Pb = $1,000, Find YTM = ?

Formula:

=RATE(nper, pmt, pv, [fv], [type], [guess])

=RATE(4, 150, -1,000, 1,000)

=RATE(B34, B36, B35, B31)

YTM = 15%

55
55
 EX 8: Rate of Return: Yield to Maturity (YTM)
C% = 15%, n = 4 years, Par = $1,000, Pb = $1,158.49, Find YTM = ?

Formula:
=RATE(nper, pmt, pv, [fv], [type], [guess])
=RATE(4, 150, -1,158.49, 1,000)
=RATE(B34, B36, B35, B31)

YTM = 10%

56
56
 EX 9: Rate of Return: Yield to Maturity (YTM)
C% = 15%, n = 4 years, Par = $1,000, Pb = $870.61, Find YTM = ?

Formula:

=RATE(nper, pmt, pv, [fv], [type],[ guess])

=RATE(4, 150, -870.61, 1,000)

=RATE(B56, B58, B57, B53)
YTM = 20%

57
57
Risks in Investing in Bonds
 Interest Rate Risk
What:
• Risk of changes in value of securities when interest rate changes
Relationship between Interest Rate and Vb
• Negative relationship between rb and Vb
Conclusion:
• When INT rate changes, the value of securities changes
• In a negative (inverse) direction

https://www.pimco.com/en-us/resources/education/everything-you-need-to-know-about-bonds
 EX: Interest Rate Risk

Negative Relationship

n rb C% Vb PAR
EX 1 5 15% = 15% $1,000 = $1,000 PAR
EX 2 5 10% < 15% $1,158.49 > $1,000 Premium
EX 3 5 20% > 15% $870.61 < $1,000 Discount
 Interest Rate Risk
Bond Price Sensitivity vs Interest Rate Risk
• Bond with shorter time to maturity, interest rate risk:
• Bond with longer time to maturity, interest rate risk:
 • EX 1: C% = 10%, n = 5 yrs., rb = 8%, Par = $1,000, Vb = ?
EX 10.1a: C=10%, rb = 10%, n = 5 • EX 2: C% = 10%, n = 5 yrs., rb = 10%, Par = $1,000, Vb = ?
Find Vb =? • EX 3: C% = 10%, n = 5 yrs., rb = 12%, Par = $1,000, Vb = ?

EX 1: Rb , Vb
• Vb = $100 (PVIFA8%, 5) + $1,000 (PVIF8%, 5)
• Vb = $1,079.85

EX 2: Rb = C% , Vb = PAR
• Vb = $100 (PVIFA10%, 5) + $1,000 (PVIF10%, 5)
• Vb = $1,000

EX 3: Rb , Vb
• Vb = $100 (PVIFA12%, 5) + $1,000 (PVIF12%, 5)
• Vb = $927.9

62
 • EX 1: C% = 10%, n = 5, 4, 3, 2, 1, 0 yrs., rb = 8%, Par = $1,000, Vb = ?
EX 10.1b: Find Vb at • EX 2: C% = 10%, n = 5, 4, 3, 2, 1, 0 yrs., rb = 10%, Par = $1,000, Vb = ?
different time to maturity • EX 3: C% = 10%, n = 5, 4, 3, 2, 1, 0 yrs., rb = 12%, Par = $1,000, Vb = ?

The value of the bond moves towards PAR as n moves closer to maturity:
 EX 10.2:
Find Bond Price at
Different Maturities

EX 1: C% = 10%, n = 10, 20, 30 yrs., rb = 8%, Vb = ?

EX 2: C% = 10%, n = 10, 20, 30 yrs., rb = 10%, Vb = ?
8% EX 3: C% = 10%, n = 10, 20, 30 yrs., rb = 12%, Vb = ?

10%
12%

64
 EX 10.3: Percentage Change in Price
If interest rate (rb) changes by a certain percentage,
what will happen to the price of the bond?
8%

% Change = (Premium – Par)÷Par

10%

12%

% Change = (Discount – Par)÷Par

Premium:
• 5 year: (1,079.85 – 1,000) / 1,000 = 7.99% % Change = (New – Old)÷Old
• 10 year: (1,134.20 – 1,000) / 1,000 = 13.42%
• 30 year: (1,225.16 – 1,000) / 1,000 = 22.52%
EX 1: C% = 10%, n = 5, 10, 30 yrs., rb = 8%, Vb = ?
Discount: EX 2: C% = 10%, n = 5, 10, 30 yrs., rb = 10%, Vb = ?
• 5 year: (927.90 – 1,000) / 1,000 = -7.21% EX 3: C% = 10%, n = 5, 10, 30 yrs., rb = 12%, Vb = ?
• 10 year: (887.00 – 1,000) / 1,000 = -11.30%
• 30 year: (838.90 – 1,000) / 1,000 = -16.11%
65
 EX 10.4: Bond Price Sensitivity
8%

Price sensitivity: (S-T maturity vs L-T maturity)

10%
If rb decreases from 10% to 8%  Vb 12%

• L-T bond is more price sensitive than S-T bonds.

• 5-year bond: Price is higher by 7.99%
• 10-year bond: Price is higher by 13.42%
• 30-year bond: Price is higher by 22.52%

If rb increases from 10% to 12%  Vb

• L-T bond is more price sensitive than S-T bonds.
• 5-year bond: Price is lower by 7.21%
• 10-year bond: Price is lower by 11.30%
• 30-year bond: Price is lower by 16.11%

66
Other Types of Bonds
 Type of Bonds (Self Reading)

• 1. Coupon payment:
– Fixed rate bond, Variable rate bond, Zero coupon bond
• 2. Collateral:
– Secured bond vs. Unsecured bond
• 3. Priority of claim
– Secured bond, Debenture, Subordinated debenture
• 4. Default risk:
– Investment grade bond vs. Non-investment grade bond
• 5. Embedded option:
– Callable bond, Convertible bond
• 6. Principal payment:
– Non-amortizing bond vs. Amortizing bond

68
EX: Fixed Rate, Unsecured,
unsubordinated Bond

http://bh.listedcompany.com/misc/DEBENTURE/20120124-BH-prospectusNo01-2011-EN.pdf
 EX: Unsecured Bond

PP
 PAR 1,000Bht EX: Secured Bond

Issuing Year
Issuer Year 000
2000
Electricity Generating Authority of Thailand

Name of investors
# bond Total price paid
bought
Mat = 2006
INT
Yearly
1st 2nd

Guaranteed by Ministry of Finance

71
71
EX: Convertible and Secured Bond

• http://investor.bumrungrad.com/factsheet.html
 EX: Convertible Bond

• http://investor.bumrungrad.com/factsheet.html
 EX: Convertible Bond

• http://investor.bumrungrad.com/news.html/id/159494/group/newsroom_set
 EX: Convertible + Secured Bond

• http://investor.bumrungrad.com/factsheet.html
 EX: Convertible and Secured Bond

http://bh.listedcompany.com/misc/DEBENTURE/20120124-BH-prospectusNo01-2011-EN.pdf
EX: Convertible
Bond

• https://i.pinimg.com/originals/6d/64/33/6d64334d8547d2074e6c9efa0a1e6048.jpg
EX : Callable Bond

Type of Bond:
• Debenture
• Registered Bond
• Senior Bond
• Unsecured Bond
• Callable Bond
 Type of Bond:
• Debenture
• Registered Bond
• Senior Bond
• Unsecured Bond

Ratin
g
 EX: Subordinate
Debenture

• http://nextbook.co/editor/?
 Debenture Bond

Unsecured +
General Creditors
Senior Bond

Unsecured +
Subordinate
Debenture
(Junior Bond)

http://www.thaibma.or.th/EN/Education/Default.aspx
 Conclusion: Priority Claim on Assets
Debt Holders
Highest Right

1. Closed-end mortgage bond

2. Open-end mortgage bonds All secured Bonds
1st mortgagebond
2nd mortgage bond
3. Debentures (senior bonds)
Unsecured Bonds
4. Subordinated Debentures
5. Preferred Stocks
Equity Holders
6. Common Stocks

Lowest Right
Exercise 1
 Exercise 1: Q1
Below is the given information about ABC Bond:
 Coupon rate (C%) = 8% per annum, paid quarterly
 Par = $1,000
 Original maturity 10 years
 Issued 4 years ago
 Market’s required yield to maturity (required rate of return) (rb) = 12%
 Current market price (Pb) = $820
1.1 Calculate the intrinsic value of the bond.
1.2 Indicate if the bond is par, premium, or discount bond. Why?
1.3 Indicate if the bond is fairly-priced, underpriced, overpriced. Why?
1.4 Should you buy or sell the bond? Why?
1.5 Calculate approximate yield to maturity of the bond.
1.6 Calculate current yield.
1.7 If the required rate of return remains constant at 12%, calculate the intrinsic value of the
bond a year later. Explain why the bond value changes that way.
 Exercise 1: Q1
Below is the given information about ABC Bond:
 Coupon rate (C%) = 8% per annum, paid quarterly
 Par = $1,000
 Original maturity 10 years
 Issued 4 years ago
 Market’s required yield to maturity (required rate of return) (rb) = 12%
 Current market price (Pb) = $820
1.1 Calculate the intrinsic value of the bond. • Rb , Vb
• Vb = $C(PVIFArb, n) + Par(PVIFrb, n) • C%  $C paid quarterly
• = $20 (PVIFA12%/4, 6*4) + 1,000(PVIF3%, 24) • $C = (8%/4)($1,000) = $20 per quarter
• = $20 (16.9355) + 1,000 (0.4919) • rb = 12% / 4 = 3%
• = 338.71 + 491.9 • n = 6 * 4 = 24 periods
• = $830.61
 Exercise 1: Q1
Below is the given information about ABC Bond:
 Coupon rate (C%) = 8% per annum, paid quarterly
 Par = $1,000
 Original maturity 10 years
 Issued 4 years ago
 Market’s required yield to maturity (required rate of return) (rb) = 12%
 Current market price (Pb) = $820
1.2 Indicate if the bond is par, premium, or discount bond. Why?
• Vb = $830.61
• Vb (830.61) < PAR (1,000)
• Discount
• rb (12%) > C% (8%)
 Exercise 1: Q1
Below is the given information about ABC Bond:
 Coupon rate (C%) = 8% per annum, paid quarterly
 Par = $1,000
 Original maturity 10 years
 Issued 4 years ago
 Market’s required yield to maturity (required rate of return) (rb) = 12%
 Current market price (Pb) = $820
1.3 Indicate if the bond is fairly-priced, underpriced, overpriced. Why?
• Underpriced / Undervalued
• Pb (820) < Vb (830.61)
 Exercise 1: Q1
Below is the given information about ABC Bond:
 Coupon rate (C%) = 8% per annum, paid quarterly
 Par = $1,000
 Original maturity 10 years
 Issued 4 years ago
 Market’s required yield to maturity (required rate of return) (rb) = 12%
 Current market price (Pb) = $820
1.4 Should you buy or sell the bond? Why?
• Buy
• Cheaper
• You are willing to pay at $830.61 (Max price), but the market price is cheaper at only
$820.
 Exercise 1: Q1
Below is the given information about ABC Bond:
 Coupon rate (C%) = 8% per annum, paid quarterly
 Par = $1,000
 Original maturity 10 years
 Issued 4 years ago
 Market’s required yield to maturity (required rate of return) (rb) = 12%
 Current market price (Pb) = $820
1.5 Calculate approximate yield to maturity of the bond.

80 + (1,000 – 820) / 6
(1,000 + 820) / 2

110 = 12.09%
910
 Exercise 1: Q1
Yc = Annual rate of return if investors buy the bond
today at the current market price (Pb)

Below is the given information about ABC Bond:

 Coupon rate (C%) = 8% per annum, paid quarterly
 Par = $1,000
 Original maturity 10 years
 Issued 4 years ago
 Market’s required yield to maturity (required rate of return) (rb) = 12%
 Current market price (Pb) = $820
1.6 Calculate current yield.

Yc = $C / Pb Yc = $C / Pb
• C = $20 • C = 8% * $1,000 = $80
• Pb = $820 • Pb = $820
• Yc = $20 / $820 = 2.44% • Yc = $80 / $820 = 9.76%
• Yc = 2.44% * 4 = 9.76%
 • C%  $C paid quarterly

Exercise 1: Q1 • $C = (8%/4)($1,000) = $20 per quarter

• rb = 12% / 4 = 3%
Below is the given information about ABC Bond: • n = 5 * 4 = 20 periods
 Coupon rate (C%) = 8% per annum, paid quarterly
 Par = $1,000
 Original maturity 10 years
 Issued 4 years ago
 Market’s required yield to maturity (required rate of return) (rb) = 12%
 Current market price (Pb) = $820
1.7 If the required rate of return remains constant at 12%, calculate the intrinsic value of the bond a year
later. Explain why the bond value changes that way.

• Vb = C/4(PVIFArb/4, n*4) + Par(PVIF rb/4, n*4)

• = 20 (PVIFA12%/4, 5*4) + 1,000 (PVIF3%, 20) • When n = 6, Vb = 830.61
• = 20 (14.8775) + 1,000 (0.5537) • When n = 5, Vb = 851.25
• ABC bond is a discount bond.
• = 297.55 + 553.7
• Vb is higher approaching PAR as time
• = $851.25
moves closer to the maturity.
 Exercise 1: Q2 (H.W.)
Two corporate bonds paying an annual coupon interest of 8% paid
semiannually. Both have $1,000 par values. The first bond has 10 years to
maturity and the second bond has 4 years to maturity.
2.1 Calculate the intrinsic value of both bonds given the market required
yield to maturity of 4%.
2.2 Calculate the intrinsic value of these bonds given the market required
yield to maturity changes to 8%.
2.3 Based on your answers in (2.1) and (2.2), clearly explain which bond has
more interest rate risk.
 Exercise 1: Q2
Two corporate bonds paying an annual coupon interest of 8% paid
semiannually. Both have $1,000 par values. The first bond has 10 years to
maturity and the second bond has 4 years to maturity.
2.1 Calculate the intrinsic value of both bonds given the market required yield
to maturity of 4%.
First Bond • Rb (4 %) < C% (8%) , Vb
• Vb = C/2(PVIFArb/2, n*2) + Par(PVIF rb/2, n*2) • C%  $C paid semiannually
• = 40 (PVIFA4%/2, 10*2) + 1,000 (PVIF2%, 20) • $C = (8%/2)($1,000) = $40 per 6 mos.
• = 40 (16.351) + 1,000 (0.6730) • rb = 4% / 2 = 2%
• = 654.04 + 673 • n = 10 * 2 = 20 periods
• = $1,327.04
 Exercise 1: Q2
Two corporate bonds paying an annual coupon interest of 8% paid
semiannually. Both have $1,000 par values. The first bond has 10 years to
maturity and the second bond has 4 years to maturity.
2.1 Calculate the intrinsic value of both bonds given the market required
yield to maturity of 4%.
Second Bond • Rb (4%) < C% (8%) , Vb
• Vb = C/2(PVIFArb/2, n*2) + Par(PVIF rb/2, n*2) • C%  $C paid semiannually
• = 40 (PVIFA4%/2, 4*2) + 1,000 (PVIF2%, 8) • $C = (8%/2)($1,000) = $40 per 6 mos.
• = 40 (7.3255) + 1,000 (0.8535) • rb = 4% / 2 = 2%
• = 293.02 + 853.5 • n = 4 * 2 = 8 periods
• = $1,146.52
 Exercise 1: Q2
Two corporate bonds paying an annual coupon interest of 8% paid
semiannually. Both have $1,000 par values. The first bond has 10 years to
maturity and the second bond has 4 years to maturity.
2.2 Calculate the intrinsic value of both bonds given the market required
yield to maturity of 8%.
First Bond • Rb = C% (8%), Vb = PAR
• Vb = C/2(PVIFArb/2, n*2) + Par(PVIF rb/2, n*2) • C%  $C paid semiannually
• = 40 (PVIFA8%/2, 10*2) + 1,000 (PVIF4%, 20) • $C = (8%/2)($1,000) = $40 per 6 mos.
• = 40 (13.590) + 1,000 (0.4564) • rb = 8% / 2 = 4%
• = 543.60 + 456.4 • n = 10 * 2 = 20 periods
• = $1,000
 Exercise 1: Q2
Two corporate bonds paying an annual coupon interest of 8% paid
semiannually. Both have $1,000 par values. The first bond has 10 years to
maturity and the second bond has 4 years to maturity.
2.2 Calculate the intrinsic value of both bonds given the market required
yield to maturity of 8%.
Second Bond • Rb = C% (8%), Vb = PAR
• Vb = C/2(PVIFArb/2, n*2) + Par(PVIF rb/2, n*2) • C%  $C paid semiannually
• = 40 (PVIFA8%/2, 4*2) + 1,000 (PVIF4%, 8) • $C = (8%/2)($1,000) = $40 per 6 mos.
• = 40 (6.7327) + 1,000 (0.7307) • rb = 8% / 2 = 4%
• = 269.31 + 730.7 • n = 4 * 2 = 8 periods
• = $1,000.01
 Exercise 1: Q2
Two corporate bonds paying an annual coupon interest of 8% paid
semiannually. Both have $1,000 par values. The first bond has 10 years to
maturity and the second bond has 4 years to maturity.
2.3 Calculate the intrinsic value of both bonds given the market required
yield to maturity of 6%.
First Bond • Rb (6%) < C% (8%) , Vb
• Vb = C/2(PVIFArb/2, n*2) + Par(PVIF rb/2, n*2) • C%  $C paid semiannually
• = 40 (PVIFA6%/2, 10*2) + 1,000 (PVIF3%, 20) • $C = (8%/2)($1,000) = $40 per 6 mos.
• = 40 (14.877) + 1,000 (0.5537) • rb = 6% / 2 = 3%
• = 595.08 + 553.7 • n = 10 * 2 = 20 periods
• = $1,148.78
 Exercise 1: Q2
Two corporate bonds paying an annual coupon interest of 8% paid
semiannually. Both have $1,000 par values. The first bond has 10 years to
maturity and the second bond has 4 years to maturity.
2.3 Calculate the intrinsic value of both bonds given the market required
yield to maturity of 6%.
Second Bond • Rb (6%) < C% (8%) , Vb
• Vb = C/2(PVIFArb/2, n*2) + Par(PVIF rb/2, n*2) • C%  $C paid semiannually
• = 40 (PVIFA6%/2, 4*2) + 1,000 (PVIF3%, 8) • $C = (8%/2)($1,000) = $40 per 6 mos.
• = 40 (7.0197) + 1,000 (0.7894) • rb = 6% / 2 = 3%
• = 280.79 + 789.4 • n = 4 * 2 = 8 periods
• = $1,070.19
 Exercise 1: Q2
2.4 Based on your answers in (2.1) and (2.3), clearly explain which bond has
more interest rate risk.

INT = 4% INT = 6% Percentage Change in Bond Value

1st (10 yrs) $1,327.04 $1,148.78 (1,148.78 – 1,327.04) / 1,327.04 = -13.43%
2nd (4 yrs) $1,146.52 $1,070.19 (1,070.19 – 1,146.52) / 1,146.52 = -6.66%

• First bond has higher interest rate risk.

• Higher percentage change in bond price.
• L-T bonds have the higher interest rate risk than S-T bonds.
Exercise 2 (HW)
 Exercise 2: Q1
1. A bond pays a coupon rate of 10% per annum. The maturity is
the next 10 years. What should be the price of the bond if the
company issues it when:
Case 1: Market interest rate is 12%
Case 2: Market interest rate is 8%
1. A bond pays a coupon rate of 10% per annum. The maturity is the next 10
years. What should be the price of the bond if the company issues it when:

• Case 1: Market interest rate is 12%

• rb , Bond price
• C%  $C = (10%)(1,000) = 100 per year
• rb = 12%
• n = 10 years
• 100 (PVIFA 12%, 10) + 1,000 (PVIF 12%, 10)
• 100 (5.6502) + 1,000 (0.3220)
• 565.02 + 322
• 887.02
 1. A bond pays a coupon rate of 10% per annum. The maturity is the next 10
years. What should be the price of the bond if the company issues it when:

• Case 2: Market interest rate is 8%

• rb: , Bond price:
• C%  $C = (10%)(1,000) = 100 per year
• rb = 8%
• n = 10 years
• 100 (PVIFA 8% 10) + 1,000 (PVIF 8%, 10)
• 100 (6.7101) + 1,000 (0.4632)
• 671.01 + 463.2
• 1,134.21
 Exercise 2: Q2
2.1 A 1,000-baht par bond paying an annual interest rate of
10% paid semiannually if it was issued 7 years ago with an
initial maturity of 10 years. YTM is 18%.
2.2 Find the price of the bond in fifth year if the market interest
rate changed to 13%
2.1 A 1,000-baht par bond paying an annual interest rate of 10% paid semiannually if it
was issued 7 years ago with an initial maturity of 10 years. YTM is 18%.

• rb: , Bond price:

• C%  $C = (10%/2)(1,000)= 50 per 6 months
• Kb = 18% / 2 = 9%
• n =3*2 = 6 periods
• 50 (PVIFA 18%/2, 3*2) + 1,000 (PVIF 9%, 6)
• 50 (4.4859) + 1,000 (0.5963)
• 224.295 + 596.3
• 820.6
2.2 Find the price of the bond in fifth year if the market interest rate
changed to 13%

• rb: , Bond price:

• C%  $C = (10%/2)(1,000)= 50 per 6 months
• rb = 13% / 2 = 6.5%
• n =5*2 = 10 periods
• 50 (PVIFA 13%/2, 5*2) + 1,000 (PVIF 6.5%, 10)
• 50 (7.1888) + 1,000 (0.5327)
• 359.44 + 532.7
• 892.14
 Exercise 2: Q3
3. AAA Bond with 1,000 par paying an annual coupon rate of 11%
semiannually for the remaining 8 years. Its current price is 900.
3.1 What should be the price of bond if required rate of return is
14%?
3.2 Is the bond sold at premium or discount?
3.3 Find approximate yield to maturity?
3.4 Find current yield.
 3. AAA Bond with 1,000 par paying an annual coupon rate of 11%
semiannually for the remaining 8 years. Its current price is 900.

• 3.1 What should be the price of bond if required rate of return is 14%?
• rb: , Bond price:
• C%  $C = (11%/2)(1,000)= 55 per 6 months
• rb = 14% / 2 = 7%
• n =8*2 = 16 periods
• 55 (PVIFA 14%/2, 8*2) + 1,000 (PVIF 7%, 16)
• 55 (9.4466) +1,000 (0.3387)
• 519.56 + 338.7
• 858.26
 3. AAA Bond with 1,000 par paying an annual coupon rate of 11%
semiannually for the remaining 8 years. Its current price is 900.

• 3.2 Is the bond sold at premium or discount?

• Vb = 858.26
• Discount (less than PAR)
• 3.3 At the current market price, is the bond overpriced or underpriced?

• Pb = 900 > Vb = 858.26

• Overpriced
• Not buy
• Expensive
• Get lower return than your required return (rb 14%)
 3. AAA Bond with 1,000 par paying an annual coupon rate of 11%
semiannually for the remaining 8 years. Its current price is 900.

3.3 Find approximate yield to maturity?

100 + (1,000 – 900) / 8

(1,000 + 900) / 2

112.5 = 11.84%
950
 3. AAA Bond with 1,000 par paying an annual coupon rate of 11%
semiannually for the remaining 8 years. Its current price is 900.

• 3.4 Find current yield.

• Yc = $C/Pb
• Current Yield = Annual return if buy bond at current market price (Pb)
• $C = Annual coupon interest payment in dollars
• $C = 110 • $C = $55
• Pb = $900
• Pb = 900
• Yc = $55 / $900 = 6.11%
• Yc = 110 / 900 • Need to adjust to annual return
• Yc = 12.22% • Yc = 6.11% * 2 = 12.22%

• Buy at lower price than PAR

• Return (12.22%) > C% (11%)
 Exercise 2: Q4
4. In January 2003, a 10-year bond was issued paying a 6% coupon rate
semiannually if the required rate of return is 12%
4.1 What should be the price of the bond in year 2009?
4.2 Is it underpriced or overpriced if the market price of this bond is 800?
Explain.
4.3 Find current yield
4.4 If investors buy the bond at the market price of 800, do they have
capital gain or loss?
4.5 Find approximate yield to maturity
 4. In January 2003, a 10-year bond was issued paying a 6% coupon
rate semiannually if the required rate of return is 12%

• 4.1What should be the price of the bond in year 2009?

• $C = (6%/2)(1,000) = 30 per 6 months
• rb = 12% / 2 = 6%
• n =4*2 = 8 periods
• 30 (PVIFA 12%/2, 4*2) + 1,000 (PVIF 6%, 8)
• 30 (6.2098) + 1,000 (0.6274)
• 186.29 + 627.4
• 813.69
 4. In January 2003, a 10-year bond was issued paying a 6% coupon
rate semiannually if the required rate of return is 12%

• 4.1What should be the price of the bond in year 2009?

• Vb = 813.69 Max Price

• At $800, Pb , (< Max Price), Return , (> rb 12%) , Buy , Cheap , Undervalued

• At $1,000, Pb , (> Max Price), Return , (< rb 12%) , Not buy , Expensive ,Overvalued

, Sell
 4. In January 2003, a 10-year bond was issued paying a 6% coupon
rate semiannually if the required rate of return is 12%

• 4.2 Is it underpriced or overpriced if the market price of this bond is 800?

Explain.
• Pb = 800 < Vb = 813.69
• Underpriced
• Buy
• Cheap to buy
• Get higher return than required return (rb12%)
 4. In January 2003, a 10-year bond was issued paying a 6% coupon rate
semiannually if the required rate of return is 12 and market price is $800.

• 4.3 Find current yield

• Yc = $C/Pb
• Current Yield = Annual return if buy bond at current market price (Pb)
• $C = Annual coupon interest payment in dollars

• $C = 60 per year
• $C = $30
• Pb = 800 • Pb = $800
• Yc = 60 / 800 = 7.5% • Yc = $30 / $800 = 3.75%
• Buy at lower price • Need to adjust to annual return
• Return (7.5%) > C% (6%) • Yc = 3.75% * 2 = 7.5%
 4. In January 2003, a 10-year bond was issued paying a 6% coupon rate
semiannually if the required rate of return is 12%

• 4.4 If investors buy the bond at the market price of 800, do they have
capital gain or loss?
• Capital Gain
• P < PAR
4. In January 2003, a 10-year bond was issued paying a 6% coupon rate
semiannually if the required rate of return is 12%

4.5 Find approximate yield to maturity if the market price is 800.

60 + (1,000 – 800) / 4
(1,000 + 800) / 2
110 = 12.22%
900