Introduction to

Bond Valuation
by Hazel Jade E. Villamar
Introduction to Bond
Valuation
Bond valuation is a fundamental
concept in finance, crucial for
investors and analysts alike. It
involves determining the fair price of
a bond, considering its future cash
flows, risk, and prevailing market
conditions. This process ensures
investors make informed decisions
about buying, selling, or holding
bonds.
Introduction to Bond
Valuation
Bond valuation is the process of
determining the present value
of a bond's future cash flows,
which are the interest payments
and principal repayment the
issuer promises to make to the
bondholder.
Understanding Bond Characteristics
Par Value
The par value, or face
value, is the amount the Coupon Rate
bond issuer will pay to The coupon rate is the
the bondholder at annual interest rate that Maturity Date
maturity. It is typically a the bond issuer
fixed amount, often promises to pay to the The maturity date is the
P1,000, and is used to bondholder. It is date on which the bond
calculate the interest expressed as a issuer will repay the
payments. percentage of the par principal amount to the
value, and the interest bondholder. It is a fixed
payments are made date, and the time
periodically, often semi- remaining until
annually. maturity is known as
the bond's term.
Factors Affecting Bond Prices

1 Interest Rates 2 Inflation

Interest rates and bond prices

have an inverse relationship.
When interest rates rise, the
value of existing bonds falls,
and vice versa. This is because
new bonds issued at higher
rates offer a more attractive
return, making older bonds
less desirable.

3 Credit Risk 4 Economic Conditions

Factors Affecting Bond Prices

1 Interest Rates 2 Inflation

Inflation erodes the purchasing

power of future cash flows. Bonds
that pay a fixed interest rate are
particularly vulnerable to
inflation. In a high-inflation
environment, investors demand
higher interest rates to
compensate for the decline in the
value of their investments.

3 Credit Risk 4 Economic Conditions

Factors Affecting Bond Prices

1 Interest Rates 2 Inflation

3 Credit Risk 4 Economic Conditions

Credit risk is the risk that

the bond issuer will default
on its obligations. Bonds
issued by companies with
a higher credit risk
typically have lower prices,
reflecting the higher
likelihood of non-payment.
Factors Affecting Bond Prices

1 Interest Rates 2 Inflation

3 Credit Risk 4 Economic Conditions

General economic
conditions, such as growth,
unemployment, and
consumer confidence, can
affect bond prices. During
periods of economic
uncertainty, investors tend
to favor lower-risk bonds,
driving their prices up.
Time Value of Money and Bond Pricing

1 Future Cash Flows

The future cash flows of a bond are the interest
payments and principal repayment the issuer
will make to the bondholder. Bond valuation
relies on the principle of the time value of
money, which states that a dollar today is worth
more than a dollar in the future due to its
earning potential.

2 Discount Rate

3 Present Value
Time Value of Money and Bond Pricing

1 Future Cash Flows

2 Discount Rate
The discount rate is the rate of return that
investors require to compensate them for the
risk of investing in the bond. It reflects the
prevailing market interest rates, the bond's
risk profile, and the time value of money.

3 Present Value
Time Value of Money and Bond Pricing

1 Future Cash Flows

2 Discount Rate

3 Present Value
The present value of a bond is the sum of the
present values of its future cash flows,
discounted at the appropriate discount rate. It
represents the current market price of the
bond.
Yield to Maturity and Bond Yields

Yield to Maturity (YTM) Current Yield Yield to Call

The yield to maturity is the
total return an investor can
expect to receive from a
bond if held until maturity. It
is calculated as the internal
rate of return (IRR) of the
bond's cash flows, taking
into account the bond's
price, par value, coupon
rate, and time to maturity.
Yield to Maturity and Bond Yields

Yield to Maturity (YTM) Current Yield Yield to Call

The current yield is the
annual interest payment
divided by the bond's
current market price. It is a
measure of the bond's return
based on its current price,
but does not consider the
future cash flows or time
value of money.
Yield to Maturity and Bond Yields

Yield to Maturity (YTM) Current Yield Yield to Call

Yield to call is the return an
investor would receive if the
bond is called before
maturity. It is calculated
based on the call price,
which is the price at which
the issuer can redeem the
bond early.
Yield to Maturity and Bond Yields

Yield to Maturity (YTM) Current Yield Yield to Call

The yield to maturity is the The current yield is the Yield to call is the return an
total return an investor can annual interest payment investor would receive if the
expect to receive from a divided by the bond's bond is called before
bond if held until maturity. It current market price. It is a maturity. It is calculated
is calculated as the internal measure of the bond's return based on the call price,
rate of return (IRR) of the based on its current price, which is the price at which
bond's cash flows, taking but does not consider the the issuer can redeem the
into account the bond's future cash flows or time bond early.
price, par value, coupon value of money.
rate, and time to maturity.
Duration and Bond Sensitivity
Duration Maturity Coupon Rate
Longer Longer Lower

Shorter Shorter Higher

Duration is a measure of a bond's price

sensitivity to changes in interest rates. It is
expressed in years and represents the
weighted average time to receive a bond's
cash flows. Higher duration bonds are more
sensitive to interest rate fluctuations,
while lower duration bonds are less
sensitive.
Credit Risk and Bond Ratings
Credit Rating Agencies Bond Ratings Risk and Return
Credit rating agencies, such as
Standard & Poor's, Moody's, and
Fitch, assess the
creditworthiness of bond
issuers and assign ratings
based on their financial
strength and ability to meet
their obligations.
Credit Risk and Bond Ratings
Credit Rating Agencies Bond Ratings Risk and Return
Bond ratings range from AAA
(highest quality) to D (default).
Higher-rated bonds are
considered safer investments,
while lower-rated bonds carry
higher credit risk. The rating
assigned by credit rating
agencies is an important factor in
determining a bond's price.
Credit Risk and Bond Ratings
Credit Rating Agencies Bond Ratings Risk and Return

Bonds with lower credit ratings

typically offer higher yields to
compensate investors for the
increased credit risk. Investors
should carefully consider the
creditworthiness of bond issuers
and their corresponding ratings
before making investment
decisions.
Valuation of Corporate Bonds
1 Cash Flow Analysis
To value a corporate bond, we must project its future
cash flows. This includes the interest payments the issuer
will make to the bondholder and the principal
repayment at maturity.

2 Discount Rate
The discount rate used in valuation is based on the
company's credit risk, market interest rates, and the
bond's specific characteristics.

3 Present Value Calculation

We discount each of the future cash flows back to the
present value using the appropriate discount rate. The
sum of these present values represents the bond's
current market price.
Valuation of Government Bonds
Risk-Free Rate Yield Curve Inflation Expectations
Government bonds are The yield curve is a Inflation is a key factor
considered to be risk-free graphical representation of affecting the valuation of
because they are backed the relationship between government bonds.
by the full faith and credit yield to maturity and Investors demand higher
of the government. As such, time to maturity for yields for bonds with
they have the lowest risk government bonds. It is a longer maturities to
compared to other types of useful tool for compensate for the risk of
bonds, making them a understanding market inflation eroding the
benchmark for risk-free expectations about future purchasing power of their
rate calculations. interest rates. investment.
Practical Applications and
Investment Strategies
Bond valuation plays a vital role in
various practical applications, including
portfolio management, investment analysis,
and risk management. Investors use bond
valuation techniques to make informed
decisions about buying, selling, or holding
bonds, and to assess the relative value of
different bonds.
Practical Applications and
Investment Strategies
Investment strategies can be tailored to
specific investment goals and risk tolerances.
For example, investors seeking a
conservative investment approach may favor
bonds with high credit ratings and short
maturities, while investors seeking higher
returns may consider bonds with lower credit
ratings or longer maturities, but with higher risk.