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    F2 Value and Pricing

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    Priyanka
    The document discusses bond valuation and related concepts: 1) It defines what a bond is, the key features like face value, interest rate, and maturity date. It distinguishes between bonds and debentures. 2) Several bond valuation examples are provided to illustrate how to calculate the present value of bond cash flows using discount tables, and determine if a bond is priced at par, premium or discount. 3) Practice questions at the end reinforce the concepts through additional examples calculating bond present values and advising if the bonds should be purchased based on required rate of return.

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    F2 Value and Pricing

    Uploaded by

    Priyanka
    19 views37 pages
    The document discusses bond valuation and related concepts: 1) It defines what a bond is, the key features like face value, interest rate, and maturity date. It distinguishes between bonds and debentures. 2) Several bond valuation examples are provided to illustrate how to calculate the present value of bond cash flows using discount tables, and determine if a bond is priced at par, premium or discount. 3) Practice questions at the end reinforce the concepts through additional examples calculating bond present values and advising if the bonds should be purchased based on required rate of return.

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    The document discusses bond valuation and related concepts: 1) It defines what a bond is, the key features like face value, interest rate, and maturity date. It distinguishes between bonds and debentures. 2) Several bond valuation examples are provided to illustrate how to calculate the present value of bond cash flows using discount tables, and determine if a bond is priced at par, premium or discount. 3) Practice questions at the end reinforce the concepts through additional examples calculating bond present values and advising if the bonds should be purchased based on required rate of return.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    19 views37 pages

    F2 Value and Pricing

    Uploaded by

    Priyanka
    The document discusses bond valuation and related concepts: 1) It defines what a bond is, the key features like face value, interest rate, and maturity date. It distinguishes between bonds and debentures. 2) Several bond valuation examples are provided to illustrate how to calculate the present value of bond cash flows using discount tables, and determine if a bond is priced at par, premium or discount. 3) Practice questions at the end reinforce the concepts through additional examples calculating bond present values and advising if the bonds should be purchased based on required rate of return.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    of 37

    Valuation and Pricing

    Ammar Hafeez
    Valuation of

    Preference Ordinary
    Bonds
    shares shares

    Deep
    Perpetual
    discount
    bonds
    bonds
    Bond
    A bond is a
    • fixed income instrument
    • which is kind of a loan made from an investor to a
    borrower

    Investors usually receive interest according to the


    rate of interest of the bond.

    Bonds could either be


    • redeemable after a certain period
    • irredeemable
    Bonds with maturity dates, implies that the
    principal amount received initially, has to be paid
    back.

    Bonds are issued by the government and the


    public sector companies in India. The private
    sector companies also issue bonds, which are
    generally called debentures in India.
    Are bonds same as debentures!?!
    Bonds Debentures
    • Financial instrument which • An instrument used for
    highlights the debt taken raising long term finances.
    of the issuing authority
    towards the holders. • Could be either secured or
    unsecured.
    • Secured by collateral.
    • Usually issued by private
    • Issued by financial companies.
    institutions, corporations,
    government agencies.
    • After the bondholders are
    paid, then comes the
    • It receives the first priority number of
    at the time of liquidation. debentureholders.
    Bonds Debentures
    • Yields a lower rate of • Higher.
    interest comparatively.

    • Doesn’t have the option • It does have an option


    of converting into of converting to equity
    equity shares. shares.
    Terminologies
    • Face value
    Face value is also called par value. A bond
    (debenture) is generally issued at a par value.
    Also, the interest is calculated on the par value.

    • Interest rate
    Interest rate is fixed and known to bondholders
    (debenture holders). Interest paid on a
    bond/debenture is tax deductible. The interest
    rate is a contractual rate.
    • Maturity
    A bond (debenture) is generally issued for a specified
    period of time. It is repaid on maturity.

    • Redemption value
    The value that a bondholder (debenture holder)
    will get on maturity is called redemption, or
    maturity, value. A bond (debenture) may be
    redeemed at par or at premium (more than par
    value).
    Redemption of a bond at discount (less than par
    value) is generally unacceptable by bond holders.
    Example
    An investor is considering to buy an INR 1000
    face value bond. The rate of return is 7 per cent
    per annum. And the bond is floated for a period
    of 5 years.
    However, the investor’s required rate of return is
    8 percent.
    What is the present value of such bond, if the
    bond matures at par.
    • Cash payment to be made today : INR 1000
    • The investor would receive INR 70 (7 percent of
    1000) as interest every year for a period of 5
    years.
    • He would also receive back INR 1000 on maturity
    (at the end of 5th year).
    • 70 + 70 + 70 + 70 + 70 + 1000
    • Now, calculating the present value of such
    amounts:
    • 70 + 70 + 70 + 70 + 70 + 1000

    • Since INR 70 is to be received for a period of 5


    years, it is a case of annuity, hence
    • 70 x 3.993 (8 percent ROR and 5 years time
    period) = 279.51 Table A - 4

    • 1000 x 0.681 (8 percent ROR and 5 years time


    period) = 681 Table A - 2
    • Therefore, total return is INR 960.51
    • This implies that INR 1000 bond is originally
    worth INR 960.51 today (only if the required ROR
    is 8 percent)
    Practice question 1
    An 8 year bond is valued at INR 1000. It has a
    coupon rate of 5 percent per annum. The bond is
    to be matured after 8 years at par.
    An investor is interested to invest into it.
    However, his required rate of return is 3 percent.
    Calculate the present value of this bond and
    advice whether the investor should buy it or
    not!?!
    Interest to be received every year = INR 50

    = 50 + 50 + 50 + 50 + 50 + 50 + 50 + 50 + 1000
    = 50 x 7.020 + 1000 x 0.789
    = 351 + 789
    = 1140

    The current price of the bond is INR 1140. Hence,


    it is advisable to buy the bond today which is
    valued at INR 1000.
    Practice question 2
    An 10 year bond is valued at INR 1500. It has a
    coupon rate of 9 percent per annum. The bond is
    to be matured after 10 years at par.
    An investor is interested to invest into it.
    However, his required rate of return is 12
    percent.
    Calculate the present value of this bond and
    advice whether the investor should buy it or
    not!?!
    Interest to be received every year = INR 135

    = 135 + 135 + 135 + 135 + 135 + 135 + 135 + 135 + 135 +


    135 + 1500
    = 135 x 5.650 + 1500 x 0.322
    = 762.75 + 483
    = 1245.75

    The current value of the bond is INR 1245.75


    Since we have to pay an INR 1500 to buy it, we would
    not proceed with it. As the amount we are paying is
    more than the current value of the bond.
    Practice question 3
    A bond is valued at INR 1000. It’s coupon rate is
    10 percent, with 7 year maturity.
    The interest payable is annually.
    How much is the present value for the bond, if
    your required rate of return is
    (a) 12 percent
    (b) 9 percent
    a)
    Interest to be received every year = INR 100

    = 100 + 100 + 100 + 100 + 100 + 100 + 100 + 1000


    = 100 x 4.564 + 1000 x 0.452
    = 456.4 + 452
    = 908.4
    b)
    Interest to be received every year = INR 100

    = 100 + 100 + 100 + 100 + 100 + 100 + 100 + 1000


    = 100 x 5.033 + 1000 x 0.547
    = 503.3 + 547
    = 1050.3
    Practice question 4
    Assume
    • INR 100 face value
    • 8 percent coupon rate of interest
    • 10 years remaining to maturity date

    If interest is paid annually, find the value of the


    bond when the required rate of return is
    a) 7 percent
    b) 8 percent
    c) 10 percent
    a)
    Interest to be received every year = INR 8

    = 8 + 8 + 8 + 8 + 8 + 8 + 8 + 8 + 8 + 8 + 100
    = 8 x 7.024 + 100 x 0.508
    = 56.192 + 50.8
    = 106.992

    The present value of the bond is INR 106.992.


    b)
    Interest to be received every year = INR 8

    = 8 + 8 + 8 + 8 + 8 + 8 + 8 + 8 + 8 + 8 + 100
    = 8 x 6.710 + 100 x 0.463
    = 53.68 + 46.3
    = 99.98

    The present value of the bond is INR 99.98.


    c)
    Interest to be received every year = INR 8

    = 8 + 8 + 8 + 8 + 8 + 8 + 8 + 8 + 8 + 8 + 100
    = 8 x 6.145 + 100 x 0.386
    = 49.16 + 38.6
    = 87.76

    The present value of the bond is INR 87.76.


    • In the same question, also indicate for each case
    whether the bond is selling at a discount, at par
    or at a premium value!?!
    a) Present value of the bond = 106.992
    Face value of the bond = 100
    Since the present value of the bond > the face value, it means
    that the bond is being floated at a premium.

    b) Present value of the bond = 99.98


    Face value of the bond = 100
    Since the present value of the bond = the face value, it means
    that the bond is being floated at par.

    c) Present value of the bond = 87.76


    Face value of the bond = 100
    Since the present value of the bond < the face value, it means
    that the bond is being floated at discount.
    In the same question,
    what would be the value of the bond, if interest is paid semi
    annually @ 10 percent?

    Interest to be received every year = INR 8


    Interest to be received in every half year = INR 4

    =4+4+4+4+4+4+4+4+4+4+4+4+4+4+4+4+4+4
    + 4 + 4 + 100
    = 4 x 12.462 + 100 x 0.377
    = 49.85 + 37.7
    = 87.55

    The present value of the bond is INR 87.55.


    Practice question 5
    The face value of a 10 year bond (with 10 percent
    coupon rate) is INR 1000.

    The interest is payable semi annually.

    Assuming 12 percent required rate of return of


    investors, compute the value of the bond.
    Interest to be received every year = INR 100
    Interest to be received every half yearly = INR 50

    = 50 + 50 + 50 + 50 + 50 + 50 + 50 + 50 + 50 + 50 + 50 +
    50 + 50 + 50 + 50 + 50 + 50 + 50 + 50 + 50 + 1000
    = 50 x 11.470 + 1000 x 0.312
    = 573.5 + 312
    = 885.5

    The present value of the bond is INR 885.5


    • What would be the present value of the bond, if
    the interest is receivable annually?
    Interest to be received every year = INR 100

    = 100 + 100 + 100 + 100 + 100 + 100 + 100 + 100 +


    100 + 100 + 1000
    = 100 x 5.650 + 1000 x 0.322
    = 565 + 322
    = 887

    The present value of the bond is INR 887


    Practice question 6
    A 10 year bond of INR 1000 has an annual rate of
    interest of 12 percent. The interest is paid semi
    annually. It is redeemable at par.
    Calculate the value of the bond if the required
    rate of return is
    a. 12 percent
    b. 16 percent
    Interest to be received every year = INR 120
    Interest to be received every half year = INR 60

    = 60 + 60 + 60 + 60 + 60 + 60 + 60 + 60 + 60 + 60 +
    60 + 60 + 60 + 60 + 60 + 60 + 60 + 60 + 60 + 60 +
    1000
    = 60 x 11.470 + 1000 x 0.312
    = 688.2 + 312
    = 1000.2
    Practice question 7
    A 10 percent INR 1000 bond is currently selling
    for INR 950.
    It has remaining life of 5 years.
    If your required rate of interest is 12 percent, will
    you buy the bond?
    Assume that interest is payable
    a) annually
    b) semi annually
    a)
    Interest to be received every year = INR 100

    = 100 + 100 + 100 + 100 + 100 + 1000


    = 100 x 3.605 + 1000 x 0.567
    = 360.5 + 567
    = 927.5

    Present value of the cash inflows = 927.5


    Present cost of the bond = 950

    No, I wouldn’t buy the bond.


    b)
    Interest to be received every year = INR 100
    Interest to be received every half yearly = INR 50

    = 50 + 50 + 50 + 50 + 50 + 50 + 50 + 50 + 50 + 50 + 1000
    = 50 x 7.360 + 1000 x 0.558
    = 368 + 558
    = 926

    Present value of the cash inflows = 926


    Present cost of the bond = 950

    No, I wouldn’t buy the bond.

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