BRILLIANT STUDENTS ACADEMY 8655, ROSHANARA ROAD,NEAR PULBANGASH METRO STATION DELHI-7
BOND VALUATION PART 1 OF 2 1. HOLDING PERIOD RETURN HPR = (Ps-Pc)+I Pc Pc = Purchase Cost Ps = Sale Price I = Interest
2. DETERMINATION OF ISSUE PRICE OF A BOND An issuer should offer its bondholders at least market interest rate of similar risk class bonds.
A)
IRREDEEMABLE BONDS ISSUE PRICE
B)
= AMOUNT OF ANNUAL INTEREST INCOME YIELD OR RETURN THE ISSUER WANTS TO OFFER TO ITS INVESTORS
REDEEMABLE BONDS
ISSUE PRICE
=
P.V. OF INTEREST + P.V. OF REDEEMABLE AMOUNT
The appropriate discount rate is the yield it wants to offer to its investors which in no case will be less than market interest rate of similar risk class bonds.
CA DIGANT CHADHA 99999468282
BRILLIANT STUDENTS ACADEMY 8655, ROSHANARA ROAD,NEAR PULBANGASH METRO STATION DELHI-7
3. DETERMINATION OF INTRINSIC VALUE OF A BOND Intrinsic value of a bond is the maximum value that an investor should pay to purchase that bond. An investor expects to earn at least the market interest rate of similar risk class bonds. Therefore, he will discount the future benefits of a bond with an appropriate discount rate which is the market interest rate. USE OF INTRINSIC VALUE If Intrinsic Value > Market Price then the bond is UNDERPRICED. If Intrinsic Value < Market Price then the bond is OVERPRICED. A) IRREDEEMABLE BONDS
INTRINSIC VALUE
=
AMOUNT OF INTEREST MARKET RATE OF INTEREST
B) REDEEMABLE BOND INTRINSIC VALUE = P.V. OF FUTURE + P.V. OF REDEEMABLE INTEREST VALUE
4. HALF YEARLY INTEREST ON BONDS In case the issuer pays interest half yearly on the bonds issued by him, then the appropriate discount rate for computing intrinsic value and issue price is also taken as half yearly discount rate and the period to maturity will be taken as n*2.
CA DIGANT CHADHA 99999468282
BRILLIANT STUDENTS ACADEMY 8655, ROSHANARA ROAD,NEAR PULBANGASH METRO STATION DELHI-7
5. DEEP DISCOUNT BONDS (DDB) Deep discount bonds are the bonds which carry a yield but interest thereon is not paid to the bondholder, instead the investors are provided return through redemption of bonds at the higher price than their issue price. These bonds are issued at a discount and redeemable at their face value on maturity date. A) ISSUE PRICE OF DDB ISSUE PRICE = FACE VALUE X P.V.FACTOR OF `1 FOR MATURITY PERIOD AT DISCOUNT RATE THAT THE ISSUER WANTS TO OFFER TO ITS INVESTORS B) INTRINSIC VALUE OF DDB INTRINSIC = VALUE
FACE X VALUE
P.V. FACTOR OF `1 FOR MATURITY PERIOD AT MARKET RATE OF INTEREST
6. DETERMINATION OF CURRENT YIELD The current yield provides the information regarding the cash income that a bond will generate in a given year, but since it does not takes into account capital gains or losses that will be realized if the bond is held until maturity or call, it does not provide an accurate measure of bonds total expected return. CURRENT YIELD
=
NEXT ANNUAL INTEREST CURRENT PRICE
X
100
CA DIGANT CHADHA 99999468282
BRILLIANT STUDENTS ACADEMY 8655, ROSHANARA ROAD,NEAR PULBANGASH METRO STATION DELHI-7
The fact that current yield does not provide an accurate measure of a bond’s total return can be illustrated with the help of DDB or Zero Coupon Bond. Since, such bond pay no annual income, they always have a current yield equal to zero. This indicates that the bond will not provide any cash interest income, but since the bond value will appreciate over a period of time, its total rate of return clearly exceeds zero.
# TOPICS COVERED IN PART 2 OF 2 1. 2. 3. 4. 5. 6. 7. 8. 9.
YIELD TO MATURITY OF A NORMAL BOND. YIELD TO MATURITY OF A DEEP DISCOUNTED BOND. YTM THEOREM. COMPUTATION OF ANNUAL TREASURY BILL RATE. BONDS ISSUED UNDER AN OPEN ENDED SCHEME. BOND REFUNDING. CONVERSION PARITY PRICE. BOND DURATION. BOND IMMUNISATION.