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    Bond Valuation

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    mariamgilani11

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    Bond Valuation

    Uploaded by

    mariamgilani11
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    Original Title

    Bond Valuation (1)

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    3 views11 pages

    Bond Valuation

    Uploaded by

    mariamgilani11

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    of 11

    Bond valuation.

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    RLPVpSSbBvVg?e=7NB58I

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    du_pk/EY0pzPolCMJHh_iURx5BTJoBQqQppSgMI808Q_2AItSayg?e=W6Dzdj
    Bond Features
     What is a bond -

    debt issued by a corporation or a governmental body.

    A bond represents a loan made by investors to the issuer.

    In return for his/her money, the investor receives a legal claim on future cash flows
    of the borrower.

     The issuer promises to:



    make regular coupon payments (coupon bond) every period until the bond matures,
    and

    pay the face (par) value of the bond when it matures.

     Default

    an issuer who fails to pay is subject to legal action on behalf of the lenders
    (bondholders).


    **Face value, also referred to as par value or nominal value, is the
    value shown on the face of a security certificate, including
    currency.
    BBA 3E Business finance 2
    Zero coupon and coupon bond.
    Zero coupon: A zero coupon bond is a bond that makes no
    periodic interest payments and is sold at a deep discount
    from face value. The buyer of the bond receives a return by
    the gradual appreciation of the security, which is redeemed
    at face value on a specified maturity date.

    3
    coupon bond
    A bond that receives periodical interest. A
    coupon or coupon payment is the annual
    interest rate paid on a bond, expressed as a
    percentage of the face value and paid from
    issue date until maturity. Coupons are
    usually referred to in terms of the coupon
    rate (the sum of coupons paid in a year
    divided by the face value of the bond in
    question). 4
    Bond valuation
    Bond valuation is a technique for determining the theoretical fair value of a
    particular bond. Bond valuation includes calculating the present value of a bond's
    future interest payments, also known as its cash flow, and the bond's value upon
    maturity, also known as its face value or par value.

    5
    Valuation of Bonds
     First Principles:

    Value of financial securities = PV of expected
    future cash flows

     To value bonds and stocks we need to:



    Estimate future cash flows:
    size (how much) and timing (when)

    Discount future cash flows at an appropriate
    rate
    Jacoby, Stangeland and Wajeeh, 2000 6
    Zero-Coupon Bonds valuation
     Information needed for valuing pure discount bonds:

    Time to maturity (T):
    T = Maturity date - today’s date

    Face value (F)

    Discount rate (r)

    0 1 2…
    T
    |-------------------|-------------------|------ …
    ------|

    F 7
     Value of a pure discount bond:
    Examples – zero coupon Bonds
    Q1. Consider a zero-coupon bond, with a face value of $1,000,
    maturing in 5 years. Suppose that the appropriate discount rate
    is 8%. What is the current value of the bond?
    A1. This is a simple TVM problem:
    Year: 0 1 2 3 4 5
    (r = 8%)
    PV0 1,000
    Use the above PV equation to solve:
    PV = F / (1 + r)T = 1,000 / (1.08)5 = $

    Q2. Suppose 6 months have past. What is the bond value now?
    A1. Again, use the above PV equation to solve:
    PV = F / (1 + r)T = 1,000 / (1.08)4.5 = $
    Note: As we get closer to maturity(T), the z.c. bond value increases
    (PVm), since we have to wait less time to receive $1,000
    8
    Coupon Bonds
    The bonds that pay periodical payments.

    What Is a Coupon/coupon rate?


    A coupon or coupon payment is the annual interest rate paid
    on a bond, expressed as a percentage of the face value and
    paid from issue date until maturity.

    9
    Coupon Bonds
     Information needed to value level-coupon bonds:

    Coupon payment dates and Time to maturity (T)

    Coupon (C) per payment period and Face value (F)

    Discount rate
    0 1 2… T
    |----------------|------------------|------- … ------|
    Coupon Coupon Coupon + F
     Value of a Level-coupon bond:
    PV = C/(1+r) + C/(1+r)2 + .. + C/(1+r)T + F/(1+r)T

    = PV of coupon payments + PV of face value 10


    Example - Coupon Bonds
    Q1. Consider a coupon bond paying a 4% coupon rate annually, with a
    face value of $1,000, maturing in 10 years. Suppose that
    the appropriate discount rate is 6%. What is the current value
    of the bond?
    A1. The time line:
    0 1 2 9 1 (Years)
    … 0 (r = 6%)

    Define:
    c = annual coupon rate (%)
    C = dollar periodic coupon payment = c%F
    In the above example:
    c = % C = c%F = =$
    F=$ T= years r= %

    11

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