BOND VALUATION

A. Terminology and Characteristics of Bonds

- Bond is long-term contract under which a borrower
(business or goverment) agrees to make payments of
interest and principal, on specific dates, to the holders of
the bond .
- Corporate Bond is a long-term debt instrument
indicating that a corporation has borrowed a certain
amount of money and promises to repay it in the future
under clearly defined terms.
- Key Characteristics of Bonds
1. Par (Face) Value is the stated face value of the bond. Its generally
represents the amount of money the firm borrows and promises to repay
on the maturity date.
2. Coupon Interest Rate is the stated annual interest rate on a bond.
3. Maturity date is a specified date on which the par value of a bond must be
repaid.
4. In the case of a firm's insolvency, a bondholder has a priority of claim to
the firm's assets before the preferred and common stockholders. Also,
bondholders must be paid interest due them before dividends can be
distributed to the stockholders

B. Bond Valuation
The process of determining the fair price of bond by calculating its expected
present value of the future interest payments and maturity value discounted at
the bondholder's required rate of return.

C. Formula




B
0
=

=
+
+
+
N
1 t
N
b
t
b
) k (1
PAR

) k (1
COUPON


) ( ) ( , , 0 n rd n rd PVIF Mx PVIFA Ix B + =
For semmi annual coupon payments
B
0
=

=
|
.
|

\
|
+
+
|
.
|

\
|
+
2N
1 t
2N
b
t
b
2
k
1
PAR

2
k
1
2

COUPON

) ( ) (
2
2 ,
2
2 ,
2
0 n
rd
n
rd
PVIF Mx PVIFA x
I
B + =

Where
Bo = value of the bond at the time zero
COUPON = the dollar interest to be received in each
payment
PAR VALUE = the par value of the bond at maturity
k
b
= the required rate of return for the bondholder
N = the number of periods to maturity
D. Yield to Maturity (YTM)
The rate of return that an investor would earn if he bought the bond at its
current market price and held it until maturity.

(

)
(

2
)


E. Yield to Call (YTC)

The rate of return that an investor would earn if he bought a callable bond at its
current market price and held it until the call date given that the bond was called
on the call date.


(

)
(

2
)


F. Current Yield
The current yield measures the annual return to an investor based on the
current price




Criteria :
If Then Bonds sells at a :
Current yield < YTM Market < Face Discount
Current yield = YTM Market = Face Par/Face Value
Current yield > YTM Market > Face Premium













PROBLEMS
1. FT hv 12
years remaining to maturity.
Interest is paid annually, the
bonds have a 1,000 par value,
and the coupon interest rate is 8%.
The bonds have a required rate of
return of 9%. What is the current
market price of these bonds?

2. Sumaryati Company has outstanding a $1,000 par-value bond with an 8%
coupon interest rate. The bond has 12 years remaining to its maturity date. If
interest is paid annually, find the value of the bond when the required return is
(1) 7%, (2) 8%, and (3) 10%

3. You just purchased a bond that matures in 5 years. The bond has a face value of
1,000 h 8% . Th h y 8.21%.
Wh h y y?

4. Andreli Industries has issued bonds that have a 10% coupon rate, payable
semiannually.The bonds mature in 8 years, have a face value of 1,000, and a
yield to maturity of 8.5%. What is the price of the bonds?

5. You own a bond that pays $100 in annual interest, with a $1,000 par value. It
matures in 15 years. Your required rate of return is 12 percent. Calculate the
value of the bond ! How does the value change if your required rate of return
increases to 15 percent or decreases to 8 percent? Explain the implications of
your answers as they relate to interest rate risk, premium bonds, and discount
bonds !

6. Calculate the yield to call on a 16 % coupon rate bond that has 10 years
remaining to maturity and its currently trading in the market at 1500 . assume
that bond can be called in 5 years from now at a call price of 1200 (par value =
1000)