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Bond Terminology
Face value/Nominal value: This can be thought of as the principal
amount on which interest is paid by the issuer.
Issue price: The price at which the bond is issued to the lender. It may
be at face value, may be at discount or may be at premium.
Redemption value: Generally bonds are redeemed at face value on
the maturity date, but some time it is also on premium.
Coupon: Bond typically pay interest periodically at a prescribed rate
of interest. The annual rate at which this interest is paid is known as
coupon rate.
Maturity: This is the future date of a bond on which the bond is
repaid and extinguished. Some bonds do not repay the principal in
one installment but spread it out over several years. In this case the
date of last installment is taken as maturity date.
Basis points: A basis point is simply one-hundredth of one percent
change in interest rates and the difference between the two interest
rate are usually stated in basis points.
Tata Capital
Maturity
1-3 Years
5 Years
Rate of Interest
10%-11% (A)
12% (A)
Minimum
Application
TDS Applicable
Rs.20,000
Rs.10,000
Yes
No
Mode of Issuance
Physical
Demat
Premature
withdrawal
At the discretion of
the company
Secondary market
selling.
Optionable
No
Attached Call/Put
option 36 months/42
months.
Security
Unsecured
Secured
Value of Bond
The value of bond or any financial assets is equal to
the sum of the present value of the cash flows
expected from it.
The value of bond is the total present value of the
expected future cash flows, the cash flow from bond
is consist of coupon payment till maturity plus the
final payment of redemption value at the time of
maturity.
Example
Suppose an Investor is considering the
purchase of a 5 years Rs.1000 per value bond
bearing a coupon rate of 7% p.a. The
investors required rate of return is 8% p.a.
How much he will be willing to pay now to
purchase the bond if the bond redeemed at
par?
Example
A 10-years bond of Rs.1000 carrying a coupon
rate of 12% p.a. The interest is paid semiannually. What is the value of the bond if the
required rate of return is 12%?
Yield to Maturity
In practice an investor considering the purchase of a
bond not quoted promised rate of return. Instead the
investor must use the bond price, maturity date and
coupon payment to infer the return offered by the bond
over its life.
The YTM is defined as the interest rate that makes the
present value of a bond payments equal to its price.
This interest rate is often viewed as a measure of the
average rate of return that will be earned on a bond if it
is bought now and held until maturity.
It is also viewed as effective rate of return expected by
an investor of a bond if the bond is held to maturity.
Example
Mr. Ramnath bought some debenture from
Y2K Ltd. The debentures is having a face value
of Rs.500 and carry a coupon of 14 percent.
Interest is payable annually. The debenture
will mature after 5 years. The current market
price of the debenture is Rs.455.
Calculate the YTM.
Assumptions (YTM):
1. All coupon and interest payment are made on
schedule.
2. The bond held to maturity.
3. The coupon payments are fully and immediately
reinvested at precisely the same interest rate as
the promised YTM.
Yield to Call:
Some bond carry a call feature that entitle the issuer
to call/buyback the bond prior to the stated
maturity. For such bonds it is a practice to
calculate the YTC as well as YTM.
Decision Criteria:
Higher the YTM better the bond, from the view point
of the investors.