02.

Valuation of Bonds
/Debentures
Prof Ravichandran
 Valuation of Bonds

Valuation of Debentures / Bonds

In corporate finance, the term is used for a

medium- to long-term debt instrument
used by large companies to borrow money.
In some countries the term is used
interchangeably with bond, loan stock or
note.
 Valuation of Bonds
/Debentures
Important terms associated with Debentures

Face Value: the amount on which the issuer pays interest, and
which, most commonly, has to be repaid at the end/ maturity.
Generally it is RS 100 or RS 1000.
Coupon :the interest rate that the issuer pays to the bond
holders. Usually this rate is fixed throughout the life of the bond
Maturity Date : the date on which the issuer has to repay the
FV.As long as all payments have been made, the issuer has no
more obligation to the bond holders after the maturity date. The
length of time until the maturity date is often referred to as the
term or tenor or maturity of a bond.
 Valuation of Securities
Debentures Valuation Model
An investor of debenture is entitled to get the following two
things
Interest at a fixed rate till maturity
Principal amount of the debenture on its maturity
Vd= PV of all the future Interest inflows+ PV of the FV paid at the maturity
Vd = PVIFA X Annual Interest Payment+ PVIF X Face Value
 Valuation of Bonds Coupon Payment
frequency Semi Annual
Semi-Annual Interest Rate and Valuation of the bond
This is the case when the interest is payable semi-annually (
twice in 1 year)
To calculate the value of the Bond
Divide the coupon rate (c )by 2
Divide the required rate of return(k) by two
Multiply the maturity period by 2
Do the calculations as before for the annual compounding
 Valuation of Securities
Mr. A holds the debenture with face value of Rs
1000 carrying an interest rate of 12 % pa. The
interest is payable semi-annually. The required rate
of return is 16% pa. The debenture is payable at a
premium of 10 % after 8 years. Calculate the value
of debenture
 Valuation of Bonds Coupon
Payment Semi Annual
Face Value= Rs 1000
Coupon Rate = 6% (12/2)
= RR =8% (16/2)
Maturity Period 16 years (8X2)
= PVIFA (16 years,6%)=10.106
=PVIF( 16 Years,4%) =.292
= Vd= 10.106 X 60 + .292 X1100
=Rs 927.56
Value of a Perpetual Debenture
 What is a perpetual Debenture ?
Perpetual debenture is also called
the perpetual bond or simply Prep.
It is defined as the bond with no maturity
date. Therefore it is advised to be treated as
the equity and not as the debt.
The issuers of this bond pay coupons on
the perpetual bonds for ever.
In this way these people have to redeem the
principal.
 Valuation of Bonds /Debenture
Perpetual Debenture
Valuation of perpetual debenture
A debenture that never matures
Rarely found in practice
Vdp = Annual Interest Payment/Required rate of Return
Example : A debenture holder is to receive an annual interest @10 %
for perpetuity. The face value of the debenture is Rs 1000.Calculte the
Value of the debenture if the required rate of return is:
1. 15%
Rs 667
2. 8%
RS 1250
3. 10%
RS 1000
Bond Yield Measures
Bond Yield to Maturity (YTM)
 Bond Yield to Maturity
Yield To Maturity( YTM)
That interest rate at which the Value of the debenture
become equal to its market price.
Example:
A companys debenture has a face value( par value) of Rs 1000,
and carry an interest rate of 9% and matures in 8 years. If the
current price of the bond in the market is Rs 800 would you buy
the bond? Discount rate is 10 %.
What is the YTM?
What is YTM of this bond
800 = 890 /(1+r)t + 1000/(1+r)8
t=1

YTM is nothing but r which equates its value to its MV

 Valuation of Securities
How to calculate( YTM)
YTM = Annual Interest Payment + (F-P)/n
(F+P)/2
F = Face Value
P= Present Value of Debenture(Market Value)
n = Maturity period of debenture
YTM = 90+ (1000-800)/8
(1000+800)/2
= 115/900 = 12.70 % > Required Rate of Return

Simply put the annualized return an investor would get by

holding a fixed income instrument until maturity
 Valuation of Securities
Example: Current Market Price of a a perpetual bond Rs
95(Face value is Rs 100).Coupon Rate is 13.5%.The Required
Rate of Return is 15 %.Calculate its intrinsic value. Should it
be bought?
What is it YTM?
Solution
Intrinsic Value( Fair Value) =13.5/.15 =RS 90
YTM for a perpetual bond =(Annual Interest Inflow/Market Price )X100
YTM= 14.2% <Required Rate of Return
Bond Valuation Theorem
Relationship between the Required Rate of Return
and Coupon Interest Rate:

We have observed earlier that the value of a

bond or debenture is influenced by the
coupon or fixed rate of interest payable on the
bond and the investors required or desired
rate of return
 Relationship between the Required
Rate of Return and Coupon Interest
Rate:
The relationship between the required rate
of return and the coupon interest rate can,
thus, be summarised as below:
(i) If the investors required rate of return and
the coupon interest rate are the same, the
value of the debt (bond or debenture) shall be
equal to its face value or paid-up value, as the
case may be.
 Relationship between the Required
Rate of Return and Coupon Interest
Rate:
(ii) If the required rate of return is higher than
the interest rate payable on bond or
debenture, the value of the bond shall be
lower than its face or paid-up value.
(iii) If the required rate of return is lower than
the interest rate payable on bond or
debenture, the value of the bond shall be
higher than its face or paid-up value.
 Illustration 4:

Face value of a Debenture = Rs. 1,000

Annual Interest Rate of Debenture = 12%
Maturity Period = 5 years
What is the value of the debenture, if:
(a) Required rate of return is 12%
(b) Required rate of return is 15%
(c) Required rate of return is 10%
 Solution:

Vd = (R) (ADFi,n) + (M)(DFi,n)

Vd = 120(3.605) + 1000 (.567)
Or, Vd = 432.60 + 567= Rs. 999.60 or say Rs. 1,000.
(b) Vd = 120 (3.352) + 1,000 (.497)
= 402.24 + 497 = Rs. 899.24
(c) Vd = 120 (3.791) + 1,000 (.621)
= 453.92 + 621= Rs. 1075.92 or say Rs. 1076