Académique Documents
Professionnel Documents
Culture Documents
FINANCIAL AND
INVESTMENT
MANAGEMENT
VALUATION OF BONDS
Learning objectives:
DEBT EQUITY
Bonds Common Stock
Preferred Stock
Example
Definition of Bonds
• Debentures
• Subordinated debentures
• Mortgage bonds
• Eurobonds
• Zero and low coupon bonds
• Junk bonds
Terminology & Characteristic of Bonds
0 1 2 3 4
Terminology & Characteristic of Bonds
S
Ct
V = (1 + k) t
t=1
V = the intrinsic value of the asset.
Ct = cash flow to be received at time t.
k = the investor’s required rate of return.
Bond Valuation
The value of the bond is the present value of future
interest ( I ) and the par value (M) of the bond.
3 essential elements in bond valuation
- the amount and timing of the cash flows ( I & M)
- the time to maturity of the bond (n)
- the investor’s required rate of return (kb)
Discount the bond’s cash flows at the investor’s
required rate of return.
the coupon interest rate (an annuity > use PVIFA).
the par value payment (a single sum> use PVIF).
n
S
It M
A) Vb = (1 + kb)t
+ (1 + kb)n
t=1
Vb : value of bond
I : interest payment
M : par value
Kb : investor’s required rate of return
n : time to maturity
or
B) Vb = RMIt (PVIFA kb, n) + RMM (PVIF kb, n)
Bonds Valuation: Annual Interest Payment
0 1 2 3 4 5
Bonds Valuation: Annual Interest Payment
RM80 RM1000
+
Vb = ∑ (1 + 0.12)t (1 + 0.12)5
= RM80(3.6048) + RM1000(0.5674)
= RM288.38 + RM567.40
= RM855.78
Bond Valuation – Semiannual Interest Payment
0 1 2 3 4 5 6
Bond Valuation – Semiannual Interest Payment
0 1 2 3 4 5
I : Interest
M - MP
YTM : I+ n M : Par Value
MP : Market Price
M + MP n : year
2