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Case on evaluating Annie Proposed

Investment in Atilier Industrial


Bonds

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What is Bond?
What Are Bonds?

A bond is a debt security. Buying a bond means you are


lending out your money.

•Bonds are also called fixed-income securities because the


cash flow from them is fixed.

•Stocks are equity; bonds are debt.

•The key reason to purchase bonds is to diversify your


portfolio.
•The issuers of bonds are governments and corporations.
•A bond is characterized by its face value,
coupon rate, maturity and issuer.
•Yield is the rate of return you get on a
bond.
•When price goes up, yield goes down, and
vice versa.
•When interest rates rise, the price of
bonds in the market falls, and vice versa.
•Bills, notes and bonds are all fixed-
income securities classified by maturity.
Why Invest in Bonds?

• many people invest in them to


preserve and increase their capital or
to receive dependable interest
income

• Investing in bonds can help you


achieve your objectives
• -Bonds generally appeal to those who are
less adventurous.

• -In a balanced investment portfolio, bonds


may provide stability.

• -Bond prices generally are less volatile than


stock prices, and bond interest payments are
generally higher than dividend payout rates.
How Well Do You Know Your Bonds?

Suppose that you buy a newly issued, ten-


year, 5% bond for $1,000. You know
that you will receive interest and a final
payment of $1,000 at the end of ten
years when the bond matures.
In all, you receive 20 interest payments
totaling $500
That’s 5% simple interest, or current yield,
disregarding the possibility that you may choose
to reinvest your interest in order to keep your
money in productive use.

This is where the idea of yield-to-maturity (YTM)


comes in.
The inverse relationship
• A bond’s price and a bond’s yield are inversely
related
• when a bond’s price falls its yield rises and vice-
versa. Why?
• Let's look at our 5% coupon bond again. If you
were to buy it for $1000, the current yield would
simply be 5% ($50 / $1,000). But if the price drops
to $950, the yield - for anyone who bought the
bond for $950 - rises to 5.26% ($50 / $950).
Intuitively, this is because the guaranteed coupon
- $50 - is now a greater percentage of the price of
the bond.
• Conversely, if you buy the bond for $1000 and its
price rises to $1050, the yield  - for anyone who
buys the bond at $1050 - falls to 4.76% ($50 /
$1050). This is because the guaranteed coupon -
$50 - is now a smaller percentage of the price of
the bond
Bond Value: Three Important Relationships

Fir st r ela tion ship


A decrease in interest rates (required rates of return) will cause the value of a bond
to increase; an interest rate increase will cause a decrease in value. The change in
value caused by changing interest rates is called interest rate risk.

Se con d r elati ons hip


1. If the bondholder's required rate of return (current interest rate) equals the
coupon interest rate, the bond will sell at par, or maturity value.
2. If the current interest rate exceeds the bond's coupon rate, the bond will sell
below par value or at a "discount.“

3. If the current interest rate is less than the bond's coupon rate, the bond will sell
above par value or at a "premium."

T hir d r el atio nshi p

A bondholder owning a long-term bond is exposed to greater interest rate risk than
when owning a short-term bonds.
What is Valuation?

• Valuation is the process that links risk and


return to determine the worth of an asset.
• To determine an asset’s worth financial
manager uses the time value of money
techniques
What is Valuation Fundamentals

• The (market) value of any investment


asset is simply the present value of
expected cash flows

• The interest rate that these cash flows

are discounted at is called the asset’s

required return.
Basic Valuation Model
Suppose an investor is considering to purchase
a five year bond of Rs.1,000/- @8% int. The
investors required rate of return is 10%. The
investor will receive cash of Rs.80/- as interest
each year for 5 years and Rs.1,000/- on
maturity. So what is the PV value of bond?

So 80 x 3.791 = 303.28 + 621 = 924.28


Yield to Maturity (YTM)
• The yield to maturitymeasures the compound annual
return to an investor and considers all bond cash flows.
It is essentially the bond’s IRR based on the current
price. Note that the yield to maturity will only be equal if
the bond is selling for its face value ($1,000).
• And that rate will be the same as the bond’s coupon
rate.
• For premium bonds, the current yield > YTM.
• For discount bonds, the current yield < YTM
Current Yield
• The Current Yield measures the annual return to an
investor based on the current price.

Current = Annual Coupon Interest


Yield Current Market Price

For example, a 10% coupon bond which is currently


selling at $1,150 would have a current yield of:

Current = $100 = 8.7%


Yield $1,150
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