Problems Bonds

Illustration 1:

An investor is considering the purchase of a

8% Rs. 1,000 bond redeemable after 5 years at
par.
The investors required rate of return is 10%.
What should he be willing to pay now to
purchase the bond?
Solution
Bonds Redeemable in Instalments
A company may issue a bond or debenture to
be redeemed periodically. In such a case,
principal amount is repaid partially each
period instead of a lump sum at maturity and
hence cash outflows each period include
interest and principal. The amount of interest
goes on decreasing each period as it is
calculated on the outstanding amount of
bond/debenture
Bonds Redeemable in Instalments
 Illustration 2:

A company is proposing to issue a 5 year

debenture of? 1,000 redeemable in equal
instalments at 14 percent rate of interest per
annum.
If an investor has a minimum required rate of
return of 12 per cent, calculate the
debentures present value for him.
What should he be willing to pay now to
purchase the debenture?
 Bonds in Perpetuity
Perpetuity bonds are the bonds which never
mature or have infinitive maturity period.
Value of such bonds is simply the discounted
value of infinite streams of interest (cash)
flows
Bonds in Perpetuity

where, Vd = Value or bond or debt

Kd = Required rate of return
R1 = Interest at period 1
R2 = Interest at period 2
R = Annual Interest (as interest is constant)
 Illustration 3:

Mr. A has a perpetual bond of the face value

of Rs. 1,000. He receives an interest of Rs. 60
annually. What would be its value if the
required rate of return is 10%?
 Solution:

Vd = R/Kd
= 60/10
= Rs. 600
 Illustration 4
An investor holds a debenture of Rs. 100
carrying a coupon rate of 12% p.a. The interest
is payable half-yearly on 30th June and 31st
December every year.
The maturity period of the debenture is 6
years and it is to be redeemed at a premium
of 10%. The investors required rate of return
is 14% p.a. Compute the value of the
debenture
 Solution:

Vd = (R/2)(ADFi/2,2n) + M (DFi/2,2n)
12/2(7.943) + 110(.444)
47.658 + 48.840
Rs. 96.498 or say Rs. 96.50
 Illustration 5

Mr. A has a perpetual bond of the face value

of Rs. 1000. He receives an interest of Rs. 60
annually. Its current value is Rs. 600. What is
the yield to maturity?
 Solution:

Vd = R/kd
or kd = R/Vd
or kd = 60/600 = .10
Thus, the yield to maturity is 10%.