From the desk of Zaheer Swati

Lecture 12 Bond Market

Financial Institution


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Zaheer A. Swati
Unit 12

BOND MARKET
The bond market also known as the debt, credit, or fixed income market is a financial market where participants buy
and sell debt securities usually in the form of bonds
A bond is a debt instrument issued by a corporation, which obligates that corporation to make period interest
payments to the holder of the bond as well as to repay the principal at the maturity date

12.1 Bonds Numerical Features
Following are some numerical features of bonds

12.1.1 Maturity or Tenure or Life: Measured in years. On the Maturity Date when the bond expires, the Issuer returns
all the money i.e. 6 months, 1 year, 3 years, 5 years, and 10 years, etc.

12.1.2 Par Value or Face Value: Principal Amount (generally printed on the bond paper) returned at maturity i.e. Rs.
1,000 or Rs. 10,000. Contrast this to Market Value (or Actual Price based on Supply/Demand) & Intrinsic or Fair Value

12.1.3 Coupon Interest Rate: percentage of Par Value paid out as interest irrespective of changes in Market Value i.e. 5
% pa, 10 % pa, 15% pa, etc. Coupon Receipt = Coupon Rate x Par Value. Coupon Receipts can be paid out monthly,
quarterly, six-monthly, annually etc. Coupon Rate = Annual coupon amount / face value of bond

12.1.4 The Indenture: The indenture is the written agreement between the corporation (the borrower) and its creditors. It
is sometimes referred to as the deed of trust

12.2 Value of the Bond (Annually)
The Value of the Bond can be calculated from the Cash Flows attached to the Bond
The bond holder will receive the coupon interest rate and he will also receive his principle amount at the time of
maturity




Or




Or





V
b
= PV of Coupon + PV of Maturity
V
b
=

1
1 i
C

+

2
1 i
C

+

3
1 i
C

+ . +

n
i
C
1
+

n
i
M
1


Floating Rate
Formula
V
b
= C [
i
i
n
) 1 (
1
1

] + M [

n
i 1
1
]
Constant Rate
Formula
Financial Institution


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Zaheer A. Swati
Unit 12

Example 12.1: Consider a bond that pays a 10% coupon rate of interest, has a par value of Rs. 1,000 and matures in 4
years. Suppose also that the market rate of interest for such a bond (required rate of return) is 8%. Calculate the intrinsic
value of bonds?

Solution:









Discount at 8%


























V
b
= Rs. 1,066.21
Bonds issued at _______________________


0 1 2 3 4

Rs. 100 Rs. 100 Rs. 100 Rs. 100
Rs. 1,000
0 1 2 3 4







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Zaheer A. Swati
Unit 12

12.3 Value of the Bond (Intra Year)
When coupon payments are made more than one time in the year






Example 12.2: Consider an 8 year, 12 percent coupon bond with a par value of Rs. 1,000 on which interest is payable
semi-annually. The required return on this bond is 14 percent?

Solution:











12.4 Floating rate bonds valuation
The Bonds those having floating rate attached either for coupon or discount rate

Example 12.3: ABC is Public Limited Company establish five year ago in Comsats Abbottabad. The company board of
director was decided to offer 1,000 no. of bonds of par value of Rs. 10 each in 2004; carrying 15 percent coupon rate and
5 year maturity period, bond would mature in 2009. The discount rate in first year (2005) was 10 percent. The rate was
same in 2006. After that market rate of return had increased to 14 % in 2007. Under rising inflation and political
instability the rate further jumped to 16 percent in 2008. We are in 2009 year and expected that market rate will remain
12 percent in this year and market value of bonds will be 9 per bond (1,000 bonds). What will be present value of bond?
Solution:






Answer: Rs. 10,402.18



V
b
= Rs. 905.50
Issued at __________________________
V
b
=
m
C
[
m i
m i
m n
/
) / 1 (
1
1
*

] + M [

m n
m i
*
/ 1
1

]

General Formula
Constant Rate
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Zaheer A. Swati
Unit 12

12.5 Console Valuation
Irredeemable bonds do not have a maturity date





Example 12.4: Suppose you could buy bond that paid Rs. 50 a year forever. Assuming that your rate of return for this
type of bond is 12 percent annually?
Solution:









12.6 Zero Coupon Bond Valuation
The price of a zero coupon bond is always less than its redemption value







Example 12.5: Suppose that ABC Company issues zero coupon bonds having a 10 year maturity and Rs. 1,000 face
value. If discount rate 8%?

Solution:













PV
c
= Rs. 416.67





PV
0
= Rs. 463.19

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Zaheer A. Swati
Unit 12

12.5 Other types of Bonds
Bonds are securities that represent debt owed by the issuer to the investor, and typically have specified payments on
specific dates.

Treasury bonds: Debt obligations of the Government Treasury that have maturities of 10 years or more
Municipal bond: State or local governments offer municipals bonds. The interest that investors receive is
exempt from some income taxes
Foreign bond (Euro Bonds): A bond issued on the domestic capital market of another country
Corporate bonds: Debt obligations issued by corporations. Following are important types of corporate bonds
Mortgage bond: A bond in which the issuer has granted the owner a lien against the pledged assets
Debenture: Any debt obligation backed strictly by the borrower's integrity, e.g. an unsecured bond
Subordinated debenture bond: An unsecured bond that ranks after secured debt, after debenture
bonds, and often after some general creditors in its claim on assets and earnings