Bond

Valuation

4-1
 Learning Objectives

 Understand the valuation of bonds

 Understand the concept of coupon rate and
investor required return
 Understand the impact of investor required
return and coupon rate on bond price
 Understand various types of bonds
 Understand the concept of Rate of Return

4-2
 Terminologies
 Bond:
Security that obligates the issuer to make specified payments
to the bondholder

 Coupon Payment (Pmt):

The interest payments made to the bondholder

 Face Value:
Also called Par Value or Maturity Value - payment at the
maturity of the bond

 Price:
Present value of bond after discounting all future cash flows
4-3
 Terminologies
 Coupon Rate (CR):
Interest payment, as a percentage of face value

 Current Yield (CY):

Present return on the basis of coupon payment and current
price of bond

 Yield to Maturity (YTM):

Investors required return on bond trading in the secondary
market (return investor received if he holds bond till maturity)

 Yield to Call (YTC):

Investors required return on callable bonds
4-4
 Difference in bonds and loans
 Loans 2 parties involved (borrower and lender
e.g. PIA and HBL
 Bonds 3 parties involved i.e. public, bank and
company
Investment in Bond

Company Bank Public

Coupon Payment / Investment Amount at Maturity

4-5
 Difference in bonds and loans
 Interest is fixed on bonds
 Interest is negotiable b/w borrower and lender in
case of loan
 Face value is fixed in bonds
 No face value is fixed in loan

4-6
 Interest Payment (Pmt)
Q) A 5-year bond with a coupon rate of 4% has a
face value of Rs.1,000. What is the annual interest
payment?
Formula:
Pmt = Face Value x CR
Pmt = 1000 x 4%
Pmt = 40
0 1 2 3 4 5

Pmt=> 40 40 40 40 40
Face Value = 1000
4-7
 Bond Price (Present Value)
Q) A 3-year bond with 10% coupon rate and
Rs.1000 face value has the yield to maturity of 8%.
Assuming annual coupon payment, calculate the
price of the bond.

Data:
n = 3 years
CR = 10%
Face Value= 1000
YTM = 8%
Price = ?
4-8
 Bond Price (Present Value)
no. of years to maturity (n)
0 1 2 3

Pmt=> 100 100 100

PV
257.71
Discounting of all payments
Calculate
Seems likePV using Annuity formula
Annuity??????
 1  (1  YTM)  n   1  (1  0.08) 3 
 PMT 
PVAn Formula???????   100  
 YTM   0.08 
4-9
 Bond Price (Present Value)
no. of years (n)
0 1 2 3

Pmt=> 100 100 100

PV
257.71
+ Face Value = 1000
793.84
Discount using Interest Factor
1051.55  1   1 
PV  FV  n 
 1000  3
4-10  (1  YTM)   (1  0.08) 
 Bond Price (Present Value)
Formula:
 1  (1  YTM)  n   1 
Price  PMT   Face Value  
n 
 YTM   (1  YTM) 

 1  (1  0.08) 3   1 
Price  100    1000  
3 
 0.08   (1  0.08) 
Price  257.71 793.84
Price  1051.55
The bond is at premium.
4-11
 Bond Price – at Premium
Current Price = Rs.1051.55
Face Value = Rs.1000

Current Price > Face Value

1051.55 > 1000

YTM < CR

4-12
 Bond Price – at Discount
Q) A 3-year bond with 8% coupon rate and
Rs.1000 face value has the yield to maturity of
10%. Assuming annual coupon payment, calculate
the price of the bond.

Data:
n = 3 years
CR = 8%
Face Value= 1000
YTM = 10%
Price = ?
4-13
 Bond Price – at Discount
Formula:
 1  (1  YTM)  n   1 
Price  PMT   Face Value  
n 
 YTM   (1  YTM) 

 1  (1  0.1) 3   1 
Price  80    1000  
3 
 0.1   (1  0.1) 
Price  198.95  751.31
Price  950.26
The bond is at discount.
4-14
 Bond Price – at Discount
Current Price = Rs.950.26
Face Value = Rs.1000

Current Price < Face Value

950.26 < 1000

YTM > CR

4-15
 Bond Price – at Par
Q) A 3-year bond with 8% coupon rate and
Rs.1000 face value has the yield to maturity of 8%.
Assuming annual coupon payment, calculate the
price of the bond.

Data:
n = 3 years
CR = 8%
Face Value= 1000
YTM = 8%
Price = ?
4-16
 Bond Price – at Par
Formula:
 1  (1  YTM)  n   1 
Price  PMT   Face Value  
n 
 YTM   (1  YTM) 

 1  (1  0.08) 3   1 
Price  80    1000  
3 
 0.08   (1  0.08) 
Price  206.17  793.83
Price  1000
The bond is at par.
4-17
 Bond Price – at Par
Current Price = Rs.1000
Face Value = Rs.1000

Current Price = Face Value

1000 = 1000

YTM = CR

4-18
 Conclusion Bond Price Behavior

YTM > CR => Bond at Discount

YTM = CR => Bond at Par

YTM < CR => Bond at Premium

4-19
 Bond Price –
Semi-annual coupon payment
Q) A 3-year bond with 10% coupon rate and Rs.1000
face value has the yield to maturity of 8%. Assuming
semi-annual coupon payment, calculate the price of
the bond.

Data:
n = 3 years
CR = 10%
Face Value = 1000
YTM = 8%
m = 2
Price = ?
4-20
 Bond Price –
Semi-annual coupon payment
Since it’s a semi-annual coupon payment,
where;
m = 2
Therefore;
n x 2 = Doubled
CR / 2 = Half
YTM / 2 = Half

4-21
 Bond Price –
Semi-annual coupon payment
Formula:

 YTM n x m   
1  (1 
Pmt    
)
1
Price   m   Face Value  
m  YTM   (1  YTM ) n x m 
   
 m   m 

Seems complex ?

4-22
 Bond Price –
Semi-annual coupon payment
Alternatively:
CR / m = 10% / 2 = 5%
YTM / m = 8% / 2 = 4%
nxm = 3x2 = 6 years
 1  (1  YTM)  n   1 
Price  PMT   Face Value  
n 
 YTM   (1  YTM) 
 1  (1  0.04) 6   1 
Price  50   1000  
6 
 0.04   (1  0.04) 

4-23
 Calculation of YTM
Q) A 3-year bond has an 8% coupon rate and a
face value of Rs.1,000. If the current price of
the bond is Rs.878.31, calculate the yield to
maturity of the bond.
Data:
n = 3 years
CR = 8%
Face Value = 1000
Price = 878.31
YTM =?
4-24
 Calculation of YTM

 1  (1  YTM)  n   1 
Price  PMT   Face Value  
n 
 YTM   (1  YTM) 

 1  (1  YTM) 3   1 
878.31  80    1000  
3 
 YTM   (1  YTM) 

Assume YTM

Current Price = Solved Value

4-25
 Calculation of YTM
Hint:
Since;
Current Price < Face Value

878.31 < 1000

And Current Price at Discount

Therefore;
YTM > CR

4-26
 Calculation of YTM

 1  (1  YTM) 3   1 
878.31  80    1000  
3 
 YTM   (1  YTM) 
Considering;
YTM = 13%; Solved Price = 881.94

YTM = 14%; Solved Price = 860.70

YTM = 13%

4-27
 Calculation of YTM
Alternate formula for approximate YTM;

Face Value − Price

PMT +
n
YTM =
(Face Value + Price) /2

1000 − 878.31
80 +
3
YTM =
(1000 + 878.31) /2

120.56
YTM = = 12.84% ⇒ 13%
939.16
4-28
 Current Yield (CY)
Q) A four-year bond has an 8% coupon rate and a
face value of Rs.1,000. If the current price of the
bond is Rs.878.31, calculate the current yield.
Formula;
CY = Pmt / Price
CY = 80 / 878.31
CY = 9.11%
Note: If two values are known then third value can
be calculated.
4-29
 Holding Period Return (HPR)
Q) A person buy a 10% annual coupon bond at
Rs.1,050, hold it for one year and sell at Rs. 1,085.
What holding period return he would achieve?

Data:
Buying Price = Rs.1,050
Selling Price = Rs.1,085
Pmt = Rs. 100

4-30
 Holding Period Return (HPR)
Formula:
HPR = Pmt + Selling Price – Buying Price
Buying Price
HPR = 100 + 1,085 – 1,050
1,050
HPR = 135
1,050
HPR = 0.1286 => 12.86%

4-31
 Holding Period Return (HPR)
Q) A 9.3% annual coupon bond with a 10-year
maturity has a YTM of 8%. Assuming the yield
curve is flat and doesn’t shift, calculate the HPR
you would achieve from buying the bond, holding it
for one year only.
Data:
Pmt = Rs.93
HPR = ?
n = 10 years
YTM = 8%
4-32
 Holding Period Return (HPR)
Buying Price:
Using formula
 1  (1  YTM)  n   1 
Price  PMT   Face Value  
n 
 YTM   (1  YTM) 
 1  (1  0.08) 10   1 
Price  93    1000  
10 
 0.08   (1  0.08) 
Price  1,087.23

4-33
 Holding Period Return (HPR)
Selling Price:
Data After one year:
Pmt = Rs.93
n = 10 years n = 9 years
YTM = 8%
0 1 2 3 4 5 6 7 8 9 10

Note: No change in YTM

4-34
 Holding Period Return (HPR)
Selling Price (After one year):
Data
Pmt = Rs.93
n = 9 years
YTM = 8%
 1  (1  0.08) 9   1 
Price  93    1000  
9 
 0.08   (1  0.08) 
Price  1,081.21

4-35
 Holding Period Return (HPR)
Formula:
HPR = Pmt + Selling Price – Buying Price
Buying Price

HPR = 93 + 1,081.21 – 1,087.23

1,087.23

HPR = 0.08 => 8%

4-36
 Annual Interest and Selling Price
Q) A 5-year bond has an 8% coupon rate and a
YTM of 10%. What annual interest payment you
will get if you hold it for 3 years and at what price
you will sell the bond after 3 years?
0 1 2 3 4 5

Pmt=> 80 80 80 Selling
For selling price: n = 3 years
Note: No change in YTM
4-37
 Annual Interest and Selling Price

 1  (1  0.1) 3   1 
Price  80    1000  
3 
 0.1   (1  0.1) 

Price  950.26

4-38
 Time Path of Bond Value
Data for Price at Premium; CR = 12%, YTM = 10%, n = 3 years
Discount; CR = 8%, YTM = 10%, n = 3 years
1,050
1,049.74
1,025 1,034.71
Bond Price

1,018.18 1,000.00
1,000
981.82
975 965.29
950.26
950
3 2 1 0
4-39 number of years to maturity (n)