Face Value Coupon Rate Maturity Redemption value Market Value

The coupon rate of a bond is the stated rate of interest that the bond will pay The coupon rate does not normally change during the life of the bond, instead the price of the bond changes as the coupon rate becomes more or less attractive relative to other interest rates The coupon rate determines the dollar amount of the annual interest payment:

Bonds with maturity Pure discount bonds Perpetual bonds

Bond value = Present value of interest + Present value of maturity value:

INTt Bn B0 = + t + (0 k d ) n + t =0 (0 k d )
n

1. Required rate of return 2. Time to maturity

When required rate = coupon rate, bond value = par value RR> coupon rate, bond value < par value RR< coupon rate, bond value > par value Discount=? Bn-B0 Premium=? B0-Bn

The value of the bond declines as the market interest rate (discount rate) increases. The value of a 10year, 12 per cent Rs 1,000 bond for the market interest rates ranging from 0 per cent to 30 per cent.

00.0 00 00.0 00 Bond Value 00 0.0 00 0.0 00 0.0 00 0.0 0 .0 0 % 0 % 0% 0 0% 0 0% 0 0% 0 0% 0

Interest Rate

The intensity of interest rate risk would be higher on bonds with long maturities than bonds with short maturities. The shorter the time period to maturity, less responsive is its market value to changes in required rate

The yield to maturity is the average annual rate of return that a bondholder will earn under the following assumptions:
The bond is held to maturity The interest payments are reinvested at the YTM

The yield to maturity is the same as the bonds internal rate of return (IRR) If bond value equals par then YTM equals CR

The yield-to-maturity (YTM) is the measure of a bonds rate of return that considers both the interest income and any capital gain or loss. YTM is bonds internal rate of return. perpetual bonds yield-to-maturity:

n =

B0 =

INT INT = + t kd t =0 (0 k d )

10

Most corporate bonds, and many older government bonds, have provisions which allow them to be called if interest rates should drop during the life of the bond Normally, if a bond is called, the bondholder is paid a premium over the face value (known as the call premium) The YTC is calculated exactly the same as YTM, except:
The call premium is added to the face value, and The first call date is used instead of the maturity date

For calculating the yield to call, the call period would be different from the maturity period and the call (or redemption) value could be different from the maturity value. Example: Suppose the 10% 10-year Rs 1,000 bond is redeemable (callable) in 5 years at a call price of Rs 1,050. The bond is currently selling for Rs 950. The bonds yield to call is 12.7%.
00 0=
0

11 1

t =0

+ ( 0 YTC )

11 , 11

+ ( 0 YTC )

The current yield is a measure of the current income from owning the bond. Current yield is the annual interest divided by the bonds current value. Current yield does not account for the capital gain or loss. Example: The annual interest is Rs 60 on the current investment of Rs 883.40. the current rate of return or the current yield is: 60/883.40 = 6.8 per cent.

13

A bond (debenture) may be amortised every year, i.e., repayment of principal every year rather at maturity. The formula for determining the value of a bond or debenture that is amortised every year, can be written as follows:
B0 = CFt + t t =0(0 k d )
n

Note that cash flow, CF, includes both the interest and repayment of the principal.
14

Pure discount bond do not carry an explicit rate of interest. It provides for the payment of a lump sum amount at a future date in exchange for the current price of the bond. The difference between the face value of the bond and its purchase price gives the return or YTM to the investor.

15

Pure discount bonds are called deepdiscount bonds or zero-interest bonds or zero-coupon bonds. The market interest rate, also called the market yield, is used as the discount rate. Value of a pure discount bond = PV of the amount on maturity:

B0 =

+ ( 0 kd )

Mn

16

Perpetual bonds, also called consols, has an indefinite life and therefore, it has no maturity value. Perpetual bonds or debentures are rarely found in practice.

17

B0= I/2* (PVIFA k/2,2n) + M* (PVIF

k/2, 2n

Value of bond selling at discount is lower with semi-annual interest than annual interest Value of bond selling at premium is higher with semi-annual interest than annual interest

Trustee Indenture Bond rating Sinking Fund Call/put provision Claim on Income/ Assets Security Convertibility Covenants

 DEFININTION: a legal document formally describing the terms of the legal relationship between a bond issuer and bondholders. The Trustee
1acts to protect the interests of bondholders 0facilitates communications between them and the issuer

the indenture promises the trustee that it will comply with a number of stated provisions includes other terms such as the sale of assets, issuance of other bonds, dividends payment changes, and other issues that may change the profitability and solvency of the issuer

 requires issuer to make annual payments to a fund the fund pays part of the principal each year trustee may also repurchase bonds in the open market

Zero interest bonds Deep discount bonds SPN FRB Income Bonds Convertible Bonds Foreign Bonds

 Debentures---negative pledge clause Subordinated Debenturesclaim on assets higher yield Mortgage bonds-lien on specific assets Equipment trust certificates Income bondspay interest only when earned Equity linked debt debt+warrant

Lower cost---low risk , tax deductibility No dilution of control

Stable return Fixed maturity Protected by trust deed

Restrictive Covenants Legal obligation Financial risk

0 Cash outflows

No voting rights Debenture prices are vulnerable to interest rates