CONCEPT OF
BOND VALUATION
PRESENTED BY:
ROHAN SINGH
OUTLINE
● Definition of Bond and Bond Valuation.
● Features of Bond.
● Reasons for Issuing Bonds.
● Bond Yield.
● Bond pricing theorems.
WHAT IS A BOND ?
● A debt investment in which an investor loans money to an entity that borrows the
funds for a defined period of time at a fixed interest rate.
● Bonds are used by companies, municipalities, states and foreign governments to
finance a variety of projects and activities.
WHAT IS BOND VALUATION ?
● A technique for determining the fair value of a particular bond is known as Bond
Valuation.
● Bond Valuation includes calculating the present value of the bond's future interest
payments, also known as its cash flow, and the bond's value upon maturity, also
known as its face value or par value.
FEATURES OF BONDS
1. A Sealed agreement
2. Repayment of principles
3. Specified time period
4. Interest payment
5. Call
TYPES OF BONDS
1. Government Bonds
2. Municipal Bonds
3. Corporate Bonds
4. Zero-Coupon Bonds
REASONS FOR ISSUING BOND
1. Reduce the cost of capital
2. Effective Tax saving
3. Widen the sources of funds
4. Preserve and control
RISK IN BONDS
1. Interest rate risk
2. Default risk
3. Marketability Risk
4. Callability Risk
5. Reinvestment Risk
BOND YIELDS
1. Nominal Yield
2. Current Yield
3. Yield To Maturity
1. NOMINAL YIELD
Nominal yield, or the coupon rate, is the stated interest rate of
the bond.
This yield percentage is the percentage of par value.
Nominal Yield = Annual Interest Payment
Par Value
2. CURRENT YIELD
● Bonds are traded in the secondary market as well,
they may sell for less or more than par value, which
will yield an interest rate that is different from the
nominal yield called the current yield or current
return.
● Since the price of bonds moves in the opposite direction
of interest rates, bond prices decrease when interest
rates increase, and vice versa.
CONTINUED...
● Bonds selling for less than par value are said to be
selling at a discount.
● Bonds selling for more than par value are said to be
selling at premium.
● CURRENT YIELD FORMULA:
Current Yield = Annual Interest Payment
Current Market Price of Bond
3. YIELD TO MATURITY(YTM)
● Yield to maturity (YTM) is the total return anticipated on a
bond if the bond is held until it matures.
● Yield to maturity is also referred to as book yield or
redemption yield.
● YIELD TO MATURITY FORMULA:
BOND VALUATION THEOREMS
THEOREM-1
● This theorem defines that there is an inversely
proportional relationship between bond price and it’s
interest rates.
● When i↓ ⇒ p↑ and
● When i↑ ⇒ p↓.
THEOREM-2
● The longest the maturity of the bond,the more
sensitive will be the price.
● YTM is 10% for all bonds.
PROOF
BOND-A BOND-B BOND-C
Term To Maturity 3 yrs 6 yrs 9 yrs
Annual Coupon Rs.10 Rs.10 Rs.10
Current price Rs.100 Rs.100 Rs.100
ASSUME THAT INTEREST RATES FALL BY 2%, SO THAT YTM
BECOMES 8%.
BOND-A BOND-B BOND-C
Term To Maturity 3 yrs 6 yrs 9 yrs
Current price Rs.105.24 Rs.109.38 Rs.112.66
Price sensitivity + Rs.5.24 + Rs.9.38 + Rs.12.66
A 2% fall in YTM causes a higher price increase
(+ Rs.12.66) for the 9 year bond.
ASSUME THAT INTEREST RATES INCREASE BY 2%, SO THAT YTM
BECOMES 12%.
BOND A BOND B BOND C
Term to maturity 3 yrs 6 yrs 9 yrs
Current price Rs.95.08 Rs.91.62 Rs.89.17
Price sensitivity - Rs.4.92 - Rs.8.38 - Rs.10.83
A 2% increase in YTM causes a higher price fall (- Rs.10.83) for the
9 year bond.
THEOREM-3
● The price changes resulting from equal absolute increases in
YTM are not symmetrical.
PROOF
BOND A BOND B BOND C
YTM falls by 2% + Rs.5.24 + Rs.9.38 + Rs.12.66
YTM rises by 2% - Rs.4.92 - Rs.8.38 - Rs.10.83
For any given maturity, a X% decrease in YTM causes a price rise that is larger than the
price rise resulting from an equal increase in YTM.
THEOREM-4
The lower a bond’s coupon, the more sensitive its price
will be to a given changes in interest rate.
PROOF
Assume annual YTM 10% for all bonds.
Term to maturity=3 years
Bond A Bond B Bond C ZCB
Annual Coupon Rs.30 Rs.15 Rs.5 0
Current price Rs.150.76 Rs.112.69 RS.87.31 Rs.74.62
ASSUME THAT INTEREST RATES INCREASE BY 2%, SO
THAT YTM BECOMES 12%.
Term to maturity = 3 yrs.
BOND-A BOND-B BOND-C
ZCB
Annual Coupon Rs.30 Rs.15 Rs.5
0
Current Price Rs.144.26 Rs.107.38 Rs.82.79
Rs.70.50
THE CHANGE IN THE PRICE OF THE BOND AS
PERCENTAGE OF THE INITIAL PRICE.
BOND-A BOND-B BOND-C ZCB
Annual Coupon Rs.30 Rs.15 Rs.5 0
% Change in Price -4.31% -4.71% -5.18% -5.52%
THANK YOU !
