Bond , Valuation & Yield

Prof(Dr.) Harsh Vardhan

25-27/10/2023
 Objective
 Bond
 Types of Bond
 Bond Valuation
 Bond Price & Yield
 YTM, Price Yield Relationship
 Yield to Maturity by approximation method
 Perpetual Bond
 Interest Rate Sensitivity

CF/MDI/Harsh/4 2
 Bond
 Bond is an instrument of long term Debt. It carries a specific interest rate
which is called the Coupon Rate. Bond issued by the government do not
have any risk of default.
 Private sector companies issue Bonds known as Debenture.
 Type of Bonds - Debenture, Corporate Bond, Secured Bond, Subordinate
Bond, Zero Coupon Bond & Perpetual Bond or Console
 Debenture promises to pay interest and principal ,but they pledge no
specific asset (referred as collateral) in case the firm does not fulfill its
promise.

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 Corporate Bonds are fixed income securities(FIS) issued by corporations to
raise funds for investment in projects, equipment or working capital.
 Secured Bond are most senior bond in firm’s capital structure and have
lowest risk of default. Other are Subordinate Bond ( claim secondary to other
bond holders).
 Convertible Bond have interest and principal charteristics of other bond with
added feature that bond holder has option to turn them back to firm in
exchange of common stock.

CF/MDI/Harsh/4 4
 Zero Coupon Bond-Unlike a Bond which pays interest every year and its face
value at Maturity, a Zero Coupon Bond promises no interest payment during
life of the bond but only payment of the principal at maturity.
 Perpetual Bond is also called Consol . They have an indefinite life and no
maturity value. Perpetual bonds are not redeemable but pay a steady stream
of interest forever.
 Preferred Stock is classified as fixed income security because its yearly
payment is stipulated as either coupon (for example ,5% of the face value ) or
a stated amount (Rs 5 preferred)
 Preferred stock differs from Bond because its payment is dividend and
therefore not a legal binding.(Preferred stock gives no voting rights to
shareholders while common stock does. Preferred stocks have priority over
company’s income ,they paid dividends before common stocks)

CF/MDI/Harsh/4 5
 Bond & its Valuation Model
 Bond is an instrument of long term Debt. It carries a specific interest rate
which is called the Coupon Rate.
 The value of a Bond is equal to the Present Value of cash flows expected
from it.
Valuation of Bond needs:
 An estimate of expected cash flows
 An estimate of required rate of return.
 Assumptions
 The coupon interest rate is fixed for the term of the Bond
 The coupon payments are made every year and next coupon payment is receivable
exactly a year thereafter.
 The Bond will be redeemed at par on maturity.
 Thus the cash flow for bond comprises of an annuity of fixed coupon
interest payable and principal amount payable at maturity.
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 Value of a Bond
𝑛 𝐶 𝑀
P= 𝑡=1 1+𝑟 𝑡 + 𝑛 ……(1)
1+𝑟
P= C*PVIFAr,n + M*PVIFr,n …..(2)
 P = Value ( in Rupee)
 n = Number of Years
 C = Annual Coupon Payment (in Rupee)
 r = Periodic Required Rate of Return or Yield or Discount rate
 M= Maturity Value
 t= Time period when payment is received.
Thus future cash flows consists of two parts :
1. A series of Coupon payment made over bond’s life.
2. A lump sum payment i.e principal which is paid at Maturity.
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 Example-1
 Consider a 10-year, 12 percent Coupon Bond with a par value of
₹ 1,000. Let us assume that the required yield on this Bond is 13
percent. Compute the price of the Bond.

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 Given :n=10,C=12%,M= ₹ 1,000, r=13%
 The Cash flows for this Bond are as follows:
10 annual coupon payments of ₹ 120,(1,000*12%= ₹ 120) and
₹ 1,000 principal repayment 10 years from now.
The value of Bond is:
P= C*PVIFAr,n + M*PVIFr,n …..(2)
P = 120 x PVIFA13%, 10 yrs + 1,000 x PVIF 13%, 10 yrs
= 120 x 5.426 + 1,000 x 0.295
= ₹ (651.1 + 295)
= ₹ 946.1

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 Value of a Bond with Semi-annual interest
𝐶
2𝑛 𝑀
P= 2
𝑡 =1 [1+𝑟]𝑡 + 𝑟 2𝑛 ……(3)
[1+ ]
2 2
𝑐
P= *PVIFAr/2,2n + M*PVIFr/2,2n .....(4)
2

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 Example-2
 Consider an 8 year, 12 percent coupon bond with a par value of ₹100 on
which interest is payable semi-annually.
 The required return on this bond is 14 percent.
 Find the Value of the Bond .

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 Ans
16 6 100
P = 𝑡=1 (1.07)𝑡 +
(1.07)16

= 6(PVIFA7%,16) + 100 (PVIF7%,16)

= ₹ 6(9.447) + ₹ 100 (0.339) = ₹ 90.6

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 Example 2 using Excel
 Consider a 8-year, 12 percent coupon Bond with a par value of ₹ 1,00.
Let us assume that the required yield on this Bond is 14 percent.
Assume that coupon is paid after every six months. The cash flows for
this bond are as follows. Find the Price of the Bond
A B C
1 Settlement 1/1/2015 Date of Purchase
2 Maturity 30/12/2022 8 years,=B2+365*8
3 Rate 12% Annual Coupon rate
4 Yield 14% Required Return per annum /Discount rate/Yield
5 Redemption 100 Maturity Value
6 Frequency 2 Number of times interest paid in a year
7 Basis 3 Represents the day count convention, actual no of
days /365 in interest calculations
8 Price 90.55 =PRICE(B2,B3,B4,B5,B6,B7,B8)
Syntax
PRICE(settlement, maturity, rate, yld, redemption,
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=PRICE(settlement, maturity, rate, yld, redemption, frequency, basis)
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 Question-1
Q1. A firm has issued 10% coupon interest rate 10 - year Bond with a face
value of ₹ 1,000. If the required rate of return is 12% ,find out the value of
Bond? Solve using formula (TVM) and Excel sheet.
Given:
C=₹100,
n=10
r=12%
M = ₹ 1,000

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 Ans 1
P= C*PVIFAr,n + M* PVIFr,n
P= 100* PVIFA12%,10 +1,000*PVIF12%,10

Po = 100 *(PVIFA12,10 ) + 1,000 * (PVIF12,10 )

= 100* 5.650 + 1000* 0.322
= 565 + 322
Po = ₹ 887

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 Bond Price using PV function -
PV(rate, nper, pmt,[fv],type)
 The required parameters are:
 Rate- This is the periodic yield to maturity. Thus ,if a bond pays semi
annually , rate will be half of YTM.
 Nper-This is the number of coupon periods remaining till maturity. Thus
for a Bond paying semi-annual coupons, it will be twice the number of
years left.
 Pmt-This is periodic coupon payment. Thus if a bond with face value of ₹
1,000 were to pay a coupon of 8% per annum on a semi annual basis, Pmt
will be ₹ 40.
 Fv- This is the face value of Bond which is generally it is ₹ 1,000
 In the PV function , cash flows in one direction are positive while those in
the other direction are negative. Thus if we want the price which
represents our investment to be positive then the cash flows received
from the bond must be negative .Thus Pmt in above case will be -40 and Fv
as -1,000. CF/MDI/Harsh/4 17
Ans 1 by Excel using PV function

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 Problem-Bond price using PV function
 Problem – Consider a semi annual bond with face value Rs 1,000 and five years
maturity. The coupon is 6% per annum and YTM 8% Per annum .
 Answer Rs 918.89

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 Problem-Bond price using PV function
 Problem – Consider a semi annual bond with face value Rs 1,000 and five years
maturity. The coupon is 6% per annum and YTM 8% Per annum .
 Thus inputs for PV function will be (0.04,10,-30,-1000).(r/2=4%,C/2=3%)

Answer Rs 918.89

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 Question-2

 A person owns a ₹ 1,000 face value Bond with five years to maturity. The
Bond makes annual interest payments of ₹ 80.
 The Bond is currently priced at ₹ 960.
 Given that the market interest rate or discount rate is 10%, should the
investor hold or sell the Bond?
 Put value in :
 P= C*PVIFAr,n + M*PVIFr,n …..(2)

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 Ans 2
 Po = 80 (PVFA5,10% ) + 1,000 * (PVF 5,10 )
= 80x 3.791 + 1,000x 0.621
= 303.28+621
= ₹ 924.28; which is its Intrinsic Value.
 Since current market value is ₹ 960,therefore the bond is
overpriced hence the Bond should be sold.

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 Example-3
 Consider a 10 years Bond carrying a coupon rate of 14% issued 3
years ago for ₹ 1,000 (par value).
a. The interest rate has fallen in last 3 years and investor expects a return of
10% from this Bond.
b. The interest rate increases after the Bond has been issued to 18%
 Find the value of Bond.

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 The original maturity is 10 years so residual maturity is 7 years .

a. P = Σ 140
(1.10)7
+
1000
(1.10)7

= 140(PVIFA10%,7) + 1,000 (PVIF10%,7)

= ₹ 1194.50

Hence as the required rate of return falls to 10%,you will be willing to pay
more than ₹ 1,000 i.e ₹ 1,194.50 or the bond is selling at Premium.

CF/MDI/Harsh/4 24
 In case interest rate increases after the bond has been issued to 18%

a. P = Σ 140
(1.18)t
+
1000
(1.18)7

= 140(PVIFA18%,7) + 1000 (PVIF18%,7)

= ₹ 847.5

Hence as the required rate of return increases to 18%,you will like to

pay less than ₹ 1,000 i.e ₹ 847.50 or the bond is selling at Discount.

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Relationship between Coupon Rate, Required Yield & Price
 A Bond Price varies inversely with the Yield or discount rate or required
rate of return.
 As the required yield increases , the PV of cash flows decreases ,hence the
price decreases(converse is also true)
 Example Bond face value 100,maturity 5 years.
 If the current price is 110 ,then it is a Premium Bond
 If the current price is =100, par value ,then it is a Par Bond
 If the current price is 90 ,then it is a Discount Bond

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Price-Yield Relationship - a Convex curve

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 Coupon Rate, Required Yield & Price
The relationship between the coupon rate, the required yield, and price is :
When the Required Yield(10%) on a bond falls below its coupon rate(14%), the bond sells at
premium.
Coupon rate > Required Yield Price > Par (Premium Bond)
When the required Yield(14%) on a bond equals its Coupon rate(14%), the bond sells at par.
Coupon rate =Required Yield Price = Par
When the required Yield (18%)on the Bond rises above its Coupon rate(14%), the bond sells at
discount.
Coupon rate < Required Yield Price < Par (Discount Bond)

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 Price-Yield Relationship
PRICE

YEILD

PRICE CHANGES WITH TIME

VALUE OF
BOND PREMIUM BOND: kd = 11% R= Kd is known as
A market rate or
PAR VALUE BOND: kd = 13%
bonds required
B
Rate of Return
DISCOUNT BOND: kd = 15%

8 7 6 5 4 3 2 1 0
CF/MDI/Harsh/4 29
YEARS TO MATURITY
 Bond Yield
 There are mainly three kinds of Yield of Bond:
1. Current Yield or Interest Yield or Running Yield
2. Yield to Maturity[YTM=IRR] or Redemption Yield
3. Yield to Call

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 Current Yield
 The Current Yield Yc is defined as Bond’s annual coupon payment
[C]divided by its Price[P].
C
Yc =
P
 It considers only of Coupon interest rate, does not consider capital gain
or loss that investor will realize if bond is purchased at a discount (or
premium) and held till maturity
 Ignores Time Value of Money hence it is incomplete & simplistic
measure of yield.
 The current yield is also called interest yield or running yield.

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 Example -4
 Current Yield of 10 year, 12% coupon Bond with par value ₹ 1,000
selling for ₹ 950 is
C
 Yc =
P
120
YC =
950
= 0.1263
= 12.63%

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 Yield to Maturity
 When you purchase a Bond ,you are not quoted a promised rate of return ,
you find YTM or r
 The Yield to Maturity ,r is the Rate of Return that an investor will receive if
the bond is held to maturity.
 Yield to Maturity (YTM) is the measure of Bond’s rate of return that
considers both interest income and any capital gain or loss.
 YTM is Internal Rate of Return . It is interest rate that makes Present Value
of the cash receivable from owning the bond equal to the price of the
Bond.
 YTM considers the current coupon income as well as capital gain or loss the
investor will realize till maturity and it takes in account timing of cash flows.
 YTM=IRR
CF/MDI/Harsh/4
33
 Question 3
 The Bonds of XYZ Ltd. are currently selling for ₹ 10,800.
 Assuming coupon rate of interest of 10% with a par value of ₹ 10,000.
 Calculate YTM (Yield To Maturity) if interest is paid annually and the maturity
period of bond is 10 years.

CF/MDI/Harsh/4 34
 Ans 3
10,800 = (1000*PVIFAkd,10 ) + 10,000 *( PVIFkd,10)
Using discount rate of 9%
1000*(PVIFAk9,10 ) + 10000 *( PVIFk9,10)
= 1000*6.418 + 10000* 0.422
=6418 + 4220
=₹ 10,638
NPV= 10,800 -10,638= ₹ 162>0 at 9%
Similarly, using Discount rate of 8% we get value to be:
1,000*6710 + 10,000*0.463 = ₹ 11,340.
NPV =10800-11340 = - ₹ 540,<0 at 8%
Hence, the YTM lies in between 8% and 9%.
= 8% + 0.76
IRR=8.76% CF/MDI/Harsh/4 35
 IRR Calculation
 Formula for calculation of IRR by interpolation method:
𝐴
 IRR =L + *[H-L]
𝐴−𝐵
 L=Lower discount rate at which NPV<0
 H= Higher discount rate at which NPV>0
 A= NPV at Lower discount rate ,L
 B= NPV at Higher Discount rate, H
−540 540 540
 IRR =8+ (9-8) = 8+ =8+ = 8+0.76=8.76%
−540−162 540+162 702

CF/MDI/Harsh/4 36
 Yield to Maturity by approximation method

 Yield to Maturity can be approximately calculated by:

𝑀−𝑃
𝑐 +
𝑛
 YTM ≃ …..(5)
0.4𝑀+0.6𝑃
 Where YTM is Yield to Maturity
 C= Annual interest payment
 M= Maturity value of Bond
 P= Price of Bond
 n= Years for Maturity

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 YTM Example-5-25/10/b/a
 Consider a ₹ 1,000 par value Bond carrying a Coupon rate of 9% ,
maturing after 8 years ,the Bond is selling for ₹ 800.
 What is YTM of this Bond ?

CF/MDI/Harsh/4 38
 𝑀−𝑃
𝑐 +
 YTM ≃ 𝑛
0.4𝑀+0.6𝑃
 Given : C= ₹ 90,M= ₹ 1,000, P= ₹ 800, n=8 years
*90+((1,000−800)/8)+
 YTM ≃ ≃ 13.06%
0.4∗1,000+0.6∗800
 Syntax
1. Yield To Maturity= YTM(RATE)
=RATE(nper,pmt,pv,[fv],[type],[guess])
2. YTM=
YIELD(settlement, maturity,rate,pr,redemption,frequency,[basis])
CF/MDI/Harsh/4 39
 YTM
YTM
Price of Bond at present (PV) 800
Par Value/Maturity Value of Bond 1000
Coupon Rate(FV) 9%
Coupon amount payable per period(PMT) 90 B3*B4
No periods(NPER) 8
Yield to Maturity(RATE) 13.20% RATE(B6,B5,-B2,B3,0)
RATE(nper,pmt,pv,[fv],[type],[guess])
YTM by Yield Formula
Settlement 01-01-2015 Date not given use any date
Maturity 30-12-2022 B10+8*365
Rate 9%
Redemption 100
Freuency 1
Basis 3
Price 80.00 800/10
Yield to Maturity 13.20% YIELD(B10,B11,B12,B16,B13,B14,B15)
YIELD(settlement,maturity,rate,pr,redemption,frequency,[basis])
CF/MDI/Harsh/4 40
 BOND YIELDS
• CURRENT YIELD
ANNUAL INTEREST
PRICE
• YIELD TO MATURITY
C C C M
P = + + …. +
(1+r) (1+r)2 (1+r)n (1+r)n
8 90 1,000
800 =  +
t=1 (1+r)t (1+r)8
AT r = 13% … RHS = 808
AT r = 14% … RHS = 768.1
808 - 800
YTM = 13% + (14% - 13%) = 13.2%
808 - 768.1
C + (M - P) / n
YTM ≃
0.4M + 0.6 P
• YIELD TO CALL
n* C M*
P =  +
CF/MDI/Harsh/4 41
t=1 (1+r)t (1+r)n
 Bond with Maturity

P0 or B0 =Bond value=Present value of interest + Present value of maturity value:

n
INTt Bn
B0   
t 1 (1  kd ) t
(1  kd ) n

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 Perpetual Bond
 Perpetual Bond is also called Consol .They have an indefinite life and no
maturity value.
 The Value of Bond Bo or P0 =
𝐼𝑛𝑡
 P0 =
𝑘𝑑
𝐼𝑛𝑡
 kd =
P0
Where,
Po is Present value of Bond
Kd = YTM= Market rate or Bond’s required rate of return
Int = Interest amount

CF/MDI/Harsh/4 43
 Yield to Maturity

 A Perpetual Bond’s Yield-to-Maturity:

n 
INT INT
B0   
t 1 (1  k d )
t
kd

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 Example-6
 If the interest rate on ₹ 1,000 par value Perpetual Bond is 8% and its
price is ₹ 800.
 What is Bond’s required rate of return?
Int
 YTM = kd = = 80/800
B0
= 0.10=10%

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 Interest Rate Sensitivity
 Bond Prices & Yields move in opposite directions ( inverse relationship)
 Bond Prices are more sensitive to yield changes-An increase in yield causes a
proportionately smaller price change than a decrease in yield of the same
magnitude.
 Price sensitivity of bonds to yield change increases at a decreasing rate of
maturity
 Prices of long-term bonds are more sensitive to interest rate changes than prices
of short term bonds.
 As maturity increases ,interest rate risk increases but at decreasing rate.
 High coupon Bond prices are less sensitive to yield changes than low coupon
bond prices -Prices of low-coupon bonds are more sensitive to interest rate
changes than prices of high coupon bonds.
 Bond prices are more sensitive to yield changes when the bond is initially selling
at a lower yield. CF/MDI/Harsh/4 46
 Relationship between change in yield to maturity & change in
Bond Price
200
Percentage change in bond price

Initial
150 Bond Coupon Maturity YTM
A 12% 5 years 10%
100 B 12% 30 years 10%
C 3% 30 years 10%
D 3% 30 years 6%
50

0
-5 -4 -3 -2 -1 0 1 2 3 4 5A
-50
B
Change in yield to maturity (%) C
D

CF/MDI/Harsh/4 47
 Bond Value and Amortisation of Principal

 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:
n
CFt
B0  
t 1 (1  kd )t

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

CF/MDI/Harsh/4 48
Thanks!!

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