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THREEBond and Stock Valuation - Bond

This document discusses the valuation of bonds, preferred stock, and common stock. It begins by defining bonds and their key features such as face value, coupon rate, maturity date, and types. It then covers the valuation of different types of bonds including zero coupon bonds, perpetual bonds, and bonds with coupon payments and maturity dates. Next, it defines preferred stock and how its valuation is similar to bond valuation. It concludes by stating the general concept of asset valuation as the present value of future cash flows.

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Raasu Kutty
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54 views22 pages

THREEBond and Stock Valuation - Bond

This document discusses the valuation of bonds, preferred stock, and common stock. It begins by defining bonds and their key features such as face value, coupon rate, maturity date, and types. It then covers the valuation of different types of bonds including zero coupon bonds, perpetual bonds, and bonds with coupon payments and maturity dates. Next, it defines preferred stock and how its valuation is similar to bond valuation. It concludes by stating the general concept of asset valuation as the present value of future cash flows.

Uploaded by

Raasu Kutty
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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THREE VALUATION OF BOND

AND STOCK
Bond Valuation
Preference stock Valuation
Common Stock Valuation
• Concept of Bond
• Features of Bond
• Types of Bond
• Bond Valuation
– Zero coupon bond
– Perpetual/ irredeemable bond
– Bond with Coupon and Maturity/ Redeemable Bond
• Preferred stock valuation
BOND
• Debt capital instrument for long term
financing.
• Fixed cost bearing source of capital.
• Security or long term promissory note issued
by burrower, promising to pay interests and
principal as per contract.
Concept of bond
 Bonds are units of corporate debt issued by companies
and securitized as tradable assets.
 A bond is referred to as a fixed income instrument
since bonds traditionally paid a fixed interest rate
(coupon) to debt holders. Variable or floating interest
rates are also now quite common.
 Bond prices are inversely correlated with interest rates:
when rates go up, bond prices fall and vice-versa.
 Bonds have maturity dates at which point the principal
amount must be paid back in full or risk default.
Features of bond
• Face/Par Value
• Face Rate/ Coupon Rate
• Market price
• Market Interest rate (Yield to maturity)
• Maturity Period
• Maturity Value
• Issue Price
• Call provision
• Sinking Fund
• Trustee
• Indenture
Types of Bond
• Corporate bonds are issued by companies. Companies issue
bonds rather than seek bank loans for debt financing in many
cases because bond markets offer more favorable terms and
lower interest rates.
• Municipal bonds are issued by states and municipalities. Some
municipal bonds offer tax-free coupon income for investors.
• Government bonds such as those issued by the U.S. Treasury.
Bonds issued by the Treasury with a year or less to maturity
are called “Bills”; bonds issued with 1–10 years to maturity are
called “notes”; and bonds issued with more than 10 years to
maturity are called “bonds”. The entire category of bonds
issued by a government treasury is often collectively referred
to as "treasuries." Government bonds issued by national
governments may be referred to as sovereign debt.
Types of Risks associated with the Bond

• Inflation risk
• Default risk
• Liquidity risk
• Maturity risk
• Reinvestment risk
Notations
• V0 =Value of bond today
• C = Coupon interest rate in %
• I = Coupon interest amount
• Kd% = market interest rate, required rate of
return
• YTM = Yield to Maturity
• n = maturity period of bond
• M = Maturity Value/Par Value
General concept of Assets Valuation

• Value = Maximum price an investor is willing


to pay for the assets.
• Equals to the sum of present values of future
net cash inflows generated by that assets.
• V = + +….. +
Bond Valuation- Zero Coupon Bond
Discounted bond
• Issued at the discounted price below par
value.
• Redeemed at contracted price ( generally par
value).
• Does not pay interest.
• Value of Zeros (Vz)=
• Calculate the value of discounted bond
with par value Rs. 1,000 and remaining
maturity period 5 years, if you need 10%
return.

• State your trading strategy for following


bond. Required rate of interest being 12%
– Zero coupon bond with Rs. 1000 par
value which matures in 7 years is trading
at Rs 510.
Bond Valuation – Perpetual Bond
• Irredeemable bond
• Pays interest indefinitely
• Won’t repay back the principal.
• Value of Bond (V0) =
Bonds of XYZ company are the perpetuities with
12% coupon. Bonds of similar types are yielding
10%. The face value of bond is Rs.1,000.
• What is the price of the bond?
• If interest rates changes yielding 15%, what is
the new value of the bond?
• At what price would these bonds trade if the
interest rates were 12%?
• Analyze and comment on the results.
Bond Valuation- Redeemable bond
• V = I. PVIFA Kd,n + M.PVIF Kd,n

• In case of multiple inter-year compounding


– V = I/m. PVIFA Kd/m,nm + M.PVIF Kd/m,nm
• A bond has 14% coupon rate. The interest is
paid semi annually and the band matures in
12 years. The market interest rate is 10%,
– What is the value of bond?
– would you purchase the bond if it is trading at Rs.
1,100?
– What might happen to the value of this bond in
future if the interest rate remains at 10%?

1276
Bond Yields
• Rate of return=
• Current yield = coupon interest/ current price
Yield to Maturity
• Nominal return gained by an investor if the
bond is held till maturity.

Current yield =

YTM = current yield + capital gain yield


Yield to maturity (YTM)
• Approx YTM =

• Calculate the value of bond at higher rate and


lower rate for interpolation.

• By interpolation,
YTM = (HR-LR)
• Calculate YTM of a bond with 10% coupon
rate and remaining life 10 years; selling at
90% of face value.
• 11.76%
• Calculate YTM of a zero coupon bond
having remaining life 5 years and selling at
Rs.500. The par value of bond being Rs.
1,000.
• 14.87%
Bond of ABC company has the remaining life of 10
years. It is selling for Rs. 1050 and has a coupon of
8%. 7.6%

• What is the current yield of the bond?


• What is its yield to maturity? 7.15%

• If this bond will have the YTM of 8%, one year


from now, what will its price be? 8%

• What will be the rate of return if you buy the


bond now and sell it at the end of year 1?
2.86%
Yield to Call
• Approx YTC =
• Interpolation same as YTM

• Five years ago, Bhatbhatini issues a 15 years


bond with 12% coupon and 10% call premium.
Calculate yield to call if it is called today.

13.53%
Preferred Stock
• Hybrid security.
• Pays fixed dividend.
• Matches with bond in almost all the aspects.
• Vp = Dp/Kp
• Vp =
• Vp = Dp. PVIFA Kp,n + M.PVIF Kp,n

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