Investment Analysis & Portfolio Management : Bond Valuation

Bond Valuation

Present Value Method

Bond value = Present value of coupon interest + Present value of Maturity value

Coupon Interest Bonds maturity value

B0 ¿ +
(1+ k)t ( 1+ k )t

Bond value (Semi annual) = Present value of interest + Present value of Maturity value

1 ∫¿ Bonds maturity value

¿+
B0 = ∑ 2 k t
k t
(1+ ) (1+ )
2 2

Coupon Interest
Present Value of Perpetual Bond =
Discount rate

Bond Return (Holding Period Return): An investor buys a bond and sells it after holding for a period. The rate of return in
that holding period is:

Price gain∨loss duringthe holding period+Couponinterest rate , if any

Holding Period =
Price at the beginnning of the holding period

The Current yield: The current yield is the coupon payment as a percentage of Current market price

Annual Coupon payment

Current yield =
Current market Price

Yield to Maturity (YTM): YTM is the single discount factor that makes present value of future cashflows from a bond equal
to the current price of the bond. In other words YTM is the rate of return, which an investor can expect to earn if the bond is
held till maturity.

Yield to Maturity (YTM) =

Couponinterest + ( Premium(P)∨Discount
Years ¿
( D)
Maturity ¿)

Present Value (P¿¿ 0)+ Face value( F)

¿
2
Investment Analysis & Portfolio Management : Bond Valuation

Yield to Call: A number of companies issue bonds with buy back or call provision, means the bond can be redeemed or called
before maturity. The procedure for calculating the yield to call is the same as for the yield to maturity. The ‘call period’ would
be different from maturity period and ‘call value’ could be different from the maturity value.

Yield to Call (YTC) =

Couponinterest + ( Call price−Purchase
Years ¿
Price
Maturity ¿)

Present Value(P¿¿ 0)+ Face value( F )

¿
2
Yield to Put: Same as yield to call, but when the bond holder has the option to sell the bond back to the issuer at a fixed price
on specified date.

Duration: Bond prices are sensitive to changes in the interest rates, and they are inversely related to the interest rates. The
intensity of the price sensitivity depends on a bond’s maturity and the coupon rate of interest. The longer the maturity of a
bond, the higher will be its sensitivity to the interest rate changes. Similarly, the price of bond with low coupon rate will be
more sensitive to the interest rate changes.

A bond’s maturity and coupon rate provide a general idea of its price sensitivity to interest rate changes. The bond’s price
sensitivity to interest rate can be estimated by its duration. A bond’s duration is measured as the weighted average of times to
each cash flow ,the weight is determined as the present value of cash flow to the bond value.

∑ PV ( CF ) x T
t=1
Duration = n

∑ PV ( CF )
t=1

Modified Duration = Duration / (1 + YTM)

Practical Problems

Present value concept (Bond):

1. An investor is considering to purchase a five-years Rs. 1000 par value bond bearing a nominal (coupon) rate of 10%
percent. The investor’s required rate of return is 8%. What should he be willing to pay now to purchase the bond if it
matures at (i) at par (ii) at a premium of 10% (iii) at a discount of 10%
2. A Rs 1000 par value bond bearing a coupon rate of 15% will mature after 8 years. What is the value of bond, if
discount rate is 10%? (Rs. 1265.9)
3. A Rs 100 par value bond bearing a coupon rate of 11% matures after 5 years. The expected yield to maturity is 15%.
The present market price is Rs. 82. Can investor buy it?(Ans. Yes because NPV is positive)
4. A 10 year bond of Rs 1000 has an annual rate of interest of 12%. The interest is paid half yearly. What is the value of
bond if the required rate of return is (i) 12% (ii) 16%?(Ans: Rs. 1000, Rs.803.59)
5. A 15% Rs 1000 bond will pay Rs.150 annual interest into perpetuity? What would be the value of bond if the market
yield (interest rate) is 10%?
Investment Analysis & Portfolio Management : Bond Valuation
6. A company proposes to sell ten-year debentures of Rs.10, 000 each. The company would repay Rs 1000 at the end of
every year and will pay interest annually at 15% on the outstanding amount. Determine the present value of the
debenture issue if the capitalization rate is 16%.(Ans: Rs. 9676)
7. An investor owns Rs.1, 000 face value bond with five years to maturity. The bond has an annual coupon of Rs 75. The
bond is currently priced at Rs 970. Given an appropriate discount rate of 10% , Should he hold or sell bond?
(Ans: Sell as PV is Rs. 905.21)
8. A bond having a face value of Rs.1000 has a coupon rate of 12.5%. The bond is redeemable on 31st December 2005.
The selling price on 31st December 2002 is Rs.806. Find out the return earned by X who purchases and keeps it upto
maturity.
9. Calculate the value of a bond having a par value of Rs.1000, coupon rate of 12% and maturity period of 8 years. The
required yield is 10%.
10. A debenture holder is to receive an annual interest of Rs.100 for perpetuity on his debentures of Rs.1000. Calculate the
value of the debenture if the required rate of returns is (a) 10% (b) 15% and (c) 8%.

Bond Return:

11. (a) An investor ‘A’ purchased a bond at a price of Rs. 900 with Rs 100 as coupon payment and sold it at Rs. 1000.
What is his holding period return?
(b) If the bond is sold for Rs. 750 after receiving Rs. 100 as coupon payment, then what is the holding period return?
(Ans: 22.22%, -5.5%)

Current Yield and Yield to Maturity:

12. A Four year bond with the 7% coupon rate and maturity value of Rs. 1000 is currently selling at Rs. 905. What is its
yield to maturity?(Ans: 9.8%)
13. Suppose a 10-year 11% coupon bond is selling for Rs.118 with a par value of Rs.100.Calculate the current yield d for
the bond .(Ans: 9.32%)
14. What is the yield to maturity of a 7.5% 20 year bond, which pays interest semiannually and sells for Rs. 93.73?
(Ans: 4.07% for semi annually and 8.14 is annual YTM )
15. A 13% bond interest payable semiannually is issued at Rs. 100. It market price is Rs. 112. Compute the current yield.
If it matures in Five years, what is the YTM of the bond? If the interest rates increase, what would be the effect on the
bondholder? (Ans: 11.60%, 9.9%)
16. Consider the data given below:

Rs.
Issue price of the bond
500

Coupon rate 14%

Term to maturity 5 years

Rs.
Market price of the bond
455

Interest is payable annually. Compute the YTM. If YTM decreases by 10%, what is the percent change in the market
price of the bond? [Ans: 16.8%, 5.77%]
17. You, as an investor, can invest in two bonds. The characteristics of two bonds are as follows:
Investment Analysis & Portfolio Management : Bond Valuation

Bond Bond
A B

Rs. Rs.
Face value
100 100

Coupon rate 9% 11%

Term to maturity 3 years 4 years

Market price Rs. 81 Rs. 98

Interest is payable annually. Compute

a) Current Yield
b) YTM
c) Duration
As an investor which bond would you choose? State the reason for the same.
a. [Ans: 11.11%, 11.22%] b. [Ans: 17.71%, 11.67%] c. [Ans: 2.739 years, 3.438 years]

18. A bond which has a coupon of 13% and a par value of Rs 100 is callable at the end of three years at a premium of
10%. It matures in six years and pays coupon semi-annually. The market price is Rs 107. Given this data, compute
yield to call.(Ans. 12.95%)
19. Suppose the 10%, 10year Rs 1000 bond is redeemable (callable) in 5 years at a call price of Rs. 1050.The bond is
currently selling for Rs. 950. What is bond’s yield to call? Also calculate YTM?(Ans: YTC= 12.7%, YTM= 11.3%)
20. Consider two bonds A and B. They have the following characteristics:

Bond A Bond B
Face value Rs. 100 Rs. 100
Coupon rate 14% 14%
Current market price Rs. 100 Rs. 100
Term to maturity 4 years 7 years
Coupon payments Annually Annually
a. Compute the YTM of Bonds A and B
b. If the interest rate falls by 1% percentage point, what would be the new market price of the bonds?
(Ans. (a) 14%, (b)-Bond A –Rs. 102.94, Bond B –Rs. 104.42) Source: (CFAFIS WB66)
21. A 15% bond is available at a price of Rs.102 (Face value = Rs. 100). It has 8 years to maturity and is callable after 4
years at Rs. 105.
a) YTM
b) Duration
c) YTC
[Ans: (a) 14.6% (b) 15.3% (c) 5.18 years]
22. A bond is available at a price of 102. The bond has a coupon of 15 percent and matures in 20 years. The bond is
callable in five years at 111.
a. What is the yield-to-maturity on this bond?
b. What is the yield-to-call on the bond?
c. Which would you place more importance on if you were to take a decision on buying the bond.

Duration of Bond
Investment Analysis & Portfolio Management : Bond Valuation
23. Calculate the duration for Band A and Bond B with 7% and 8% coupons having maturity period of 4 years. The face
value is Rs. 1000. Both the bonds are currently yielding 6 percent.(Ans: 3.631 years, 3.593 years)
24. The following data are available for a bond:

Face value Rs 100

Coupon interest 15% p.a.
Maturity 6 years
Redemption value Rs 90
Current Market Price Rs. 89
Yield to maturity 18%
Calculate the duration of bond?

25. Consider the following data regarding two bonds A & B.

Bond A Bond B
Coupon Interest 8% 10%
Maturity 5 years 8 years
Market rate of interest 10% p.a 8% p.a.
Face value 1000 1000
Redemption Value Rs. 950 Rs. 1010
Calculate Duration and Modified Duration of two bonds and decide which should be preferable for investment

purpose?

26. A bond has a par value of Rs.100 and carries a 9 percent per annum coupon payment. The yield to maturity is 7
percent and the maturity period is 5 years. Compute the duration and volatility of the bond?
27. An investor buys a bond with four years to maturity. The bond has a coupon rate of 9% and is priced Rs. 100 in the
market.
(a) What is the duration of the bond?
(b) What will be the percentage change in the price of bond if the interest rate rises to 10%.
Ans: (a) 3.53 years, (b) (3.181%)
28. An investor has Rs. 50000 to make one time investment. His son has entered the higher secondary school and he need
his money back after two years for his son’s education expenses. As investor’s cash outflow is one time outflow
duration is simply two years. He has choice of two types of bonds.
(a) Bond A has a coupon rate of 7% and maturity period of four years with a current yield of 10%. CPM id Rs. 904.90.
(b) Bond A has a coupon rate of 6% and maturity period of one year with a current yield of 10%. CPM id Rs. 963.64 .