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Valuation of Bond

The document discusses the basic concepts of valuation of securities including the discounted cash flow valuation model. It states that the value of any investment is the sum of the present values of its future cash flows, discounted at an appropriate rate. It provides the mathematical formula for calculating the value of an asset as the present value of future cash flows. The document also discusses basics of bonds and debentures, including key terms and sample valuation questions.

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Abhishek Upadhaya
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43 views5 pages

Valuation of Bond

The document discusses the basic concepts of valuation of securities including the discounted cash flow valuation model. It states that the value of any investment is the sum of the present values of its future cash flows, discounted at an appropriate rate. It provides the mathematical formula for calculating the value of an asset as the present value of future cash flows. The document also discusses basics of bonds and debentures, including key terms and sample valuation questions.

Uploaded by

Abhishek Upadhaya
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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1.

Basic concept of valuation of securities


Valuation is the process of determining the current worth of a security. Investment process requires
the valuation of securities in which the investments are proposed. The value of a security may be
compared with the current market price of the security to get an idea as to whether a particular
security is overpriced, underpriced or correctly priced.

Meaning of the word ‘securities’

Securities refer to tradable financial instruments or assets that have economic value. Companies
issue these instruments to raise capital for financing their activities. Common examples include
shares, bonds etc. The Securities and Exchange Board of India (SEBI) regulates the issue of such
financial instruments in India.

2. Basic Valuation Model


The Basic Investent Valuation Model

The basic valuation model lies at the heart of all investment decisions and, as such, is an important
concept to understand.

The model is the bedrock of all good investment decisions, whether regarding shares, property, or
bonds. It will assist you to make dispassionate investment decisions, to avoid getting caught up in
hype.

So, what is this magic model? The basic valuation model is the discounted cash flow model: quite
simply, the value of ANY investment is the sum of Present Value (PV) of its future cash-flows.
The PV of future cash-flow after one year is written algebraically as FV/(1+r) (where FV equals the
cash flow and r is the discount rate). For example, if you receive Rs.100 in one year's time, the
present value of the cash flow is Rs.90.91, if it was discounted back at a rate of 10%. That is, 100/1.1
= 90.91

Therefore, the value of an investment is the sum of all future cash-flows, discounted at an
appropriate rate.
Mathematical description of the basic investment valuation model

An asset whether financial or real derives its value from the cash flows associated with it. The cash
flows must be evaluated on the present value basis. The value of an asset is equal to the present
value of the benefits associated with it. Thus, the value of any asset at time ‘0’ may be calculated by
the following formula:

V0 = CF1/(1+i)1 + CF2/(1+i)2 + CF3/(1+i)3 +………+ CFn/(1+i)n


Where,

V0 = Value at time ‘0’ or ‘now’

CF = Cash flow in the respective year

i = annual interest rate

n = number of years

3. Bond and Debenture - Basics

Bond

Debenture
Difference between Bond and Debenture

4. Bonds/Debentures - Terminologies
5. Valualtion of Bond/Debentures
6. Questions on Bonds and Debentures
Question – 1

A company issues 2.5% Rs 1000 bonds with 10 years to maturity. The other similar bonds are sold to
yield 5%. The payment of interest is yearly. Find the intrinsic value of the bond. Also, if the required
rate is 2.5%, 2% or 3% p.a. (per annum), what will be the present value in each case?

Question – 2

An investor is considering the purchase of the following bond:-

Face Value (Par Value) = Rs. 100

Coupon Rate = 11%

Maturity = 3 years

If he wants a yield of 13%, what is the maximum price, he should be ready to pay for?

Question – 3

Mr. A has invested in 8% debentures of Rs. 500 which are redeemable after 5 years at par. Calculate
the value of bond if the required rate of return is 14% and 7%.

Question – 4

Face value of 10% bonds issued by a company is Rs. 100. The bonds are redeemable at Rs. 110 at the
end of year 5. Determine the value of bond if the required yield is (i) 5% and (ii) 10%.

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