Valuation of Bond

 Bond valuation is a way to determine the theoretical fair value (or par
value) of a particular bond.
 It involves calculating the present value of a bond's expected future
coupon payments, or cash flow, and the bond's value upon maturity, or
face value.
 As a bond's par value and interest payments are set, bond valuation
helps investors figure out what rate of return would make a bond
investment worth the cost.

A bond is a debt instrument that provides a steady income stream to the

investor in the form of coupon payments. At the maturity date, the full face
value of the bond is repaid to the bondholder. The characteristics of a regular
bond include:

 Coupon rate: Some bonds have an interest rate, also known as the
coupon rate, which is paid to bondholders semi-annually. The coupon
rate is the fixed return that an investor earns periodically until it matures.
 Maturity date: All bonds have maturity dates, some short-term, others
long-term. When a bond matures, the bond issuer repays the investor
the full face value of the bond.
 Current price: Depending on the level of interest rate in the
environment, the investor may purchase a bond at par, below par, or
above par. For example, if market interest rates increase, the value of a
bond will decrease since the coupon rate will be lower than the interest
rate in the economy. When this occurs, the bond will trade at a discount,
that is, below par. However, the bondholder will be paid the full face
value of the bond at maturity even though he purchased it for less than
the par value.

Coupon Bond Valuation

Calculating the value of a coupon bond factors in the annual or semi-annual
coupon payment and the par value of the bond.

The present value of expected cash flows is added to the present value of the
face value of the bond as seen in the following formula:
 For example, let’s find the value of a corporate bond with an annual
interest rate of 5%, making semi-annual interest payments for 2 years,
after which the bond matures and the principal must be repaid.
Assume a YTM of 3%:

 F = $1,000 for corporate bond

 Coupon rateannual = 5%, therefore, Coupon ratesemi-annual = 5% / 2 = 2.5%
 C = 2.5% x $1000 = $25 per period
 t = 2 years x 2 = 4 periods for semi-annual coupon payments
 T = 4 periods

1. Present value of semi-annual payments = 25 / (1.03)1 + 25 / (1.03)2 + 25

/ (1.03)3 + 25 / (1.03)4 = 24.27 + 23.56 + 22.88 + 22.21 = 92.93
2. Present value of face value = 1000 / (1.03)4 = 888.49

Therefore, value of bond = $92.93 + $888.49 = $981.42

 A bond that matures in four years, has a coupon rate of

10% and has a maturity value of US$ 100. The bond pays
interest annually and has a discount rate of 8%.
Ans: The cash flow of this bond is:

YEAR CASH FLOW

 1 US$ 10

2 US$ 10

3 US$ 10

4 US$ 110

The present value of each cash flow is:

Year 1 – Present Value (PV1) = $10/ (1.08)1 = US$ 9.26

Year 2 – Present Value (PV2) = $10/ (1.08)2 = US$ 8.57

Year 3 – Present Value (PV3) = $10/ (1.08)3 = US$ 7.94

Year 4 – Present Value (PV4) = $110/ (1.08)4 = US$ 80.85

Now adding all cash flows

Thus, Present Value of Bond = 9.25+8.57+7.94+80.85 = US$

106.62

 suppose that a bond has a face value of $1,000, a coupon rate of 4% and a maturity of
four years. The bond makes annual coupon payments. Determine bond price as follows
If the yield to maturity is 4%
If the yield to maturity is 5%
If the yield to maturity is 3%
These results show the following important relationship:

 if y > coupon rate, P < face value

 if y = coupon rate, P = face value
 if y < coupon rate, P > face value

These results also demonstrate that there is an inverse relationship between yields
and bond prices:
 when yields rise, bond prices fall
 when yields fall, bond prices rise

Zero Coupon Bonds valuation

A zero-coupon bond does not make any coupon payments; instead, it is sold to
investors at a discount from face value. The difference between the price paid for the
bond and the face value, known as a capital gain, is the return to the investor. The
pricing formula for a zero coupon bond is:
As an example, suppose that a two-year zero-coupon bond is issued with a face value
of $1,000. The discount rate for this bond is 4%. What is the market price of this
bond?

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 considered a long-term bond yield but
is expressed as an annual rate. In other words, it is the internal rate of return
(IRR) of an investment in a bond if the investor holds the bond until maturity,
with all payments made as scheduled and reinvested at the same rate.

Yield to maturity is also referred to as "book yield" or "redemption yield."

Yield to maturity is similar to current yield, which divides annual cash inflows
from a bond by the market price of that bond to determine how much money
one would make by buying a bond and holding it for one year. Yet, unlike
current yield, YTM accounts for the present value of a bond's future coupon
payments. In other words, it factors in the time value of money, whereas a
simple current yield calculation does not. As such, it is often considered a
more thorough means of calculating the return from a bond.

The formula to calculate YTM of a discount bond is as follows:

However, there is a trial-and-error method for finding YTM with the following
present value formula:
Duration of Bond
Macaulay Duration
Macaulay duration finds the present value of a bond's future coupon payments
and maturity value.
Concept of Immunization
Bond immunization is an investment strategy used to minimize the interest rate risk
of bond investments by adjusting the portfolio duration to match the investor's
investment time horizon. It does this by locking in a fixed rate of return during the
amount of time an investor plans to keep the investment without cashing it in.

Immunization locks in a fixed rate of return during the amount of time an investor
plans to keep the bond without cashing it in.

Normally, interest rates affect bond prices inversely. When interest rates go up,
bond prices go down. But when a bond portfolio is immunized, the investor receives
a specific rate of return over a given time period regardless of what happens to
interest rates during that time. In other words, the bond is "immune" to fluctuating
interest rates.

To immunize a bond portfolio, you need to know the duration of the bonds in the
portfolio and adjust the portfolio so that the portfolio's duration equals the
investment time horizon.

Valuation of Shares
Valuation of shares is the process of knowing the value of a company’s
shares. Share valuation is done based on quantitative techniques and
share value will vary depending on the market demand and supply.

Value per share = (Net Assets – Preference Share Capital) / (No. of Equity
Shares)

i. Earning Yield

Shares are valued on the basis of expected earning and the normal rate of
return. Under this method, value per share is calculated using the below
formula: