Chapter - 6: Security Valuation

Chapter - 6
SECURITY VALUATION
UNIT-I:
BOND VALUATION
Learning Outcomes
After reading this chapter student shall be able to understand:
 Theory of Valuation
 Return Concepts
 Equity Risk Premium
 Required Return on Equity
 Discount Rate Selection in Relation to Cash Flows
 Approaches to Valuation of Equity Shares
 Valuation of Preference Shares
 Valuation of Debentures/ Bonds
 Arbitrage Pricing Theory
// CA NAGENDRA SAH // WWW.FMGURU.ORG

Page 6.2 STRATEGIC FINANCIAL MANAGEMENT
ANNUAL EQUAL COUPON BOND VALUE
Question No. 1A [SM-OLD]
Mr. A is willing to purchase a five years 1,000 par value bond having a coupon rate of 9%. A’s required rate of
return is 10%. How much Mr. A should pay to purchase the bond if it matures at par?
Additional information in CMA-PTP:

[Given: PVIFA (10%, 5 years) = 3.791 and PVIF (10%, 5 years) = 0.621]
[Given: PVIFA (9%, 5 years) = 3.890 and PVIF (9%, 5 years) = 0.650]
[CMA-PTP-June-2015-2M] [CMA-PTP-Dec-2014-2M]
Ans:  962.19
Question No. 1B [May-2016-5M] [Nov-2003-8M]
Bright Computers Limited is planning to issue a debenture series with a face value of 1,000 each for a term of
10 years with the following coupon rates:
Yearly coupon rate:
Years
14 8%
58 9%
9  10 13%
The current market rate on similar debenture is 15% p.a. The company proposes to price the issue in such a way
that a yield of 16% compounded rate of return is received by the investors. The redeemable price of the debenture
will be at 10% premium on maturity. What should be the issue price of debenture?
PV @ 16% for 1 to 10 years are: .862, .743, .641, .552, .476, .410, .354, .305, .263, .227 respectively.
Ans: issue Price = 676.29
Question No. 1C [May-2000-8M] [MTP-Nov-2014-10M]

John inherited the following securities on his uncle’s death:
Types of Security Nos. Annual Coupon % Maturity Years Yield (%)
Bond A ( 1,000) 10 9 3 12
Bond B ( 1,000) 10 10 5 12
Preference shares C ( 100) 100 11 * 13*
Preference shares D ( 100) 100 12 * 13*
*likelihood of being called at a premium over par.
Compute the current value of his uncle’s portfolio.
[CMA-june-2009-6M] [CMA-Compendium] [CMA-MTP-June-2014-4M]
Ans:  36,250
 TEST YOUR KNOWLEDGE

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Question No. 1.1 [Nov-2019-Old-5M] [MTP-May-2014-8M]
Nominal value of 10% bonds issued by a company is 100. The bonds are redeemable at 110 at the end of year
5. Determine the value of the bond if required yield is (i) 5%, (ii) 5.1% (iii) 10% and (iv) 10.1%.
Ans: (i) 129.48; (ii) 128.95; (iii) 106.207; (iv) 105.80

SECURITY VALUATION Page 6.3
Question No. 1.2
An 8.5% bond of 1000 face value with five years maturity at par and yield to maturity of 10% has 954.74 as
the current market value. Calculate the price of the bond and compare it with market price. What action should the
holder of bond take? [CMA-June-2019-6M]
PERPETUAL BOND, ZERO COUPON BOND & SEMI ANNUAL COUPON BOND
Question No. 2A [Nov-2010-5 M]
Calculate market price of:
(i) 10% Government on India security currently quoted at 110, but interest rate is expected to go up by 1%
(ii) A bond with 7.5% coupon interest, face value 10,000 & term to maturity of 2 years, presently yielding 6%.
Interest payable half yearly.
Ans: (i) Market price = 99.10 (ii) Market price = 10,279
Question No. 2B [RTP-May-2010]

On 1 June 2003 the financial manager of Gadgets Corporation’s Pension Fund Trust is reviewing strategy regarding
the fund. Over 60% of the fund is invested in fixed rate long-term bonds. Interest rates are expected to be quite
volatile for the next few years.
Among the pension fund’s current investments are two AAA rated bonds:
1) Zero coupon June 2018
2) 12% Gilt June 2018 (interest is payable semi-annually)
The current annual redemption yield (yield to maturity) on both bonds is 6%. The semi-annual yield may be assumed to
be 3%. Both bonds have a par value and redemption value of $100.
Required to estimate the market price of each of the bonds if interest rates (yields):
(i) increase by 1%;
(ii) decrease by 1%.
[Given PVF (2.5%, 30) = 0.4767, PVF (3%, 30) = 0.412, PVF (3.5%, 30) = 0.3563]
Ans: (i) MV of Zero coup bond = $ 36.25, Gilt = 145.98; (ii) MV of Zero Coup Bond = $48.10, Gilt = 173.25

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Question No. 2.1
Genpact Ltd. has outstanding a 14% coupon bond with three years to maturity. Interest payments are made semi-
annually. Assume a face value of  100.
(a) What would be its price if the bond’s yield were 12%? If it were 15%?
(b) Instead of a coupon bond, suppose it were a zero coupon, pure discount instrument. If the yield were 14%,
what would be the market price? (Semi-annual compounding)
Ans: (a) Price =  104.92,  97.658; (b) Price = 66.63.

VARIABLE COUPON BOND
Question No. 3A [RTP-May-2011]
ABC Ltd has the following outstanding bond
Bond Coupon Maturity
Series X 8% 10 Years
Series Y Variable changes annually comparable to prevailing rate 10 years
Initially these bonds were issued at face value of 10,000 with yield to maturity of 8%.
Assuming that:
(i) After 2 year from the date of issue interest on comparable bonds is 10% then what should be the price of
each bond?
(ii) If after 2 additional years the interest on comparable bond is 7%, then what should be the price of each
bond?
(iii) What conclusions you can draw from the prices of bonds computed above
Ans: (i) X = 8,938; Y = 10,005; (ii) X = 10,474; Y = 9,997
(iii) Price of bond X moves inversely with change in interest rate, whereas, price of bond Y
does not fluctuate, because coupon rate is adjusted according to change in interest rate.
CONVERTIBLE BOND VALUE

Question No. 4A [RTP-May-2010]
Phototech plc has in issue 9% bonds which are redeemable at their par value of £100 in five years’ time.
Alternatively, each bond may be converted on that date into 20 ordinary shares of the company. The current ordinary
share price of Phototech plc is £4·45 and this is expected to grow at a rate of 6·5% per year for the foreseeable
future. Phototech plc has a cost of debt of 7% per year.
Required:
Calculate the following current values for each £ 100 convertible bond:
(i) market value; (ii) floor value;
(ii) Conversion premium.
Ans: (i) Mkt. Value = £123.89; (ii) Floor value = £108.20; (iii) conversion premium = 39.2

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Question No. 4.1 [RTP-May-2015]
Suppose Mr. A is offered a 10% Convertible Bond (par value 1,000) which either can be redeemed after 4 years
at a premium of 5% or get converted into 25 equity shares currently trading at 33.50 and expected to grow by 5%
each year. You are required to determine the minimum price Mr. A shall be ready to pay for bond if his expected
rate of return is 11%.
Ans: Minimum value (i.e. Floor Value) = 1002.15
COMPONENT OF INTEREST AND PRINCIPAL IN BOND AND PRICE YIELD RELATION
Question No. 5A [June-2009-8M]
Consider two bonds, one with 5 years to maturity and the other with 20 years to maturity. Both the bonds have a
face value of  1,000 and coupon rate of 8% (with annual interest payments) and both are selling at par. Assume
that the yields of both the bonds fall to 6%, whether the price of bond will increase or decrease? What percentage
of this increase/decrease comes from a change in the present value of bond’s principal amount and what percentage
of this increase/decrease comes from a change in the present value of bond’s interest payments?
Ans: Price of bond will increase;
Increase due to change in PV of principal: 5Y Bond = 78.6%, 20Y Bond = 42.68%
Increase due to change in PV of interest payments: 5Y B = 20.86%, 20Y B= 57.49%


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Question No. 5.1 [RTP-Nov-2009]
Given a five-year, 8% coupon bond with a face value of  1,000 and coupon payments made annually, determine
its values given it is trading at the following yields: 8%, 6% and 10%. Comment on the price and yield relation you
observe. What are the percentage changes in value when the yield goes from 8% to 6% and when it goes from 8%
to 10%?
Ans: When 8%, value = 1,000.44; When 6%, value=1083.96; When 10%, value = 924.28
Comment: Bond price has inverse relationship with bond yield.
AMORTISABLE BOND VALUE

A PSU is proposing to sell an 8 years bond of  1,000 at 10% coupon rate per annum. The bond amount will be amortized
equally over its life, if an investor has a minimum required rate of return of 8%, what is the bond’s present value?
Ans: 1070.15
EXTENSION OF LIFE OF BOND (VALUE)

Question No. 7A [SSM-2016] [RTP-May-2011]
Petfeed Plc has outstanding a high yield bond with following features:
Face Value = £10,000
Coupon = 10%
Maturity = 6 Year
Special feature = Company can extend the life of bond to 12 years.
Presently the interest rate on equivalent bond is 8%
(a) If an investor expects that interest will be 8.5%, six year from now then how much he should pay for this bond
now.
(b) Now suppose on the basis of that expectation he invests in the bond but interest rate turn out to be 12% six year
from now, then what will be his potential loss/Gain.
Ans: (a) £10,923; (b) Prob. Loss = 1742
YIELD TO MATURITY (YTM) AND HOLDING PERIOD RETURN

Mr. A had purchased a bond at a price of  800 with a coupon payment of  150 and sold at for  1,000.
(i) What is his holding period return?
(ii) If the bond is sold for  750 after receiving  150 as coupon payment, then what is his holding period
return?
Ans: (i) HPR = 43.75%; (ii) HPR = 12.5%
Question No. 8B [Nov-2010-Old-5 Marks]

If the market price of the bond is 95; Years to maturity = 6 years; coupon rate = 13% p.a. (paid annually) and
issued price is 100. What is the yield to maturity?
Ans: Approx YTM = 14.18%

Question No. 8C [May-2004-old-5marks]
There is a 9% 5-year bond issue in the market. The issue price is  90 and the redemption price  105. For an
investor with marginal income tax rate of 30% and capital gains tax rate of 10% (assuming no indexation), what is
the post-tax yield to maturity?
[CMA Compendium]
Ans: YTM = 9.49%.
Question No. 8D [SM-OLD]
An investor purchased at par a bond with a face value of  1000. The bond had five years to maturity and a 10%
coupon rate, the bond was called two years later for a price of  1200, after making its second annual interest
payment. He then reinvested the proceeds in a bond selling at its face value of  1000, with three years to maturity
and a 7% coupon rate. What was his actual YTM over the five-year period?
Ans: YTM = 12.87%
Question No. 8E [RTP-Nov-2019-New] [MTP-May-2019-New-7M]

A hypothetical company ABC Ltd. issued a 10% Debenture (Face Value of ₹1000) of the duration of 10 years,
currently trading at ₹850 per debenture. The bond is convertible into 50 equity shares being quoted at ₹17 per
share.
If yield on equivalent comparable bond is 11.80%, then calculate the spread of yield of the above bond from this
comparable bond.
Present values t1 t2 t3 t4 t5 t6 t7 t8 t9 t10
PVIF 0.11, t 0.901 0.812 0.731 0.659 0.593 0.535 0.482 0.434 0.391 0.352
PVIF 0.13, t 0.885 0.783 0.693 0.613 0.543 0.480 0.425 0.376 0.333 0.295

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Question No. 8.1 [RTP-Nov-2009]
It is now January 1, 2009, and Mr. X is considering the purchase of an outstanding Municipal Corporation bond
that was issued on January 1, 2007, the Municipal bond has a 9.5 percent annual coupon and a 30-year original
maturity (it matures on December 31, 2037). Interest rates have declined since the bond was issued, and the bond
now is selling at 116.575 % of par, or 1,165.75. Determine the yield to maturity (YTM) of this bond for Mr. X.
Ans: 8%
Question No. 8.2 [Nov-2009-New-4 M]
An investor is considering the purchase of the following Bond:
Face value  100
Coupon rate 11%
Maturity 3 years
(i) If he wants a yield of 13% what is the maximum price he should be ready to pay for?
(ii) If the Bond is selling for 97.60, what would be his yield?
Ans: (i)  95.27; (ii) 11.94%
Question No. 8.3 [SM-OLD]
Mr. Mehta recently purchased a bond with a  1,000 face value, a 10% coupon rate, and 4 years to maturity.
The bond makes annual interest payments, the first to be received one year from today. Mr. Mehta paid 
1,032.40 for the bond. Calculate:
(i) The bond’s yield-to-maturity.
(ii) The bond’s yield-to-call, if the bond can be called two years from now at a price of  1,100.
Ans: YTM = 9%; YTC = 12.83%

YIELD AND VALUE OF BOND
Question No. 9A [RTP-May-2019-New] [Nov-2011-8 M] [Nov-2008-Old-5]
Based on the credit rating of bonds, Mr. Z has decided to apply the following discount rates for valuing bonds :
Credit Rating Discount Rate
AAA 364 day T bill rate + 3% spread
AA AAA + 2% spread
A AAA + 3% spread
He is considering to invest in AA rated, 1,000 face value bond currently selling at 1,025.86. The bond has five
years to maturity and the coupon rate on the bond is 15% p.a. payable annually. The next interest payment is due
one year from today and the bond is redeemable at par. (Assume the 364 day T-bill rate to be 9%).
You are required to calculate the intrinsic value of the bond for Mr. Z. Should he invests in the bond? Also calculate
the current yield and the Yield to Maturity (YTM) of the bond.
[CMA-Dec-2010-6 M] [CMA-Dec-2012-7 M ] [CMA Compendium]
Ans: Intrinsic Value = 1033.95; Yes; Current Yield = 14.62%; YTM = 14.23%.
Question No. 9B [Nov-2007-Old-6M]

MP Ltd. issued a new series of bonds on January 1, 2000. The bonds were sold at par ( 1,000), having a
coupon rate 10% p.a. and mature on 31 st December, 2015. Coupon payments are made semiannually on June
30th and December 31 st each year. Assume that you purchased an outstanding MP Ltd. Bond on 1 st March,
2008 when the going interest rate was 12%.
Required:
(i) What was the YTM of MP Ltd. Bonds as on January 1, 2000?
(ii) What amount you should pay to complete the transaction? Of that amount how much should be accrued
interest and how much would represent bonds basic value.
Ans: (i) YTM = 10%, (ii) Pay 916.669; Accrued int. = 16.45; Basic value as on 1.3.08 = 900
Question No. 9C
An investor has a cash of $10,000,000 at disposal. He wants to invest in a bond with $1,000 nominal value and
whose dirty price is equal to 107.457%.
(i) What is the number of bonds he will buy?
(ii) Same question if the nominal value and the dirty price of the bond are respectively $100 and 98.453%.
[Note: Dirty Price = Clean Price + Accrued Interest]
[CMA-MTP-June-2014-New-4M]
Ans: (i) 9,306.048[i.e. 1000,00,000/(1000 × 107.457%)]; (ii) 101,571.31 [i.e. 1000,00,000/(100 × 98.453 %)]
Question No. 9D [May-2018-Old-4M]

A bond is held for a period of 45 days. The current discount yield is 6% per annum. It is expected that current
yield will increase by 200 basis point and current market price will come down by 2.50
Calculate:
(i) Face value of bond and
(ii) Bond Equivalent yield
Ans


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Question No. 9.1 [SM-OLD]
An Investor is considering investing in a bond currently selling for  8,785.07. The bond has four years to
maturity, a  10,000 face value, and 8% coupon rate. The next annual interest payment is due one year from
today. The approximate discount factor for investments of similar risk is 10%.
Calculate:
(i) The intrinsic value of the bond. Based on this calculation, should the investor purchase the bond?
(ii) The YTM of the bond. Based on this calculation, should he purchase the bond?
Ans: (i) Intrinsic Value = 9366; yes purchase the bond (ii) YTM = 12%; Yes purchase the bond
Question No. 9.2 [May-2015-8M]

On 31st March, 2013, the following information about Bonds is available:
Name of Security Face Value Maturity Date Coupon Coupon
 Rate Date(s)
Zero coupon 10,000 31st March, 2023 N.A. N.A.
T-Bill 1,00,000 20th June, 2013 N.A. N.A.
10.71% GOI 2023 100 31st March, 2023 10.71 31st March
10% GOI 2018 100 31st March, 2018 10.00 31st March & 30th September
Calculate:
(i) If 10 years yield is 7.5% p.a. what price the Zero Coupon Bond would fetch on 31st March, 2013?
(ii) What will be the annualized yield if the T-Bill is traded @ 98500?
(iii) If 10.71% GOI 2023 Bond having yield to maturity is 8%, what price would it fetch on April 1, 2013 (after
coupon payment on 31st March)?
(iii) If 10% GOI 2018 Bond having yield to maturity is 8%, what price would it fetch on April 1, 2013 (after
coupon payment on 31st March)?
ACTUAL REALISED YIELD OR MODIFIED YIELD

Question No. 10A [Study Mat.]
An investor acquired at par a bond for 1,000 that offered a 15% coupon rate. At the time of purchase, the
bond had four years to maturity. Assuming annual interest payments, calculate his actual yield -to-maturity if
all the interest payments were reinvested in an investment, earning 18% per year. What would his actual yield-
to-maturity be if all interest payments were spend immediately upon receipt?
Ans: YTM = 15.55%, YTM = 12.47%
Question No 10B [MTP-May-2015-5M]

Mr. X purchases a 5 year 8.5% Coupon Bond for a price of 907.60 (Face Value  1000) that has a YTM of
11%. You are required to compute reinvested interest amount on this bond.
Ans: Reinvested Interest 104.36


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Question No. 10.1 [MTP-Nov-2014-8M]
XYZ Ltd.’s bond (Face Value of  1000) with 4 years maturity is currently trading at  900 carrying a coupon rate
of 15%. Assuming that the reinvestment rate is 16%, you are required to calculate Realized Yield to Maturity of the
bond.
Ans: Return= 18.26%
Also refer Q- 13.2 (Point-iii)
BOND INDIFFERENCE BETWEEN TAXABLE BOND & TAX FREE BOND

Question No. 11A [RTP-Nov-2009-old]
Given a two-year, 8% coupon bond with a face value of  1,000 and with annual coupon payments that is fully
taxable and selling at par, and an identical bond that is tax free, what would the yield and price on the tax-free bond
have to be for an investor in a 35% tax bracket to be indifferent between the two bonds?
Ans: Yield = 5.2%; Price = 1052.33
SOME CONCEPTS RELATED TO CONVERTIBLE BOND

Question No. 12A [RTP-Nov-2017] [Nov-2008-New-8M] [RTP-Nov-2015]
The data given below relates to a convertible bond :
Face value 250
Coupon rate 12%
No. of shares per bond 20
Market price of share 12
Straight value of bond 235
Market price of convertible bond 265
Calculate:
(i) Stock value of bond.
(ii) The percentage of downside risk.
(iii) The conversion premium
(iv) The conversion parity price of the stock.
Ans: (i) 240 (ii) 11.32%; (iii) 10.42%; (iv) 13.25
Question No. 12B [MTP-Nov-2018-New-8M] [May-2014-8M]

GHI Ltd. AAA rated company has issued fully convertible bonds on the following terms a year ago:
Face value of bond :  1000
Coupon (interest rate) : 8.5%
Time to Maturity (remaining) : 3 years
Interest payment : Annual at the end of year
Principle Repayment : At the end of bond maturity
Conversion ratio (Number of shares per bond) : 25
Current market price per share : 45
Market price of convertible bond : 1175

AAA rated company can issue plain vanilla bonds without conversion option at an interest rate 9.5%
Required: Calculate as of today:
(i) Straight Value of bond
(ii) Conversion Value of the bond
(iii) Conversion Premium.
(iv) Percentage of downside risk.
(v) Conversion Parity Price.
t 1 2 3
PVIF0.095 , t 0.9132 0.8340 0.7617
Ans: (i) 975.35; (ii) 1125; (iii) 4.44% (iv) 16.99%; (v) 47
Question No. 12C [May-2018-Old-5M] [SSM-2016] [RTP-Nov-12] [RTP-May-2013] [RTP-May-2015]

The following data is related to 8.5 % fully convertible (into Equity shares) Debentures issued by JAC Ltd. at 
1000.
Market Price of Debenture  900
Conversion Ratio 30
Straight Value of debenture  700
Market Price of Equity share on the date of conversion  25
Expected Dividend Per Share 1
You are required to calculate:

(a) Conversion Value of Debenture
(b) Market Conversion Price
(c) Conversion Premium per share
(d) Ratio Conversion Premium
(e) Premium over Straight Value of Debenture
(f) Favorable income different per share
(g) Premium payback period
Ans: (a) 750; (b) 30; (c) 5; (d) 20%; (e) 28.6%; (f) 1.833; (g) 2.73 years.

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Question No. 12.1 [SM-NEW] [May-2018-New-6M] [Nov-2009-4M]
Saranam Ltd. has issued convertible debentures with coupon rate 12%. Each debenture has an option to convert
to 20 equity shares at any time until the date of maturity. Debentures will be redeemed at  100 on maturity
of 5 years. An investor generally requires a rate of return of 8% p.a. on a 5-years security. As an investor when
will you exercise conversion for given market prices of the equity share of (i)  4, (ii)  5 and (iii)  6.
Cumulative PV factor for 8% for 5 Years = 3.993
PV factor for 8% for year 5 = 0.681
Ans: Unless the mkt. price is 6, conversion should not be exercised.
Question No. 12.2 [Nov-2010-5M]

A convertible bond with a face value of 1,000 is issued at 1,350 with a coupon rate of 10.5%. The conversion
rate is 14 shares per bond. The current market price of bond and share is 1,475 and 80 respectively. What is
the premium over conversion value?
Ans: 31.7%
Question No. 12.3 [Nov-2011-6M] [As RTP-Nov-2010]
Pineapple Ltd has issued fully convertible 12 percent debentures of  5,000 face value, convertible into 10 equity
shares. The current market price of the debentures is  5,400. The present market price of equity shares is  430.
Calculate:
(i) The conversion percentage premium, and
(ii) The conversion value
Ans: (i) Conversion Premium = 25.58%; (ii) CV = 4300
BOND DURATION AND BOND VOLATILITY

Question No. 13A [Nov-2015-5M] [2005-8M] [RTP-June-2009/Nov-2011] [RTP-Nov-2012]
The following data are available for a bond
Face value  1,000
Coupon Rate 11%
Years to Maturity 6
Redemption value  1,000
Yield to maturity 15%
(Round-off your answers to 3 decimals)
Calculate the following in respect of the bond:
(i) Current Market Price.
(ii) Duration of the Bond.
(iii) Volatility of the Bond
(iv) Expected market price if increase in required yield is by 100 basis points.
(v) Expected market price if decrease in required yield is by 75 basis points.
[CMA Compendium]
Ans: (i) 834.48; (ii) 4.570; (iii) 3.974; (iv) 801.318; (iv) 859.35
Question No. 13B [Nov-2005-8M]

The Investment portfolio of a bank is as follows:
Government Bond Coupon Rate Purchase rate Duration
(F.V.  100 per Bond) (Years)
G.O.I. 2006 11.68 106.50 3.50
G.O.I. 2010 7.55 105.00 6.50
G.O.I. 2015 7.38 105.00 7.50
G.O.I. 2022 8.35 110.00 8.75
G.O.I. 2032 7.95 101.00 13.00
Face value of total Investment is  5 crores in each Government Bond.
Calculate actual Investment in portfolio.
What is a suitable action to churn out investment portfolio in the following scenario?
1. Interest rates are expected to lower by 25 basis points.
2. Interest rates are expected to raise by 75 basis points.
Also calculate the revised duration of investment portfolio in each scenario.
Ans: Actual Investment =  2,637.50 Lakh;
Revised duration in 1 st scenario=9.75Years, in 2 nd = 6.55Year

Question No. 13C [May-2007-6M]
Find the current market price of a bond having face value 1,00,000 redeemable after 6 year maturity with
YTM at 16% payable annually and duration 4.3202 years.
Given 1.16 6 = 2.4364.
[CMA Compendium]
Ans: Current Market Price =  96.275; [Hint: Coupon Rate = 15%]

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 13.1 [June-2009-12M]
(a) Consider a bond selling at its par value of  1,000, with 6 years to maturity and a 7% coupon rate (with annual
interest payment), what is bond’s d uration?
(b) If the YTM of the bond in (a) above increases to 10%, how it affects the bond’s duration? And why?
(c) Why should the duration of a coupon carrying bond always be less than the time to its maturity?
Ans: (a) Duration = 5.098 Y; (b) Duration = 5.02 Y.
Question No. 13.2 [RTP-May-2018-New] [Nov-2008-6M] [RTP- Nov-2009] [RTP-May-2012]

XL Ispat Ltd. has made an issue of 14 per cent non-convertible debentures on January 1, 2007. These debentures
have a face value of 100 and are currently traded in the market at a price of 90.
Interest on these NCDs will be paid through post-dated cheques dated June 30 and December 31. Interest payments
for the first 3 years will be paid in advance through post-dated cheques while for the last 2 years post-dated cheques
will be issued at the third year. The bond is redeemable at par on December 31, 2011 at the end of 5 years.
Required:
(i) Estimate the current yield and the YTM of the bond.
(ii) Calculate the duration of the NCD.
(iii) Assuming that intermediate coupon payments are, not available for reinvestment Calculate the realized yield
on the NCD.
Ans: (i) Current Yield = 15.55%, YTM = 17.14%; (ii) Duration = 3.8524; (iii) Realized yield = 13.56%
Question No. 13.3 [RTP-May-2014] [CMA-PTP-June-2014-8M]

Mr. A is planning for making investment in bonds of one the two companies X Ltd. and Y Ltd. The detail of these
bonds is as follows:
Company Face value Coupon rate Maturity period
X Ltd. 10,000 6% 5 Years
Y Ltd. 10,000 4% 5 Years
The current market price of X Ltd’s bond is 10,796.80 and both bonds have same Yield to Maturity (YTM). Since
Mr. A considers duration of bonds as the basis of decision making, you are required to calculate the duration of
each bond and your decision.
Ans: Duration -X is 4.4878 years say 4.49 years; Duration -Y is 4.6280 years say 4.63 years.
Decision: Since the duration of Bond of Y Ltd. is lower hence it should be preferred. However difference between the
duration of bond is not much higher and with higher coupon rate of X Ltd.’s bond, Mr. A should go for X Ltd.’s bond.
Question No. 13.4 [MTP-May-2015-Old-5M]

Blue Tooth Mutual Fund is planning to float a fixed income fund of  100 crore on 1 January 2015 with a term of
7 years. If the target duration of fund is 51⁄2 years and has expected rate of return of 8.00%, then determine the
amount of interest it has to earn annually on it investment after defraying management expenses of 10% of amount
income earned.

Question No. 13.5 [MTP-Nov-2019-New-8M]

A Ltd. has issued convertible bonds, which carries a coupon rate of 14%. Each bond is convertible into 20 equity
shares of the company A Ltd. The prevailing interest rate for similar credit rating bond is 8%. The convertible
bond has 5 years maturity. It is redeemable at par at Rs. 100. The relevant present value table is as follows;
Present Value t1 t2 t3 t4 t5
PVIF0.14, t 0.877 0.769 0.675 0.592 0.519
PVIF0.08, t 0.926 0.857 0.794 0.735 0.681
You are required to estimate: (Calculations be made upto 3 decimal places)
(i) current market price of the bond, assuming it being equal to its fundamental value,
(ii) minimum market price of equity share at which bond holder should exercise conversion option; and
(iii) duration of the bond.
Ans: (i) Rs.124, (ii) 6.20, (iii) 4.028
BOND IMMUNIZATION
Question No. 14A [MPT-Nov-2018-6M] [Nov-2015-6M]
Mr. A will need  1,00,000 after two years for which he wants to make one-time necessary investment now. He
has a choice of two types of bonds. Their details are as below:
Bond X Bond Y
Face value 1,000 1,000
Coupon 7% payable annually 8% payable annually
Years to maturity 1 4
Current price  972.73  936.52
Current Yield 10% 10%
Advice Mr. A whether he should invest all his money in one type of bond or he should buy both the bonds and, if
so, in which quantity? Assume that there will not be any call risk or default risk.
Ans: Invest in both. X: 51.83 (i.e. 52 Bond); Y: 34.42 (i.e. 34 Bond)
Question No. 14B [Nov-2018-New-12M]
The following data are available for three bonds A, B and C. These bonds are used by a bond portfolio manager to
fund an outflow scheduled in 6 years. Current yield is 9%. All bonds have face value of RS 100. Each and will be
redeemed at Par. Interest is payable annually.
Bond Maturity ( Years) Coupon Rate
A 10 10%
B 8 11%
C 5 9%
(i) Calculate the duration of each bond.

(ii) The bond portfolio manager has been asked to keep 45% of the portfolio money in bond A. Calculate the %
amount to be invested in bond B and C that need to be purchased to immunize the portfolio.
(iii) After the portfolio has been formulated, the interest rate change occurs, increasing the yield to 11%. The new
duration of these bonds are:
Bond A = 7.15 years, Bond B = 6.03 years and Bond C = 4.72 A = 7.15 years , Bond B = 6.03 years
And Bond C = 4.27 years
Is the portfolio still immunised? Why or why not?
(iv) Determine the new percentage of B and C bonds that are need to immunise the portfolio. Bond A remaining
at 45% of the portfolio.

Present values be used as follows
PV T1 T2 T3 T4 T5 T6 T7 T8 T9 T10
PVIF0.09,t 0.917 0.842 0.772 0.708 0.650 0.596 0.547 0.502 0.460 0.4224
BOND REFUNDING DECISION

Question No. 15A [SM-NEW] [June-2009-6M] [RTP-Nov-2011] [As May-2013-6M]
ABC Ltd. has  300 million, 12% bonds outstanding with 6 years remaining to maturity. Since interest rates are
falling, ABC Ltd. is contemplating of refunding these bonds with a  300 million issue of 6 years bonds carrying a
coupon rate of 10%. Issue cost of the new bond will be  6 million and the call premium is 4%  9 million being
the unamortized portion of issue cost of old bonds can be written off no sooner the old bonds are called off. Marginal
tax rate of ABC Ltd. is 30%. You are required to analyse the bond refunding decision.
Ans: NPV = 7.6 Mill. [Use discount rate 7%]
Question No. 15B [Nov-2018-New-8M] [Nov-2005-5M] [RTP-Nov-2014]

M/s Transindia Ltd. is contemplating calling  3 crores of 30 year’s, 1,000 bond issued 5 years ago with a
coupon interest rate of 14 per cent. The bonds have a call price of 1,140 and had initially collected proceeds
of  2.91 crores due to a discount of  30 per bond. The initial floating cost was  3,60,000. The Company
intends to sell  3 crores of 12 per cent coupon rate, 25 years bonds to raise funds for retiring the old bonds.
It proposes to sell the new bonds at their par value of  1,000.
The estimated floatation cost is 4,00,000. The company is paying 40% tax and its after tax cost of debt is
8%. As the new bonds must first be sold and their proceeds, then used to retire old bonds, the company expects
a two months period of overlapping interest during which interest must be paid on both the old and new bonds.
What is the feasibility of refunding bonds?
[CMA Compendium] [As-CMA-June-2013-9M]
Ans: NPV =  8.1198 Lakh

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 15.1
PQR Ltd. has  100 million, 18% bonds outstanding with 10 years remaining to maturity. As interest rates
have fallen PQR Ltd can refund these bonds with a  100 million issue of 10-year bonds carrying a coupon
rate of 16%, the call premium will be 5%. The issue costs on the new bonds will be  5 million. The
unamortized portion of the issue cost on the old bonds is  3 million and these can be written off no sooner
the one bonds are called. PQR Ltd. marginal tax rate is 40%.
Ans: NPV = 1.20 Mill [Hint: Net initial outflow = 6.8 mill; Annual saving = 1.28mill; Discount rate = 9.6%]
Question No. 15.2 [Nov-2001-8M]

A firm has a bond outstanding  3,00,00,000. The bond has 12 years remaining until maturity, has a 12.5% coupon
and is callable at  1,050 per bond; it had floatation costs of  4,20,000 which are being amortized at  30,000
annually. The floatation costs for a new issue will be  9,00,000 and the current interest rate will be 10 per cent.
The after tax cost of the debt is 6%. Should the firm refund the outstanding debt? Show detailed workings. Consider
Corporate Income-tax rate at 50%.
Ans: NPV =  18.626 Lakh [Hint: Net initial outflow = 14.7; Annual saving = 3.975; discount rate = 6%]

ISSUE OF BOND
Question No. 16A [May-2001-12M]
The HLL has  8.00 crore of 10% mortgage bonds outstanding under an open-end scheme. The scheme allows
additional bonds to be issued as long as all of the following conditions are met:
 Income before tax  Bond Interest 
(1) Pre - tax interest coverage   remains greater than 4.
 Bond Interest 
(2) Net depreciated value of mortgage assets remains twice the amount of the mortgage debt.
(3) Debt-to-equity ratio remains below 0.5.
The HLL has net income after taxes of  2 crores and a 40% tax-rate,  40 crores in equity and  30 crores in
depreciated assets, covered by the mortgage.
Assuming that 50% of the proceeds of a new issue would be added to the base of mortgaged assets and that
the company has no Sinking Fund payments until next year, how much more 10% debt could be sold under
each of the three conditions? Which protective covenant is binding?
[CMA Compendium]
Ans: Condition-1 < 3.1 Cr; Cond.-2 < 9.33Cr; Cond.-3 < 12 Cr.;
Condition 1 is binding, hence issue additional bond at least 3.10 Cr.
BOND QUESTION TO BE COVERED IN INTEREST RATE RISK MANAGEMENT

Question No. 17A
[Nov-2008-4M] [RTP- Nov-2009] [To be covered in Interest rate risk Management]
The following is the Yield structure of AAA rated debenture:
Period Yield (%)
3 months 8.5%
6 months 9.25
1 year 10.50
2 years 11.25
3 years and above 12.00
(i) Based on the expectation theory calculate the implicit one-year forward rates in year 2 and year 3.
(ii) If the interest rate increases by 50 basis points, what will be the percentage change in the price of the bond
having a maturity of 5 years? Assume that the bond is fairly priced at the moment at 1,000.
Question No. 17B [Nov-2018-Old-5M] [Nov-2013-5M] [To be covered in Interest rate risk Management]
ABC Ltd. Issued 9%, 5 year bonds of  1000/- each having a maturity of 3 years. The present rate of interest is
12% for one year tenure. It is expected that forward rate of interest for one year tenure is going to fall by 75 basis
points and further by 50 basis for every next year in future for the same tenure. This bond has a beta value of 1.02
and is more popular in the market due to less credit risk.
Calculate:
(i) Intrinsic value of bond
(ii) Expected price of bond in the market

Security Valuation (Bond) Page 1
Security Valuation
[UNIT-I: Bond]
By CA Nagendra Sah
CA Nagendra Sah / www.fmguru.org








































































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Chapter - 6: Security Valuation

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Additional information in CMA-PTP:

Question No. 1C [May-2000-8M] [MTP-Nov-2014-10M]

 TEST YOUR KNOWLEDGE

// CA NAGENDRA SAH // WWW.FMGURU.ORG

Question No. 2B [RTP-May-2010]

 TEST YOUR KNOWLEDGE

// CA NAGENDRA SAH // WWW.FMGURU.ORG

CONVERTIBLE BOND VALUE

 TEST YOUR KNOWLEDGE

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 TEST YOUR KNOWLEDGE

AMORTISABLE BOND VALUE

EXTENSION OF LIFE OF BOND (VALUE)

YIELD TO MATURITY (YTM) AND HOLDING PERIOD RETURN

Question No. 8B [Nov-2010-Old-5 Marks]

// CA NAGENDRA SAH // WWW.FMGURU.ORG

Question No. 8E [RTP-Nov-2019-New] [MTP-May-2019-New-7M]

 TEST YOUR KNOWLEDGE

// CA NAGENDRA SAH // WWW.FMGURU.ORG

Question No. 9B [Nov-2007-Old-6M]

Question No. 9D [May-2018-Old-4M]

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 TEST YOUR KNOWLEDGE

Question No. 9.2 [May-2015-8M]

ACTUAL REALISED YIELD OR MODIFIED YIELD

Question No 10B [MTP-May-2015-5M]

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 TEST YOUR KNOWLEDGE

BOND INDIFFERENCE BETWEEN TAXABLE BOND & TAX FREE BOND

SOME CONCEPTS RELATED TO CONVERTIBLE BOND

Question No. 12B [MTP-Nov-2018-New-8M] [May-2014-8M]

// CA NAGENDRA SAH // WWW.FMGURU.ORG

Question No. 12C [May-2018-Old-5M] [SSM-2016] [RTP-Nov-12] [RTP-May-2013] [RTP-May-2015]

You are required to calculate:

 TEST YOUR KNOWLEDGE

Question No. 12.2 [Nov-2010-5M]

BOND DURATION AND BOND VOLATILITY

Question No. 13B [Nov-2005-8M]

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 TEST YOUR KNOWLEDGE

Question No. 13.2 [RTP-May-2018-New] [Nov-2008-6M] [RTP- Nov-2009] [RTP-May-2012]

Question No. 13.3 [RTP-May-2014] [CMA-PTP-June-2014-8M]

Question No. 13.4 [MTP-May-2015-Old-5M]

// CA NAGENDRA SAH // WWW.FMGURU.ORG

Question No. 13.5 [MTP-Nov-2019-New-8M]

(i) Calculate the duration of each bond.

// CA NAGENDRA SAH // WWW.FMGURU.ORG

BOND REFUNDING DECISION

Question No. 15B [Nov-2018-New-8M] [Nov-2005-5M] [RTP-Nov-2014]

 TEST YOUR KNOWLEDGE

Question No. 15.2 [Nov-2001-8M]

// CA NAGENDRA SAH // WWW.FMGURU.ORG

BOND QUESTION TO BE COVERED IN INTEREST RATE RISK MANAGEMENT

// CA NAGENDRA SAH // WWW.FMGURU.ORG

CA Nagendra Sah / www.fmguru.org

CA Nagendra Sah / www.fmguru.org

CA Nagendra Sah / www.fmguru.org

CA Nagendra Sah / www.fmguru.org

CA Nagendra Sah / www.fmguru.org

CA Nagendra Sah / www.fmguru.org

CA Nagendra Sah / www.fmguru.org