Time value of Money

• PV = FV/(1+r)n

• PVA = AMT [(1-(1+r)-n)/r]

• FV = PV(1+r)n

• FVA = AMT [((1+r)n - 1)/r]

 What are Bonds
• Bonds are instruments issued by Governments
and Corporations to borrow money from the
public.
• Short term Govt. bonds are usually called
Treasury Bills.
• Long term Government Bonds in Pakistan are
called PIBs or Pakistan Investment Bonds and
long term corporate bonds are called Term
Finance Certificates or TFCs.
 Attributes of a Bond
• Face Value of a bond.
• Coupon Rate.
• Frequency of Coupon Payments
• Maturity.
• Price.
 Regular or Plain Vanilla Bond
• Interest payments at fixed intervals.
• Sells at discount or premium (depends on
required rate of return and coupon rate).
• Face Value is paid on Maturity with last
coupon/interest payment. Face Value + Coupon

Coupon Payments

1 2 3 4 5 6 7 8
Time periods
Price
 Price of Regular Bond
• Price = C [(1-(1+r)-n)/r] + M/(1+r)n

Where
C = Coupon Amount
r = Periodic required rate of return
n = Total number of compounding periods
remaining till maturity
M = Face Value

• Note: The factor [(1-(1+r)-n)/r] stands for present value of

Annuity
 Example
• What is the fair price of a 5 year bond with
face value of Rs. 1,000 and annual coupon rate
of 6% (compounded semiannually) if annual
required rate of return is 7%?
Coupon Payment = 1000 x (0.06/2) = Rs. 30
Price = C [(1-(1+r)-n)/r] + M/(1+r)n
= 30 x [(1-(1+0.035)- 10)/0.035] + 1000/(1+0.035)10
= 30 x 8.317 + 1000/ 1.411
= 249.51 + 708.72
= Rs. 958.23 (Discount Price)
 Example
• What is the fair price of a 5 year bond with
face value of Rs. 1,000 and annual coupon rate
of 6% (compounded semiannually) if annual
required rate of return is 5%?
Coupon Payment = 1000 x (0.06/2) = Rs. 30
Price = C [(1-(1+r)-n)/r] + M/(1+r)n
= 30 x [(1-(1+0.025)- 10)/0.025] + 1000/(1+0.025)10
= 262.56 + 781.20
= Rs. 1043.76 (Premium Price)
 Treasury Bills
• No interest payments.
• Sells at discount price.
• Face Value is paid on Maturity.
• Risk Free.
• Issued for less than a year. Price = M [1-(r x n/360)]
Face Value
r = Required Rate of Return

M = Face Value
Days till maturity (n)
n = Days till maturity
Price
 Example
• What is the fair price of a 180 day treasury
with face value of Rs. 1,000 if annual required
rate of return is 6%?
 Price of Bond and RRR
• Price of the Bond is inversely proportional to
Required Rate of Return or Market Interest
Rate.
• If RRR < Coupon Rate; Bond’s price will be
higher than its face value i.e., sells at a
premium.
• If RRR > Coupon Rate; Bond’s price will be
lower than its face value i.e., sells at a discount.
 Yield to Maturity (YTM)
• Yield to Maturity is the rate of return that the investor
earns if bond is held till maturity.
• All other things being equal; YTM depends on the price
paid for the bond.
• If all other factors are held constant; as price paid for the
bond increases, YTM decreases and vice versa.

• Note: YTM is not Coupon rate of the bond

• YTM is also called IRR or Internal Rate of Return of the
bond.
 YTM of a Regular Bond
• Can be calculated manually using trial and
error
• Usually Calculated using MS Excel or a
Financial Calculator
 YTM using Excel
• What is the YTM of a 5 year bond with face value of Rs. 1,000 and
annual coupon rate of 6% (compounded semiannually) if it is being
sold for Rs. 950?

• Note: Excel will give you periodic IRR. You have to annualize it by
multiplying it with number of compounding periods in a year.
 Callable Bonds
• Has the option of being redeemed by the
issuer before maturity date. Called the call
date.
• Usually pays a higher coupon rate than a
regular bond with same attributes.
• Issuer pays a premium on face value if called
before the maturity date.
 Callable Bond Valuation
• Price = C [(1-(1+r)-n)/r] + M/(1+r)n
Where
C = Coupon Amount
i = Periodic required rate of return
n = Total number of compounding periods
remaining till Call date
M = Call Value
 Example
• What is the fair price of a 5 year callable bond with face value of Rs.
1,000 and annual coupon rate of 6% (compounded semiannually) if
annual required rate of return is 7%? Bond has the option to be
called back 4 years from now at Rs. 1,100.

• C?
• M?
• n?
• r?

Note: Whenever confused in such problems, make a bond payment

structure.