Valuation and Pricing

Ammar Hafeez
 Valuation of

Preference Ordinary
Bonds
shares shares

Deep
Perpetual
discount
bonds
bonds
Bond
A bond is a
• fixed income instrument
• which is kind of a loan made from an investor to a
borrower

Investors usually receive interest according to the

rate of interest of the bond.

Bonds could either be

• redeemable after a certain period
• irredeemable
Bonds with maturity dates, implies that the
principal amount received initially, has to be paid
back.

Bonds are issued by the government and the

public sector companies in India. The private
sector companies also issue bonds, which are
generally called debentures in India.
Are bonds same as debentures!?!
 Bonds
• Financial instrument which
highlights the debt taken
of the issuing authority
towards the holders.
• Secured by collateral.
• Issued by financial
institutions, corporations,
government agencies.
• It receives the first priority
at the time of liquidation.
Debentures
• An instrument used for
raising long term finances.
• Could be either secured or
unsecured.
• Usually issued by private
companies.
• After the bondholders are
paid, then comes the
number of
debentureholders.
 Bonds Debentures
• Yields a lower rate of • Higher.
interest comparatively.

• Doesn’t have the option • It does have an option

of converting into of converting to equity
equity shares. shares.
Terminologies
• Face value
Face value is also called par value. A bond
(debenture) is generally issued at a par value.
Also, the interest is calculated on the par value.

• Interest rate
Interest rate is fixed and known to bondholders
(debenture holders). Interest paid on a
bond/debenture is tax deductible. The interest
rate is a contractual rate.
• Maturity
A bond (debenture) is generally issued for a specified
period of time. It is repaid on maturity.

• Redemption value
The value that a bondholder (debenture holder)
will get on maturity is called redemption, or
maturity, value. A bond (debenture) may be
redeemed at par or at premium (more than par
value).
Redemption of a bond at discount (less than par
value) is generally unacceptable by bond holders.
Example
An investor is considering to buy an INR 1000
face value bond. The rate of return is 7 per cent
per annum. And the bond is floated for a period
of 5 years.
However, the investor’s required rate of return is
8 percent.
What is the present value of such bond, if the
bond matures at par.
• Cash payment to be made today : INR 1000
• The investor would receive INR 70 (7 percent of
1000) as interest every year for a period of 5
years.
• He would also receive back INR 1000 on maturity
(at the end of 5th year).
• 70 + 70 + 70 + 70 + 70 + 1000
• Now, calculating the present value of such
amounts:
• 70 + 70 + 70 + 70 + 70 + 1000

• Since INR 70 is to be received for a period of 5

years, it is a case of annuity, hence
• 70 x 3.993 (8 percent ROR and 5 years time
period) = 279.51 Table A - 4

• 1000 x 0.681 (8 percent ROR and 5 years time

period) = 681 Table A - 2
• Therefore, total return is INR 960.51
• This implies that INR 1000 bond is originally
worth INR 960.51 today (only if the required ROR
is 8 percent)
Practice question 1
An 8 year bond is valued at INR 1000. It has a
coupon rate of 5 percent per annum. The bond is
to be matured after 8 years at par.
An investor is interested to invest into it.
However, his required rate of return is 3 percent.
Calculate the present value of this bond and
advice whether the investor should buy it or
not!?!
 Interest to be received every year = INR 50

= 50 + 50 + 50 + 50 + 50 + 50 + 50 + 50 + 1000
= 50 x 7.020 + 1000 x 0.789
= 351 + 789
= 1140

The current price of the bond is INR 1140. Hence,

it is advisable to buy the bond today which is
valued at INR 1000.
Practice question 2
An 10 year bond is valued at INR 1500. It has a
coupon rate of 9 percent per annum. The bond is
to be matured after 10 years at par.
An investor is interested to invest into it.
However, his required rate of return is 12
percent.
Calculate the present value of this bond and
advice whether the investor should buy it or
not!?!
 Interest to be received every year = INR 135

= 135 + 135 + 135 + 135 + 135 + 135 + 135 + 135 + 135 +

135 + 1500
= 135 x 5.650 + 1500 x 0.322
= 762.75 + 483
= 1245.75

The current value of the bond is INR 1245.75

Since we have to pay an INR 1500 to buy it, we would
not proceed with it. As the amount we are paying is
more than the current value of the bond.
 Practice question 3
A bond is valued at INR 1000. It’s coupon rate is
10 percent, with 7 year maturity.
The interest payable is annually.
How much is the present value for the bond, if
your required rate of return is
(a) 12 percent
(b) 9 percent
a)
Interest to be received every year = INR 100

= 100 + 100 + 100 + 100 + 100 + 100 + 100 + 1000

= 100 x 4.564 + 1000 x 0.452
= 456.4 + 452
= 908.4
b)
Interest to be received every year = INR 100

= 100 + 100 + 100 + 100 + 100 + 100 + 100 + 1000

= 100 x 5.033 + 1000 x 0.547
= 503.3 + 547
= 1050.3
Practice question 4
Assume
• INR 100 face value
• 8 percent coupon rate of interest
• 10 years remaining to maturity date

If interest is paid annually, find the value of the

bond when the required rate of return is
a) 7 percent
b) 8 percent
c) 10 percent
a)
Interest to be received every year = INR 8

= 8 + 8 + 8 + 8 + 8 + 8 + 8 + 8 + 8 + 8 + 100
= 8 x 7.024 + 100 x 0.508
= 56.192 + 50.8
= 106.992

The present value of the bond is INR 106.992.

b)
Interest to be received every year = INR 8

= 8 + 8 + 8 + 8 + 8 + 8 + 8 + 8 + 8 + 8 + 100
= 8 x 6.710 + 100 x 0.463
= 53.68 + 46.3
= 99.98

The present value of the bond is INR 99.98.

c)
Interest to be received every year = INR 8

= 8 + 8 + 8 + 8 + 8 + 8 + 8 + 8 + 8 + 8 + 100
= 8 x 6.145 + 100 x 0.386
= 49.16 + 38.6
= 87.76

The present value of the bond is INR 87.76.

• In the same question, also indicate for each case
whether the bond is selling at a discount, at par
or at a premium value!?!
a) Present value of the bond = 106.992
Face value of the bond = 100
Since the present value of the bond > the face value, it means
that the bond is being floated at a premium.

b) Present value of the bond = 99.98

Face value of the bond = 100
Since the present value of the bond = the face value, it means
that the bond is being floated at par.

c) Present value of the bond = 87.76

Face value of the bond = 100
Since the present value of the bond < the face value, it means
that the bond is being floated at discount.
 In the same question,
what would be the value of the bond, if interest is paid semi
annually @ 10 percent?

Interest to be received every year = INR 8

Interest to be received in every half year = INR 4

=4+4+4+4+4+4+4+4+4+4+4+4+4+4+4+4+4+4
+ 4 + 4 + 100
= 4 x 12.462 + 100 x 0.377
= 49.85 + 37.7
= 87.55

The present value of the bond is INR 87.55.

Practice question 5
The face value of a 10 year bond (with 10 percent
coupon rate) is INR 1000.

The interest is payable semi annually.

Assuming 12 percent required rate of return of

investors, compute the value of the bond.
 Interest to be received every year = INR 100
Interest to be received every half yearly = INR 50

= 50 + 50 + 50 + 50 + 50 + 50 + 50 + 50 + 50 + 50 + 50 +
50 + 50 + 50 + 50 + 50 + 50 + 50 + 50 + 50 + 1000
= 50 x 11.470 + 1000 x 0.312
= 573.5 + 312
= 885.5

The present value of the bond is INR 885.5

• What would be the present value of the bond, if
the interest is receivable annually?
Interest to be received every year = INR 100

= 100 + 100 + 100 + 100 + 100 + 100 + 100 + 100 +

100 + 100 + 1000
= 100 x 5.650 + 1000 x 0.322
= 565 + 322
= 887

The present value of the bond is INR 887

Practice question 6
A 10 year bond of INR 1000 has an annual rate of
interest of 12 percent. The interest is paid semi
annually. It is redeemable at par.
Calculate the value of the bond if the required
rate of return is
a. 12 percent
b. 16 percent
Interest to be received every year = INR 120
Interest to be received every half year = INR 60

= 60 + 60 + 60 + 60 + 60 + 60 + 60 + 60 + 60 + 60 +
60 + 60 + 60 + 60 + 60 + 60 + 60 + 60 + 60 + 60 +
1000
= 60 x 11.470 + 1000 x 0.312
= 688.2 + 312
= 1000.2
Practice question 7
A 10 percent INR 1000 bond is currently selling
for INR 950.
It has remaining life of 5 years.
If your required rate of interest is 12 percent, will
you buy the bond?
Assume that interest is payable
a) annually
b) semi annually
a)
Interest to be received every year = INR 100

= 100 + 100 + 100 + 100 + 100 + 1000

= 100 x 3.605 + 1000 x 0.567
= 360.5 + 567
= 927.5

Present value of the cash inflows = 927.5

Present cost of the bond = 950

No, I wouldn’t buy the bond.

b)
Interest to be received every year = INR 100
Interest to be received every half yearly = INR 50

= 50 + 50 + 50 + 50 + 50 + 50 + 50 + 50 + 50 + 50 + 1000
= 50 x 7.360 + 1000 x 0.558
= 368 + 558
= 926

Present value of the cash inflows = 926

Present cost of the bond = 950

No, I wouldn’t buy the bond.