S 7 – Valuation of Bonds

Prof. B.B.Chakrabarti
IIM Calcutta
 How to Value Bonds?
• Primary Principle:
– Value of financial securities = PV of expected
future cash flows
• Bond value is, therefore, determined by the
present value of the coupon payments and par
value.
 Price of Bonds

• Bond prices are quoted in different ways in different

markets. Some of them are as follows;
a) Rupee or Dollar value – Rs. 98.62 or $99.35
b) As a percentage of face value
A bond selling at 950 would be selling at 95% of its face
value of say $1,000 and would therefore be quoted at 95.
c) By their yield
“2.15% yield” – The 2.15% is the YTM based on the current
market price. Using the YTM, one can calculate the price.
d) As a spread over Treasuries
If a trader is offering a corporate bond at  “+155” and the
yield of the comparable treasury is 2.00%, the yield on the
corporate bond would be 3.55%.
 Price of Bonds

• US G-Secs are quoted in thirty-seconds (1/32) of a dollar.

The quoted price is for a bond with a face value of 100.
Thus, a quote of 90-05 in US G-Sec indicates that the
quoted price for a bond with a face value of $100,000 is
$90,156.25
• The quoted price is not the same as the cash price paid
by the purchaser.
• Cash price = Quoted price + Accrued Interest since last
coupon date
• Quoted price is referred to as Clean Price and Cash price
as Dirty Price by the traders.
 Price of Bonds - Example
Suppose that it is March 5, 2017, and the bond under
consideration is an 11% coupon bond with semi-annual
coupon maturing on July 10, 2019, with a quoted price of
Rs.95.50.

- The most recent coupon date is January 10, 2017, and

the next coupon date is July 10, 2017.

- The number of days between January 10, 2017, and

March 5, 2017, is 54, and 181 between January 10, 2017,
and July 10, 2017.
 Price of Bonds - Example
- On a bond with Rs.100 face value, the coupon
payment is Rs.5.50 on January 10 and July 10.
- The accrued interest on March 5, 2017, is the share
of the July 10 coupon accruing to the bondholder on
March 5, 2017.
- Because actual/actual in period is used for Treasury
bonds, this is
(54/181)*Rs.5.5 = Rs.1.64
- The cash price per Rs.100 face value bond is
therefore
Rs.95.5+ Rs.1.64 = Rs.97.14
 Valuation of a Bond

N= no. of coupons P = price today

C= annual coupon y = yield

N
C/2 100
P 
j 1 (1  y / 2) (1  y / 2)
j N
 Zero Coupon Bond: Example
Find the value of a 30-year zero-coupon bond
with a Rs.1,000 par value and a YTM of 6%.

$0 $0 $0 $1,000

0 1 2 29 30

FV Rs.1,000
PV    Rs.174.11
T 30
(1  y ) (1.06)
 Coupon Bonds
• Make periodic coupon payments in addition to
the maturity value
• The payments are equal each period.
Therefore, the bond is just a combination of
an annuity and a terminal (maturity) value.
• Coupon payments are typically semiannual.
• Effective annual rate (EAR) =
(1 + R/m)m – 1
 Coupon Bond: Example
• Consider a bond with a 6 3/8% coupon that expires
in December 2020.
– The Par Value of the bond is Rs.1,000.
– Coupon payments are made semi-annually (June 30 and
December 31 for this particular bond).
– Since the coupon rate is 6 3/8%, the payment is
Rs.31.875.
– YTM is 5%
– On January 1, 2016 the size and timing of cash flows are:
Rs.31.875 Rs.31.875 Rs.31.875 Rs.1,031.875

1 / 1 / 16 6 / 30 / 16 12 / 31 / 16 6 / 30 / 20 12 / 31 / 20
 Coupon Bond: Example
• The semi-annual yield is 2.5%.

Rs.31.875  1  Rs.1,000
PV  1    Rs.1,060.17
10
.05 2  (1.025)  (1.025)10
 Bond Concepts
 Bond prices and market interest rates move
in opposite directions.
 When coupon rate = YTM, price = par value
 When coupon rate > YTM, price > par value
(premium bond)
 When coupon rate < YTM, price < par value
(discount bond)
 YTM and Bond Value
When the YTM < coupon, the bond
1300 trades at a premium.
Bond Value

1200

1100 When the YTM = coupon, the

bond trades at par.
1000

800
0 0.01 0.02 0.03 0.04 0.05 0.06 0.07 0.08 0.09 0.1
6 3/8 Discount Rate
When the YTM > coupon, the bond trades at a discount.
Additional Problems

Microsoft Office
Excel Worksheet