PAPER : Financial Management

By

Arijit Sen

Asst. Prof. in Finance

Valuation of Debt: Bond Valuation
A bond may be described in terms of par value, coupon
rate & maturity date.

The par value is the value stated on the face of the bond.
It represents the amount the issuer promises to pay at
the time of the maturity.

The coupon rate is the interest rate payable to the

bondholder.
The maturity date is the date when the principal amount
is payable to the bondholder.

The bond indenture, the contract between the issuer &

the bondholder specifies the par value, coupon rate &
maturity date.

For e.g., an issuer may sell a bond with a par value of

Rs 4,000, a coupon rate of 4% payable semi-annually &
a maturity period of 16 years.
The buyer of a such a bond would receive an interest of
Rs 80 every six months for 16 years & a principal
amount of Rs 4,000 at the end of 16 years.

 Different types of bonds (Refer Pdf)

 Bond Prices

The value of a bond or any asset is equal to the present

value of the cash flows expected from it. Hence,
determining the value of the bond requires:

 An estimate of the required cash flows

 An estimate of the required rate of return
Following assumptions are generally made in case of
bond valuation:

The coupon interest rate is fixed for the term of the

bond
 The coupon payments are made each year & the
next coupon payment is receivable exactly a year
from now on
 The bond will be redeemed at par on maturity
Given these assumptions the cash flow for a
noncallable bond comprises of an annuity of a fixed
coupon interest payable annually & the principal
amount payable at maturity.

Thus, the value of a bond is:

where, P is the value, n is the number of years to
maturity, C is the annual coupon payment, r is the
periodic return, M is the maturity value & t is the time
period when the payment is received.

Since the stream of the annual coupon payments is an

ordinary annuity the formula for present value of an
ordinary annuity can be applied.
Hence, the bond value is given by the formula:

P = C * PVIFAr,n+ M*PVIFr,n

Problem (Refer Pdf)

 Bond Value with Semi-annual Interest

Most of the bonds pay interest semi-annually. Hence, the formula

for valuation of such bonds will be:

where,
P is the value of the bond, C/2 is the semi-annual interest, r/2 is the
discount rate applicable to a half-year period, M is the maturity
value, 2n is the maturity period expressed in terms of half-yearly
periods.
 Consider a 10 year, 12% coupon bond with a par
value of Rs 600 on which interest is payable semi-
annually. The required rate of return on this bond is
16%.
Please correct
The value of the bond is: the values of
variables
‘C’ ,‘r/2’ & ‘2n’
as per the
problem (stated
above)

or, P= 36*PVIFA 8%,20+600*PVIF8%,20

or, P = 36* 9.818 + 600 *0.215
or,, P = Rs 484.44