TOPIC 5 BOND EVALUATION What is bond n

TOPIC 5 : BOND EVALUATION

What is bond? n Publicly traded n Long term debt security n Fixed income securities

Fixed income security n interest payments and the principal repayment for a typical bond are specified at the time the bond is issued and fixed for the life of the bond

Bondissuer Bondholder

Bondissuer and Bondholder The bond issuer is the party who is interested to raise funds through bonds The bond issuer agrees to pay a fixed amount of interest to the bondholder on a periodic basis until a specified maturity date

What happens at maturity date? ? ?

How do you define bond? n Bond is a long term fixed income security in which the issuer (borrower) has agreed to pay fixed income payments for a specified period and to pay a fixed amount of principal at maturity to the bondholder (lender)

Example n Miss Bond Corp. would like to raise RM 1000 through bonds. With this raised fund of RM 1000 Miss Bond will purchase a new machine that would help him to design new product. Miss Bond, the bond issuer promised to pay 10% interest annually for 10 years to the person who purchased his bond. At the end of the ten year period, he will pay the bondholder (the purchaser) the principal amount that is RM 1000.

How much money would you receive altogether from this investment?

n Putting the concept of time value of money aside, you will gain RM 1000 by investing RM 1000. n End of year 10, you will receive n (Principal + interest) = RM 1000 + (RM 100 x 10 years).

Bond Valuation n The price of a bond equals to the present value of the interest payments plus the present value of the principal. n Thus, price is : Vb = Coupon Payment/m(PVIFA r/m, nxm) + Principal (PVIF r/m, nxm )

Vb = Coupon Payment/m(PVIFA r/m, nxm) + Principal (PVIF r/m, nxm ) Where : Vb Coupon Payment = Intrinsic value/price of the bond = Coupon rate x par value m = How many times the coupon payment is paid in a year PVIFA = Table PVIF = Table r = Required rate of return/yield to maturity n = Years remaining to maturity

Example of bond evaluation n i. e Miss Bond Corporation n Assuming the required rate of return of this investment is 12%.

Exercise n You are interested to invest your money in corporate bond. Currently you are evaluating two bonds. Bond ABC and Bond XYZ. Bond ABC pays 8. 5% coupon annually having a maturity period of 10 years. Bond XYZ pays 12% coupon semi-annually (15 years bond) issued 6 years ago. n a) Determine the value of each bond if the market interest rate for both bonds is 10%.

Conclusion n Bond definition n Bond Valuation

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