Bonds • What is bonds • Valuation of bonds
What is a Bond? A Bond represents a contract whereby one party lends money to another on pre-determined terms with regards to rate and periodicity of interest, repayment of principal amount by the borrower to the lender.
Segments of Bonds in India: • Government Bonds- Centre, State & State-sponsored • Corporate Bonds- Commercial papers & Bonds
Terms used frequently: • • • • •
Face Value Market Value Redemption value Coupon rate Maturity
Types of Bonds: On the basis of coupon: • Zero coupon bond • Fixed coupon bond • Floating rate coupon bond
On the basis of option: • Callable bonds • Puttable bonds • Convertible bonds
Basic Bond Valuation Model A technique for determining the fair value of a particular bond.
Calculation using discounting method: Bond Price= ÎŁ Coupon payments (n) + Redemption Value (1+r)^n (1+r)^n
Calculation using Tables: When to use PVIF & when to use PVIFA
Calculation using Excel: Bond Price- Simple Present Value formula is used To compute the YTM- Rate Function is used To compute Effective Annual Rate- EFFECT function is used
Bond Yield: • Current Yield- Relates the Annual Coupon Payments to the Market Price CY= Annual Interest Price • Yield to Maturity- The interest rate at which the present value of cash flows from owning the Bond is equal to its price. • Yield to call- The interest rate at which the present value of cash flows from owning the bond, till the bond is called by the issuer, is equal to its price.
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