1. PRESENTATION BY NYASHA KARASA

2. SECURITY VALUATION -BONDS

3. Organisation of content
Security
Valuation
Lesson objectives
Importance of Securities
Video presentation summarising the topic
Types of Securities
Types of Bonds
Features of bonds
Valuation of redeemable and irredeemable Bonds
Risks associated with Bonds

4. LESSON OBJECTIVES
Security Valuation
Distinguish between direct and indirect claim securities
Describe the general valuation model of bonds
Carry out valuation of redeemable and irredeemable bonds

5. Importance of securities
Security Valuation
Securities are a piece of paper (certificates)that represent the claims that investors have against the assets of the firm. These claims therefore arise because the firm must buy assets in order to generate income and obtains funds from investors who supply funds in the form of loans. The most important forms of long term capital securities that a firm can issue are shares ,debentures or bonds.

6. Importance of securities
Security Valuation
It is important for us to study the value of these claims they represent a cost to the company. The value of a security is determined by the expected cashflows that the investor expects to get from holding the security.

8. Types of securities
Security Valuation
Direct claim securities-which have direct claims against the Cashflows produced by the firm`s assets. The values of these securities are therefore tied directly to the values of the assets on which the investor have a claim. Examples of direct claims securities are bonds also known as debentures.
Indirect claims {also known as derivatives }are securities whose value are derived from the values of other securities.

9. Valuation of securities

10. This can also be presented as Vo =+

11. Where V0 =Value of the asset at time now
CFt =Expected Cash flows at time t
i= Required Rate of Return at time t
n= the life of the asset
The value of a security, such as a bond or a share, is the present value of the expected cashflows discounted at the security’s required rate of return.

12. Bond Valuation
Security Valuation
Bond
Def-It is an instrument with a contractual obligation between the borrower and the lender where the borrower promises to pay back the principle and the interest at specified dates.
It is built upon the concept of time value of money. Financial institutions derive their value from cash flows they generate in future.

13. Types of bonds Treasury Bonds-These are long term government bonds.
Security Valuation
Treasury Bonds-These are long term government bonds.
Corporate Bonds – Those issued by private companies also financial institutions.
Municipal Bonds- those issued by local authorities to finance their expenditure.
Foreign Bonds-Issued by foreign companies and foreign government.

14. Types of Bonds
Security Valuation
Callable and convertible bonds – A callable bond is one which maybe paid off, that is called prior to the date of maturity This is advantageous to the company of the interest rates are expected to fall in the future.
Convertible Bond – is one which can be converted into an agreed number of the firm `s ordinary shares after an agreed period of time.

15. Features of Bonds
Security Valuation
Term to maturity-The time were the borrower is expected to owner obligations thus the date at which the par value must be paid.
Par value ,nominal or face value- it represents the amount of money actually borrowed by the firm .
Coupon – is the interest rate ,the interest can be paid annually or semi annually .For example if a bond is issued at a par value of and a coupon rate of 15%. $1000*0.15=$150

16. Features of Bonds
Security Valuation
Yield to maturity - it is the discount rate that equates the present value of the future cash flows of the bond to the current market price of the bond.
Horizon date -It is the date at which the buyer of the bond desires to liquidate their investments
Zero coupon bond-These are bonds that pay only one payment to the holder at maturity and they are sold at a discount.

17. Valuation of irredeemable bond bonds
Security Valuation
Valuation of irredeemable bond bonds
It is the present value of of a perpetuity.
Vb = INT kd
Where int=Interest rate
Kd =is the required rate of return
E.g a firm issues bonds with a par value of $1 000and a coupon rate of 18% .The required rate of return on these bonds is 24%.What should be the value of these bonds?
Where INT =0.18*1 000 =$ 180

18. Irredeemable bonds Therefore vb =180/0.24 = $ 750
Security Valuation
Therefore vb =180/0.24 = $ 750
Thus $750 is the intrinsic value of the bond .

19. Valuation of redeemable Bonds
Security Valuation
There are two cashflows that are expected annual interest payments that are received from the date of issue up to the date of maturity and the terminal cash flows that is received at the end of the year of maturity.
The pattern of the CFs mimics an ordinary annuity so;
PV= PVIFAn,%× R
Vb =Int/(1+kd)^t +M/1+kd)^n
Where n = number of years to maturity
Kd = required rate of return on the bond

21. Vb = INT ( PVIFA kd,n ) + M ( PVIFkd,n )

22. Valuation of redeemable bonds
Security Valuation
M = the principal repayment when the bond is redeemed .
Vb =INT(PVIFAkd,n)
Example :a company has bonds which are outstanding whose characteristics are as follows Required rate of return Kd =15%
Years left to maturity n =15years
Coupon = 20%,par value = $1000

23. A company has bonds which are outstanding whose characteristics are shown below. Use this information to calculate the value of the bond.
Required rate of return / YTM, kd = 15%
Years left to maturity, n, = 15 years,
Coupon rate = 20%
Par value = $ 1000.

24. Valuation of redeemable bonds
Vb = INT ( PVIFAkd,n ) + M ( PVIFkd,n )
Where, INT = 0.20 x = $200, kd = 0.15
Thus, Vb = 200 ( ) ( ) =
= $
Valuation of redeemable bonds
Where INT (PVIFAkd,n) + M(PVIFkd ,n)
Where ,INT = 0.20 *1000 = $200 ,kd =0.15
Thus vb=200(5.8474) +1000(0.1229)
Vb =
Vb = $

25. Semi annual Compounding
Security Valuation
Divide the annual coupon interest by 2
Multiply the years to maturity by 2 to determine the number of semi annual periods
Divide the annual interest rate (kd) by two.

27. Vb = * +

28. Example
A firm has a bond with a par value of $ and a coupon rate of 18%pa, payable semi- annually. The required rate of return is 14% and the bond has 8 years to maturity. Calculate the value of the bond.

29. Discounts and Premiums on Bonds
If interest rates increase, the required rate of return on a bond will also increase.
If the required rate of return then becomes higher than the coupon rate, the bond will sell at a discount, that is below the par value.
If, on the other hand, interest rates decline, the required rate of return will also decline. If the required rate or return falls to a level which is below the coupon rate, the bond will sell at a premium.

30. When kd is equal to the coupon rate , the bond will sell at par,
When kd is greater than the coupon rate, the bond will sell at a discount,
When kd is less than coupon rate, the bond will sell at a premium,

31. An increase in interest rates will cause the prices of outstanding bonds to decline,
A decline in interest rates will cause the prices of outstanding bonds to increase.
The market value of a bond will always approach par value as its maturity date approaches.

32. Risks associated with bonds
Security Valuation
Coupon Risk
Price Risk
Default Risk
Liquidity risk
Horizon Date and Bond risk
For more information you can follow the link below for a video lecture

33. Questions Briefly outline the characteristics of the following bonds.
Security Valuation
Briefly outline the characteristics of the following bonds.
Convertible bonds
Zero coupon bond
Calculate the market value of a bond with a par value of $1000 ,a coupon rate of 26% per year ,payable semi annually .The bond is trading at a yield of 28%.It has 10 years remaining to maturity.
References

34. Security Valuation
References
Eugine F Brigham et al ,1999,Financial Management (9th Ed) ,The Dryden Press .
Van Horne ,JC ,Financial Management and Policy (9 th Ed),Prentice Hall
Money and Capital Markets ,PS Rose ,Prentice Hall