1. Pricing/Valuation of Bond Valuation of Long-Term Securities Valuation of Financial Assets

2. Accounting equation: Assets= liabilities + capitalFA
Also called real assets
( physically existing assets and functioning ) ST LT
Tradable
(Having book value & trade in market)
Bond
Debenture
TFC
Non-tradable
(Only have book value)
Bank loan
Syndicate loan
Also called consotium

3. Bond
Bond is a paper having face value written on the bond and it’s the debt instrument issued by firm or corporate or government.
Debenture
Debenture is also the debt instrument issued by firm having fixed rate of return.

4. TFC (Term Finance Certificate)
TFC is also the debt instrument issued by the firm for raising the short or medium funds.
Syndicate Loan Or Consotium
Joint venture of banks providing a loans to company or corporate.
More than one bank join for providing a loan to company when one bank is unable to provide loan to the company they join with each other.

5. Bond  Coupon (Interest earned on bond you can say it coupon)
Stock  Dividend
Project  NPV (Value creation is value greater than zero)
Company  FCF (Future cash flow)

6. Price/Value
Price is the present value of future cash flow discounted at an appropriate rate of return or discount rate.
On loan cost (interest) we pay denoted by “i”
On tradable cost (interest) we pay denoted by “kd” & “ke”
Kd= Cost of debt
Ke=Cost of equity

7. Financial Asset
Always financial assets are the claims of real asset.

8. Important Steps While Discussing the Bond/Stock
Step-1:- Pricing/Valuation of Bond/Stock
At what price I will buy bond
At what price company will sell the bond
Step-2:- Yield to Maturity (YTM)
Definition:- Average rate of return if the bond is purchased on market price and held till maturity.
YTM is changeable/variable over the life of bond
Coupon is constant over the life of bond

9. Important Steps While Discussing the Bond/Stock
Step-3:- Duration
Duration is average life of bond
Systematic risk of bond/bond market will be just like Beta which is the risk of stock/stock market
Higher the life of bond higher will be the risk
Step-4:- Convexity
Sensitivity of bond price due to change in interest rate

10. Indenture (Steps/Terms of Contract)
Coupon Rate
Interest calculated on the face value of bond
Face Value
It’s the price written on the bond
Maturity
Maturity is the life of bond
Payments Schedule
Frequency of payments (which can be made Annually, Semi-Annually, Quarterly, Monthly)

11. Indenture (Steps/Terms of Contract)
Callable or Not
Either the bond is buy back (callable) or not by company before maturity
Convertible or Not
Either the bond is convert able or not into stock at the time of maturity.
E.g.; If bond price=1000, Market price per share=100, Shares=10

12. Indenture (Steps/Terms of Contract)
Redemption Value (If Callable)
Price of bond before maturity if its callable
Security or Collateral
Either the bond is secured or unsecured
If secured then we can say it Mortgage bond
If unsecured then we can say it Naked bond

13. Types of Bond
Government Bond
Corporate Bond
Domestic Bond
Global Bond

14. Types of Bond Government Bond Issued by state at zero coupon rate
If life of bond is < 1 year we can say it T-Bill
If life of bond is > 1 year we can say it T-Note
T-Bills are always issued in discount bases
Always face value of bond is less than its today price
Face value is same as future value

15. Types of Bond Corporate bond
Issued by the company and maturity will be more than one year.
Two types of corporate bond
Domestic Bond
Offered to only local investors
Global Bond
Offered to local and foreign investor

16. Features of corporate bond
Zero coupon bond
Coupon payment bond
Foreign bond
Euro bond
Sukkuk bond
Dual currency bond
Currency option bond
Cocktail bond
Mortgage bong (secured)
Naked bond (Unsecured)

17. Features of Corporate Bond1
Foreign Bond
If US company issued the bond in Pakistan in Rs
Currency is same as per country
Euro Bond
If US company issued the bond in Pakistan in $
Different currency as per the country currency

18. Features of Corporate Bond2
Dual Currency Bond
Coupon in one currency
Face value in another currency
Currency Option Bond
Coupon is the choice
Face value is the desire of company
Cocktail Bond
Choice on face value
Coupon is the desire of company

19. Features of Corporate Bond3
Zero Coupon Bond
No interest
Coupon Payment Bond
Fixed Rate
Floating Rate
KIBOR + Fixed Rate
KIBOR (Karachi Inter Bank Offering Rate)
Definition:- The rate issued by state bank of Pakistan to commercial banks for lending/borrowing with in the bank

20. Features of Corporate Bond4
Mortgage Bond
Secured bond
Naked Bond
Unsecured bond 5
SUKKUK Bond
Islamic bond
Shari compliance bond

21. Example
10% of 1000 face value bond trading in the market having 5 years life and rate of return (yield rate OR discount rate OR interest rate)
What is the fair price/value of bond
What will be the duration
What will be the convexity is yield rate increases by 1% and decrease by 2%
Note:- The rate which is given before the face value will always represent the coupon rate.

22. Solution Coupon Rate = 10% Face Value = 1000 Coupon Amount = 100
Maturity = 5 years
Kd = 12%
1000

23. Solution P = C1_ + C2__+ C3__+ C4_ + C5__+ FV__
(1 + kd)1 (1 + kd)2 (1 + kd)3 (1 + kd)4 (1 + kd)5 (1 + kd)5
P = _+ 100_+ 100_+ 100_+ 100_ _
(1.12)1 (1.12)2 (1.12)3 (1.12)4 (1.12)5 (1.12)5
P = 927.4
Year
Cash Flows
PVIF
P.V.
CFs * PVIF * t 1
100
0.891
89.1 2
0.797
79.7
159.4 3
0.717
71.1
213.3 4
0.634
63.4
254 5
1100
0.566
623.7
3118.5
Total
927.4
3834.3

24. Solution PVIF(i,t) = 1 _ (1+i) t FVIF(i,t) = (1+i) t
Duration = S (CF*PVIF(i,t)*t) = =4.13
S(CF * PVIF(i,t))
Always duration is less than the life of maturity
PVIF(i,t) = 1 _
(1+i) t
FVIF(i,t) = (1+i) t

25. Solution Convexity = -D * i__ 1+kd D = 4.12 Kd = 12% If increase by 1%
i = 1% increase
Convexity = * 0.01_ =0.037
1.12
= 3.7%

26. YTM (Yield to Maturity)
Kd/Rate of return
Average rate when bond is purchased at market price and held till maturity
Higher the rate, lower will be price or present value
Formula of YTM and pricing is same, if one thing is missing other can be found

27. YTM (Yield to Maturity)
Formula
+ Faced Value
(1+YTM) t
Po = C C C C C FV__
(1+YTM)1 (1+YTM)2 (1+YTM)3 (1+YTM)4 (1+YTM)5 (1+YTM)5
If maturity is 5 years

28. YTM (Yield to Maturity)
YTM can be found by hit & trail method OR Trail & error method
Price/present value of future cash flows of a bond will be equal to its face value
When bond is discounted at coupon rate during its life at any time if,
Coupon rate=Rate of return
Then face value and present value will always equal

29. Selling The Bond Discount Par Premium Mkt < P.V.
YTM > Coupon Rate
Par
Mkt = P.V.
YTM = Coupon Rate
Premium
Mkt > P.V.
YTM < Coupon Rate

30. Yield Curve (Term Structure)
Its a graphical explanation of term structure of interest rate
Its also the relationship between interest rate and maturity period
Longer the life, larger or higher will be the interest rate