1. Financial Management B 642
Valuation of Bonds
Financial Management
B 642

2. Outline Meaning of a Bond Types of Bonds
Features/characteristics of a Bond
How to Value a Bond
Annual Coupon Paying Bonds
Semiannual Coupon Paying Bonds
Bond Yields
Nominal Yield
Current Yield
Yield to Maturity (Required Rate of Return)

3. Meaning of a Bond
Bond represents an agreement between a borrower (issuer) and lender (buyer) whereby
the borrower agrees to make regular interest payments and
to repay the principal at maturity of the loan
It is a debt instrument requiring the issuer also called the debtor or borrower
To pay interest over some specified period of time
to repay to the lender/investor the amount borrowed and
It is the legal obligation of the firm to meet the above two requirements

4. Features of a Bond Face Value Maturity Coupon Callable/Non-callable
Secured/Unsecured Bonds
Registered/Bearer Bonds
Provisions for paying off bonds

5. Types of Bonds Zero Coupon Bonds Floating Rate Bonds Callable Bonds
Convertibles
Eurobonds

6. Valuation of Bonds
Process of determining the fair market value of a financial asset on the basis of present value of expected/anticipated cash flows
Three step process:
Estimate the expected cash flows
Determine the appropriate interest rate or interest rates to discount the cash flows
Compute the present value of the expected cash flows in step 1 by discounted them with interest rate (s) in step 2

7. Value of a Bond Today
Depends on the present value of expected cash flows from the bond
Need to estimate
Expected cash flows
The appropriate required yield/discount rate
What are the expected cash flows for a plain-vanilla bond?
Coupon Payment at regular intervals during the life of the bond
Repayment of principal at maturity of the bond
Par Bonds
Discount Bonds
Premium Bonds

8. Bond Yields Nominal Yield Current Yield Yield to Maturity
Coupon of a bond is the nominal yield of a bond
Current Yield
Annual coupon amount divided by the current market price of the bond
Yield to Maturity
Rate of return promised to an investor if you purchased the bond at the current market price given coupon and maturity of the bond