s2_valuation of bonds
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SECTION 1: CONCEPT OF VALUATION
Book Value
Replacement Value
Liquidation Value
Going Concern Value
Market Value
Intrinsic Value
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VALUATION CONCEPTS
- Accounting concept- Value recorded in books of accounts; historical cost
- BV of Assets = Historical Cost ± Depreciation
- BV of Intangibles = Acquisition cost ± Amortization
- BV of Debt = Stated outstanding amount
- Networth = BV of assets ± BV of liabilities
Book Value
Replacement Value
- Value that will be required to spend if all the assets were to replaced incurrent condition
- Difficult to estimate
- Likely to ignore intangibles and utility of existing assets
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VALUATION CONCEPTS
Liquid at i on Value
- Amount realized if the business is terminated and all assets are sold- Will not include value of intangibles
- Minimum value that company will accept if sold its business
Goi ng Concern Value
- Amount realized if the company sold its business as an operating business
- Always higher than liquidation value
- Reflects future value of assets and intangibles
Market Value
- Current price at which asset or security is being bought or sold in the market
Intri nsi c Value
- Economic value
- PV of cash flows expected from a security discounted at rate of returnappropriated for the risk associated with the security
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SECTION 2: VALUATION OF BONDS
Features of a Bond
Bond Valuation
Bond Yield
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FEATURES OF A BOND
- A long term promissory note for raising loan
- Carries a promise by the borrowing company to make i nterest payment to the
debenture holders of specifi ed amount , at a specified time and also to repay the pri nci pal amount at the end of the specifi ed peri od
F ace Value / Par Value
- Value stated on face of the bond
Coupon Rate
- Interest rate on a bond ; known to bondholders
- Interest = Par Value x Coupon rate
- Interest paid on bond is tax deductible
Maturi ty
- Issued for a specified time and repaid at the end of it i.e. maturity
Red empt i on Value
- Value received by bondholder on maturity
Market Value
- Current price at which bond is being bought or sold in the market
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VALUATION OF A BOND
Bond wi th Maturi ty ± Annual Interest Payment
n C M
P = 7 +
t =1 (1+r )t (1+r )n
Bond wi th Maturi ty ± Semi Annual Interest Payment
2 n C/ 2 M
P = 7 +
t =1 (1+r / 2 )t (1+r / 2 )2n
P = C x P V IF A r,n + M x PVIF r,n
P=C/2 xPVIF A r/2, 2n + M x P V IF r/2,2n
Perpetual Bond
P = C / r
P = Value of bond
C = Annual couponpayment
M = Maturity valuer = Periodic requiredreturn
t = time period whenpayment is received
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1. A Rs. 100 par value bond beari ng coupon rate o f 12% wi ll mature i n 5 years. W hat i s the value o f the bond, if the di scount rate i s 1 5 %?
Ans: Rs. 89.92
2. A Rs. 100 par value bond bears coupon rate o f 14% and matures i n 2
years. Interest i s payable semi annually. Compute value o f the bond, if thedi scount rate i s 16%?
Ans: Rs. 96.72
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PRICE - YIELD RELATIONSHIP
PRICE
YIELD
PRICE CHANGES WITH TIMEVALUE OF
BOND
PREMIUM BOND:
A
PAR VALUE BOND:
B
DISCOUNT BOND:
8 7 6 5 4 3 2 1 0 YEARS TO MATURIT Y
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YIELD TO MATURIT YC C C M
P = + + «. +(1+r ) (1+r )2 (1+r )n (1+r )n
8 90 1,000
800 = 7 +
t =1 (1+r )t (1+r )8
AT r = 13% « RHS = 808
AT r = 14% « RHS = 768.1
YTM
= 13% + (14% - 13%)x 808 - 800 = 13.2%808 ± 768.1
C + (M - P ) / n
YTM
0.4M + 0.6 P
YIELD TO MATURITY
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1. Market pri ce o f a Rs. 1000 par value bond carryi ng coupon rate o f 14%
and maturi ng a f ter 5 years i s Rs. 10 5 0. W hat i s the approx YTM on thi sbond ?
Ans: 12.62%
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SECTION 3: VALUATION OF PREFERENCE
SHARES
Preference Share Valuation
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PREFERENCE SHARE VALUATION
Red eemable Pre f erence Share
n D M
P = 7 +
t =1 (1+r p)t (1+r p)n
Irred eemable Pre f erence Share
P = D / rp
P = Value of preference share
D = Annual dividend
n = Life of preference share
rp = Periodic required return onpreference share
M = Maturity value
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1. Suppose an i nvestor i s consid eri ng to buy a 12 year, 10% Rs.100 par value pre f erence shares. The red empt i on pri ce o f pre f erence share on maturi ty i s Rs. 120. The i nvestor's requi red rate o f return i s 11%. W hat shoul d she be
wi ll i ng to pay f or the share now?
Rs. 99.24