28-07-2012, 02:56 PM
BASICS OF VALUATION AND BONDS VALUATION
BASICS OF VALUATION.ppt (Size: 1.22 MB / Downloads: 66)
WHAT IS BOND?
A bond represents a promise to return the bondholder’s money, or principal, on a specified maturity date. Until that time, the borrower also makes periodic interest payments (called coupons) to the bondholder (usually semi-annually or annually) and pay the par value at maturity.
Characteristic of Bonds
Claims on Asset and Income
In the case of insolvency, claims of debt bonds are honored to come ahead those of common or preferred stock.
Par value (M) Its face value that is returned the bondholder at maturity.
Coupon Interest Rate (I) The percentage of the par value of the bond that will be paid out annually in the form of interest.
Maturity (n) The length of time until the bond issuer returns the par value to the bondholder and terminates or redeems the bond.
Indenture
-The bond contract between the firm and the trustee representing the bondholders.
-An indenture sets the terms of the bond; for example, the coupon rate, par value, the period until maturity, any special features like convertibility or whether it is callable, repayment provision and (if any) lists restrictive provisions which are designed to protect bondholders.
Bond Ratings
These ratings involve a judgment about the future risk potential of the bond. The poorer the bond rating, the higher the rate of return demanded in the capital markets.
BOND VALUATION
The essential elements in bond valuation are:
- Interest rate and par value (I & M)
- the time to maturity of the bond (n)
- the investor’s required rate of return (kb)
Discount the bond’s cash flows at the investor’s required rate of return.
the coupon interest rate (an annuity;PVIFA).
the par value payment (a single sum;PVIF).
Main Risks for Bondholders
Changes in current Interest rates – if interest rates rise, the market value of bonds will fall.
Default Risk – this may mean no or partial payment on debt as in bankruptcy cases.
Call Risk – If bonds are called before maturity date. Bond are generally called when interest rates drop. Thus investors will have to reinvest the money received at a lower rate.