Bond Valuation

UNIT - 6
BOND VALUATION
1. Current Yield
a. What is the current yield of 10 years 12% coupon bond with a face value of Rs. 1000 and
currently selling at Rs. 950.
Solution: Calculation of Current Yield:
CY = In/Po x 100
In = Annual Interest = 1000 x 12% = 120
Po = 950
CY = 120/950 X 100
CY = 12.63%
Interpretation: since the bond is currently selling at discount (950<1000) hence the current
yield of 12.63% is greater than the coupon rate of 12%.
b. The face value of a bond is 1000 and it is currently selling at Rs. 1200 with a coupon rate of
12% with 10 years to maturity. Calculate the current yield from the bond.
Solution: Calculation of Current Yield:
CY = In/Po x 100
In = Annual Interest = 1000 x 12% = 120
Po = 1200
CY = 120/1200 X 100
CY = 10%
Interpretation: since the bond is currently selling at premium (1200>1000) hence the current
yield of 10% is lesser than the coupon rate of 12%.
2. Spot Interest Rate

a. The face value of a zero coupon bond is 1000. It is currently selling at Rs. 797.19 and the
investor will receive the principal amount of Rs. 1000 after two years of maturity of the
bond. Calculate the spot interest rate on this zero coupon bond.
Solution: Calculation of spot interest rate on zero coupon bond
(1 + k)2 = FV/(1 + k)2
(1 + k)2 = 1000/797.19
(1 + k)2 = 1.2544
(1 + k) = Square root of 1.2544
K = 1.12 -1
K =0.12 or 12%
3. Yield to Maturity
YTM = I + (F – P)/n /0.4F +0.6T

I = Interest
F = Face value of the bond
P = Price of the bond
N = No of years
T = Value of the bond today
a. Mr. Arun recently purchased a bond with Rs. 1000 face value at 10% coupon rate and 4
years to maturity. The bond makes annual interest payment. Mr. Arun paid Rs. 1032.40
for the bond. What is the bond yield to maturity?
Solution: Calculation of Bond yield to maturity
YTM = I + (F – P)/n /0.4F +0.6T
I = 1000 X 10% = 100
F = 1000
P = 1032.40
N = 4 Years
T = 1032.40
YTM = 100 + (1000 – 1032.40)/4 /0.4 X 1000 + 0.6 X 1032.40
= 100 + (-32.40)/4 /400 + 619.44
=100 – 8.1/1019.44
= 91.9/1019.44
YTM = 0.09 or 9%
4. Yield to Call
a. Let's say you buy a bond with a face value of Rs. 1,000 and a coupon
rate of 5%. The bond matures in 10 years, but the issuer can call the
bond for face value (Rs. 1,000) in two years if they choose. You buy the
bond for Rs. 960, a discount to face value. Calculate the yield to call.
Solution: Calculation of Yield to call
YTC = 50+(1000 – 960)/2 /(1000 + 960)/2
=50 + (40)/2 /1960/2
= 50 + 20 / 980
= 70/980
YTC = 0.071 OR 7.1%
5. Bond Duration
a. A bond with face value of Rs.100 , has a coupon rate of 12% issued three years ago is
redeemable after five years from now at a premium of 5%. The interest rate
prevailing in the market currently is 14%. Estimate the bond duration.
Solution: Estimation of Bond Duration:
Year Cash Flow (Rs.) PV Factor at 14% Present Value PV multiplied by year
1 12 0.8772 10.5264 10.5264
2 12 0.7695 9.2340 18.4680
3 12 0.6750 8.1000 24.3000
4 12 0.5921 7.1052 28.4208
5 12 0.5194 6.2328 31.1640
5 105 0.5194 54.5370 272.6850
Total =95.7354 = 386.0402
Bond Duration = Sum of PV multiplied by year/Sum of present value

= 386.0402/95.7354
= 4.03 years
b. A bond has a face value of Rs. 100 redeemable after 5 years. The coupon rate on this bond
is 15% and the maturity is 5 years. The bond will be redeemable at the par of Rs 100 after 5
years. Since the bond is newly issued by the company, the coupon rate will be same as the
market interest rate. And the market price of the bond is also equal to the face value of the
bond. Calculate the bond duration.
Solution: Calculation of Bond Duration
Year Cash Flow (Rs.) PV Factor at 15% Present Value PV multiplied by year
1 15 0.8696 13.0440 13.0440
2 15 0.7561 11.3415 22.6830
3 15 0.6575 9.8625 29.5875
4 15 0.5718 8.5770 34.3080
5 115 (100+15) 0.4972 57.1780 285.8900
Total = 100.0030 = 385.5125
Bond Duration = Sum of PV multiplied by year/Sum of present value

= 385.5125/100.0030
= 3.855 years
Bond Prices
P0 = n sum t=1 * It/(1+k)t +MV/(1+K)n
a. A bond with face value of Rs. 1000 was issued five years ago at a
coupon rate of 10%. The bond had a maturity period of 10 years
and as of today, and therefore 5 more years are left for final
repayment of the bond at par. If the current market interest rate
is 14% calculate the present value of the bond.
Solution: Calculation of Present value of the bond
P0 = n sum t=1 * It/(1+k)t +MV/(1+K)n
= 5 sum t=1 * 100/(1+0.14)t + 1000/(1+0.14)5

= (100 * PV factor for 5 years annuity at 14%)+ (1000*PV factor at
14% for year 5)
= (100*3.4332)+(1000*0.5194)
=343.32+519.40
Present value of the bond =Rs. 862.71
OR
Year Cash flow PV Factor at Present value

14%
1 100 0.8772 87.72
2 100 0.7695 76.95
3 100 0.6750 67.50
4 100 0.5921 59.21
5 100 0.5194 51.94
Total 343.32
MV = 1000 * 0.5194= 519.4

Present value of the bond = 343.32+519.4 = Rs. 862.71

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UNIT - 6

2. Spot Interest Rate

Solution: Calculation of spot interest rate on zero coupon bond

(1 + k)2 = FV/(1 + k)2

(1 + k) = Square root of 1.2544

YTM = I + (F – P)/n /0.4F +0.6T

Solution: Calculation of Bond yield to maturity

YTM = I + (F – P)/n /0.4F +0.6T

I = 1000 X 10% = 100

YTM = 100 + (1000 – 1032.40)/4 /0.4 X 1000 + 0.6 X 1032.40

= 100 + (-32.40)/4 /400 + 619.44

Solution: Calculation of Yield to call

YTC = 50+(1000 – 960)/2 /(1000 + 960)/2

=50 + (40)/2 /1960/2

YTC = 0.071 OR 7.1%

Solution: Estimation of Bond Duration:

Bond Duration = Sum of PV multiplied by year/Sum of present value

Bond Duration = Sum of PV multiplied by year/Sum of present value

P0 = n sum t=1 * It/(1+k)t +MV/(1+K)n

Solution: Calculation of Present value of the bond

P0 = n sum t=1 * It/(1+k)t +MV/(1+K)n

= 5 sum t=1 * 100/(1+0.14)t + 1000/(1+0.14)5

Year Cash flow PV Factor at Present value

MV = 1000 * 0.5194= 519.4

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