CONTENTSKEY LEARNINGSBOND YIELDBOND VALUATION AND PRICINGCREDIT RATINGRISKSYIELD CURVEMALKEILS PROPERTIES
KEY LEARNINGSDebt instruments
Issuers of Bonds
Features of Bonds
Types of Debt Instruments
DEBT INSTRUMENTSA bond is a debt security, in which the issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest (the coupon) and/or to repay the principal at a later date, termed as maturity. Bonds provide the borrower with external funds to finance long-term investments, or, in the case of government bonds, to finance current expenditure.
ISSUER OF BONDSBonds are generally issued byPublic authoritiesCredit institutionsCompaniesThe most common process of issuing bonds is through underwriting.
FEATURES OF BONDNominal, Principal or Face amountIssue priceMaturity dateCoupon rateIndentures and CovenantsCoupon datesOptionality i.e. callability, putability, call dates and put datesSecurity
Types of Debt InstrumentsSecured and unsecured debenturesConvertible and Non-convertible debenturesZero interest fully convertible debenturesSecured Premium NotesCallable and Putable Bond
Floating Rate BondsCoupon rate of these bonds is tied to some benchmarkEg coupon rate =Bank rate +2%Not popular in India
Deep Discount BondsType of zero interest bondNon convertibleRedeemed after expiry of specific period at face valueReturn on these bonds is difference between issue price and maturity valueNo coupon rate and no interest during life of the DDB
Junk BondsHigh risk bondsHigh yield bondsNo or low credit ratingFavourable for speculators
Municipal BondsIssued by civic authorities of a cityObjective is to raise funds for developmentTax benefits may or may not be availableCoupon rate is lowCredit rating of issuing municipiality
*BOND YEILDPercentage rate of return on the amount invested.
Benchmark for evaluating investment instruments.
It may or may not be same as coupon rate.
*Bond Yield Depends on:-PAR VALUE The principal amount of a bond. Issue price and Redemption value may be > or < face value.COUPON RATE (Normal yield) Rate at which fixed annual monetary amount is payable to lender by borrower.MATURITY Period after expiry of which redemption repayment is made to investor.MARKET PRICE Return depends on the price paid for debt.
*TYPES OF YIELDBOND YIELD
NORMAL YIELDCURRENT YIELDYIELD TO MATURITYYIELD TO CALLREALISED YIELDPURPOSE
Coupon rate.Current year rate of return.Annual rate of return till maturity.Annual rate of return till callTotal return over the holding period
*YIELD TO MATURITYIt is market rate of return on market rate of interest.CONDITIONS
Bond is purchased today at current market price.Bond is held by investor till maturity.Interest received are reinvested at YTM itself.No interest default by the company.
*P = Interest * PVAF(YTM,n) + RV * PVF(YTM,n)
P = Market PricePVAF = Present Value Annuity FactorPVF = Present Value FactorYTM = Yield to MaturityN = Life of the Bond in yearsRV = Redemption ValueYIELD TO MATURITY
BOND PRICING AND VALUATION
*QUESTION Investors are generally faced with the question To invest in a particular bond or not
*ANSWER Compare the securitys market price with its value The security could be
Over pricedUnder priced
*VALUE OF A BONDThe value of a bond is defined as the sum of the present values of the future interest payments plus the present value of the redemption repayment.It is discounted at the required rate of return called the market interest rate
*VALUATION OF A ZERO COUPON BOND
Market price Face value of bond of = bond
Where, r = yield to maturity n = maturity period of the bond (1+r )n
*VALUATION OF FIXED INTEREST RATE BONDS
Market price = Interest * PVAF(r,n) + RV *PVF (r,n)
Where, RV = Redemption value
CREDIT RATINGSEach of the agencies assigns its ratings based on an in-depth analysis of the issuer's financial condition and management, economic and debt characteristics, and the specific revenue sources securing the bond.
Credit RiskMoody'sStandard andPoor'sFitch
Very SpeculativeB, CaaB, CCC, CCB, CCC, CC, C
DefaultCa, CDDDD, DD, D
TypeTypical FeaturesCentral Government SecuritiesMedium long term bonds issued by RBI on behalf of GOI.Coupon payment are semi annuallyState Government SecuritiesMedium long term bonds issued by RBI on behalf of state govt.Coupon payment are semi annually
Government Guaranteed BondsMedium long term bonds issued by govt agencies and guaranteed by central or state govt.Coupon payment are semi annually
PSUMedium long term bonds issued by PSU.51% govt equity stakeCorporateShort - Medium term bonds issued by private companies.Coupon payment are semi annually
Risk Associated with Investing in BondsInterest Rate RiskThe price of the bond will change in the opposite direction from the change in interest rate. As interest rate rises the bond price decreases and vice versa.
Reinvestment Income or Reinvestment RiskThe additional income from such reinvestment called interest on interest, depends on the prevailing interest rate levels at the time of reinvestment.
If the issuer of a bond will fail to satisfy the terms of the obligation with respect to the timely payment of interest and repayment of the amount borrowed.
Purchasing power risk arises because of the variation in the value of cash flow from the security due to inflation.
Exchange Rate Risk
Risk associated with the currency value for non-rupee denominated bonds. Eg: US treasury bond
Trading in bonds is very thin. Risk that the investor may not be able to sell the bond when he wants.
Term Structure Of Interest RatesIt depicts the relationship between maturity and interest rates.Graphical representation known as the YIELD CURVE.The curve deals with the YTM and there is an implied assumption that all the interest received will be reinvested at a rate equal to the YTM.
NORMAL YIELD CURVE
INVERSE YIELD CURVE
FLAT YIELD CURVEYIELDMATURITY
MALKIELS PROPERTIESREQUIRED RATE OF RETURN (YIELD TO MATURITY)
As interest rate changes , the bond value also changes. The change in bond value due to change in interest rates is known as Interest Rate Risk.Yield to maturityBond value
Coupon Rate, YTM, Bond Value, and Par ValueIf YTM =Coupon Rate ,then Bond value = Par Value
If YTM < Coupon Rate,then Bond value > Par Value
If YTM > Coupon Rate,then Bond value< Par Value
Bond Valuation and Time to Maturity
The value of the bond approaches its par value as the time to maturity approaches its maturity date.
Values of long-term bonds are more sensitive to interest rate variations than the short-term bonds.
BY:-Akanksha AilawadiAkanksha Sawant Akansha Agarwal Akshat Gupta Himanshi SachdevaPawan AgarwalSaahil ThukralTarandeep Singh SethiVaishali Jaiswal