1453975109ch 4 Bond Valuation

C H A P TE R - 4
BOND VALUATION
Lesson from this topic
If we both exchange one rupee, we both have one rupee each, but if we exchange one
good thought, we both have two thoughts.
Comparison is the best way to judge your progress. But dont compare with others, just
compare your yesterday with your today.
18
16
14
12
10
8 P
6
4
2
0
M11 N11 M12 N12 M13 N13 M14 N14 M15
M11 = May-2011
N11=Nov-2011
CHAPTER-4 BOND VALUATION 4.1
4.1 Bond
A negotiable certificates evidencing indebtness. It is normally unsecured. A company,

municipality or government agency generally issues a debt security.
Bond issues are considered fixed income securities because they impose fixed financial
obligations on the issuers. The issuers agrees to
(a) Pay fixed amount of interest periodically to the holder of bond.
(b) Repay a fixed amount of principal at the date of maturity.
4.1.1 Some Basics of Bond
(a) Face Value: This is the value stated on the face of the bond and is also known as par
value. It represents the amount of borrowing by the firm which will be repaid after a
specific period of time.
(b) Redemption value of Bond: The Face value of bond is repaid at the end of maturity
period, is known as redemption value of bond. A bond may be redeemed at par, at
premium or at discount.
(c) Market value: A bond may be traded in a stock exchange. Market value is the price at
which the bond is usually bought or sold. Market value may be different from par value.
(d) Coupon Rate or Interest: A bond carries a specific rate of interest which is also called a
coupon rate.
Interest Amt = Face value of Bond x Coupon Rate
(e) Maturity: It is the number of years after which Redemption value is paid.
(f) Call Date: Bonds which can be redeemed prior to maturity. The call date represents the
date at which the bond can be called.
(g) Call Price: It is a price at which Bond can be called back before maturity.
4.2 Bond Value and Yield to Maturity [From Q-1 to 17]

ICAI ICSI ICWA
Nov-2003 M-8 June-2002 M-6 Dec-2002
Nov-2007 M-6 Dec-2003
Nov-2008 M-5 Dec-2004
Nov-2009 M-4
Nov-2010 M-2.5+2.5
Nov-2010 M-5
Nov-2011 M-8
Nov-2013 M-5
May-2015 M-2+2+2
4.2.1 VALUE OF BOND

(a) Bonds with Maturity B0 = Intt x PVAF(n years, RR) + RV x PVF(nth years, RR)
(b) Perpetual Bond B0 = Intt/RR
(c) Zero Coupon Bond B0 = RV x PVF(nth years, RR)
4.2.2 YIELD TO MATURITY (YTM)

(a) The rate of return which makes the discounted value of cash flows equal to the bond's
market value is known as the YTM of the bond. So, a bonds YTM may be defined as the IRR
for a given level of risk.
(b) At YTM
Market value of Bond = PV of Cash flow of Bond at YTM
(c) Approximate YTM

I (l-t)+(RV - NP)/N
Kd = (RV+NP)/2
(d) Find Actual YTM
First we should find two NPV at two different rates, then apply
YTM = LR + [NPVLR x (Diff of Rate)]/(NPVLR NPVHR)
(e) YTM is also known as yield means actual return of bond.
(f) Yield to Maturity

(i) Bonds with Maturity YTM = LR + [NPVLR]*Diff of rate/[NPVLR NPVHR]
(ii) Perpetual Bond YTM = Intt/Actual Market Price
(iii) Zero Coupon Bond YTM = LR + [NPVLR]*Diff of rate/[NPVLR NPVHR]
4.2.3 Pricing of BOND

Conditions Pricing Action
(a) IF B0 > Actual price of Bond Overpriced It should not be purchased or it can be sold
(b) IF B0 < Actual price of Bond Underpriced It should be purchased or it should not be sold
(c) IF B0 = Actual price of Bond Correctly It may be purchased
Note: The appropriate discount rate would depend upon the risk of the bond. The risk in holding
the government bond is less than the risk associated with debentures issued by a company.
Bonds with Maturity

Question-1 A bond of Rs.1,000 bearing a coupon rate of 12% is redeemable at par in 10 years.
Find out the value of the bond if:
(a) Required rate of return of Ram-12%, Shyam-10% and Mohan-14%. [Ans: Rs.1,000;
Rs.1,123.40; Rs.895.92]
(b) If actual Price of Bond is Rs.1050, whether it should be bought or sold.
(c) What is actual YTM for Ram, Shyam & Mohan.
Imp Concept
(a) Value of bond is depended on the required rate of return. Higher the required rate of return
lower will be the value of the Bond and vice versa.
(b) Required rate of return depends on Investor and it may vary from investor to investor.
(c) Same bond may have different fair value for different investor depending on their required
rate of return.
(d) YTM is same for all investors because cash outflow, cash inflow and period are same for all
investor.
Question-1A A Rs.5,000 bond with a 10% coupon rate matures in 8 years.

(a) Calculate value of bond for an investor whose required rate of return is 11 %.
(b) If bond is selling at 97%. What is YTM. [Ans: PV = Rs.4,743; MP = Rs.4,850]
Question-1B [Nov-2009] [N] [M-4] [SP] An investors is considering the purchase of the
following Bond:
Face value Rs.100
Coupon rate 11 %
Maturity 3 years
(a) If he wants a yield of 13% what is the maximum price he should be ready to pay for?
(b) If the Bond is selling for Rs.97.60, what would be his yield?
Question-1C [June-02-CS] [M-6]

Question-1D [Nov-2010] [M-5]
Question-1E [May-2015] [M-2]
4.3 BOND VALUATION BEHAVIOR

[If Redemption value is equal to Face value]
(a) If RR = CR then Bond Value = Par Value.
(b) If RR > CR then Bond Value < Par Value.
(c) If RR < CR then Bond Value > Par Value.
4.4 Bond Value in case of Semi-Annual Interest
Bo = Intt/2 x PVAF(2n years, DR/2) + RV x PVF(2nth years, DR/2)
Question-2 [Nov-2010] [M-2.5] Calculate Market Price of a bond with 7.5% coupon interest,
Face value Rs.10,000 & Term to maturity of 2 years, presently yielding 6%. Interest payable half
yearly.
Question-2A [ICWA-Dec-2002] A Company invested in a 5 year bond issue of another

company in 2010 carrying a coupon rate of 10% p.a. The interest payable at half yearly rests and
the principal repayable after 5 years in 2014 end. The current market yield has fallen to 9%
during 2011. The investor company wanted to take advantage of fall in market yield by selling
the bond to any willing buyer. Compute the value of the bond at the end of 2011. Assume par
value of each bond Rs.1000
Question-2B [SM]
Question-2C [May-2015] [M-2]
4.5 Calculation of value of Bond if Coupon rate changes from year to year
With the change in coupon rate, only interest amt p.a. will change and other part will remain
same.
Question-3 [Nov-2003] [M-8] M/s Agfa Industries is planning to issue a debenture series on the
following terms:
Face value Rs.100
Term of maturity 10 years
Yearly coupon rate
Years
1-4 9%
5-8 10%
9-10 14%
The current market rate on similar debentures is 15% per annum. The Company proposes to
price the issue in such a manner that it can yield 16% compounded rate of return to the
investors. The Company also proposes to redeem the debentures at 5% premium on maturity.
Determine the issue price of the debentures.
Question-3A [CS-Dec-2004] [SP] Blue Ltd is contemplating a debenture issue on the following
terms:
Face value Rs.100
Term of maturity 7 years
Yearly coupon rate
Years
1-2 8%
3-4 12%
5-7 15%
The current market rate on similar debentures is 15% per annum. The Company proposes to
price the issue in such a manner that it can yield 16% compounded rate of return to the
investors. The Company also proposes to redeem the debentures at 5% premium on maturity.
Determine the issue price of the debentures.
4.6 Bond value if required rate of return changes every year

1.26 Calculation of PVF
1) If Discount Rate for n years are same
PVF1 = 1/(1+DR)1
PVF2 = 1/(1+DR)2
PVF3 = 1/(1+DR)3
Example
Same Method 1 Method 2
Year Discount Rate PVF PVF PVF PVF
1 10% 1/(1.1) = 0.909 1/(1.1) = 0.909
2 10% 1/(1.1)(1.1) = 0.826 0.909/(1.1) = 0.826
3 10% 1/(1.1)(1.1)(1.1) = 0.751 0.826/(1.1) = 0.751
4 10% 1/(1.1)(1.1)(1.1)(1.1) = 0.683 0.751/(1.1) = 0.683
2) If Discount Rate for n years are not same
PVF1 = 1/(1+DR1)
PVF2 = 1/(1+DR1)*(1+DR2)
PVF3 = 1/(1+DR1)*(1+DR2)*(1+DR3)
Example
Different Method 1 Method 2
Year Discount Rate PVF PVF
1 10% 1/(1.1) = 0.909 1/(1.1) = 0.909
2 11% 1/(1.1)(1.11) = 0.819 0.909/(1.11) = 0.819
3 12% 1/(1.1)(1.11)(1.12) = 0.731 0.819/(1.12) = 0.731
4 13% 1/(1.1)(1.11)(1.12)(1.13) = 0.647 0.731/(1.13) = 0.647
Question-4 Consider a 10% bond having maturity of 4 years and face value of Rs.1000. The
interest rates in the market expected to be 8% in year 1, 9% in year 2, 11% in year 3 and 12%
in year 4. Calculate value of the bond. Also calculate YTM of the bond if the actual market price of
the bond is equal to value calculated above.
Question-4A [SP] In an economy, the prices of Bonds reveal the following pattern of forward
rates:
Year Forward rates
1 7%
2 8%
3 9%
Suppose you are interested in purchasing a 6%Bond of Rs.1,000, maturity 3 years, what should
be the price?
Question-5 [Nov-2013] [M-5] ABC Ltd issued 9% bonds of Rs.1000 each having a maturity of
3 years. The present interest rate is 12% for one year tenure. It is expected that forward rate of
interest for one year tenure is going to fall by 75 basis points and further by 50 basis points for
very next year in further for the same tenure. This bond has a beta value of 1.02 and is more
popular in the market dues to less credit risk.
Calculate
(a) Intrinsic Value of Bond
(b) Expected price of bond in the market
4.7 Bond price is cum interest
(a) Generally Bond price is ex interest. Bond Price cum Interest means it includes Interest amt
accrued till the date of its valuation
(b) First we will calculate interest amt accrued
(c) Then we will calculate Bond Price ex interest

Bond Price ex Interest = Bond Price cum Interest Interest accrued
Ex: 12% debentures of Rs.100 on which interest is payable annually on 31 Dec.

Bond price cum interest = Rs.110 as on 30/03/2102
30/03/2012 30/06/2012 31/12/2012
Bond Price cum Interest Rs.110 Rs.111 Rs.114
Interest Accrued but not due 3% 6% 12%
Interest amt included in Bond Price Rs.3 Rs.6 Rs.12
Bond Price Ex Interest Rs.107 Rs.105 Rs.102
Question-6 A company has outstanding 8% debentures of Rs.10,00,000 on which interest is

payable annually on 31 Dec. The debentures are due for redemption at par on 1.1.1993. The
market price of debenture on 31.12.1989 was Rs.103 cum interest. Ignore tax. What do you
estimate to be current market rate of interest? (This is also called yield to maturity.)
4.8 Current Yield
(a) Current Yield: Yield to maturity is not the same as the current yield. Current yield is the
annual interest divided by the bonds current value. Current yield considers only the annual
interest and does not account for the capital gain or loss.
(b) Current Yield = Annual Interest / Current Market Price
Question-7 [Nov-2008] [M-5] [Nov-2011] [M-8] Based on the credit rating of the bonds,
Mr. X has decided to apply the following discount rates for valuing bonds:
Credit Rating Discount rate
AAA T - bill rate + 3% spread
AA AAA + 2% spread
A AAA+ 3% spread
He is considering to invest in a AA rated, Rs.1,000 face value bond currently selling at
Rs.1025.86. The bond has five years to maturity and the coupon rate on the bond is 15% p.a.
payable annually. The next interest payment is due one year from today and the bond is
redeemable at par. (Assume the T-bill rate to be 9%). You are required to
(c) Calculate the intrinsic value of the bond for Mr. X. Should he invests in the bond: [Ans:
Rs.1033.95]
(d) Calculate the current yield and the yield to maturity (YTM) of the bond. [Ans: 14.62%,
14.23%]
Imp Concept
In calculation of YTM, interest and capital gain both are considered. While in calculation of
Current Yield, only interest is considered. Capital gain is ignored.
4.8 Calculation of Value or YTM if bond is redeemed in installment
Question-8 ABC Ltd. has raised Rs.50 crore through an issue of 9% bond. Each bond has a face
value of Rs.500 and 10 years term to maturity. As per the terms of the issue each bond is
redeemable in four equal installment starting from the end of 7th year. You are required to find
out the price of the bond if YTM is 13%. And what is the Current Yield? [Ans: Rs.401.16;
11.21%]
Question-8A [SP] A PSU is proposing to sell a 8 years bond of Rs.1,000 at 10% coupon rate
p.a. The bond amount will be amortized equally over its life. If an investor has a minimum
required rate of return of 8%. What is the bond's present value/ Issue Price? [Ans: 1070.33]
Question-9 [SP] Bonds of MIL of FV of Rs.100 with 10% coupon paid semi annually, are selling
at 5% discount on the face value. These bonds will be redeemed at par by equal installments at
the end of 5th and 6th years. MIL has an effective tax rate of 40%. What is the YTM of the Bond.
Question-9A [CS-Dec-2003]
4.9 Holding Period Return

(a) Holding Period is the period for which a Bond is held. The holding period may be few
months or few years. If nothing is specified, we can assume 1 year period as holding
period.
(b) Holding period return on investment

= [(B1 B0) + Interest] x 100/B0
(c) (B1 B0) is known as Capital Gain and (B1 B0)/B0 is known as return due to capital gain
(d) interest/B0 is due to interest and known as current yield
Question-10 A had purchased a bond at a price of Rs.800 with a coupon payment of Rs.150 and
sold it for Rs.1,000.
(a) What is his holding return? [Ans: 43.75%]
(b) If the bond is sold for Rs.750 after receiving Rs.150 as coupon payment, then what is his
holding period return? [Ans: 12.5%]
4.10 Calculation of Bond value at the end of each year till expiration
(a) Bonds with Maturity B0 = Intt x PVAF(n years, RR) + RV x PVF(nth years, RR)
B1 = Intt x PVAF(n-1 years, RR) + RV x PVF([n-1]th years, RR)
B2 = Intt x PVAF(n-2 years, RR) + RV x PVF([n-2]th years, RR)
(b) Perpetual Bond B0 = Intt/RR

B1 = Intt/RR
B2 = Intt/RR
(c) Zero Coupon Bond B0 = RV x PVF(nth years, RR)

B1 = RV x PVF([n-1]th years, RR)
B2 = RV x PVF([n-2]th years, RR)
Question-11 A Company has issued a bond on 1.4.2003 having nominal value of Rs.100 and a
coupon rate of 15% redeemable after 5 years at a premium of Rs.25. An investor whose desired
rate of return is 18% wishes to know the issue price of bond at the end of each year till maturity.
Question-11A [SP] A company invested in a 5 year bond issue of another company in 2002
carrying coupon rate of 10% per annum, the interest payable at half- yearly rests and the
principal repayable after 5 years in 2006 end. The current market yield has fallen to 9% during
2003. The Investor Company wanted to take advantage of the fall in market yield by selling the
bond to any willing buyer. Compute the value of the bond at the end of 2003. Assume par value
of each bond Rs.1,000. [Ans: Rs.1025.90]
4.11 Yield to Call

Yield to Call: A number of companies issue bond with buy back of call provision. Thus a bond
can be redeemed or called before maturity. Yield for call is calculated in the same way as yield to
maturity.
Question-12 Mr. X purchased a bond with Rs.1000 face value. It has 10% coupon rate and 4
years to maturity. Interest is payable annually. Mr. X paid Rs.1032.40 for bond.
(a) What is the bonds yield to maturity? [Ans: 8.98%]
(b) If bond can be called 2 years from now at a price of 1100, what is its yield to call?. [Ans:
12.75%]
Question-12A [SP] A bond is currently traded at Rs.950. Its face value is Rs.1,000. Coupon
rate is 10%. It is redeemable at par after 5 years from today. However the company has an
option of calling it after 3 years from today at 5% premium. Find Yield to Call.
4.12 Value and YTM of Perpetual Bond/ Irredeemable Bond
Value of Irredeemable Bond B0 = Intt/Required rate of return = Intt/YTM
YTM of irredeemable Bond YTM = Intt/Bo
Question-13 A 10% bond of FV of Rs.100 is irredeemable.

(a) Calculate value of Bond if required rate of return is 12%
(b) Calculate YTM if actual price of Bond is Rs.95
Question-13A A Company has sold Rs.1,000, 12% perpetual debentures 10 years ago. Interest
rates have risen since then, so that debentures of this company are now selling at 15% yield
basis.
Determine the current indicated/ expected market price of the debentures. Would you like to buy
the debentures for Rs.700? [Ans: Yes]
Quesiton-14 [Nov-2010] [M-2.5] [N] Calculate Market Price of 10% Government of India
security currently quoted at Rs.110, but interest rate is expected to go up by 1%.
4.13 PURE DISCOUNTS BOND OR DEEP DISCOUNT BONDS (DDB) or Zero

Coupon Bond
[May-2012] [M-4] Write short notes on Zero Coupon Bond
Solution
As name indicates these bonds do not pay interest during the life of the bonds. Instead, zero
coupon bonds are issued at discounted price to their face value, which is the amount a bond will
be worth when it matures. When a zero coupon bond matures, the investor will receive one lump
sum (face value) equal to the initial investment plus interest that has been accrued on the
investment made. The maturity dates on zero coupon bonds are usually long term. These
maturity dates allow an investor for a long range planning. Zero coupon bonds issued by banks,
government and private sector companies.
YTM of Zero Coupon Bond YTM LR + [NPVLR]*Diff of rate/[NPVLR NPVHR]

=
Value of Zero coupon Bond B0 RV*PVF(Required Rate, nth Yr)
Question-15 A DDB is issued for a maturity period of ten years and having a par value of Rs.
25,000. Find out the value of the DDB given that the required rate of return is 15%.
Question-15A [SP] A Deep Discount Bond was issued by financial institution for a maturity
period of 10 years and having a par value of Rs.25000. Find out the value of the Bond if the
required rate of return is 16%.
Question-15B [May-2015] [M-2]
4.13.1 YTM of zero coupon Bond

Question-16 A company issues Zero coupon bonds of 10 years maturity. Issue price Rs.260.
Maturity value Rs.1000. Ignore tax. Calculate YTM?
Question-16A [SP] The following is the list of prices of zero coupon bonds of various maturities.
Calculate the yields to maturity of each bond.
Maturity (Years) Market Price of Rs.1000 face value bond
1 Rs.952.38
2 Rs.890.00
3 Rs.816.30
4.13.2 Imputed Interest income in case of Deep Discount Bond
Imputed Interest first year = B1 B0
Imputed Interest Second year = B2 B1
Imputed Interest Third year = B3 B2 So on
Value of Zero coupon bond at the end of 1st year B1 = B0 + Intt of One year
Question-17 A company issues a 10 years maturity zero coupon bond having face value
(maturity value) of Rs. 1000 on basis of YTM of 10%. What is the imputed interest income in the
first year, second year and 10th year?
4.14 Commercial Paper [Q-18 to 20]

ICAI RTP ICSI ICWA
Nov-2003 M-4 June-2007 M-5
May-2005 M-2 Nov-2011 02
May-2007 M-4 Nov-2014 17
May-2009 M-4
Nov-2012 M-5+4
May-2015 M-2
[Nov-2012] [M-4] Write short notes on commercial paper.

Solution
A Commercial paper is an unsecured money market instrument issued in the form of a
promissory note. The CP comes under the regulation of RBI which issued guidelines in 1990 on
the basis of the recommendations of the Vaghul working group.
These guidelines were aimed at:
(i) Enabling the highly rated corporate borrowers to diversify their sources of short term
borrowings; and
(ii) To Provide additional instrument to the short term investors;
It can be issued for maturities between 7 days and a maximum upto one year from the date of
issue. These can be issued in denominations of Rs.5 lacs or multiples thereof.
Eligibility Criteria for issuer of commercial paper
(i) The tangible net worth of the company is Rs.5 Cr or more as per audited balance sheet of
the company;
(ii) The fund based working capital limit is not less than Rs.5 cr;
(iii) The company is required to get the credit rating from rating agencies such as CRISIL and
ICRA.
(iv) At the time of issue of CP, credit rating should not be more than 2 months old.
(v) The minimum Current Ratio should be 1.33:1
(vi) For public sector company, there are no listing requirement but for companies other than
PSU, the same should be listed on one or more stock exchanges.
(vii) All issue exp shall be born by Company issuing CP.
Imp Concept
(a) Value or YTM of Commercial Paper may be calculated in the same way as of Zero Coupon
Bond.
(b) Only difference between two is that maturity period of zero coupon bond is more than one
year and while maturity period of commercial paper is up to 1 year
(c) It can be issued for maturities between 7 days and a maximum upto one year from the date
of issue. These can be issued in denominations of Rs.5 lacs or multiples thereof
(d) Issue Price/ Purchase Price at t0 = RV/(I+PIR)1
PIR = IR p.a.*No of days of CP/365 or IR p.a.*No of months of CP/12
(e) Value of CP at any day = Purchase Price + Interest due till valuation day
(f) Value of CP at any day = Redemption value Interest to be due till maturity
Question-18 [June-2007-CS] [M-5] Kastor Ltd issued CP as per following conditions:
Date of issue 19/10/2006
Date of maturity 17/01/2007
Interest rate 7.25% p.a.
FV of commercial paper 10 crs
What was the net amount received by the company on issue of commercial paper.
Question-18A [May-2009] [M-4] Z Co. Ltd issued commercial paper worth Rs.10
crores as per following details:
Date of issue: 16 January, 2009
Date of maturity 17 April, 2009
No. of days: 91
Interest rate 12.04% p.a
What was the net amount received by the company on issue of CP? (Charges of intermediary
may be ignored)
Question-18B [Nov-2003] [M-4] [RTP-Nov-2014-17] [SP] M Ltd. has to make a payment

on 30th January, 2004 of Rs.80 lakhs. It has surplus cash today, i.e. 31st October, 2003; and
has decided to invest sufficient cash in a bank's Certificate of Deposit scheme offering an yield of
8% p.a. on simple interest basis. What is the amount to be invested now?
Question-18C [RTP-Nov-2011-2] Suppose Govt. pays Rs.5,000 at maturity for 91 days

Treasury Bill. If Mr. Y is desirous to earn an annualized discount rate of 3.5%, then how he can
pay for it
1.27 Calculation of Effective annual interest rate from periodical interest rate
If Periodic Interest rate is given, and Compounding is periodically

Effective annual Interest = (1+Periodic Interest rate)No of Periods in a year 1
If Periodic Interest rate is given, and Compounding Annually

Effective annual Interest = Periodic Interest rate*12/Period
Question-19 [Nov-2012] [M-5] Calculate the current price and the bond equivalent yield
[using simple compounding] of a money market instrument with the face value of Rs.100 and
discount yield of 8% in 90 days. Take 1 year = 360 days.
Question-19A [May-2007] [M-4] A money market instrument with face value of Rs.100 and
discount yield of 6% will mature in 45 days. You are required to calculate:
(a) Current price of the instrument.
(b) Bond equivalent yield
(c) Effective annual return.
Question-19B [May-2005] [M-2] [SP] RBI sold a 91 day T-bill of face value of Rs.100 at an
yield of 6%. What was the issue price? Calculate effective annual interest rate.
4.15 Calculation of Effective interest rate if Current Market Price and

Redemption value and maturity period is given
(a) Interest amount for the period of CP = Redemption price Issue Price
(b) Interest rate for the period = Interest/Issue Price
Question-20 Ram has deposited Rs.100 and received back Rs.108 after 90 days. Calculate
effective rate of interest p.a.
Question-20A Calculate the effective annual interest rates of the following two securities:
(a) 3 months maturity treasury bill, face value Rs. 1000, currently selling at Rs. 973.
(b) 10 years maturity Government security selling at par; coupon rate is 10% payable half-
yearly.
Question-20B [RTP-Nov-2011-2] [SP] Suppose Mr. X purchase Treasury Bill for Rs.9,940
maturing in 91 days for Rs.10,000. Then would be annualized investment rate for Mr. X and
annualized discount rate for the Govt. Investment.
4.16 Calculation of Total Cost of Fund [Q-21 to Q-22]

ICAI ICSI ICWA
May-2006 M-6
May-2012 M-5
May-2014 M-5
(a) Total Cost of Fund in % = Effective Interest p.a. + Issue Exp p.a. [Like, Brokerage fees,
Stamp Duty]
Question-21 [May-2006] [M-6] From the following particulars calculate the effective interest
p.a. as well as the total cost of funds to ABC Ltd. which is planning a Commercial Paper issue
Issue price of CP Rs.97,350
Face value Rs.1,00,000
Maturity period 3 months
Issue expenses:
Brokerage: 0.125% for 3 month
Rating: 0.5% P.A
Stamp duty: 0.125% for 3 month
Question-21A [May-2012] [M-5] [SP] LMN & Co. plans to issue Commercial Paper (CP) of
Rs.1,00,000 at a price of Rs.98,000.
Maturity Period: 4 Months
Expenses for issue of CP are :
(i) Brokerage 0.10%
(ii) Rating Charges 0.60% and
(iii) Stamp Duty 0.15%
Find the Effective Interest Rate per annum and the cost of Fund.
(b) If Cost of Issue/ Fund is given in amount then

Cost of Issue in % = Cost of Fund in Amt/Net amount utilized for Operation
Question-22 [May-2014] [M-5] AXY Ltd. is able to issue commercial paper of Rs.50,00,000
every 4 months at a rate of 12.5% p.a. The cost of placement of commercial paper issue is
Rs.2500 per issue. AXY Ltd. is required to maintain line of credit Rs.1,50,000 in bank balance.
The applicable income tax rate for AXY Ltd. is 30%. What is the cost of funds (after taxes) to AXY
Ltd. for commercial paper issue? The maturity of commercial paper is four months.
4.17 RELATIONSHIP BETWEEN BOND VALUE AND THE INTEREST RATE RISK
(a) As the interest rate varies, the bond value also changes.
There is a negative relationship between bond values and the market interest rates.
(b) This interest rate risk is higher in case of bonds of longer maturity as compared to the
bonds of shorter maturity. The bond with a longer maturity is more exposed to variations in
interest rate. This argument also explains as to why the short term bonds have lower rate of
interest than the long term bond.
[Nov-2005] [M-2.5] What is the interest rate risk, reinvestment risk and default risk & what
are the types of risk involved in investment in G Sec.
4.17.1 Bond Risk

Unsystematic risk Internal Risk. It refers to default risk i.e, the issuer may default in
payment of interest or principal or both.
Systematic risk It is also known as interest risk. Interest risk refers to change in market
interest rate during the holding period. Systematic risk can be divided in two parts.
Interest Risk: Interest risk refers to change in market interest rate during the holding period.
Bond prices decrease with increase in Market interest and vice versa.
Reinvestment Risk: Change in market interest rate during the holding period affects the return
from the bond investment as the investor shall be reinvesting the interest income of the bond at
the changed rate. The risk here is that the rate at which the interim cash flows are reinvested
may fall thereby affecting the returns.
Default Risk: This type of risk in the context of a Government security is always zero. However,
these securities suffer from a small variant of default risk i.e. maturity risk. Maturity risk is the
risk associated with the likelihood of government issuing a new security in place of redeeming the
existing security. In case of Corporate Securities it is referred to as credit risk.
Two type of risk are involved in G-Sec (i) Interest Risk and (ii) Reinvestment Risk.
4.18 Bond Duration and Interest Rate Sensitivity [Q-23 to 29]
ICAI RTP ICSI ICWA
Nov-2005 M-8 + 8 Nov-2012 Dec-2007 M-6
May-2007 M-6 May-2014 3
May-2009 M-10
4.18.1 Bond Duration

Duration is the weighted average time to receive the PV of Bond. The weights are the present
value of the payment, using the bonds YTM as the discount rate. (Duration is called as Macaulay
Duration)
Two bond with similar maturity but different coupon rate and flow patterns will have different
durations.
The duration of lower coupon bond is higher than the duration of higher coupon bond.
Maturity Period Bond Duration = Through Table OR
[Non Zero Coupon Bond] 1+YTM - (1+YTM) + T(CR-YTM)
YTM CR[(1+YTM)T 1] + YTM
Zero Coupon Bond Bond Duration = Maturity Period
Irredeemable Bond Bond Duration = (YTM+1)/YTM
4.18.2 Volatility of Bond

Volatility refers to the sensitivity of the bond price to change in the current interest rate.
The intensity of the price sensitivity depends on a bonds maturity and the coupon rate of
interest.
The longer the maturity of a bond, the higher will be its sensitivity to the interest rate changes.
Similarly, the price of a bond with low coupon rate will be more sensitive to interest rate
changes.
The volatility or the interest rate sensitivity of a bond:

Volatility of bond = Duration
(1+ YTM/n)
Where n is the no of interest payment in year.
Question-23
Face Value of the Bond = Rs.1000; Coupon Rate = 8.5%; Current market price = Rs.943.15
YTM = 10%. Maturity Period = 5 yrs.
(a) Calculate Bond duration and volatility of the Bond.
(b) Calculate price of bond if YTM is 11%
Question-23A
Face Value of the Bond = Rs.1000; Coupon Rate = 11.5%; Current market price = Rs.1056.85
YTM = 10%. Maturity Period = 5 yrs.
(a) Calculate Bond duration and volatility of the Bond.
(b) Calculate price of bond in YTM is 11%
Question-23B [Nov-2005] [M-8] [CS-Dec-2007] [M-6] [RTP-Nov-2012]

Question-24 [RTP-May-2014-3] [SP]
Mr A is planning for making investment in bonds of one of the 2 companies X Ltd and Y Ltd. The
details of these bonds is as follows:
Company Face Value Coupon Rate Maturity Period
X Ltd Rs.10000 6% 5 Years
Y Ltd Rs.10000 4% 5 Years
The current market price of X Ltds bond is Rs.10796.80 and both bonds have same YTM. Since
Mr A considers duration of bonds as the basis of decision making, you are required to calculate
the duration of each bond and your decision.
Question-25 Duration of bond is 4.50 years. YTM =8% p.a. payable half yearly. Find the %
change in its price if the YTM declines from 8% to 7%.
Question-25A
4.18.3 Bond duration of Zero coupon Bond
Zero Coupon Bond Bond Duration = Maturity Period
Question-26 3 years maturity zero coupon bond is currently sold at Rs.816. Its maturity value is
Rs.1000. Find its duration. YTM is 7%
Imp Note
Bond duration of zero coupon bond is always equal to its maturity period.
4.18.4 Calculation of Bond value on the basis of Bond duration
Question-27 [May-2007] [M-6] [SP] Find the current market price of a bond having face
value of Rs.1,00,000 redeemable after 6 year maturity with YTM at 16% payable annually and
duration 4.3202 years. Given 1.166 = 2.4364
4.18.5 Duration to Call

Question-28 [SP] 11%, ABC Ltd bond is a callable bond with a face value of Rs.1000. it has a
remaining maturity of 5 yrs and the coupon is payable annually. The bond can be called by the
issuer after 3 yrs from now at a call price of Rs.1100. The bond is currently trading at a price of
Rs.985. you are required to calculate the duration to call of 11%, ABC Ltd Bond.
4.19 Sale or purchase of bond on the basis of Bond Duration

There is inverse relationship between interest rate and bond price.
Bond Duration Volatility Change in Bond Price
Larger Larger Large
Smaller Smaller Small
Interest rate expected to be lower Interest rate expected to be higher
Bond price will increase Bond price will decrease
Bond of higher duration should be bought Bond of higher duration should be sold
Bond of lower duration should be sold Bond of lower duration should be bought
Bond Duration of Portfolio

Bond duration of portfolio = BD1*W1 + BD2*W2 + BD3*W3 + BD4*W4 + BD5*W5 +
Question-29 [Nov-2005] [M-8] The Investment portfolio bank is as follows:

Government Coupon Rate Purchase rate Duration
Bond (F.V. Rs.I00 per Bond) .(Years)
G.O.I. 2006 11.68 106.50 3.50
G.O.I. 2010 7.55 105.00 6.50
G.O.I.2015 7.38 105.00 7.50
G.O.I. 2022 8.35 110.00 8.75
G.O.I. 2032 7.95 101.00 13.00
Face value of total Investment is Rs.5 cores in each Government Bond. Calculate actual
Investment in portfolio. What is a suitable action to churn out investment portfolio in the
following scenario?
(a) Interest rates are expected to be lower by 25 basis points.
(b) Interest rates are expected to be raised by 75 basis points.
Question-29A [SP] An inflow of Rs.1500000 is available and is to be invested in the following

bond portfolio in the % specified.
Bond % of Money to be invested Duration of the bond (years)
1 10 10.35
2 22 4.25
3 19 7.50
4 7 9.50
5 17 12.67
6 6 5.82
7 11 8.50
8 8 6.71
(i) The face value of all the above bond is Rs.1000 and the YTM is 9%. Calculate the duration of
the bond portfolio.
(ii) What is a suitable action to churn out investment portfolio in the following scenario?
(a) Interest rates are expected to lower by 25 basis points
(b) Interest rates are expected to raise by 75 basis points
4.20 Convertible Bonds and Debenture [Q-30 to Q-32]

ICAI RTP ICSI ICWA
Nov-2008 M-8 Nov-2012 4
Nov-2009 M-4 May-2013 13
Nov-2010 M-5 May-2015 8
Nov-2011 M-6
May-2014 M-8
These are the bonds which have to be converted into specified number of equity shares of
company issuing these bonds within a specified period.
In India most of the convertible bonds been issued on the basis of compulsory conversion i.e. the
bonds are compulsorily convertible' number of specified number of shares; there is no discretion
of the bond holder. In USA European countries, convertible bonds are option convertible bonds
i.e. conversion takes place if bond holder so desire.
An example of option convertible bond: Suppose a company issues 7% convertible bonds of $

each, maturity 7 years, redemption at par. The bond holder can get his bond converted into 4
equity shares after 2 years of issuance. Now whether the bond will be converted into equity
shares or not, it is at the discretion of the bond holder. Suppose he gets the bonds converted into
shares, the company's liability towards principal and interest will extinguish. If he does not get
the bond converted, he will be entitled to receive interest periodically and on maturity he will get
the redemption amount of $100.
The convertibility option lowers the interest rate that the issuer would otherwise have to pay
without this feature, and it appeals to investors who want current income, but would like to take
advantage of any growth in the issuer company.
Let us understand a few terms related to convertible debentures:
(a) Conversion ratio = The number of shares for which each bond can be converted
(b) Conversion price is the exercise price at which the investor converts his bond into equity
shares.
Conversion Price = Par value of Bond / Conversion Ratio
(c) Conversion parity price of Share or Market conversion price : It is the price of Share
at which CMP of CB and Conversion value would be equal
Conversion parity price of Share = CMP of Convertible Debenture / Conversion Ratio
(d) Straight value of a Bond- This term is used with reference to optional convertible bonds.
The straight bond value is what the convertible bond would sell for if it could not be
converted into equity shares. It is the price of an equivalent non-convertible bond.
Straight Value of Convertible Bond = CMP of Non Convertible Bond
(e) Downside risk: If the share price goes much below the conversion price, it is expected by
market forces that conversion option won't be exercised; the market price of the
convertible bond will be equal to straight value of bond. This will result in loss for the
investor. This loss is referred to as downside risk.
Downside risk or Premium over Investment Value (%)
= (CMP of CB CMP of NCB)*100/CMP of NCB
Downside risk or Premium over Investment Value (Amt)
= (CMP of CB CMP of NCB)
(f) Stock value of bond or Conversion Value of Bond

= CMP of share X Conversion ratio
(g) Conversion premium or Premium over conversion value: The extent by which the
market value of a convertible security exceeds the conversion value.
Conversion Premium or Ratio of Conversion Premium (%) = (CMP of CB Conversion
Value)*100/ Conversion Value
Conversion Premium (Amt) = (CMP of CB Conversion Value)
Conversion Premium per share = Conversion Premium/Conversion Ratio OR
Conversion Premium per share = Conversion Parity Price of Share - CMP of Share
(h) Favorable income differential = Interest Income p.a. Dividend per Share*Conversion
Ratio
Favorable income differential per Share = (Interest Income p.a. Dividend per
Share*Conversion Ratio)/Conversion Ratio
(i) Premium pay back period Financial Services or Break Even Period
= Conversion premium per share/Favorable income Differential Per share OR
= Conversion Premium/Favorable Income Differential
Question-30 M/s Reliance Industries have issued earlier a 11.5% convertible bond of face value
Rs.1,000 maturing in 2007. After a period of 3 years on the option of the investor each of these
bonds can be converted into 50 equity shares of face value Rs.10 each. The investment value of
similar non- convertible bond is Rs.870. The current market prices of the bond and the share are
Rs.970 and Rs.18.50 respectively. The dividend per share for 2000-200 1 is Rs.2.12. You are
required to
(a) Conversion parity price of share
(b) Conversion Premium or Premium over conversion value
(c) Conversion premium per share
(d) Premium over investment value
(e) Favorable income differential
(f) Favorable income differential per share
(g) Break even period.
Question-30A [RTP-Nov-2012-4] [RTP-May-2013-13] [RTP-May-2015-8] [SP] The

following data is related to 8.5% Fully Convertible (into Equity shares) Debentures issued by JAC
Ltd. at Rs. 1000.
Market Price of debenture Rs.900
Conversion Ratio 30
Straight value of Debenture 700
Market Price of Equity share on the date of Conversion 25
Expected Dividend Per share 1
You are required to calculate:
a) Conversion Value of Debenture
b) Market Conversion Price
c) Conversion Premium per share
d) Ratio of Conversion Premium
e) Premium over Straight Value of Debenture
f) Favorable income differential per share
g) Premium pay back period Financial Services
Question-30B [Nov-2010] [M-5]

Question-30C [Nov-2011] [M-6]
Question-30D [Nov-2008] [M-8]
Question-31 [May-2014] [M-8] GHI Ltd., AAA rated company has issued fully convertible
bonds on the following terms, a year ago:
Face value of bond Rs. 1000
Coupon (interest rate) 8.5%
Time to Maturity (remaining) 3 year
Interest Payment Annual, at the end of the year
Principal Repayment At the end of bond maturity
Conversion ratio (number of shares per bond) 25
Current market of convertible bond Rs. 45
Market price of convertible bond Rs. 1175
AAA rated company can issue plain vanilla bonds without conversion option at an interest rates of
9.5%.
Required : Calculate as of today :
(i) Straight Value of bond.
(ii) Conversion Value of the bond.
(iii) Conversion Premium.
(iv)Percentage of downside risk.
(v) Conversion Party price.
T 1 2 3
PVIF of 9.5% 0.9132 0.8340 0.7617
Question-32 [Nov-2009] [M-4] Saran am Ltd. has issued convertible debentures with coupon
rate 12%. Each debenture has an option to convert to 20 equity shares at any time until the date
of maturity. Debentures will be redeemed at Rs.100 on maturity of 5 years. An investor generally
requires a rate of return of 8% p.a. on a 5-year security. As an investor when will you exercise
conversion for given market prices of the equity share of (a) Rs.4, (b) Rs.5 (c) Rs.6.
Cumulative PV factor for 8% for 5 years 3.993
Pv factor for 8% FOR YEAR 5 0.681
4.21 Redemption of old Bond and issue of new Bond [Q-33 to Q-34]
ICAI RTP ICSI ICWA
Nov-2001 Nov-2011
Nov-2005 M-10 Nov-2014
May-2009 M-06
May-2013 M-06
Calculation of PVCO if old bond is not redeemed

Particulars Cash Flow Tax Applicability Year PVCO
Interest on old Bond CO Intt p.a.*(1-TR) t1 to tn PVAF(DR%, n yrs)
RV of Old Bond CO RV tn PVF(DR%, nth yr)
Tax Saving on amortization of Issue cost on old Bond CI Amortisation p.a.*TR t1 to tn PVAF(6%,12 yrs)
Calculation of PVCO if old bond is redeemed with new bond

Particulars Cash Tax Applicability Year PVF/PVAF
Flow
Interest on new Bond CO Intt*(1-TR) t1 to tn PVAF(DR%, n yrs)
RV of new Bond CO RV tn PVF(DR%, nth yr)
Tax Saving on amortization of Issue cost on new Bond CI Amortisation p.a.*TR t1 to tn PVAF(DR%, n yrs)
Issue of new Bond CI (Issue Price-Issue Cost)*No of Bonds t0 1
Redemption of Old Bond including Premium CO Callable Value of old Bond t0 1
Tax saving on premium on old Bond CI Premium on old Bond*TR t1 PVF(DR%, 1 yrs)
Tax saving on writing off of unamortized cost of old CI Unmortised Cost on old Bond*TR t1 PVF(DR%, 1 yrs)
Bond
Question-33 [May-2009] [M-6] [RTP-Nov-2011] ABC Ltd. has Rs.300 million, 12% bonds
outstanding with six years remaining to maturity. Since interest rates are falling. ABC Ltd. is
contemplating of refunding these bonds with a Rs.300 million issue of 6 year bonds carrying a
coupon rate of 10%. Issue cost of the new bonds will be Rs.6 million and the call premium is 4%.
Rs.9 million being the unamortized portion of issue cost of old bonds can be written off no sooner
the old bonds are called off. Marginal tax rate of ABC Ltd. is 30%. You are required to analyse
the bond refunding decision.
Question-33A [Nov-2001] A firm has a bond outstanding of Rs.3,00,00,000. The bond has 12
years remaining until maturity has a 12.5% coupon and is callable at Rs.1,050 per bond. It had
flotation costs of Rs.4,20,000, which are being amortized at Rs.30,000 annually. The flotation
costs for a new issue will be Rs.9,00,000 and the current interest rate will be 10%. The after tax
cost of the debt is 6%. Should the firm refund the outstanding debt? Show detailed working.
Consider corporate income tax at 50%.
Question-33B [May-2013] [M-6]
4.21.1 Overlapping Interest

Question-34 [Nov-2005] [M-10] [RTP-Nov-2014]
M/s Transindia Ltd is contemplating calling Rs.3 crores of 30 years Rs.1000 bond issued 5 years
ago with a coupon interest rate of 14%. The bonds have a call price of Rs.1140 and had initially
collected proceeds of Rs.2.91 crores due to discount of Rs.30 per bond. The initial floating cost
was Rs.360000. The company intends to sell Rs.3 crores of 12% coupon rate, 25 years bonds to
raise funds for retiring the old bonds. It proposes to sell the new bonds at their par value of
Rs.1000. The estimated floatation cost is Rs.400000. The company is paying 40% tax and is after
cost of debt is 8%. As the new bonds must first be sold and their proceeds, then used to retire
old bonds, the company expects a two months period of overlapping interest during which
interest must be paid on both the old and new bonds. What is the feasibility of refunding bonds?
[Ans: NPV = Rs.811980, Refunding of bonds is recommended]
4.22 Calculation of Forward Rate [Q-35 to Q-37]

ICAI ICSI ICWA
Nov-2007
Nov-2008 M-4
May-2010 M-8
This concept is based on Expectation Theory.
(a) Forward rate is the interest rate that we expect today to prevail in the market after
certain period.
(b) Forward rate for the first year is the rate of interest that we expect, in the beginning of
the first year to earn on our investment made in the beginning of the 1st year till the end of
the first year. It is also referred as spot rate for 1st year.
(c) Forward rate for the Second year is the rate of interest that we expect today, to earn on
our investment made in the beginning of the 2nd year till the end of the 2nd year.
And so on.
(d) Calculation of Forward rate for the first year

(1 + YTM) = (1 + FR)
First year YTM and Forward rate is equal
(e) Calculation of forward rate for Second Year

(1+YTM)2 = (1+FR1)(1+FR2)
(f) Calculation of forward rate for third Year

(1+YTM)3 = (1+FR1)(1+FR2) (1+FR3)
Alternative method
B0 = Intt1/(1+FR1) + (Intt2 + RV)/(1+FR1)(1+FR2)
Question-35
What spot and forward rates are implied in the following bonds: (Face value Rs.100)
(a) Bond A Zero-Coupon; Maturity 1 year; Price Rs.93.46
(b) Bond B Coupon 5%; Maturity 2 years; Price Rs.98.13
(c) Bond C Coupon 9%; Maturity 3 years; Price Rs.104.62
Question-35A [May-2010] [M-8] [SP] Consider the following date for Government Securities:
Face value Interest (Rate%) Maturity (Years) Current price (Rs.)
1,00,000 0 1 91,000
1,00,000 10.5 2 99,000
1,00,000 11.0 3 99,500
1,00,000 11.5 4 99,900
Calculate the forward interest rates.
Question-35B [Nov-2007]
Question-36 [Nov-2008] [M-4] The following is the Yield structure of AAA rated debenture:
Period Yield (%)
3 month 8.5%
6 month 9.25
1 year 10.50
2 year 11.25
3 year and above 12.00
(a) Based on the expectation theory calculate the implicit one-year forward rates in year 2 and
year 3.
(b) If the interest rate increases by 50 basis points, what will be the percentage change in the
price of the bond having a maturity of 5 years? Assume that the bond is fairly priced at the
moment at Rs.1,000.
Question-36A [SP] The following table represents the yield curve of a particular types of bonds
issued by a company
Maturity period (Years) YTM %
1 10
2 11
3 12
What are the forward rates?
Question-37 [SP] The YTM of 1-year maturity zero coupon bond is 6% and that of 2-year
maturity zero coupon bond is 7%. If the company issues a 2-year maturity 8% coupon bond of
Rs. 1000 face value, what should be appropriate issue price?
4.23 Value of Bond at date Other than Due date of Interest
(a) First we will calculate ex interest value of bond on due date of Interest
(b) Value of Bond at date other than due date = Bond Value calculated above*(1+PIR)
Question-38 [Nov-2007] [M-6] MP Ltd. issued a new series of bonds on January 1, 2000. The
bonds were sold at par (Rs.1,000), having a coupon rate 10% p.a. and mature on 31st
December, 2015. Coupon payments are made semi-annually on June 30th and December 31st
each year. Assume that you purchased an outstanding MP Ltd. Bond on 1st March, 2008 when
the going interest rate was 12%.
Required:
(a) What was the YTM of MP Ltd. Bonds as on January 1, 2000?
(b) What amount you should pay to complete the transaction? Of that amount how much should
be accrued interest and how much would represent bonds basic value.
4.24 Contribution of Interest and Principal into changes in Price due to change
in YTM
Question-39 [May-2009] [M-20]
Consider two bonds, one with 5 years to maturity and the other with 20 years to maturity. Both
the bonds have a face value of Rs. 1,000 and coupon rate of 8% (with annual interest payments)
and both are selling at par. Assume that the yields of both the bonds fall to 6%, whether the
price of bond will increase or decrease? What percentage of this increase/decrease comes from a
change in the present value of bond's principal amount and what percentage of this
increase/decrease comes from a change in the present value of bond's interest payments?
4.25 Calculation of actual return if Investor invests in different securities

First we have to calculate cash inflow and out flow from different securities and then discount it
by two rate to get actual return like [IRR or YTM]
Question-40 Ram purchased at par a bond with a face value of Rs.1,000. The bond had five
years to maturity and a 10% coupon rate. The bond was called two years later for a price of
Rs.1,200 after making its second annual interest payment. Ram then reinvested the proceeds in
a bond selling at its face value of Rs.1,000 with three years to maturity and a 7% coupon rate.
What was Ram's actual YTM over the five year period?
Question-41 Sen. acquired at par a bond for Rs.1,000 that offered a 15% coupon rate. At the
time of purchase the bond had four years to maturity. Assuming annual interest payments
calculate Sen's actual yield-to-maturity if all the interest payments were reinvested in an
investment earning 18% per year. What would Sen's actual yield-to maturity be if all interest
payments were spend immediately upon receipt?
4.26 Calculation of YTM if there is taxation
In case of taxation, we have to calculate cash inflow and cash outflow after tax and then discount
it by two rate to get YTM
Question-42 [May-2004] [M-8] There is a 9% 5-year bond issue in the market. The issue
price is Rs.90 and the redemption price Rs.105. For an investor with marginal income tax rate of
30% and capital gains tax rate of 10% (assuming no indexation). What is the post-tax yield to
maturity?
CHAPTER-4 BOND VALUATION-SOLUTION 4.1
Solution-1
(a)
Face Value of the Bond = Rs.1000
Coupon Rate = 12%
Interest P.a. = Face Value of the Bond*Coupon Rate = Rs.1000*12% = Rs.120 p.a.
Maturity Period = 10 yrs
RV = Rs.1000 [Assuming]
Value of Bond for Ram
B0 at 12% = Intt x PVAF(10 years, 12%) + RV x PVF(10th years, 12%) = PVCI12% (Not Part of Ans in Exam)
B0 at 12% = 120*5.651 + 1000*0.322 = Rs.1000 = PVCI12% (Not Part of Ans in Exam)
Value of Bond for Shyam

B0 at 10% = 120*6.144 + 1000*0.386 = Rs.1123 = PVCI10% (Not Part of Ans in Exam)
Value of Bond for Mohan

B0 at 14% = PVCI14% = Intt x PVAF(10 years, 14%) + RV x PVF(10th years, 14%) = PVCI14% (Not Part of Ans in Exam)
B0 at 14% = PVCI14% = 120*5.217 + 1000*0.270 = Rs.896.04 = PVCI14% (Not Part of Ans in Exam)
(b) If Actual price of the bond = Rs.1050

Only Shyam will buy it but Ram and Mohan will not buy it.
(c) Actual return of Bond [YTM] for Ram, Shyam and Mohan if they buy it at Rs.1050
Cash Outflow for Ram, Shyam and Mohan = Rs.1050 [not Part of Ans in Exam]
Cash inflow for all of them = Rs.120 intt for 10 years and Rs.1000 at the end of 10th year. [not Part of Ans in Exam]
Since we have cash inflow and outflow, hence we can calculate IRR of above cash inflow and outflow, which is known as
YTM of the Bond [not Part of Ans in Exam]
B0 at 12% = 120*5.651 + 1000*0.322 = Rs.1000
NPV at 12% = PVCI PVCO
= B0 at 12% - Purchase price of Bond or current market price of bond
= Rs.1000 Rs.1050 = - Rs.50
Since NPV is negative, then take Discount rate = 10%
B0 at 10% = 120*6.144 + 1000*0.386 = Rs.1123
= Rs.1123 Rs.1050 = Rs.73
YTM or IRR or Actual Return of Bond = LR + [NPVLR]*Diff of rate/[NPVLR NPVHR]

= 10% + (73*2) /73+50 = 11.18%
Solution-1A
(a)
Coupon Rate = 10%
Interest P.a. = Face Value of the Bond * Coupon Rate = Rs.5000*10% = Rs.500 p.a.
Value of Bond at 11% for an investor
B0 at 11% = 500*5.147 + 5000*0.434 = Rs.4743.50 = PVCI11% (Not Part of Ans in Exam)
(b) If Actual price of the bond = Rs.5000*97% = Rs.4850

Since B0 at 11% < Actual price of Bond, hence bond is overpriced. It should not be purchased.
(c) Actual return of Bond [YTM] if it is purchased at Rs.4850

Cash Outflow = Rs.4850 (Not Part of Ans in Exam)
Cash inflow = Rs.500 intt for 8 years and Rs.5000 at the end of 8th year. (Not Part of Ans in Exam)
Since we have cash inflow and outflow, hence we can calculate IRR of above cash inflow and outflow, which is known as
YTM of the Bond (Not Part of Ans in Exam)
B0 at 11% 500*5.147 + 5000*0.434 = Rs.4743.50
= Rs.4743.50 Rs.4850 = - Rs.106.50
B0 at 10% 500*5.334 + 5000*0.467 = Rs.5000
= Rs.5000 Rs.4850 = Rs.150

= 10% + (150*1)/150+106.50 = 10.58%
Comment: Actual return from bond is 10.58% while required return is 11%, hence bond should not be purchased
Solution-1B
a)
Coupon Rate = 11%
Value of Bond at 13%
B0 at 13% = Intt x PVAF(3 years, 13%) + RV x PVF(3rd year, 13%) = PVCI13% (Not Part of Ans in Exam)
B0 at 13% = 11*2.361 + 100*0.693 = Rs.95.27 = PVCI13% (Not Part of Ans in Exam)
(b) If Actual price of the bond = Rs.97.60

Since B0 at 13% < Actual price of Bond, hence bond is overpriced. It should not be purchased.
(c) Actual return of Bond [YTM] if it is purchased at Rs.97.60

Cash Outflow = Rs.97.60 (Not Part of Ans in Exam)
Cash inflow = Rs.11 intt for 3 years and Rs.100 at the end of 3rd year. (Not Part of Ans in Exam)
B0 at 13% 11*2.361 + 100*0.693 = Rs.95.27
= Rs.95.27 Rs.97.60 = - Rs.2.33
B0 at 11% = 11*2.444 + 100*0.731 = Rs.100
= Rs.100 Rs.97.60 = Rs.2.40

= 11% + (2.40*2)/[2.40+2.33] = 12.01%
Comment: Actual return from bond is 12.01% while required return is 13%, hence bond should not be purchased
Solution-2
Coupon Rate = 7.5%
Interest P.a. = Face Value of the Bond * Coupon Rate = Rs.10000*7.5% = Rs.750 p.a.
Half yearly interest = Rs.750/2 = Rs.375
No of Period = 4 half year
Required rate = 6% p.a.
Required rate = 3% half year
Value of Bond at 3%
B0 at 3% = Half yearly Intt*PVAF(4 half year, 3%) + RV*PVF(4th half year, 3%)
B0 at 3% = 375*3.717 + 10000*0.888 = Rs.10273.88
Solution-2A
Coupon Rate = 10%
Half yearly interest = Rs.100/2 = Rs.50
No of Period = 6 half year
Required rate = 4.5% half year
Value of Bond at 4.5%

B0 at 4.5% = Half yearly Intt*PVAF(6 half year, 4.5%) + RV*PVF(6th half year, 4.5%)
B0 at 4.5% = 50*5.158 + 1000*0.768 = Rs.1025.90
Solution-3
Coupon Rate = varies
RV = at 5% premium = Rs.105
Years Cash inflow (Rs.) PVF @ 16% PV
1 9 0.862 7.758
2 9 0.743 6.687
3 9 0.641 5.769
4 9 0.552 4.968
5 10 0.476 4.76
6 10 0.410 4.10
7 10 0.354 3.54
8 10 0.305 3.05
9 14 0.263 3.682
10 14+105 =119 0.227 27.013
71.327
Thus the debentures should be priced at Rs. 71.327
Solution-3A
Calculation of PV
Years Cash out flow (Rs.) PVF @ 16% PV
1 8 0.862 6.90
2 8 0.743 5.95
3 12 0.641 7.69
4 12 0.552 6.63
5 15 0.476 7.14
6 15 0.410 6.16
7 15 0.354 5.31
7 105 0.354 37.15
82.93
Thus the debentures should be priced at Rs. 82.93
Solution-4
Coupon Rate = 10%
Interest p.a. = Rs.1000*10% = Rs.100
PVAF of Different required rate in different year
Method 1 Method 2
1 8% 1/(1.08) = 0.926 1/(1.08) = 0.926
2 9% 1/(1.08)(1.09) = 0.849 0.926/(1.09) = 0.849
3 11% 1/(1.08)(1.09)(1.11) = 0.765 0.849/(1.11) = 0.765
4 12% 1/(1.08)(1.09)(1.11)(1.12) = 0.683 0.765/(1.12) = 0.683
3.224 3.224
B0 = PVCI Intt*PVAF(4 years) + RV*PVF(4th year)

B0 = PVCI 100*3.224 + 1000*.683 = Rs.1005.40
(b) Actual return of Bond [YTM] if it is purchased at Rs.1005.40

Cash Outflow = Rs.1005.40 [Not part of Ans]
Cash inflow = Rs.100 intt for 4 years and Rs.1000 at the end of 4th year. [Not part of Ans]
B0 at 10% = PVCI10% Intt*PVAF(4 years, 10%) + RV*PVF(4th year, 10%)
B0 at 10% = PVCI10% 100*3.169 + 1000*0.683 = Rs.1000
= Rs.1000 Rs.1005.40 = - Rs.5.40
B0 at 9% = PVCI9% 100*3.239 + 1000*0.708 = Rs.1031.90
= Rs.1031.90 Rs.1005.40 = Rs.26.50

= 9% + (26.50*1)/[26.50+5.40] = 9.83%
Solution-4A
Coupon Rate = 6%
Interest p.a. = Rs.1000*6% = Rs.60
Method 1 Method 2
1 7% 1/(1.07) = 0.935 1/(1.07) = 0.935
2 8% 1/(1.08)(1.07) = 0.865 0.935/(1.08) = 0.865
3 9% 1/(1.07)(1.08)(1.09) = 0.794 0.865/(1.09) = 0.794
2.594 2.594
B0 = Intt*PVAF(3 years) + RV*PVF(3rd year)

B0 = 60*2.594 + 1000*.794 = Rs.949.64
Alternative Method
B0 = PVCI = Price of the bond = [60/(1.07) + 60/(1.07*1.08) + 1060/1.07*1.08*1.09)] = 949.53
Solution-5
(a)
Coupon Rate = 9%
Forward Interest Rate
1st Year = 12%
2nd Year = 11.25%
3rd Year = 10.75%
Method 1 Method 2
1 12% 1/(1.12) = 0.893 1/(1.12) = 0.893
2 11.25% 1/(1.12)(1.1125) = 0.803 0.893/(1.1125) = 0.803
3 10.75% 1/(1.07)(1.08)(1.09) = 0.725 0.803/(1.1075) = 0.725
2.421 2.421
B0 = Intt*PVAF(3 years) + RV*PVF(3rd year)

B0 = 90*2.421 + 1000*0.725 = Rs.942.89
Alternative Method
B0 = Price of the bond = [90/(1.12) + 90/(1.12*1.1125) + 1090/1.12*1.1125*1.1075)] = 942.89
(b)
Beta of Bond = 1.02 [It shows riskiness of Bond with respect to market]
Fair Value of Bond = Rs.942.89
Expected Market Price of Bond = Rs.942.89*1.02 = Rs.961.75
Solution-6
Market Price of Debenture [Cum Interest] = Rs.103 as on 31/12/1989
Coupon Rate = 8%
Interest is payable annually hence intt of Rs.8 is included in above price
Market Price of Debenture [Ex Interest] = Cum Interest price of Debenture Intt Due = Rs.103 Rs.8 = Rs.95
App Return [First DR] = [Interest p.a. + (RV NP)/N]/[(RV+NP)/2] = [8 + (100-95)/3]/(95+100)/2 = 9.91%
(b) Actual return of Bond [YTM] if it is purchased at Rs.95

Cash Outflow = Rs.95 [Not part of Ans]
Cash inflow = Rs.8 intt for 3 years and Rs.100 at the end of 3rd year. [Not part of Ans]
B0 at 10% = Intt x PVAF(3 years, 10%) + RV x PVF(3rd year, 10%)
B0 at 10% = 8*2.486 + 100*0.751 = Rs.94.98
= Rs.94.98 Rs.95 = - Rs.0.02
YTM = 10%
Solution-7
Coupon Rate = 15%
RV = Rs.1000
T B rate =9%
Applicable discount rate
For AAA rating bond=9+3=12%
For AA rating bond=12% + 2% = 14%
B0 at 14% = PVCI14% = Intt x PVAF(5 years, 14%) + RV x PVF(5TH year, 14%)
B0 at 14% = PVCI14% = 150*3.432 + 1000*0.519 = Rs.1033.80
If Actual price of the bond = Rs.1025.86

Since B0 at 14% > Actual price of Bond, hence bond is underpriced. It should be purchased.
(c) Actual return of Bond [YTM] if it is purchased at Rs.1025.86
Cash Outflow = Rs.1025.86 [Not part of answer]
Cash inflow = Rs.150 intt for 5 years and Rs.1000 at the end of 5th year. [Not part of answer]
B0 at 14% = PVCI14% = 150*3.432 + 1000*0.519 = Rs.1033.80
= Rs.1033.80 Rs.1025.86 = Rs.7.94
Since NPV is positive, then take Discount rate = 15%
B0 at 15% = PVCI14% = 150*3.353 + 1000*0.497 = Rs.999.95
= Rs.999.95 Rs.1025.86 = -Rs.25.91

= 14% + (7.94*1)/[7.94+25.91] = 14.234%
Current Yield = Intt amt/Current market price of Bond = 150/1025.86 = 0.1462 = 14.62%
Solution-8
Face value of bond =500
Interest rate =9%
Annual redemption from 7th to 10 year=500/4=125
Year Principal Interest @9% Principal Total PVF =13% Present value
outstanding repayment
1 500 45 - 45 p.a
2 500 45 - 45 p.a 3.998 179.91
3 500 45 - 45 p.a
4 500 45 - 45 p.a
5 500 45 - 45 p.a
6 500 45 - 45 p.a
7 500 45 125 170 .425 72.25
8 375 33.75 125 158.75 .376 59.69
9 250 22.50 125 147.50 .333 49.12
10 125 11.25 125 136.25 .295 40.19
Intrinsic value 401.16
B0 = Rs.401.16
Current Yield = Next income x 100 = 45 x 100 = 11.21%
Current price 401.16
Solution-8A
Face value of bond =1000
Annual repayment = Face value/life =1000/8=Rs.125
Year Principal Interest @10% Principal Total PVF@8% Present value
outstanding repayment
1 1000 100 125 225 .926 208.35
2 875 87.50 125 212.50 .857 182.11
3 750 75 125 200 .794 158.50
4 625 62.50 125 187.50 .735 137.81
5 500 50 125 175 .681 119.18
6 375 37.50 125 162.50 .630 102.38
7 250 25 125 150 .583 87.45
8 125 12.5 125 137.5 .540 74.25
Intrinsic value or fair value of bond 1070.33
Solution-9
Face value of the bond = Rs.100
Purchase price of bond = 95% of face value = Rs.95
Coupon Rate = 10%
Tax rate of MIL = 40% [Not relevant for investor]
Half Yr O/s Amt of Bond Intt Redemption Amt Cash Flow PVF=5% PV PVF=6% PV
0 (95.00) 1.000 (95.00) 1.000 (95.00)
1 100.00 5.00 - 5.00 0.952 4.76 0.943 4.72
2 100.00 5.00 - 5.00 0.907 4.54 0.890 4.45
3 100.00 5.00 - 5.00 0.864 4.32 0.840 4.20
4 100.00 5.00 - 5.00 0.823 4.12 0.792 3.96
5 100.00 5.00 - 5.00 0.784 3.92 0.747 3.74
6 100.00 5.00 - 5.00 0.746 3.73 0.705 3.53
7 100.00 5.00 - 5.00 0.711 3.56 0.665 3.33
8 100.00 5.00 - 5.00 0.677 3.39 0.627 3.14
9 100.00 5.00 - 5.00 0.645 3.23 0.592 2.96
10 100.00 5.00 50.00 55.00 0.614 33.77 0.558 30.69
11 50.00 2.50 - 2.50 0.585 1.46 0.527 1.32
12 50.00 2.50 50.00 52.50 0.557 29.24 0.497 26.09
NPV 5.02 (2.89)

= 5% + (5.02*1)/[5.02+2.89] = 5.63%
Yearly YTM = 5.63%*2 = 11.26%
Solution-10 Holding Period: It is considered to be a period of one year. The bond will provide capital appreciation and
also interest over a year.
Purchase Price = B0 = Rs.800
Sale Price = B1 = Rs.1000
Interest received = Rs.150
Holding Period return = [(B1 B0) + Interest] x 100/B0 = [(1000-800)+150]*100/800 = 43.75%
Return due to capital gain = (B1 B0)*100/B0 = (1000-800)*100/800 = 25%
Current yield = Interest p.a./B0 = 150/800 = 0.1875 = 18.75%
Solution-11
Coupon Rate = 15%
RV = Rs.125
Required rate of return = 18%
Value of Bond at 18% as on 01/04/2003
B0 at 18% = Intt x PVAF(5 years, 18%) + RV x PVF(5TH year, 18%)
B0 at 18% = 15*3.127 + 125*0.437 = Rs.101.53

Value of Bond as on 01/04/2004
B1 at 18% = 15*2.690 + 125*0.516 = Rs.104.85

B2 at 18% = 15*2.174 + 125*0.609 = Rs.108.73

B3 at 18% = Intt x PVAF(2 years, 18%) + RV x PVF(2nd year, 18%)
B3 at 18% = 15*1.565 + 125*0.718 = Rs.113.225

B4 at 18% = Intt x PVF(1 year, 18%) + RV x PVF(1st year, 18%)
B4 at 18% = 15*0.847 + 125*0.847 = Rs.118.58

B5 at 18% = Intt x PVF(0 year, 18%) + RV x PVF(0 year, 18%)
B5 at 18% = 15*1 + 125*1 = Rs.140
Solution-11A The bond was issued at start of 2002

Face Value of bond =1000
Half Yearly Interest =1000 x 10% x 6/12 = Rs.50
Current Yield =9% p.a i.e., 4.5% per half year
The Current date 2003 end assumed that the interest of 2003 has been paid, now remaining period = 6 half years
The intrinsic value of bond at 4.5% half yearly discount rate =
Value of Bond as on 31/12/2003 at 4.5% half year
B0 at 4.5% = Intt x PVAF(6 half year, 4.5%) + RV x PVF(6th half year, 4.5%)
B0 at 4.5% = 50*5.158 + 1000*0.768 = Rs.1025.90
Solution-12
Coupon Rate = 10%
RV = Rs.1000 [Assume]
Purchase price of Bond = Rs.1032.40
Cash inflow = Rs.100 intt for 4 years and Rs.1000 at the end of 4th year. [Not part of Ans]
Value of Bond at 9%
B0 at 9% = 100*3.239 + 1000*0.708 = Rs.1031.90

= Rs.1031.90 Rs.1032.40 = - Rs.0.54
B0 at 8% = 100*3.312 + 1000*0.735 = Rs.1066.20
= Rs.1066.20 Rs.1032.40 = Rs.33.80

= 8% + (33.80*1)/[33.80+0.50] = 8.98%
Calculation of YTC
Coupon Rate = 10%
Call Period = 2 yrs
RV = Rs.1100
Purchase price of Bond = Rs.1032.40
Cash inflow = Rs.100 intt for 2 years and Rs.1100 at the end of 2nd year. [Not part of Ans]

B0 at 12% = Intt x PVAF(2 years, 12%) + RV x PVF(2nd year, 12%)
B0 at 12% = 100*1.690 + 1100*0.797 = Rs.1045.70

= Rs.1045.70 Rs.1032.40 = Rs.13.30
B0 at 13% = 100*1.668 + 1100*0.783 = Rs.1028.10
= Rs.1028.10 Rs.1032.40 = - Rs.4.30

= 12% + (13.30*1)/[13.30+4.30] = 12.75%
Solution-12A
Calculation of YTC
Coupon Rate = 10%
Call Period = 3 yrs
RV = Rs.1050
Purchase price of Bond = Rs.950
Cash inflow = Rs.100 intt for 3 years and Rs.1050 at the end of 3rd year. [Not part of Ans]
Average return per year per Bond (till call): [(400) / (3)] =133.33
Approximate annual yield = [133.33 /950] 100 =14.04%

B0 at 14% = 100*2.321 + 1050*0.675 = Rs.940.85
= Rs.940.85 Rs.950 = - Rs.9.15
B0 at 13% = 100*2.361 + 1050*0.693 = Rs.963.75
= Rs.963.75 Rs.950 = Rs.13.75

= 13% + (13.75*1)/[13.75+9.15] = 13.6%
Solution-13
FV of Bond = Rs.100
Coupon Rate = 10%
Interest p.a. = Rs.100*10% = Rs.10 for indefinite period
RV = 0
(a) Value of irredeemable Bond at 12% [Constant Cash inflows for indefinite period]
B0 at 12% = PVCI12% = Interest p.a./Required Return = Rs.10/0.12 = Rs.83.33
(b) YTM of irredeemable Bond

Maturity Period = Indefinite Period
RV = Rs.0
Cash inflow = Rs.10 for indefinite period [Not part of Ans]
Actual Return = Constant Cash inflow/B0 = 10/95 = 0.1053 = 10.53%
Solution-13A
Face value = Rs.1000
Annual interest = Rs.120 (12%)
YTM = 15%
Time = Infinite
Value of Debenture = Annual Interest/YTM
= 120/.15 = Rs.800
Market price of Debenture = Rs.700
This bond should be purchased.
Solution-14
Face Value = Rs.100 [Assume]
Coupon Rate = 10%
Interest P.a. = Face Value * Coupon Rate = Rs.100*10% = Rs.10 p.a.
Maturity Period = Indefinite Period
Current Market price of Bond = Rs.110
YTM of irredeemable Bond = Intt/Bo = 10/110 = .0909 = 9.09%
If yield go up by 1% i.e. 10.09

then market price would be = Annual Interest/YTM = 10/.1009 = Rs.99.108
Solution-15
Coupon Rate = 0% [No interest is paid every year but it is accumulated into bond value]
RV = Rs.25000
B0 at 15% = Intt x PVAF(10 years, 15%) + RV x PVF(10th year, 15%)
B0 at 15% = 0*5.019 + 25000*0.247 = Rs.6175
Solution-15A
RV = Rs.25000
B0 at 16% = 0*4.833 + 25000*0.227 = Rs.5675
Solution-16
RV = Rs.1000
Issue Price = Rs.260 [Purchase Price]
Cash Outflow = Rs.260 [Not Part of Ans]
Cash inflow = Rs.0 intt for 10 years and Rs.1000 at the end of 10th year. [Not Part of Ans]
Present value of Rs.1,000 to be received after 10 years = Rs.260 [Not Part of Ans]
PV of Re.1 to be received after 10 years =0.26. Consulting the PVF table, we find that the rate of interest in this case is in
the range of 14% to 15%.

B0 at 14% = 0*5.217 + 1000*0.270 = Rs.270
= Rs.270 Rs.260 = Rs.10
B0 at 15% = 0*5.019 + 1000*0.247 = Rs.247
= Rs.247 Rs.260 = - Rs.13

= 14% + (10*1)/[10+13] = 14.434%
Solution-16A
(i)
Maturity Period = 1 yr
RV = Rs.1000
Issue Price = Rs.952.38 [Purchase Price]
Cash Outflow = Rs.952.38 [Not Part of Ans]
Cash inflow = Rs.0 intt for 1 year and Rs.1000 at the end of 1st year. [Not Part of Ans]
Present value of Rs.1,000 to be received after 1 year =Rs.952.38 [Not Part of Ans]
PV of Re.1 to be received after 1 years =0.95238 Consulting the PVF table, we find that the rate of interest in this case is
in the range of 5%
Hence, YTM = 5%
(ii)
RV = Rs.1000
Cash inflow = Rs.0 intt for 2 years and Rs.1000 at the end of 2nd year. [Not Part of Ans]
Present value of Rs.1,000 to be received after 2 year =Rs.890 [Not Part of Ans]
PV of Re.1 to be received after 2 years =0.890 Consulting the PVF table, we find that the rate of interest in this case is in
the range of 6%
Hence, YTM = 6%
Alternative,
1000*(1+r)2 = 890
(1+r)2 = 1.1235
1+r = 1.0599
r = .0599 = 5.99%
(iii)
RV = Rs.1000
Cash inflow = Rs.0 intt for 3 years and Rs.1000 at the end of 3rd year. [Not Part of Ans]
Present value of Rs.1,000 to be received after 3rd years =Rs.816.30 [Not Part of Ans]
PV of Re.1 to be received after 3rd years =0.81630. Consulting the PVF table, we find that the rate of interest in this case
is in the range of 7%.
Hence, YTM = 7%
Solution-17
RV = Rs.1000
YTM = 10%
Value of Bond at 10% at t0
B0 at 10% = 0*6.144 + 1000*0.386 = Rs.386

B1 at 10% = RV x PVF(9th year, 10%)
B1 at 10% = 1000*0.424 = Rs.424

B2 at 10% = RV x PVF(8th year, 10%)
B2 at 10% = 1000*0.467 = Rs.467

B9 at 10% = RV x PVF(1st year, 10%)
B9 at 10% = 1000*0.909 = Rs.909

B10 at 10% = RV x PVF(0 yr, 10%)
B10 at 10% = 1000*1 = Rs.1000
Interest for the period

1st year B1 B0 = 424 386 = Rs.38
nd
2 year B2 B1 = 467 424 = Rs.43
10th Year B10 B9 = 1000 909 = Rs.91
Solution-18
RV of Commercial Paper = FV of commercial Paper = Rs.10 Crs
Maturity Period = 12+30+31+17 = 90 Days
Interest rate = 7.25% p.a.
Interest rate for 90 days = 7.25*90/365 = 1.79%
Since interest is included in RV of CP for 90 days, hence
Issue price = RV/1+0.0179 = 10/1.0179 = 9.82 crs
Solution-18A
(i) Assume that 1 year = 365 days
RV of Commercial Paper = FV of commercial Paper = Rs.10 Crs
Maturity Period = 15+28+31+17 = 91 Days
Interest rate p.a. = 12.04%
Interest rate for 91 days = 0.1204 x 91/365 = 0.03 = 3%
Since interest is included in RV of CP for 91 days, hence
Issue price = RV x PVF(91 days, IR%)
Issue Price = 10 Cr/1.03 = Rs.9.708 Cr
Issue price = Rs.9.708 Crs
Solution-18B
No of days in maturity = 30/01/2004 to 01/11/2003 = 91 days
Annual interest = 8%
Required amt on 30.01.2004 = Rs.80 lakhs [For understanding, it is face value of Bond]
Amt to be deposited = Required Amt*PVF(91 days, IR%)
Amt to be deposited = 80 lacs/1.02 = Rs.78.43 lacs
Solution-18C
No of days in maturity = 91 days
Annual interest = 3.5%
Interest rate for 91 days = 0.035 x 91/365 = 0.0087 = 0.87%
Required amt on 30.01.2004 = Rs.80 lakhs [For understanding, it is face value of Bond]
Amt to be deposited = Required Amt*PVF(91 days, IR%)
Amt to be deposited = 80 lacs/1.02 = Rs.78.43 lacs
Solution-19
No of days in maturity = 90 days
1 year = 360 days
Interest p.a. = 8%
RV = Rs.100
Current Price = RV*PVF(90 days, IR%) = 100/1.02 = Rs.98.039
Current price of money market instrument = Rs.98.039
Equivalent yield or Effective interest rate p.a. = = (1 + PIR)4 1 = (1.02)360/90 1 = 1.0824 1 = 0.0824 = 8.24%
As per suggested answer

Equivalent yield = 2*12/3 = 8% [Assuming compounding annually]
Solution-19A
Interest p.a. = 6%
Interest rate for 45 days = 0.06 x 45/360 = 0.0075
RV = Rs.100
Because interest of 45 days is accumulated in RV
Current price of Instrument = RV*PVF(45 days, IR%)
Current Price = 100/1.0075 = Rs.99.26
(ii) Bond equivalent yield = 0.0075x360/45 = 6%
(iii) Effective annual return is calculated as compounded interest i.e. interest compounding every period of interest.
Hence Effective Interest = (1+PIR)No of Periods in a year 1 = (1.0075)360/45 1 = 6.16%
Solution-19B
Interest rate for 91 days = 0.06 x 91/364 = 0.015 = 1.5%
RV = Rs.100
PV of Redemption value [Because interest of 91 days is accumulated in RV] = RV x PVF(91 days, IR%)
PV of Redemption price = 100/1.015 = Rs.98.52
Issue price = Rs.98.52
(ii) Effective annual return is calculated as compounded interest i.e. interest compounding every period of interest.
Hence Effective Interest = (1+PIR)No of Periods in a year 1 = (1.015)364/91 1 = 1.0613 1 = .0613 = 6.13%
Solution-20
Deposit Amt = Rs.100
Maturity Amt = Rs.108
Period = 90 days
Interest of 90 days is accumulated in maturity amt, hence
Interest amt for 90 days = Maturity Amt Deposit Amt = 108 100 = Rs.8
Interest rate for 3 months = Interest amt/Deposit Amt = Rs.8/100 = 8%
Assuming compounding quarterly
Effective Annual interest = (1 + Quarterly Interest)4 1 = (1.08)4 1 = 1.36 1 = 0.36 = 36%
Solution-20A
(a)
Redemption Value = Rs.1000
CMP of Treasury Bill = Rs.973
Maturity Period = 3 months
Since interest is included in RV of Treasury Bill for 3 months, hence
Interest amt for 3 months = RV CMP of TB = 1000-973 = Rs.27
Periodic Interest rate for 3 months = Interest Amt for 3 months/CMP = 27/973 = 0.02775 = 2.775%
Assuming compounding quarterly
Effective Annual interest = (1 + Quarterly Interest)4 1 = (1.02775)4 1 = 1.1157 1 = .1157 = 11.57%
(b)
Coupon Rate = 10% payable half yearly
Half yearly interest = 5%
Assuming Compounding half yearly
Effective Annual interest = (1 + Half Yearly Interest)2 1 = (1.05)2 1 = .1025 = 10.25%
Solution-20B
CMP or Issue Price = Rs.9940
Maturity Period = 91 days
Interest for 91 days = RV CMP = 10000-9940 = Rs.60
Periodic Interest rate for 91 days = Interest Amt for 91 days/CMP = 60/9940 = 0.0060 = 0.6%
Assuming compounding annually
Effective Annual interest = Period interest rate * 365/Period = 0.6*365/91 = 2.40%
Discount Rate for Govt Investment = Period interest rate * 360/Period = 0.6*360/91 = 2.37%
Solution-21
(a)
CMP or Issue Price of CP = Rs.97350
Since interest is included in RV of CP for 3 months, hence
Interest amt for 3 months = RV CMP = 100000-97350 = Rs.2650
Cost of funds to the company
Effective interest p.a. 10.89%
Brokerage (0.125*4) 0.50%
Rating charge 0.50%
Stamp duty (0.125%*4) 0.50
Cost of funds p.a. 12.39%
Solution-21A
(a)
CMP or Issue Price = Rs.98000
Since interest is included in RV of CP for 4 months, hence
Interest amt for 4 months = RV CMP = 100000-98000 = Rs.2000
Cost of funds to the company
Effective interest 6.12%
Brokerage 0.1% [Assuming Annually] 0.10%
Rating charge = 0.6% [Assuming Annually] 0.60%
Stamp duty = 0.15% [Assuming Annually] 0.15%
Cost of funds 6.97%
Note: In the question it has not been clearly mentioned whether issue expenses pertain to a year or 4 months. Although
above solution is based on the assumption that this expense pertain to year.
Alternative Solution
Cost of Funds to the company [assuming expenses for issue is given for 4months basis]
Effective Interest rate = 6.12%
Brokerage = 0.10*12/4 = 0.30%
Rating Charges = 0.60*12/4 = 1.80%
Stamp Duty = 0.15*12/4 = 0.45%
Cost of Funds = 8.67%
Cost of funds in amount

Assuming issue exp is based on Rs.98000
Cost of Fund = 98000*8.67% = Rs.8496.00
(b) If Cost of Issue/ Fund is given in amount then

Cost of Issue in % = Cost of Fund in Amt/Net amount utilized for Operation
Solution-22
Issue Price = Rs.5000000
Interest Rate = 12.5% p.a.
Interest amt of 4 months = 5000000*12.5%*4/12 = Rs.208333
Cost of Placement per issue = Rs.2500
Total Cost of Issue = Rs.208333+2500 = Rs.210833 [Assuming incurred at the beginning]
Tax rate = 30%
Cost of Issue [NOT] = Rs.210833*0.7 = Rs.147583
Fund remain blocked in bank Account = Rs.150000
Net amount that can be utilized for operation = Rs.5000000-210833-150000 = Rs.4639167
Cost of Fund = Cost of Issue/Net Amount of Utilisation = 147583/4639167 = 0.0318 = 3.18% for 4 months
Cost of Fund p.a. = 3.18*12/4 = 9.54%
Solution-23
Face value of the Bond = Rs.1000
Coupon Rate = 8.5%
Interest Amt = Rs.85
RV = Rs.1000
Bond Duration
Year Cash Inflow PVF=10% PV Weight Weight * Year
1 85.00 0.909 77.27 0.082 0.082
2 85.00 0.826 70.21 0.074 0.149
3 85.00 0.751 63.84 0.068 0.203
4 85.00 0.683 58.06 0.062 0.246
5 1,085.00 0.621 673.79 0.714 3.572
PV of Bond 943.15 1.000 4.252
Bond Duration = 4.252 yrs
Volatility of Bond = Bond Duration/[1+YTM/n]
Volatility of Bond = 4.252/1.1 = 3.865%
Volatility of bond says that if YTM increase by 1% then price of bond will decrease by 3.865% and vice versa
(b)
Volatility of Bond = 3.865%
Current market price of Bond = Rs.943.15
Current YTM = 10%
If YTM increase by 1% then price of bond will decrease by 3.865%
Hence price of bond at 11% YTM = Current maket price of Bond * [1-Volatility of Bond*(Increase in YTM)]
= Rs.943.15(1-0.0386*1) = Rs.943.15*0.9614 = Rs.906.7444
Cross verification of price of Bond at YTM = 11% [Not part of ans in Exam]
Year Cash Inflow PVF=11% PV
1 85.00 0.901 76.59
2 85.00 0.812 69.02
3 85.00 0.731 62.14
4 85.00 0.659 56.02
5 1,085.00 0.593 643.41
PV of Bond 907.16
Solution-23A
Face value of the Bond = Rs.1000
Coupon Rate = 11.5%
Interest Amt = Rs.115
RV = Rs.1000
Bond Duration
1 115.00 0.909 104.54 0.099 0.099
2 115.00 0.826 94.99 0.090 0.180
3 115.00 0.751 86.37 0.082 0.245
4 115.00 0.683 78.55 0.074 0.297
5 1,115.00 0.621 692.42 0.655 3.276
PV of Bond 1,056.85 1.000 4.097
Volatility of bond says that if YTM increase by 1% then price of bond will decrease by 3.724% and vice versa
(b)
Volatility of Bond = 3.724%
Current market price of Bond = Rs.1056.85
Current YTM = 10%
If YTM increase by 1% then price of bond will decrease by 3.724%
Hence price of bond at 11% YTM = Current maket price of Bond * [1-Volatility of Bond*(Increase in YTM)]
= Rs.1056.85*(1-.03724*1) = Rs.1056.85*0.96276 = Rs.1017.493
Cross verification of price of Bond at YTM = 11% [Not part of Ans in Exam]
Year Cash Inflow PVF=10% PV
1 115.00 0.901 103.62
2 115.00 0.812 93.38
3 115.00 0.731 84.07
4 115.00 0.659 75.79
5 1,115.00 0.593 661.20
PV of Bond 1,018.04
Solution-24
For calculation of duration of bond, we need YTM
WN-Calculation of YTM of X Ltds Bond
CMP of Bond = Rs.10796.80
FV = Rs.10000
CR = 6%
Interest p.a. = Rs.10000*6% = Rs.600 p.a.
Maturity Period = 5 years
B0 at 6% = Rs.10000 [Since FV and RV is equal]
NPV at 6% = B0 at 6% - CMP of bond
= Rs.10000 Rs.10796.80 = - Rs.796.80
B0 at 4% = 600*4.453 + 10000*0.822 = Rs.10891.80
NPV at 12% = Rs.10891.80 Rs.10796.80 = Rs.95

= 4% + (95*2)/(95+796.80) = 4.20%
Calculation of Bond duration of X Ltds Bond at YTM = 4.20%

1 600 0.960 576.00 0.053 0.053
2 600 0.921 552.60 0.051 0.102
3 600 0.884 530.40 0.049 0.147
4 600 0.848 508.80 0.047 0.189
5 10,600.00 0.814 8,628.40 0.799 3.996
PV of Bond 10796.20 1.000 4.488
Bond Duration of X Ltds Bond= 4.488 yrs
Calculation of Bond duration of Y Ltds Bond at YTM = 4.20%

Coupon Rate = 4%
1 400 0.960 384.00 0.039 0.039
2 400 0.921 368.40 0.037 0.074
3 400 0.884 353.60 0.036 0.107
4 400 0.848 339.20 0.034 0.137
5 10,400.00 0.814 8,465.60 0.854 4.271
PV of Bond 9,910.80 1.000 4.628
Bond Duration of Y Ltds Bond= 4.628 yrs
Decision: Since the duration of Bond of X Ltd is lower, hence it should be preferred.
Solution-25
YTM = 8% p.a.
Volatility of bond says that if YTM increase by 1% then price of bond will decrease by 4.326% and vice versa.
There is inverse relationship between Bond price and YTM, if YTM decreases by 1%, then price of the Bond will increase
by 4.326%
Solution-26
Period Cash Inflow PVF = 7% PV of cash Proportion of PV Period x
inflows Proportion
1 0 0.935 0 0 0
2 0 0.873 0 0 0
3 1000 0.816 816 1 3
Total 816 1 3
Duration = 3
Solution-27
Let annual interest = C
Year Cash Flow PVF = 16% PV of Cash Inflow PV of Cash Inflow * Year
1 C 0.862 C0.862 0.862c
2 C 0.743 C0.743 1.486c
3 C 0.641 C0.641 1.923c
4 C 0.552 C0.552 2.208c
5 C 0.476 C0.476 2.308c
6 C 0.410 C0.410 2.460c
6 100000 0.410 1,00,0000.410 2,46,000
3.684C +41000 246000 +11.319c
Bond Duration = Sum of [PV of Cash Inflow*Year]/Current price of Bond
4.3203 = (246000 +11.319C) / (3.684c +41000)
15.915985 C +177132.3 =246000 +11.319 C
4.596985 C =68867.7
C =14981 say 15000
Coupon rate =15%
Interest p.a. = FV of Debenture*Coupon rate = Rs.100000*15% = Rs.15000
Current price of debenture = Intt*PVAF(6 yrs, 16%) + RV*PVF(6th yr, 16%) = 15000*3.685 +100000*0.410 =96275
Solution-28
Calculation of YTC
Coupon Rate = 11%
Call Period = 3 yrs
RV = Rs.1100

B0 at 13% = 110*2.361 + 1100*0.693 = Rs.1022.01
= Rs.1022.01 Rs.985 = Rs.37.01
B0 at 15% = 110*2.284 + 1100*0.658 = Rs.975.04
= Rs.975.04 Rs.985 = - Rs.9.96
YTC or IRR or Actual Return of Bond = LR + [NPVLR]*Diff of rate/[NPVLR NPVHR]

= 13% + (37.01*2)/[37.01+9.96] = 14.575%
Duration to call for 11%, ABC Ltd Bond

Year Cash Inflow PVF=14.575% PV Weight Weight * Year
1 110.00 0.873 96.03 0.098 0.098
2 110.00 0.762 83.82 0.085 0.170
3 1,210.00 0.665 804.65 0.817 2.452
984.50 1.00 2.72
Solution-29 Calculation of Actual investment of Portfolio and Bond Duration of Portfolio
Purchase Face of Security Amt of Bond of Duration of

Security Price Purchased Investment Weight Bond Duration Portfolio
GOI 2006 106.50 5.00 532.50 0.20 3.500 0.707
GOI 2010 105.00 5.00 525.00 0.20 6.500 1.294
GOI 2015 105.00 5.00 525.00 0.20 7.500 1.493
GOI 2022 110.00 5.00 550.00 0.21 8.750 1.829
GOI 2032 101.00 5.00 505.00 0.19 13.000 2.483
Total Investment 2,637.50 1.00 Bond Duration 7.806
Suitable action to churn out investment portfolio in following scenario

To reduce risk and to maximize profit or minimize losses
(a) There is inverse relationship between Interest rate and price of Bond. Bond having high duration will have high
volatility and vice versa. Hence if interest rates are expected to be lower by 25 basis points, in such case, we should
increase the average duration of our portfolio by purchasing bond having high duration i.e. GOI 2032 and selling bond
having low duration i.e. GOI 2006.
(b) There is inverse relationship between Interest rate and price of Bond. Bond having high duration will have high
volatility and vice versa. Hence if interest rates are expected to be increased by 75 basis points, in such case, we should
decrease the average duration of our portfolio by purchasing bond having low duration i.e. GOI 2010 and selling bond
having having duration i.e. GOI 2032.
Solution-29A
(i) Calculation of Weighted average duration of portfolio
Bond % of Money to be invested Duration of the bond (years) % * Duration
1 10 10.35 1.035
2 22 4.25 0.935
3 19 7.50 1.425
4 7 9.50 0.665
5 17 12.67 2.1539
6 6 5.82 0.3492
7 11 8.50 0.935
8 8 6.71 0.5368
8.00
Bond duration of Portfolio = 8.00 yrs
(ii) Suitable action to churn out investment portfolio in following scenario

To reduce risk and to maximize profit or minimize losses.
(a) There is inverse relationship between Interest rate and price of Bond. Bond having high duration will have high
volatility and vice versa. Hence if interest rates are expected to be lower by 25 basis points, in such case, we should
increase the average duration of our portfolio by purchasing bond having high duration i.e. Bond 5 and selling bond
having low duration i.e. Bond 4.
(b) There is inverse relationship between Interest rate and price of Bond. Bond having high duration will have high
volatility and vice versa. Hence if interest rates are expected to be increased by 75 basis points, in such case, we should
decrease the average duration of our portfolio by purchasing bond having low duration i.e. Bond 6 and selling bond
having duration i.e. Bond 5.
Solution-30
CMP of convertible bond = 970
No of equity shares on conversion = 50 shares
CMP of share =18.50
Convertible value of convertible bond =18.50 x 50 = 925
CMP of non-convertible bond or Straight value of Bond =870
Interest on convertible bond =11.5% of 1000 = 115
Dividend per share =2.12
(i)
Conversion parity price of Share = CMP of CB /Conversion Ratio = 970/50 Rs.19.40
(ii) Premium over conversion value

Conversion Premium or Premium over conversion value or Ratio of Conversion Premium
= (CMP of CB Conversion Value)*100/ Conversion Value
= (970-925)*100/925 = 4.86%
Conversion Premium or Premium over conversion value (Amt) = (CMP of CB Conversion Value) = 970-925 = Rs.45
(iii) Conversion premium per share

Conversion premium per Share = Conversion Premium/Conversion Ratio = 45/50 = Rs.0.90
Conversion Premium per share = Conversion Parity Price of Share - CMP of Share = = 19.40 18.50 = Rs.0.90
(iv) Premium over Investment

Downside risk or Premium over Investment Value (%) = (CMP of CB CMP of NCB)*100/CMP of NCB
= (970-870)*100/870 = 11.49%
Downside risk or Premium over Investment Value (Amt) = (CMP of CB CMP of NCB) = (970-870) = Rs.100
(v)
Annual dividend on 50 shares = Rs.2.12*5 = Rs.106
Annual interest on CB = Rs.115
Favorable income differential = Interest Income p.a. Dividend per Share*Conversion Ratio = 115-106 = Rs.9
Favorable income differential per Share = (Interest Income p.a. Dividend per Share*Conversion Ratio)/Conversion
Ratio = (115-106)/50 = Rs.0.18
(vi)
Premium pay back period Financial Services or Break Even Period = Conversion Premium/Favorable Income Differential
= Rs.45/5 = 5 Years OR
= Conversion Premium per Share/Favorable Income differential per share = 0.9/0.18 = 5 years
Solution-30A
a) Conversion value of Debenture = CMP of Equity share x Conversion Ratio =25x30 = Rs.750
b) Market Conversion Price = CMP of CB /Conversion Ratio = 900/30 = Rs.30
c) Conversion Premium per share
Conversion Premium = (CMP of CB Conversion Value) = 900-750 = Rs.150
Conversion Premium per share = Conversion Premium/Conversion Ratio = Rs.150/30 = Rs.5 OR
= Conversion Parity Price of Share CMP of Share =30-25 = Rs.5
(d)
Conversion Premium or Premium over conversion value or Ratio of Conversion Premium
= (CMP of CB Conversion Value)*100/ Conversion Value = (900-750)*100/750 = 20%
(e) Premium over Straight Value Debenture

Downside risk or Premium over Investment Value (%) = (CMP of CB CMP of NCB)*100/CMP of NCB
= (900-700)*100/700 = 2 8.57%
Downside risk or Premium over Investment Value (Amt) = (CMP of CB CMP of NCB) = (900-700) = Rs.200
(f)
Annual dividend on 30 shares = Rs.1*30 = Rs.30
Annual interest on CB = Rs.85
Favorable income differential = Interest Income p.a. Dividend per Share*Conversion Ratio = 85-30 = Rs.55
Favorable income differential per Share = (Interest Income p.a. Dividend per Share*Conversion Ratio)/Conversion
Ratio = (85-30)/30 = Rs.1.833
(g)
Premium pay back period Financial Services or Break Even Period = Conversion Premium/Favorable Income Differential
= Rs.150/55 = 2.73 Years OR
= Conversion Premium per Share/Favorable Income differential per share = 5/1.833 = 2.73 years
Solution-31
Coupon Rate of CB = 8.5%
Interest P.a. = Face Value of the Bond*Coupon Rate = Rs.1000*8.5% = Rs.85 p.a.
Coupon rate of NCB = 9.5%
B0 at 9.5% = Intt x PVAF(3 years, 9.5%) + RV x PVF(3rd years, 9.5%)
B0 at 12% = 85*2.5089 + 1000*0.7617 = Rs.975
(i) Straight Value of Bond = Rs.975
CMP of convertible bond Rs.1175

Conversion Ratio 25
CMP of share Rs.45
CMP of non-convertible bond or Straight value of Bond Rs.975
Interest on convertible bond 8.5%
(ii)
Conversion value of Bond = CMP of share*Conversion Ratio = Rs.45*25 = Rs.1125
(ii) Conversion Premium or Premium over conversion value or Ratio of Conversion Premium
= (CMP of CB Conversion Value)*100/ Conversion Value
= (1175-1125)*100/1125 = 4.44%
Conversion Premium or Premium over conversion value (Amt) = (CMP of CB Conversion Value) = 1175-1125 = Rs.50
(ii) Conversion premium per share [As per Suggested]

Conversion premium per Share = Conversion Premium/Conversion Ratio = 50/25 = Rs.2
(iii) % of Downside risk or Premium over Investment Value (%) = (CMP of CB CMP of NCB)*100/CMP of NCB
= (1175-975)*100/975 = 20.51%
(iv) Conversion parity price of Share = CMP of CB/ Conversion Ratio = 1175/25 = Rs.47
Solution-32
Face Value of the Debenture = Rs.100
Coupon Rate = 12%
RV = Rs.100
RR = 8%
Value of Debenture at 8% if it is not converted into share
B0 at 8% = Intt x PVAF(5 years, 8%) + RV x PVF(5th years, 8%)
B0 at 8% = 12*3.993 + 100*0.681 = Rs.116.01
Convertible value of debenture

CMP of Share Convertible Ratio Convertible Value of Debenture
Rs.4 20 Rs.80
Rs.5 20 Rs.100
Rs.6 20 Rs.120
Hence, unless the market price is Rs. 6 conversion should not be exercised.
Solution-33
Option 1 If Old Bond is not redeemed
Existing outstanding debts =300 M
Interest rate =12%
Interest P.a. = Rs.300*12% = Rs.36 m for 6 years
Remaining life =6 years
Unamortized issue cost =9M
Amortisation of Issue cost p.a. = 9/6 = 1.5m
Assume Unamortised cost is tax deductible
Tax rate = 30%
Cost of Capital = 10%*0.7 = 7%
PV of Cash out flow if old Bond is continuously used (Amt in m)
Year Particulars Amt PVF=7% PVCO
1 to 6 Interest on old Bond 36*0.7 4.766 120.10
6th RV of Old Bond 300 0.666 199.80
1 to 6 Tax Saving on amortization of Issue cost on old Bond -1.5*0.3 4.766 -2.145
317.75
Option 2 If Old Bond is redeemed and new Bond is issued

Callable Value of Old Bond = 4% Premium
Total Callable Value of Old Bond = 300*1.04 = Rs.312 m
Premium payable on old bond =Rs.12m
Floatation cost of new bond = Rs.6m
Amortisation cost of New Bond p.a. = Rs.6/6 = 1m p.a.
Coupon Rate of New Bond = 10%
New bond issue value = 300 m
Intt p.a. on new Bond = Rs.300*10% = Rs.30m
Net receipt on issue of new bond = 300 - 6(issue cost)] = 294 m
1 to 6 Interest on new Bond 30*0.7 4.766 100.08
6th RV of new Bond 300 0.666 199.80
1 to 6 Tax Saving on amortization of Issue cost on new Bond -1*0.3 4.766 -1.43
0 Issue of new Bond (Net Receipts) -294 1 -294
0 Redemption of Old Bond including Premium 312 1 312
1 Tax saving on premium on old Bond -12*0.3 0.935 -3.37
Tax saving on writing off of unamortized cost of old Bond -9*0.3 0.935 -2.58
310.50
Since PVCO under option 2 is less than option 1, hence Bond should be redeemed
Solution-33A
Existing outstanding debts = 300 lakh
Interest rate =12.5%
Interest P.a. = Rs.300*12.5% = Rs.37.50 lakhs for 12 years
Remaining life =12 years
Unamortized issue cost = 12*30000 =3.60 lakhs
Tax rate = 50%
PV of Cash out flow if old Bond is continuously used
Year Particulars Amt (Lacs) PVF=6% PVCO
1 to 12 Interest on old Bond 37.50*0.5 8.383 157.18
12th RV of Old Bond 300 0.497 149.10
305.03

Callable Value of Old Bond = 1050 per Bond
Total Callable Value of Old Bond = 1050*300/1000 = Rs.315 lacs
Premium payable on old bond =Rs.15 lacs
Floatation cost of new bond = Rs.9 lacs
Amortisation cost of New Bond p.a. = Rs.9/12 = 0.75 lacs p.a.
New bond issue value = 300 lacs
Intt p.a. on new Bond = Rs.300*10% = Rs.30 lacs
Net receipt on issue of new bond = 300 - 9(issue cost)] = 291 lacs
12th RV of new Bond 300 0.497 149.10
1 to 12 Tax Saving on amortization of Issue cost on new Bond -0.75*0.5 8.383 -3.14
1 Tax saving on writing off of unamortized cost of old Bond -3.60*0.5 0.943 -1.70
286.93
Solution-34
Existing outstanding debts = 300 lacs
Interest rate =14%
Interest P.a. = Rs.300*14% = Rs.42 lacs for 25 years
Remaining life = 25 years
Discount on old Bond = 9 lacs
Floatation cost on Old Bond = 3.6 lacs
Amortisation of Issue cost p.a. = 12.6/30 = 0.42 lacs
Unamortised Cost of Old Bond = 12.6 0.42*5 = 10.5 lacs
Tax rate = 40%
Cost of Capital = 8%
PV of Cash out flow if old Bond is continuously used
Year Particulars Amt (Lacs) PVF=8% PVCO
1 to 25 Interest on old Bond 42*0.6 10.674 268.98
25th RV of Old Bond 300 0.146 43.80
310.99

Callable Value of Old Bond = 1140 per Bond
Total Callable Value of Old Bond = 1140*300/1000 = Rs.342 lacs
Premium payable on old bond =Rs.42 lacs
Floatation cost of new bond = Rs.4 lacs
Amortisation cost of New Bond p.a. = Rs.4/25 = 0.16 lacs p.a.
New bond issue value = 300 lacs
Intt p.a. on new Bond = Rs.300*12% = Rs.36 lacs
Net receipt on issue of new bond = 300 - 4(issue cost)] = 296 lacs
25th RV of new Bond 300 0.146 43.80
1 to 25 Tax Saving on amortization of Issue cost on new Bond -0.16*0.4 10.674 -0.68
1 Tax saving on writing off of unamortized cost of old Bond -10.5*0.4 0.926 -3.89
0 Overlapping Interest of 2 months = 300*14%*2/12 = 7 7 1 7
0 Tax saving on Overlapping interest -7*0.4 0.926 -2.59
304.69
Solution-35
(a)
For Zero coupon Bond,
Bo = RV*PVF1
RV*1/(1+DR) = Bo
1+DR = RV/Bo
DR = 100/93.46 1 = 0.0699 = 7%
Spot rate = 7%
(b) For bond with coupon rate

FV = Rs.100
CR = 5%
Intt p.a. = Rs.5
RV = 100
Bo = Rs.98.13
Discount rate for first year = 7%
Bo = Intt1/1.07 + (Intt2+RV)/1.07*(1+FR2)
5/1.07 + 105/(1.07)(1+ FR2) = Rs.98.13
FR2 =5%
(c) For bond with coupon rate

FV = Rs.100
CR = 9%
Intt p.a. = Rs.9
RV = 100
Discount rate for first year = 7%
Discount rate for second year = 5%
Bo = Rs.104.62
Bo = Intt1/1.07 + Intt2/[1.07*1.05] + [Intt3 + RV]/[1.07*1.05*(1+FR3]
9/1.07 + 9/(1.07)(1.05) + 109/(1.07)(1.05)(1+r) = Rs.104.62
FR3 =10%
Solution-35A
(a) Consider one year security
For Zero coupon Bond,
Bo = RV*PVF1
RV*1/(1+DR) = Bo
1+DR = RV/Bo
DR = 100000/91000 1 = 1.099 1 = 9.9%
(b) Consider 2 year security of coupon rate

FV = Rs.100000
CR = 10.5%
Intt p.a. = Rs.10500
RV = 100000
Bo = Rs.99000
Discount rate for first year = 9.9%
Bo = Intt1/1.0928 + (Intt2+RV)/1.0928*(1+FR2)
10500/1.099 + 110500/(1.099)(1+ FR2) = Rs.99000
9554.14 + 100546.00/(1+ FR2) = 99000
(1 + FR2) = 100546/(99000-9554.14)
FR2 = 1.1240 -1 = .1240 = 12.40%
(c) Consider 3 year security of coupon rate

FV = Rs.100000
CR = 11%
RV = 100000
Bo = Rs.99500
Discount rate for second year = 12.4%
Bo = Intt1/1.099 + Intt2/1.099*1.124 + (Intt3 + RV)/1.099*1.124*(1+FR3)

11000/1.099 + 11000/(1.099*1.124) + 111000/1.099*1.124*(1+FR3) = Rs.99500
10009.10 + 8904.90 + 89858.46/(1+FR3) = 99500
(1 + FR3) = 89858.46/(99500-10009.10-8904.90)
FR3 = 1.115 - 1 = 0.115 = 11.50%
(d) Consider 4 year security of coupon rate

FV = Rs.100000
CR = 11.5%
RV = 100000
Bo = Rs.99900
Discount rate for second year = 12.4%
Discount rate for 3rd year = 11.5%
Bo = Intt1/1.099 + Intt2/(1.099*1.124) + Intt3/(1.099*1.124*1.115) + (Intt4 + RV)/(1.099*1.124*1.115)*(1+FR4)

11500/1.099 + 11500/(1.099*1.124) + 11500/(1.099*1.124*1.115)+111500/(1.099*1.124*1.115)*(1+FR4)= Rs.99900
10464.06 + 9309.66 + 8349.47 + 80953.57/(1+FR4) = 99900
(1 + FR4) = 80953.57/(99900-10464.06-9309.66-8349.47)
FR4 = 1.128 - 1 = 0.128 = 12.80%
Solution-36
(a) For 2 years YTM = 11.25
For first year Spot rate = 10.5% = FR1
Based on expectation theory
(1+YTM)2 = (1+FR1)(1+FR2)
(1.1125)2 = (1.105)(1+FR2)
FR2 = 12%
For 3 years YTM = 12%

For first year Sport rate = 10.5% = FR1
For Second year forward rate = 12%%
(1+YTM)3 = (1+FR1)(1+FR2) (1+FR3)
(1.12)3 = (1.105)(1.12) (1+FR3)
FR3 = 13.52%
(b) If fairly priced at Rs.1000 and rate of interest increases to 12.5% the percentage change will be as follows:
Price = 1000(1.12)5/(1.125)5 = 1762.34168/1.8020
= 977.99 or Rs.978
% change = 1000 978/1000 x 100 = 22/1000 x100 = 2.2%
Alternative Method
Coupon Rate = 12% = YTM [As bond is fairly priced]
B0 at 12.5% = Intt x PVAF(5 years, 12.5%) + RV x PVF(5th years, 12.5%)
B0 at 12.5% = 120*3.560 + 1000*0.555 = Rs.982.20
% change = (1000 982)*100/1000 = 18*100/1000 = 1.8%
Solution-36A
(a) For 2 years YTM = 11%
For first year Spot rate = 10% = FR1
(1+YTM)2 = (1+FR1)(1+FR2)
(1.11)2 = (1.1)(1+FR2)
FR2 = 1.2321/1.1 -1 = 1.12 -1 = 12%
For 3 years YTM = 12%

For first year Sport rate = 10% = FR1
For Second year forward rate = 12%%
(1+YTM)3 = (1+FR1)(1+FR2) (1+FR3)
(1.12)3 = (1.1)(1.12) (1+FR3)
FR3 = 1.4049/1.232 1 = 1.1403 1 = 14.03%
Solution-37
Appropriate price = 80/ (1.06) + 1080/ (1.07)2= 1018.79
Alternative way:
Suppose we invest Rs. 100 today, it will grow to Rs. 106 after 1 year.
Suppose we invest Rs. 100 today, it will grow to 100(1.07)2 after 2 years
Forward rate for year 1 = 6%
Forward rate for year 2 = [100(1.07)2/ 1.06] - 1 = 8.00996
Appropriate price = 80/ (1.06) + 1080/ {(1.06) (1.08009)} = 1018.79
Solution-38
(i)
Market value of Bond = Face value of Bond [RV = FV]
YTM = CR
Since the bonds were sold at par, hence YTM of Bond as on 1, Jan 2000 were 10%
(ii)
Coupon Rate = 10%
Half yearly Interest = Rs.50
Maturity Period from 01/01/2008 = 8 yrs
Value of Bond at 12% as on 01/01/2008
B0 at 12% = Intt x PVAF(16 Period, 6%) + RV x PVF(16th Period, 6%)
B0 at 12% = 50*10.105 + 1000*0.394 = Rs.899.25
Value of Bond as on 01/01/2008 = Rs.899.25
Value of Bond as on 01/03/2008 = 899.25*1.02 = 917.24
Payment for Complete transaction = 917.24
Interest accrued = 50*2/6 = 16.67
Bonds basic value = 917.24 16.67 = 900.57
Solution-39
(a) If the yield of the bond falls the price will always increase. This can be shown by following
calculation.
5 year Bond
Coupon Rate = 8%
Value of Bond at 6%
B0 at 6% = Intt x PVAF(5 years, 6%) + RV x PVF(5th Year, 6%)
B0 at 6% = 80*4.212 + 1000*0.747 = Rs.1083.96
Increase in 5 year's bond price = Rs. 83.96
20 year Bond
Coupon Rate = 8%
Value of Bond at 6%
B0 at 6% = Intt x PVAF(20 years, 6%) + RV x PVF(20th Year, 6%)
B0 at 6% = 80*11.469 + 1000*0.312 = Rs.1229.52
So increase in bond price is Rs. 229.52
PRICE INCREASE DUE TO CHANGE IN PV OF PRINCIPAL

5 yrs. Bond
= RV*PVF(5th Year, 6%) - RV*PVF(5th Year, 8%)
= 1000*0.747 1000*0.681 = 747 - 681 = Rs.66.00
% Change in price due to change in PV of Principal = Rs.66/83.96 = 79%
20 yrs. Bond
= RV*PVF(20th Year, 6%) - RV*PVF(20th Year, 8%)
= 1000*0.312 1000*0.215 = 312 - 215 = Rs.97.00
% Change in price due to change in PV of Principal = Rs.97/229.52 = 42%
PRICE CHANGE DUE TO CHANGE IN PV OF INTEREST

5 yrs. Bond
= Rs.80 x (PVAF 6%, 5) - Rs.80 x (PVIAF 8%, 5)
= Rs.80 x 4.212 - Rs.80 x 3.993 = Rs.336.96 - Rs.319.44 = Rs.17.52
Change in price Rs.17.52/ Rs.83.96 x 100 = 20.86%
20 yrs. Bond
= Rs.80 x PVAF 6%, 20) - Rs.80 x (PVAF 8%,20)
= Rs.80 x 11.47 - Rs.80 x 9.82 = Rs.917.60 - Rs.785.60 = Rs.132
Change in price = Rs.132/ Rs.229.60 x 100 = 57.49%
Solution-40
Initial purchase of bond =Rs.1000
Annual interest for 2 years =Rs.100 each
Callable value at end of year 2 =1200
Again Investment in another bond Rs. 1000 (Assuming Bond cannot be issuedin part)
Annual Interest =7% of 1000=Rs.70
Redeemable value =1000
[Not part of answer in exam]
Cash flows
Year:
0 =(-)1000
1 100
2 100+1200-1000=300
3 70
4 70
5 70+1000=1070
Taking a discount rate 9% [slightly higher than the interest rate of 7% because inflow on 1 & 2 year is better i.e., 100 &
300 as compare to 70]
= [100*0.917 + 300*0.842 + 70*0.772 + 70*0.708 + 1070*0.650] 1000
= [91.70+252.60+54.04+49.56+695.50] -1000 = 1143.40-1000 = 143.40
Taking a discount rate 15% , PV of inflows
= [100*0.870 + 300*0.756 + 70*0.658 + 70*0.572 + 1070*0.497] 1000 = (-) 68.31
YTM or IRR or Actual Return from investment = LR + [NPVLR]*Diff of rate/[NPVLR NPVHR]

= 9% + (143.40*6)/(143.30+68.31) = 13.06%
Solution-41 While calculating NPV, it is assumed that the intermediate cash inflows are reinvested at a rate equal to cost
of capital being uses as discount rate. Here the reinvestment is at 18%.
Face Value of bond =1000
Annual Interest =150
Life =4 years
Re investment of Interest =18%
Cash inflow at the end of 4th year = 150*(1.18)3 + 150*(1.18)2 + 150*(1.18)1 + 150*(1.18)0 + 1000
= 246.45 + 208.86 + 177 + 150 + 1000 =1782.31
Initial Outflows = 1000
Applying Discount rate 20%
PVCI at 20% = 1782.31/ (1.20)4 = 859.52
NPV =859.52-1000 = -140.48
Applying Discount rate 15%

4
PV of inflows =1782.31/(1.15) = 1019.48
NPV = 1019.48 -1000 = 19.48
YTM or IRR or Actual Return from investment = LR + [NPVLR]*Diff of rate/[NPVLR NPVHR]

= 15% + (19.48*5)/(19.48.30+140.48) = 15.60%
Solution-42
Face value of the Bond = Rs.100 [Assuming]
Coupon rate = 9%
Interest p.a = Rs.100*9% = Rs.9 p.a.
RV = Rs.105
Cash Outflow = Rs.90
Cash inflow = Rs.9 intt for 5 years and Rs.105 at the end of 5th year before tax.
Income Tax rate = 30% and Capital gain tax rate = 10%
Interest after tax = Rs.9*0.7 = Rs.6.30 for 5 yrs
Capital Gain = RV Purchase price = 105-90 = Rs.15
Capital gain tax = Rs.15*10% = Rs.1.50
RV [after capital gain tax] = Rs.105-1.50 = Rs.103.50
App annual return = (6.30 + [(103.50-90)/5])/[(90+103.50)/2] = (6.30+2.70)/96.75 = 9.30%
Calculation of Actual Return

First discount rate = 10% as calculated above.
B0 at 10% = 6.30*3.790 + 103.50*0.621 = Rs.88.15
= Rs.88.15 Rs.90 = - Rs.1.85
B0 at 9% = = 6.30*3.889 + 103.50*0.650 = Rs.91.77
= Rs.91.77 Rs.90 = Rs.1.77

= 9% + (1.77*1)/(1.77+1.85) = 9.49%

1453975109ch 4 Bond Valuation

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

1453975109ch 4 Bond Valuation

Uploaded by

Copyright:

Available Formats

C H A P TE R - 4

A negotiable certificates evidencing indebtness. It is normally unsecured. A company,

4.1.1 Some Basics of Bond

4.2 Bond Value and Yield to Maturity [From Q-1 to 17]

4.2.1 VALUE OF BOND

(b) Perpetual Bond B0 = Intt/RR

(c) Zero Coupon Bond B0 = RV x PVF(nth years, RR)

4.2.2 YIELD TO MATURITY (YTM)

(c) Approximate YTM

(e) YTM is also known as yield means actual return of bond.

(f) Yield to Maturity

4.2.3 Pricing of BOND

Bonds with Maturity

Question-1A A Rs.5,000 bond with a 10% coupon rate matures in 8 years.

Question-1C [June-02-CS] [M-6]

4.3 BOND VALUATION BEHAVIOR

(a) If RR = CR then Bond Value = Par Value.

(b) If RR > CR then Bond Value < Par Value.

(c) If RR < CR then Bond Value > Par Value.

4.4 Bond Value in case of Semi-Annual Interest

Bo = Intt/2 x PVAF(2n years, DR/2) + RV x PVF(2nth years, DR/2)

Question-2A [ICWA-Dec-2002] A Company invested in a 5 year bond issue of another

4.6 Bond value if required rate of return changes every year

1) If Discount Rate for n years are same

2) If Discount Rate for n years are not same

4.7 Bond price is cum interest

(b) First we will calculate interest amt accrued

(c) Then we will calculate Bond Price ex interest

Ex: 12% debentures of Rs.100 on which interest is payable annually on 31 Dec.

Question-6 A company has outstanding 8% debentures of Rs.10,00,000 on which interest is

(b) Current Yield = Annual Interest / Current Market Price

4.8 Calculation of Value or YTM if bond is redeemed in installment

4.9 Holding Period Return

(b) Holding period return on investment

(d) interest/B0 is due to interest and known as current yield

(b) Perpetual Bond B0 = Intt/RR

(c) Zero Coupon Bond B0 = RV x PVF(nth years, RR)

4.11 Yield to Call

Value of Irredeemable Bond B0 = Intt/Required rate of return = Intt/YTM

YTM of irredeemable Bond YTM = Intt/Bo

Question-13 A 10% bond of FV of Rs.100 is irredeemable.

4.13 PURE DISCOUNTS BOND OR DEEP DISCOUNT BONDS (DDB) or Zero

YTM of Zero Coupon Bond YTM LR + [NPVLR]*Diff of rate/[NPVLR NPVHR]

Question-15B [May-2015] [M-2]

4.13.1 YTM of zero coupon Bond

4.13.2 Imputed Interest income in case of Deep Discount Bond

Imputed Interest first year = B1 B0

Imputed Interest Second year = B2 B1

Imputed Interest Third year = B3 B2 So on

4.14 Commercial Paper [Q-18 to 20]

[Nov-2012] [M-4] Write short notes on commercial paper.

(d) Issue Price/ Purchase Price at t0 = RV/(I+PIR)1

PIR = IR p.a.*No of days of CP/365 or IR p.a.*No of months of CP/12

Question-18 [June-2007-CS] [M-5] Kastor Ltd issued CP as per following conditions:

Date of issue 19/10/2006

Date of maturity 17/01/2007

Interest rate 7.25% p.a.

FV of commercial paper 10 crs

Question-18B [Nov-2003] [M-4] [RTP-Nov-2014-17] [SP] M Ltd. has to make a payment

Question-18C [RTP-Nov-2011-2] Suppose Govt. pays Rs.5,000 at maturity for 91 days

If Periodic Interest rate is given, and Compounding is periodically

If Periodic Interest rate is given, and Compounding Annually

4.15 Calculation of Effective interest rate if Current Market Price and

(b) Interest rate for the period = Interest/Issue Price

PIR = IR p.a.No of days of CP/365 or IR p.a.No of months of CP/12

B0 = PVCI InttPVAF(4 years) + RVPVF(4th year)

B0 = InttPVAF(3 years) + RVPVF(3rd year)

B0 = InttPVAF(3 years) + RVPVF(3rd year)

B0 at 14% = PVCI14% = 1503.432 + 10000.519 = Rs.1033.80