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A long-term debt instrument in which a borrower agrees to make payments of principal and interest, on specific dates, to the bond holders. Bonds are issued when companies want to borrow smaller amounts of money from numerous lenders. Buying a bond means you are lending out your money
Sample of Bond
bond
Firm A
Capital
Bondholders
Receive interest payments until the term ends
Bond Characteristics
Formula
Present Value of Bond = Present value annuity of interest payments + Present value of principal repayment
or
Present Value of Bond
= I (PVA) + P (PV)
k%n k%n
I K
= Interest payment / coupon payment = Market interest rate / required rate of return on the bond
N
P
EXAMPLE
Assume that you purchased a bond with 15 years remaining to maturity with 15% coupon rate. The interest payment is paid annually and also assume that par value is RM 1000. If the required rate of return on bonds of this risk and maturity is 15%, what will the bond sell for?
Value of Bond
= I (PVA) + P (PV)
k%n
15%, 15
k%n
15%, 15
METHOD 2 CALCULATOR
CPT
PV
INPUTS
15 N
15 I/Y PV
-1000
150 PMT
1000 FV
OUTPUT
CONT.
Assume that you purchased a bond with 15 years remaining to maturity with 15% coupon rate. The interest payment is paid annually and also assume that par value is RM 1000. If the required rate of return on bonds of this risk and maturity is 15%, what will the bond sell for?
What would be the bonds value after one year if the required rate of return were down to 10% or up to 20% respectively?
EQUATION 1
Value of Bond = 150 (PVA) + 1000 (PV)
10%, 14 10%, 14
EQUATION 2
Value of Bond = 150 (PVA) + 1000 (PV)
20%, 14 10%, 14
CPT
PV
INPUTS
14 N
10 I/Y PV
-1368.33
150 PMT
1000 FV
OUTPUT
CPT
PV
INPUTS
14 N
20 I/Y PV
-769.47
150 PMT
1000 FV
OUTPUT
EXERCISE 1
Mr. Azmin purchased a bond with 10 years remaining to maturity with 10% coupon rate. The interest payment is paid annually and also assume that par value is RM 1000. If the required rate of return on bonds of this risk and maturity is 10%, what will the bond sell for?
= 10% (1000)
K = 10% N = 10
= RM 1000
METHOD 1 : FORMULA
Value of Bond
CPT
PV
INPUTS
10 N
10 I/Y PV
-1000
100 PMT
1000 FV
OUTPUT
Mr. Azmi purchased a bond with 10 years remaining to maturity with 10% coupon rate. The interest payment is paid annually and also assume that par value is RM 1000. If the required rate of return on bonds of this risk and maturity is 10%, what will the bond sell for?
What would be the bonds value after two years if the required rate of return were down to 5% or up to 15% respectively?
K = 5%
N =8 P
= RM 1000
5%, 8 5%, 8
Value of Bond = 10% (1000) (PVA) + 1000 (PV) = 100 (6.4632) + 1000 (0.6768) = 646.32 + 676.80
K = 5% N =8 P
INPUTS
= RM 1000
8 N 5 I/Y PV
-1323.16
100 PMT
1000 FV
OUTPUT
K = 15%
N =8 P
= RM 1000
15%, 8 51%, 8
Value of Bond = 10% (1000) (PVA) + 1000 (PV) = 100 (4.4873) + 1000 (0.3269) = 448.73 + 326.90
K = 15% N =8 P
INPUTS
= RM 1000
8 N 15 I/Y PV
-775.63
100 PMT
1000 FV
OUTPUT
INTEPRETATION
Sell at Par Value Sell at Premium Sell at Discount
Whenever the required rate of return is lower than the coupon rate
I>K 10% > 5%
Whenever the required rate of return than the coupon return is higher rate I<K 10% < 15% PV Bond = RM 775.63
PV Bond = RM1000
PV Bond = RM 1323.12
YIELD-TO-MATURITY (YTM)
It is another name for : Rate of return Internal rate of return Market interest rate Discount rate of return It is the required yield expected by the investors There are 3 methods to calculate the YTM:Trial and Error YTM formula Calculator
1. Type of bond: Discount Bond 2. Features: Market yield (market interest) is greater than Coupon rate. 3. k > I
Begin searching with k = 15% (because the value of I = 15%) and higher than 15%. So now we assume the value of k as 15% and 16%. At k = 15%, Bond Price = RM999.85 At k = 16%, Bond Price = RM951.95
k = 15%
RM999.85
k=?
RM960
k = 16
RM951.95
YTM FORMULA
I+ YTM = M- Value of Bond N