Investment & Portfolio

Management
VALUING BONDS: BASIC
PRINCIPLES
Instructor: M.Jibran Sheikh
jibransheikh@comsats.edu
.pk

The value or market price of a bond depends on

how much investors are prepared to pay for the
interest payments and the return of the principal
which the bond promises to pay. This can be
determined as the present value of the expected
cash flows. If we can simplify for a moment and
assume that the cash flows are certain, interest
payments are made annually and there is a single
rate that is appropriate for discounting all of the
cash flows that a bond holder can anticipate, the
value of a bond can be determined as:

Formula

The discount rate is given by the

market determined rate of return that
can be expected on bonds of the same
maturity, coupon rate and risk.
The valuation equation assumes that
the bond is being valued immediately
following the receipt of an interest
payment.

Example
A bond with a nominal value of 1 00
issued four years ago has six years to
run to maturity. It carries a coupon
interest rate of 8 per cent, but bonds
issued today with six years to maturity
are offering an interest rate of only 5
per cent.

Why bond is selling above its par

value?????????????

Yield to Maturity
The yield to maturity is the discount rate that equates
the present value of the expected cash flows from
holding a bond with its current price

Where

rcB = for coupon interest rate of bond

y =is the yield on a bond, and it is usually assumed
that this is derived on the basis of an equilibrium price
for a bond, and therefore the yield constitutes the
market rate of return on the bond in question