Bond valuation is the method of ascertaining the fair market value of bonds. It involves the computation of present values of future cash outflows associated with the bonds, that is, payment of interest and also its value on redemption. As the maturity amount and the coupon rate is constant, bond valuation assists the prospective investors to determine the rate of return at which the investment would yield some benefit.
In a nutshell the valuation process contains 3 basic steps:-
- Estimation of expected cash flows.
- Determination of the present value discounting factor.
- Calculation of the PV of Cash inflows by applying such rate of discount.
However, owing to the complexities of the industry this technique sometimes assumes a difficult structure and thus students often need bond valuation homework help which are offered by learned experts, online to help them cope up with such complications.
Apart from this, experts specialized in this field offer assistance on the study of allied factors such as
- The worthiness and credit rating of the issuing company – which gives security regarding the recoverability of the investment.
- The probability of escalation of the price of the bond, keeping in view the trend of growth of the company.
- The discount rate subsisting in the market as a whole for the purpose of comparison.
Recognizing the suitable discount rates
In general the lowest rate of interest at which the investor should undertake the investment is the return expected from a Treasury Bond. On the other hand other bonds such as the ones issued by companies are subject to an additional risk premium factor over and above the risk free rate of return which makes the yield somewhat higher.
Valuation of the Bond
As discussed earlier the present value of the future cash inflows are required to be found out. The PV is nothing but the sum that would have to be put into the bond today to produce the future monetary inflow. The year in which the cash is expected to be generated along with the corresponding annuity factor together affects the present value. In order to have the net present value, the cash flows are to be ascertained and evaluated for each independent year. The summation of such separate figures will bring out the resultant net value of the bond.
It can be further clarified in the following manner:-
Let, T be the time period of inflow,
PV at T = Expected CI / (1 + I )T
On calculating the independent cash flows at T1 T2 T3 ….. etc,
They are to be simply clubbed together to get the total PV in the following way:-
PV at T1 = xxx
PV at T2= xxx
PV at T3 = xxx
TOTAL PV = xxx
Some Numerical Examples to get Bond Valuation Homework Help and clear idea
Question:Suppose the bonds of a particular company XYZ Incorporated, are issued for redemption in 11 years with the rate of interest of 8% and a Par value of $10000. Annual interest is paid at the rate of 5%
The individual cash flows are as follows:
- Year One: $500
- Year Two: $900
- Year Three: $ 400
- Year Four: $ 600
- Year Five: $550
- Year Six: $800
- Year Seven: $600
- Year Eight: $300
- Year Nine: $450
- Year Ten: $700
- Year Eleven: $ 800
The Present Value of cash Inflows are computed as:
- First year: $500/1.051
- Second Year: $900/1.052
- Third Year: $400/1.053
- Fourth Year: $600/1.054
- Fifth Year: $550/1.055
- Sixth Year: $800/1.056
- Seventh Year: $600/1.057
- Eighth Year: $300/1.058
- Ninth Year: $450/1.059
- Tenth Year: $700/1.0510
- Eleventh Year: $800/1.058
The required net value of the bond will be the summation of the eleven PV calculated above, that is, $3088 (Approximately) .
Change of valuation with change in interest
Whenever there is an increase or decrease of rate of interest, it impacts the bond in terms of value. Quite naturally a higher yield percentage would have a positive effect on the value of the bond because the annuity factor wouldcorrespond the new rate whereas a lower coupon rate would manifest a decline in the value of bonds. An investor must always keep this correlation in mind while evaluating and considering an investment in hand.
Change in Valuation due to proximity of redemption
To enable the student to get proper Bond Valuation Homework Help the finance expert must also enlighten the pupils with the probable effects of proximity towards redemption.
There are 3 probable situations in this regard:-
- If redeemed at premium, value will fall.
- If redeemed at discount, value will rise.
- If redeemed at par, value will stay constant.
Under-valuation and Over-valuation
Bond valuation homework help is also sought by students where they are faced with problems of over and under valuation. In the conventional approach only one yield rate is used. But the problem lies where there are multiple rates of interest. Concurrently there is an aspect of comparison with market values. If the values obtained by the investor with the valuation technique lies above the respective market values then they are over- valued to such extent. Similarly when the market price is above the calculated values the bonds are under-valued. Over-valued bonds should be sold or transferred right away.
Actual Rate and Market Rate of Interest: Impact
When actual rate offered by the company is more than the prevailing market interest rate then the company shall issue such bonds at apremium, that is at a price higher than the par value.
If the actual rate is lower than the market average, then the bond is generally issued at a discount, that is, lower than the par value. The reason is that an investor would otherwise not buy the bonds if he is getting a better yield in the bonds of other companies. This forms an integral part of bond valuation homework help.
However there is no impact on the redemption value (maturity amount) which may be at par, premium or even discount.