Valuation of bonds and debenturesPresentation Transcript
SIR. SRINIVAS. FACULTY.
DOS IN COMMERCE.
MEANING AND DEFINITION.
DIFFERENCE BETWEEN THEM.
VALUATION OF BONDS AND DEBENTURE VALUE.
Life is full of surprises, and even more so when it comes to
finances. A person having a good income today may face
financial crisis in future. To avoid these unforeseen financial
crises everyone invests in different instruments that can fetch
extra income. There are many options available in the market
that can be classified as risky and non risky. It is very well
understood that risky options yield higher gains but non risky
ones can give very low returns. Debentures and bonds are two
such options that can be taken for good returns on ones
investment. Debenture is an instrument issued by a company
that can be convertible or non convertible into equities. Bonds
are issued by companies or by government and can be seen as a
loan taken by them to meet their financial needs. These two
instruments are basically loan taken from the investor but have
very different repayment conditions.
A debt investment in which an investor loans money to
an entity (corporate or governmental) that borrows the
funds for a defined period of time at a fixed interest rate.
Bonds are used by companies, municipalities, states and
central governments and foreign governments to finance
a variety of projects and activities.
Bonds are commonly referred to as fixed-income
securities and are one of the three main asset classes,
along with stocks and cash equivalents.
A type of debt instrument that is not secured by physical
assets or collateral. Debentures are backed only by the general
creditworthiness and reputation of the issuer. Both
corporations and governments frequently issue this type of
bond in order to secure capital. Like other types of bonds,
debentures are documented in an indenture.
Debentures have no collateral. Bond buyers generally
purchase debentures based on the belief that the bond
issuer is unlikely to default on the repayment. An example
of a government debenture would be any government-
issued Treasury bond (T-bond) or Treasury bill (T-bill). T-
bonds and T-bills are generally considered risk free because
governments, at worst, can print off more money or raise
taxes to pay these types of debts.
Both bonds and debentures are instruments available to
a company to raise money from the public. This is the
similarity between the two, but on closer inspection, we
find that there are many glaring differences between the
Bonds are more secure than debentures. As a
debenture holder, you provide unsecured loan to the
company. It carries a higher rate of interest as the
company does not give any collateral to you for your
money. For this reason bond holders receive a lower
rate of interest but are more secure.
If there is any bankruptcy, bondholders are paid first
and the liability towards debenture holders is less.
Debenture holders get periodical interest on their
money and upon completion of the term they get their
principal amount back.
Bond holders do not receive periodical payments.
Rather, they get principal plus interest accrued upon the
completion of the term. They are much more secure
than debentures and are issued mostly by government
• Bonds are more secure than debentures, but the rate of
interest is lower
• Debentures are unsecured loans but carries a higher
rate of interest
• In bankruptcy, bondholders are paid first, but liability
towards debenture holders is less
• Debenture holders get periodical interest
• Bond holders receive accrued payment upon
completion of the term
• Bonds are more secure as they are mostly issued by
1. Determine the coupon rate of the bond. The
coupon rate is the yield of the bond at par value. For
example, a bond with a face value of $1000 and a
coupon rate of 10% pays $100 interest annually.
2. Divide the annual interest amount by the
number of times interest is paid per year, to
arrive at I. For example, if the bond pays interest
semi-annually, it pays I = $50 per period (6 months)
3. Determine the minimum rate of return required,
or discount rate. How high a rate of return is
acceptable to you to invest in the bond? Take into
consideration the inflation rate (historically around 10-
12% per year), the quality of the bond (higher rate of
return is required to compensate for more risky issues),
the current market interest rate of issues of similar
quality), and the rates of return offered by alternative
investments. The discount rate takes the time value of
money into account. Divide the discount rate required
by the number of periods per year, to arrive at the
required rate of return per period, k. For example, if I
require a minimum rate of 12% return annually for the
bond above paying interest semi-annually, k = 12%/2 =
4. Determine the number of periods interest is paid,
n, by multiplying the number of years till maturity
by the number of times interest is paid. For
example, if the above bond matures in 10 years and
pays interest semi-annually has n = 10*2 = 20 interest
5. Plug in I, k and n into the present value annuity
formula PVA = I[1-(1+k)^-n]/k to arrive at the
present value of interest payments. In my example,
the present value of interest payments is $50[1-
(1+0.06)^-20]/0.06 = $885.30.
6. Plug in k and n into the present value formula PV
= FV/(1+k)^n to arrive at the present value of the
principal of the bond (FV) of $1000 at maturity. For
our example, PV = $1000/(1+0.025)^20 = $311.80.
7. Add the present value of interest to the present
value of principal, to arrive at the present bond
value. For our example, the bond value = $ 885.30 + $
311.80 = $1197.10.
A 100 par value bond bears a coupon rate of 14 per cent
and matures after five years. Interest is payable semi-
annually. Compute the value of the bond if the required
rate of return is 16 per cent.
[bond value= $475]
The method we followed so far, for
calculating the value of the bonds and
debentures is general method. But
practically to know the value of the bonds
and debentures, we need to go with the
other formulae according to the types of
bonds and debentures.
1st YEAR MFM.
DOS IN COMMERCE.