Learn everything about Bond Valuation Basics. Get a fair idea about what is concept of bond valuation. This can act as a building base for the other advanced bond valuation concepts

1. CA Nikhil Jobanputra
189
Bond Valuation
Meaning of Bonds
When a company has to raise long term debt, one of the modes of raising the funds is
by issuing debentures. For all practical reasons, a debenture and a bond are one and
the same.
Bonds or debentures can be called financial Instruments which are contracts that give
rise to a financial liability for one party (the one who issues such bonds) and a financial
asset for the other party (the one who holds such bonds or debentures). Bond is a fixed
income bearing security that provides interest at a definite rate to the investors.
When an investor acquires a bond, he expects interest over the period and the
redeemable value to be received at the maturity date or redemption date. In other
word, after acquiring a bond, the investor receives a stream of cash flows. The total
present value of such stream of cash flow (including the present value of redeemable
value) is considered as the value of such bond.
For the purpose of bond valuation the following terms must be clarified:
1. Face Value
2. Coupon Rate
3. Coupon payments
4. Issue Price
5. Market Price
6. Maturity Date
7. Redemption Price
8. Intrinsic Value
9. Callable & Puttable Bonds
10. Call Date & Call Price
11. Current Yield
12. Yield to Maturity (YTM)
13. Yield to Call (YTC) (For Callable Bonds)
14. Zero Coupon Bonds (ZCB)
15. Deep Discount Bonds (DDB)
16. Annuity Bonds
17. Bond STRIPS
18. Par Bonds, Premium Bonds and Discount Bonds
19. Convertible Bonds (OCDs & CCDs)
20. Straight Value of Convertible Bond
21. Stock Value of Convertible Bond
22. Conversion Parity Price
23. Conversion Premium
24. Clean Price & Dirty Price

2. Incito Academy – Final CA – Strategic Financial Management
Bond Valuation
190
Issue Price of a bond is at which a new bond is priced by theissuer. Bonds can be issued
at Par, Premium or Discount.
Market Price of a bond indicates the price at which the bond can be bought or sold in
the open market.
What do you mean by Coupon Rate and Coupon Payments?
Suppose a bond promises to pay interest at the rate of 8% per annum, then such rate
is called “Coupon Rate”. The Coupon Rate is always applicable on the face value of the
bond irrespective of its issue price or prevailing market price. For example, 9%
Government of India Bonds provide half yearly interest on 30th
June and 31st
December. The face value of the bond is ` 1,000. The interest paid on each bond will
be ` 1,000 x 9% x 6/12 = ` 45 on each of the interest payment dates. The interest
payment of ` 45 during each of the months June and December are known as “Coupon
Payments”.
Coupon Rate is the rate of interest attached to the bond and it applies on the face
value, for example, a 9% bond with face value of ` 1,000 will have interest payments of
` 1,000 x 9% = ` 90 every year. It should be noted that the interest on bonds can be
payable quarterly, half yearly or annually in general.
What is the Intrinsic Value of the Bond?
Intrinsic value of the bond is the aggregate present value of all coupon payments and
the redemption amount, determined by using a discounting rate which is expected
rate of return by the investor.
Maturity Date of a bond is the date at which a bond is redeemable or is due for
redemption. A bond is generally redeemed at par or premium.
Bond Valuation: Basic Principle
As discussed earlier, the present value of the stream of cash flows including the
present value of the redemption price is considered as the value of the bond and more
specifically the intrinsic value of the bond or the fair market value of the bond (For this
purpose the market price of the bond is always called as Actual Market Price and not
Fair Market Price).
In order to arrive at the present value of the stream of cash flows, a discounting rate
has to be used. This discounting rate is known as the desired yield rate or required
yield rate. In other words the discounting rate is the required rate of return by the
investor.

3. Incito Academy – Final CA – Strategic Financial Management
CA Nikhil Jobanputra
191
As generally known, increasing the discounting rate results into reduction in present
value, and the decrease in discounting rate increases the present value. It can be
concluded that the discounting rate or the desired yield rate and bond value are
inversely related.
Face Value; Intrinsic Value & Market Value:
(Classification of the bond as Par, Premium or Discount bond)
At the time of issue:
If the bond is issued at its face value it is par bond
If issued above its face value it is premium bond
If issued below its face value it is discount bond
Once the bond is floated:
Then comparison is made among the three values:
 Face Value
 Intrinsic Value and
 Market Value.
If intrinsic value of a bond equals to its face value it is a par bond.
If intrinsic value is more than the face value it is a premium bond.
If intrinsic value is less than the face value it is a discount bond.
It should be noted that the market price of bond will generally be near to its intrinsic
value. Therefore, intrinsic value can be considered to be a major force driving the
market price of the bond. However, the difference between the intrinsic value and
market price is also obvious.
 If market price of a bond is equal to itsintrinsic value then such bond is considered
to be fairly priced in the market.
 If the market price of bond is more than its intrinsic value, then such bond is
considered to be overpriced.
 If the market price of a bond is less than its intrinsic value, then such bond is
considered to be underpriced.
Actions to be taken by Investor
1. If the Actual Market Price of bond is less than the Fair Market Value or the Intrinsic
Value → Buy such Bonds.
2. If the Actual Market Price of bond is more than the Fair Market Value or the
Intrinsic Value → Sell such Bonds.
3. If the Actual Market Price of bond is equal to the Intrinsic Value → Take No Action.