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Bond Valuation and Yield on Bond

 

 

Learning Objective:

To understand the application of bond valuation for investment decisions.

 

Learning Outcome:

After attempting this GDB, the students would be able to understand the application of bond valuation for investment decisions.

 

The Case:

 

Suppose, you are working as an investment consultant in a consultancy firm and most of your clients are habitual investors, who are maintaining their own portfolios comprising of various combinations of stocks and bonds.

Mr. Zahid, a habitual investor comes to you for consulting about adding one more potential investing option to his existing portfolio. Currently, as per your analysis, there are two bonds available in the market with the following data:

 

 

Bond A

Bond B

Maturity

3 years

8 years

Coupon payment

10% Annual

10% Semiannual

Yield

6.23%

9.8%

 

*Note: Interest rate fluctuations are high in the market

 

Required:

  • Suggest Mr. Zahid, who is interested to add only one bond to his portfolio about the suitable bond for his portfolio.
  • Support your choice by elaborating the reason on which the suggested bond is considered as a preferred option.

 

Views: 3003

Replies to This Discussion

Long term bond are Very Sensitive To Interest Rates – Long term bonds have high durations, which means their prices tend to fluctuate wildly in response to relatively mild changes in interest rates. Most long term bond funds seem to hover around an effective duration of 10 years or so, which means the fund’s NAV will rise or fall about 10% for every 1% change in interest rates.

saman rafiq yeh sab to B k pas hn.............ap ny A ko day di hn

higher the maturity higher the rate of risk and the more chances of the fluctuation

A k pas low risk hy...............jahan risk low hoga wo better hoga

dua A ki bat ki hai mein ne bola hai jis k muturity kaam hogi wo suitable hoga

interest rate be to falactuate  kar raha ha.means note ma ha k zada be ho sakta ha kam be then what u say?

note mein toh sirf high ka btya howa hai market mein fihal wo zydah jaraha hai per us k elwa sab kuch bond A ki tarf hai 

still confusing

Please check my solution.

 

Attachments:

(i)

Face value= FV=Rs. 100

Annual Coupon = 10%

Yield = 6.23%

Maturity = 3 yrs

CF = Coupon Interest Rate * Par value

CF = 10% * 100

CF = Rs. 10 p.a

PV (6.23%) = CF /(1+6.23%)+ CF /(1+6.23%)2+ CF /(1+6.23%)3+ FV /(1+6.23%)3

PV = 10/1.0623 +10/(1.063) 2 + 10/(1.063) 3+ 100/(1.063) 3

PV = 9.41 + 8.85 + 8.33 + 83.26

Bond Price = 109.85

Rs. 100 today at 10% mark-up for 3 years is worth positive Rs. 109.85 to the client today.

 

 

(ii)

Face value= FV=Rs. 100

Semi Annual Coupon = 10%

Yield = 9.8%, semi-annual = 4.9%

Maturity = 8 yrs

Total Coupon payments = 2*8 = 16 coupon payments

Each coupon payment = 10%*100

                                                = Rs. 10 p.6m

Bond Price = 10 * [1 – [ 1/(1+0.049)16]]/0.049 + 100/(1+0.049)16

Bond Price = 10 *[1-0.465]/0.049 + 100/2.15

Bind Price = 109 + 46.5

Bond Price = 155.5 = 156

Rs. 100 today at 10% mark-up semi-annual for 8 years is worth positive Rs. 156 to the client today.

 

When Market Interest Rate (ie. Investors’ Required Rate of Return) Increases, the Value (or

Price) of Bond Decreases. So, when interest rate in denominator goes up the present value (price) will decrease. When investor buy a long term bond he is locked in investment for long term period there are more chances of fluctuation in interest rate and the inflation rate.

So, the impact of interest rate changes on Long Term bonds is greater. Long Term Bond Prices fluctuate more because their Coupon Rates are fixed (or locked) for a long time even though Market Interest Rates are fluctuating daily; therefore the price of Long Bonds has to constantly keep adjusting. Price of the long term bond fluctuates more as compared to the short term bond.  So we will suggest Bond A to Mr. Zahid to add in his portfolio.

 Farhan Karim Shaikh gud & thanks 

Note @ All: You don’t need to go any other site for this assignment/GDB/Online Quiz solution, Because All discussed data of our members in this discussion are going from here to other sites. You can judge this at other sites yourself. So don’t waste your precious time with different links.

i)

Face value= FV=Rs. 100

Annual Coupon = 10%

Yield = 6.23%

Maturity = 3 yrs

CF = Coupon Interest Rate * Par value

CF = 10% * 100

CF = Rs. 10 p.a

PV (6.23%) = CF /(1+6.23%)+ CF /(1+6.23%)2+ CF /(1+6.23%)3+ FV /(1+6.23%)3

PV = 10/1.0623 +10/(1.063) 2 + 10/(1.063) 3+ 100/(1.063) 3

PV = 9.41 + 8.85 + 8.33 + 83.26

Bond Price = 109.85

Rs. 100 today at 10% mark-up for 3 years is worth positive Rs. 109.85 to the client today.

 

 

(ii)

Face value= FV=Rs. 100

Semi Annual Coupon = 10%

Yield = 9.8%, semi-annual = 4.9%

Maturity = 8 yrs

Total Coupon payments = 2*8 = 16 coupon payments

Each coupon payment = 10%*100

                                                = Rs. 10 p.6m

Bond Price = 10 * [1 – [ 1/(1+0.049)16]]/0.049 + 100/(1+0.049)16

Bond Price = 10 *[1-0.465]/0.049 + 100/2.15

Bind Price = 109 + 46.5

Bond Price = 155.5 = 156

Rs. 100 today at 10% mark-up semi-annual for 8 years is worth positive Rs. 156 to the client today.

 

When Market Interest Rate (ie. Investors’ Required Rate of Return) Increases, the Value (or

Price) of Bond Decreases. So, when interest rate in denominator goes up the present value (price) will decrease. When investor buy a long term bond he is locked in investment for long term period there are more chances of fluctuation in interest rate and the inflation rate.

So, the impact of interest rate changes on Long Term bonds is greater. Long Term Bond Prices fluctuate more because their Coupon Rates are fixed (or locked) for a long time even though Market Interest Rates are fluctuating daily; therefore the price of Long Bonds has to constantly keep adjusting. Price of the long term bond fluctuates more as compared to the short term bond.  So we will suggest Bond A to Mr. Zahid to add in his portfolio.

 

Dear friends, if we consider the face value of both the bonds Rs. 1000. Then apparently it seems that investment in bond B will be better. Rest i can better comment after detailed calculations. 
Ab reasoning apni apni. Bond B will be more suitable for investment. Keep the aspects of Long Bond - Risk Theory (Handout page 68) Bond Portfolio Theory and Bond Maturity (Life) Tradeoff in mind while giving reasons

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