SUPPLEMENTAL NOTES ON CHAPTER 6

Bond Valuation
Bonds are fixed income security normally used to fund long term assets or projects. The types of bonds
are normally based on the issuer i.e. could be a corporate bond, treasury or government bonds, or
municipal bonds.

Bonds are considered fixed income because the holder were guaranteed to receive interest based on
the interest rates stated or covenanted by the issuer to the investor. Given that the bonds are long term,
the default and credit risk is probable. Hence, the value of the bond changes depending on the
appreciation of the market to its riskiness. Normally, credit rating agencies also evaluate the issuers
ability to repay the bond that forms part of the bond value.

The investor or issue must also be aware about this value. The value of the bond is of course should be
the (1) face value of the bond and (2) the interest it will yield in the future. Given this the formula on
bond valuation is written as follows:
𝑛
1 1
𝐵𝑜 = 𝐼 × [∑ 𝑡 ]+𝑀 ×[ ]
(1 + 𝑟𝑑 ) (1 + 𝑟𝑑 )𝑛
𝑡=1

Bo = present value of the bond

I = annual interest paid in dollars
n = number of years to maturity
M = par value in dollars
rd = required return

The first part of the equation deals with the determination of the value of the interest received; while
the 2nd part of the equation deals with the determination of the value of the bonds at the point of
investment, meaning it is expected the value will accrete until the maturity of the bonds. Normally,
bonds are paid in balloon or one-time, unless otherwise stated.

To illustrate, a firm has issue a PHp1,000 par value bonds with a 9% stated interest rate outstanding. The
issue pays interest annually and has 20 years remaining to its maturity. If the bonds of similar risk are
currently earning 11%, the firm’s bonds will be sold for how much?
𝑛
1 1
𝐵𝑜 = 𝐼 × [∑ 𝑡 ]+𝑀 ×[ ]
(1 + 𝑟𝑑 ) (1 + 𝑟𝑑 )𝑛
𝑡=1
20
1 1
𝐵𝑜 = (1,000 𝑥 9%) × [∑ 20 ] + 1,000 × [ ]
(1 + 11%) (1 + 11%)20
𝑡=1

𝐵𝑜 = 90 × 7.963 + 1,000 × 0.124

𝐵𝑜 = 716.67 + 124.03
𝐵𝑜 = 840.70
With the same assumptions, except that the interest are paid on semi-annual basis, how much will the
bonds be sold at?
𝑛
1 1
𝐵𝑜 = 𝐼 × [∑ 𝑡 ]+𝑀 ×[ ]
(1 + 𝑟𝑑 ) (1 + 𝑟𝑑 )𝑛
𝑡=1
40
1 1
𝐵𝑜 = (1,000 𝑥 4.5%) × [∑ 40 ] + 1,000 × [ ]
(1 + 5.5%) (1 + 5.5%)40
𝑡=2

𝐵𝑜 = 45 × 16.0461 + 1,000 × 0.1175

𝐵𝑜 = 722.08 + 117.46
𝐵𝑜 = 839.54
Observe that the value of the bonds increased. The increase is driven by the compounding effect of the
interest as the half of its value was received 6 months earlier that the original case. It can also be noted
further that since that nominal interest is lower than effective the discount is expected.

Exercises

1. BSA2-1 Corp. has an issue of Php1,000 par value bonds with a 14% annual interest rate. The
bonds will mature in 10 years. Bonds of the similar nature and risk profile will yield a 12% return.
The current value of the bond is _________
a. Php791.00 c. Php1,000.00
b. Php1,052.24 d. Php1,113.00

2. Calculate the value of Republic of BSA2-4 with a par value of Php1,000 that will mature in 10
years with a coupon rate of 12% payable on a quarterly basis. The required return on a similar-
risk bonds is 20%.
a. Php656.77 c. Php845.66
b. Php835.45 d. Php2,201.08

3. BSA2-2P Inc. is expanding its business to the south. It issued five hundred Php1,000 maturing in
12 years with a coupon rate of 14%, paid semi-annually, that has a yield to maturity of 13%. How
much is the value of the bond?
a. Php302,000 c. Php530,000
b. Php545,000 d. Php536,500

4. You received Php10,000 and is considering purchasing 10 bonds of CAF Corp. The bond has a par
value of Php1,000 with 10% coupon and will mature in 10 years. If the prevailing return in the
market will yield 9%, how much is the bond will be sold and can you purchase 10 bonds?

5. BASA Technologies Inc. has an outstanding issue of 10% bond with par value of Php1,000,
payable semi-annually. The bond was issued 25 years ago and has 5 years to maturity. How
much is the bond assuming 14% rate of return?

Prepared by: Marvin V. Lascano