VALUATION OF BONDS

AND STOCKS
 CONCEPTS OF VALUE

• Liquidation Value

• Going Concern Value

• Book Value

• Market Value

• Intrinsic Value
 VALUE OF A BOND

n
P=Σ C
+
M
t=1 (1+r)t (1+r)n

P = C x PVIFAr,n + M x PVIFr,n
 ILLUSTRATION
To illustrate how to compute the price of a bond, consider a 10-year, 12
percent coupon bond with a par value of 1,000. Let us assume that the
required yield on this bond is 13 percent. The cash flows for this bond
are as follows:
• 10 annual coupon payments of Rs. 120
• Rs. 1000 principal repayment 10 years from now
The value of the bond is:
P = 120 x PVIFA13%, 10 yrs + 1,000 x PVIF 13%, 10 yrs
= 120 x 5.426 + 1,000 x 0.295
= 651.1 + 295 = Rs. 946.1
VALUE OF A BOND WITH SEMI-ANNUAL
INTEREST

2n
P = Σ C/2
(1+r/2)t
+
M
(1+r/2)2n
t=1

P = C/ 2 x PVIFAr/2,2n + M ( PVIFr2,2n)
 ILLUSTRATION
As an illustration, consider an 8 year, 12 percent coupon bond with a par
value of Rs. 100 on which interest is payable semi-annually. The
required return on this bond is 14 percent.
Applying Eq.(7.2) the value of the bond is:

16
P=Σ 6
+
100
t=1 (1.07)t (1.07)16

= 6(PVIFA7%,16) + 100 (PVIF7%,16)

= Rs. 6(9.447) + Rs.100 (0.339) = Rs. 90.6
PRICE-YIELD RELATIONSHIP
 Coupon Rate, Required Yield, & Price

To sum up, the relationship between the coupon rate,

the required yield, and the price is as follows:
Coupon rate > Required yield Price > Par (Premium bond)

Coupon rate > Required yield Price = Par

Coupon rate < Required yield Price < Par (Discount bond)
 PRICE - YIELD RELATIONSHIP
PRICE

YEILD

PRICE CHANGES WITH TIME

VALUE OF
BOND PREMIUM BOND: rd = 11%

A
PAR VALUE BOND: rd = 13%
B
DISCOUNT BOND: rd = 15%

8 7 6 5 4 3 2 1 0
YEARS TO MATURITY
 BOND YIELDS
• CURRENT YIELD
ANNUAL INTEREST
PRICE
• YIELD TO MATURITY
C C C M
P = + + …. +
(1+r) (1+r)2 (1+r)n (1+r)n
8 90 1,000
800 =  +
t=1 (1+r)t (1+r)8
AT r = 13% … RHS = 808
AT r = 14% … RHS = 768.1
808 - 800
YTM = 13% + (14% - 13%) = 13.2%
808 - 768.1
C + (M - P) / n
YTM ≃
0.4M + 0.6 P
• YIELD TO CALL
n* C M*
P =  +
t=1 (1+r)t (1+r)n
 VALUATION OF PREFERENCE STOCK
n
P=Σ D
+
M
t=1 (1+rp)t (1+rp)n

Since the stream of dividends is an ordinary annuity, we can apply the

formula for the present value of an ordinary annuity. Hence the value of
the preference stock is:

Po = D x PVIFArp,n + M x PVIFr p,n

To illustrate how to compute the value of a preference stock, consider an
8 year, 10 percent preference stock with a par value of Rs. 1000. The
required return on this preference stock is 9 percent.
VALUATION OF PREFERENCE STOCK

The value of the preference stock is

P = 100 x PVIFA 9%, 8yrs + 1000 x PVIF 9%, 8 yrs

= 100 x 5.535 x 1000 x 0.502

= Rs. 1110.5
 DIVIDEND DISCOUNT MODEL
• SINGLE PERIOD VALUATION MODEL
D1 P1
P0 = +
(1+r) (1+r)
• MULTI - PERIOD VALUATION MODEL
 Dt
P0 = 
t=1 (1+r)t
• ZERO GROWTH MODEL
D
P0 =
r
• CONSTANT GROWTH MODEL
D1
P0 =
r-g
Two stage growth model
(refer to class notes)