# Bond Valuation Essay

Unit 4

Unit 4

4.1 Introduction 4.2 Valuation of Bonds Types of Bonds 4.2.1 Irredeemable or Perpetual Bonds

Valuation Of Bonds And Shares

4.2.2 Redeemable or Bonds with Maturity Period 4.2.3 Zero Coupon Bond Bondyield Measures 4.2.1 Holding Period Rate of Return 4.2.2 Current Yield 4.2.3 Yield to Maturity (YTM) 4.2.4 Bond Value Theorems 4.3 Valuation of Shares 4.3.1 Valuation of Preference Shares 4.3.2 Valuation of Ordinary Shares 4.4 Summary Solved Problems Terminal Questions Answers to SAQs and TQs

4.1

Introduction

Valuation is the process of linking risk with returns to determine the worth of an asset. Assets can be real or financial; securities are called

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Concept of Intrinsic value: A security can be evaluated by the series of dividends or interest payments receivable over a period of time. In other words, a security can be defined as the present value of the future cash streams – the intrinsic value of an asset is equal to the present value of the benefits associated with it. The expected returns (cash inflows) are discounted using the required return commensurate with the risk. Mathematically, it can be represented by:

1 2 3 n V0=C1/(1+i) + C2/(1+i) + C3/(1+i) + Cn/(1+i) n = Cn/(1+i)

Where V0=Value of the asset at time zero (t=0) P0=Present value of the asset Cn=Expected cash flow at the end of period n i=Discount rate or required rate of return on the cash flows n=Expected life of an asset.

Example: Assuming a discount rate of 10% and the cash flows associated with 2 projects A and B over a 3 year period, determine the value of the assets.

Sikkim Manipal University

51

Financial Management

Unit 4

Year 1 2 3 Solution:

Cash flows Cash flows of A(Rs.) of B(Rs) 20000 20000 20000 10000 20000 30000

Value of asset A= 20000 PVIFA(10%,3y) =20000*2.487 =Rs. 49470 Value of asset B=10000PVIF(10%,1) + 20000PVIF(10%,2) + 30000PVIF (10%,3) =10000*0.909 + 20000*0.826 + 30000*0.751 =9090+16520+22530 =Rs. 48140 Example: Calculate the value