Bond Valuation

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Lecture 03: Applying the Time Value of Money to Security Valuation – Valuation of Bonds and Debt Securities

A bond or a debenture is a long term debt instrument carrying a fixed rate of interest which is known to investors. A bond is redeemable after a specified period. Bonds are also called gilt edged securities or gilt when issued by the government since it is free of default risk.

Features of a Bond or Debenture
• Face Value – Face value is called par value. A bond / debenture is generally issued at a par value and interest is paid on the par value. • Interest Rate – Interest rate is fixed and known to the bondholders / debenture holders. Interest paid on a bond is tax deductible. The interest rate is also called the coupon rate. • Maturity – A bond is issued for a specified period of time. It is repaid on maturity. • Redemption Value – The value which a bondholder will get on maturity is called redemption value. • Market Value – A bond / debenture may be traded on the stock exchange. The price at which it is currently sold or bought is called the market value of the bond / debenture.

A bond is a long-term promissory note that promises to pay the bondholder a predetermined, fixed amount of interest each year until maturity. At maturity, the principal will be paid to the bondholder. In the case of a firm's insolvency, a bondholder has a priority of claim to the firm's assets before the preferred and common stockholders. Also, bondholders must be paid interest due them before dividends can be distributed to the stockholders. A bond's par value is the amount that will be repaid by the firm when the bond matures. The contractual agreement of the bond specifies a coupon interest rate that is expressed either as a percent of the par value or as a flat amount of interest which the borrowing firm promises to pay the bondholder each year. For example: A $1,000 par value bond specifying a coupon interest rate of 9 percent is equivalent to...
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