bond valuation

How will bond valuation help you

Bonds are a type of debt security and considered an IOU between the Borrower (issuer of the bond) and the Lender (investor – you). When you buy a bond essentially you are loaning out your money for a fixed period of time to be returned at the end of the period. Typically, you buy the bond at a market price and you receive periodic interest payments called, “coupons”, over the security term plus, a redemption value (aka par value) at maturity of the term.

Bonds and common stocks are the two most commonly accepted and compared investment vehicles and most portfolios comprise of a large proportion of each. There are strong followings for each with many opinions for and against. Some regard particular bonds as the safer alternative to common stocks because of government support and are often recommended for investors who are positioned later in their investment cycle who don’t have the luxury of time to recover from any potential heavy losses. In addition, the interest payments from bond issues are an added benefit for investors looking to supplement their incomes.



 

Like most investment vehicles, bonds come in a variety of flavours and complexities. For simplicity, most bonds are grouped into government bonds and corporate bonds. Government bonds are the more secure of the two simply because they are issued and backed by the full credibility of the government while corporate bonds are secured by the particular company issuing the facility (eg BHP or ANZ). Naturally, it’s more likely for a company to experience a negative operating position resulting in a default on the interest payment than it is for a government so to compensate for the added risk it is common to experience a higher interest payment when purchasing corporate bonds.

In determining which bond will suit your needs it is important to look at several factors, among them are 1) yield to maturity aka yield 2) market price and 3) term. Through the use of the Bond Valuation Calculator you will be able to analyse two of the three requirements which will provide you with a simple method for bond comparison and valuation. All the information you need to use the model will be available from the Bond Prospectus or Term Sheet – here is an example.

Bond Valuation Calculator

How this calculator works

The purpose of this calculator is to provide two key outputs that can be used in your bond evaluations. By entering key inputs such as settlement date, coupon rate, coupon frequency, maturity date, and redemption value you can determine either the yield to maturity or the market price.

An example – Yield to maturity

Assume you have decided to diversify your investment portfolio with some government bonds to reduce overall risk and provide some additional income through interest payment receipts. Based on your personal circumstances you are interested in long term options of 10 years and have come across two government bonds that appear quite similar.

Bond #1 prospectus outlines a market price of $104.54, maturity date of 28/12/2025, a coupon rate of 5% paid semi-annually (2.5% every 6 months), redemption value of $100. Bond #2 outlines a market price of $98.12, maturity date of 1/12/2025, a coupon rate of 3.5% paid semi-annually (1.75% every 6 months), redemption value of $100. By entering the data into the model you will return a yield to maturity for Bond #1 and Bond #2 of 4.43% and 3.73% respectively. The results indicate that Bond #1 sold at a premium (a value above the redemption value) but, the higher coupon interest payment actually returned a better yield than Bond #2 which sold at a discount but, issued a lower coupon payment.

An example – Market price

Assuming you would like to determine whether or not a bond is selling at a premium, fair value or a discount. In addition, you would like to compare two bonds for market price.

Bond #1 prospectus outlines a yield of 2.55%, a coupon rate of 3.5% (paid semi-annually at 1.75% per period), a maturity period of about 10 years and a redemption value of $100. Based on this, the market price aka the purchase price of $108.34 is computed and indicates is it being sold at a premium because it is above the redemption value.

Bond #2 displays similar attributes with the one exception, the yield is 3%. The outcome is a market price of $104.26 and also indicates sale at a premium however, the price is less than that of Bond #1 and would suggest on this basis alone the better option.

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Limitations

The calculator doesn’t take into consideration personal circumstances or specific attributes of bonds eg. fixed, floating, indexed, government or corporate and therefore is limited in the overall evaluation.

Instructions

Walk-through:

Yield

  1. Enter the settlement date – this is the date the bond will settle and you assume ownership. Typically 3 days from buy initiative.
  2. Enter the coupon rate – this is the annual interest payment rate indicated on the bond prospectus
  3. Enter the coupon frequency – how often the interest payment will be made to you. Select 1 for once a year (annual), 2 for every six months (semi-annually) and 4 for every 3 months (quarterly).
  4. Enter the maturity date – the date when the bond term concludes you receive your final coupon plus the redemption value.
  5. Enter the market price – the price you will pay for the bond at the prevailing market rate (excludes brokerage).
  6. Enter the redemption value – Also known as Par Value or Face Value, this is the unadjusted value of the security and is usually set at the benchmark of $100.

Price

  1. Enter the settlement date – this is the date the bond will settle and you assume ownership. Typically 3 days from buy initiative.
  2. Enter the coupon rate – this is the annual interest payment rate indicated on the bond prospectus
  3. Enter the coupon frequency – how often the interest payment will be made to you. Select 1 for once a year (annual), 2 for every six months (semi-annually) and 4 for every 3 months (quarterly).
  4. Enter the maturity date – the date when the bond term concludes you receive your final coupon plus the redemption value.
  5. Enter the yield – the rate of return you could expect from the security when considerations are made for coupon payments, market price, bond term and redemption value
  6. Enter the redemption value – Also known as Par Value or Face Value, this is the unadjusted value of the security and is usually set at the benchmark of $100.

Bond Valuation

All fields marked with * are mandatory
Yield
Bond 1
Bond 2
Settlement date
Settlement date
Coupon rate(%)
Coupon rate(%)
Coupon frequency
Coupon frequency
Maturity date
Maturity date
Market price
Market price
Redemption value
Redemption value
Yield(%)
Yield(%)
Market price
Bond 1
Bond 2
Settlement date
Settlement date
Coupon rate(%)
Coupon rate(%)
Coupon frequency
Coupon frequency
Maturity date
Maturity date
Yield(%)
Yield(%)
Redemption value
Redemption value
Market price
Market price

 

Up Next – Planning for Retirement

The final topic that will be discussed in this brief introduction to financial management and planning is the retirement phase. There are two sections detailed ahead:

  1. Planning for retirement – retirement fund accumulation before retirement
  2. Planning for retirement – after retirement pension required

 

PLANNING FOR RETIREMENT

 

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