Bonds Evaluation

BOND VALUATION AND YIELD

In valuing a bond ( or any such security ) we are primarily concerned with discounting ( or capitalizing ) the cash flow stream that the investor would receive over the life of the instrument.

The discount ( capitalisation ) rate applied to the cash flow stream will differ among bonds depending on the risk structure of the bond issue.

Future Value and Present Value of an Annuity ( REVISION)

1.Ordinary Annuities.

If $10,000 is deposited each year in a savings account paying 15% p.a., how much will you have after 3 years?

We know : n

FVAn = PMT ∑ ( 1 + i )ⁿ-t

t=1

A simplification of the approach is to find the future value interest factor for an ordinary annuity, when interest is compounded annually at i percent for n periods, using tables or a calculator.

FVAn = PMT ( FVIFA i,n )

FVAn = PMT ( 3.4725 )

= $10,000 ( 3.4725 )

= $ 34, 725

=======

COMPOUNDING MORE THAN ONCE PER YEAR

Interest is paid on many financial instruments more than once per year, often semi- annually ( twice per year). If you deposit $100 in a savings account that compounds interest semi- annually, with a nominal interest rate of 8 % pa the future value after 6

Months would be :

FV 0.05 = PMT ( 1 + [ i ] )

-------------

m

where m= the number of times interest is paid per year.

FV 0.05 = 100 ( 1 + [ 0.08 ] = $104

2

i.e. 4 % interest after 6 months.

At the end of 1 year the...