Transcript DEBT INSTRUMENTS - Learning Financial Management

CONTENTS
• KEY LEARNINGS
• BOND YIELD
• BOND VALUATION AND
PRICING
• CREDIT RATING
• RISKS
• YIELD CURVE
• MALKEIL’S PROPERTIES
KEY LEARNINGS
Debt instruments
Issuers of Bonds
Features of Bonds
Types of Debt Instruments
DEBT INSTRUMENTS
• A bond is a debt security, in which the
issuer owes the holders a debt and,
depending on the terms of the bond, is
obliged to pay interest (the coupon)
and/or to repay the principal at a later
date, termed as maturity.
• Bonds provide the borrower with
external funds to finance long-term
investments, or, in the case of
government bonds, to finance current
expenditure.
ISSUER OF BONDS
Bonds are generally issued by
• Public authorities
• Credit institutions
• Companies
• The most common process of issuing
bonds is through underwriting.
FEATURES OF BOND
•
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•
•
•
•
•
Nominal, Principal or Face amount
Issue price
Maturity date
Coupon rate
Indentures and Covenants
Coupon dates
Optionality i.e. callability, putability, call
dates and put dates
• Security
Types of Debt Instruments
• Secured and unsecured debentures
• Convertible and Non-convertible
debentures
• Zero interest fully convertible
debentures
• Secured Premium Notes
• Callable and Putable Bond
Floating Rate Bonds
• Coupon rate of these bonds is tied
to some benchmark
• Eg coupon rate =Bank rate +2%
• Not popular in India
Deep Discount Bonds
• Type of zero interest bond
• Non convertible
• Redeemed after expiry of specific period
at face value
• Return on these bonds is difference
between issue price and maturity value
• No coupon rate and no interest during
life of the DDB
Junk Bonds
•
•
•
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High risk bonds
High yield bonds
No or low credit rating
Favourable for speculators
Municipal Bonds
• Issued by civic authorities of a city
• Objective is to raise funds for
development
• Tax benefits may or may not be
available
• Coupon rate is low
• Credit rating of issuing municipiality
BOND YEILD
• Percentage rate of return on the
amount invested.
• Benchmark for evaluating
investment instruments.
• It may or may not be same as
coupon rate.
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Bond Yield Depends on:1. PAR VALUE – The principal amount of a
bond. Issue price and Redemption value
may be > or < face value.
2. COUPON RATE (Normal yield) – Rate at
which fixed annual monetary amount is
payable to lender by borrower.
3. MATURITY – Period after expiry of which
redemption repayment is made to investor.
4. MARKET PRICE – Return depends on the
price paid for debt.
13
TYPES OF YIELD
BOND YIELD
1. NORMAL YIELD
2. CURRENT YIELD
3. YIELD TO
MATURITY
4. YIELD TO CALL
5. REALISED
YIELD
PURPOSE
1.
2.
3.
4.
5.
Coupon rate.
Current year rate of
return.
Annual rate of
return till maturity.
Annual rate of
return till call
Total return over
the holding period
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YIELD TO MATURITY
•
•
1.
2.
3.
4.
It is market rate of return on market
rate of interest.
CONDITIONS –
Bond is purchased today at current
market price.
Bond is held by investor till maturity.
Interest received are reinvested at
YTM itself.
No interest default by the company.
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YIELD TO MATURITY
• P = Interest * PVAF(YTM,n) + RV *
PVF(YTM,n)
P
= Market Price
PVAF = Present Value Annuity Factor
PVF = Present Value Factor
YTM = Yield to Maturity
N
= Life of the Bond in years
RV = Redemption Value
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BOND PRICING
AND
VALUATION
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QUESTION
Investors are generally faced with the
question “To invest in a particular
bond or not”
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ANSWER
• Compare the security’s market
price with its “value”
• The security could be
Over
priced
Under
priced
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VALUE OF A BOND
• The value of a bond is defined as the
sum of the present values of the future
interest payments plus the present value
of the redemption repayment.
• It is discounted at the required rate of
return called the market interest rate
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VALUATION OF A ZERO
COUPON BOND
Market price
of
=
bond
Face value of bond
(1+r )n
Where, r = yield to maturity
n = maturity period of the bond
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VALUATION OF FIXED
INTEREST RATE BONDS
Market price = Interest * PVAF(r,n) + RV
*PVF (r,n)
Where, RV = Redemption value
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CREDIT RATINGS
• Each of the agencies assigns its ratings based
on an in-depth analysis of the issuer's financial
condition and management, economic and debt
characteristics, and the specific revenue
sources securing the bond.
Credit Ratings
Credit Risk
Moody's
Standard and
Poor's
Fitch
Prime
Aaa
AAA
AAA
Excellent
Aa
AA
AA
Upper Medium
A
A
A
Lower Medium
Baa
BBB
BBB
Speculative
Ba
BB
BB
Very Speculative
B, Caa
B, CCC, CC
B, CCC, CC, C
Default
Ca, C
D
DDD, DD, D
Debt Instruments
Type
Typical Features
Central Government Securities
Medium – long term bonds issued by
RBI on behalf of GOI.
Coupon payment are semi annually
State Government Securities
Medium – long term bonds issued by
RBI on behalf of state govt.
Coupon payment are semi annually
Government – Guaranteed Bonds
Medium – long term bonds issued by
govt agencies and guaranteed by central
or state govt.
Coupon payment are semi annually
PSU
Medium – long term bonds issued by
PSU.
51% govt equity stake
Corporate
Short - Medium term bonds issued by
private companies.
Coupon payment are semi annually
Risk Associated with
Investing in Bonds
• Interest Rate Risk
• The price of the bond will change in the opposite
direction from the change in interest rate. As interest
rate rises the bond price decreases and vice versa.
• Reinvestment Income or Reinvestment Risk
• The additional income from such reinvestment called
interest on interest, depends on the prevailing interest
rate levels at the time of reinvestment.
• Credit Risk
• If the issuer of a bond will fail to satisfy
the terms of the obligation with respect
to the timely payment of interest and
repayment of the amount borrowed.
• Inflation Risk
• Purchasing power risk arises because of the
variation in the value of cash flow from the
security due to inflation.
• Exchange Rate Risk
• Risk associated with the currency value for nonrupee denominated bonds. Eg: US treasury
bond
• Liquidity Risk
Trading in bonds is very thin. Risk that
the investor may not be able to sell the
bond when he wants.
Term Structure Of
Interest Rates
• It depicts the relationship between
maturity and interest rates.
• Graphical representation known as the
YIELD CURVE.
• The curve deals with the YTM and there
is an implied assumption that all the
interest received will be reinvested at a
rate equal to the YTM.
NORMAL YIELD CURVE
YIELD
MATURITY
INVERSE YIELD CURVE
YIELD
MATURITY
YIELD
MATURITY
FLAT YIELD CURVE
YIELD
MATURITY
MALKIEL’S PROPERTIES
REQUIRED RATE OF RETURN (YIELD TO MATURITY)
As interest rate changes , the bond value also changes. The
change in bond value due to change in interest rates is
known as Interest Rate Risk.
Bond value
Yield to maturity
Coupon Rate, YTM, Bond
Value, and Par Value
•If YTM =Coupon Rate ,then Bond value = Par
Value
•If YTM < Coupon Rate,then Bond value > Par
Value
•If YTM > Coupon Rate,then Bond value< Par
Value
Bond Valuation and Time to
Maturity
• The value of the bond approaches its par value
as the time to maturity approaches its maturity
date.
•Values of long-term bonds are more sensitive to
interest rate variations than the short-term
bonds.
BY:Akanksha Ailawadi
Akanksha Sawant
Akansha Agarwal
Akshat Gupta
Himanshi Sachdeva
Pawan Agarwal
Saahil Thukral
Tarandeep Singh Sethi
Vaishali Jaiswal