Valuation of Corporate Securities

 Self-Paced Overview

Valuing Bonds

Bonds are a corporate security representing debt of the company. They are easily valued since the cash flows are easy to identify. The cash flows associated with bonds are the coupon paymentsCoupon Payments:Periodic interest payments on a bond. Usually made semiannually. on the bond each coupon period and the maturity valueMaturity Value:Par value/face value on a bond. Amount to be repaid at maturity. or face valueFace Value:Par value/maturity value on a bond. Amount to be repaid at maturity. of the bond. Most bonds in the U.S. pay coupons semiannually and most bonds have maturity values of $1000 each. The following example illustrates how easily bonds are priced.

Price a 5% coupon, $1000 bond with 5 years to maturity if other bonds of similar quality are sold to yield 8%.

The coupon payments would be $50 per year (5% of $1000) or $25 each six months. There will be 10 compounding periods (2 × 5 years.) The maturity value is $1000. The bonds will be discounted at the market rate which is 8% per year or 4% each six months.

Periods Cash Flow × PVIF @ 4% = Discounted Cash Flow
1-10 $25 × 8.111 = $202.78
10 $1000 × .676 = $676.00

If one wanted to sell this bond for $980, no one would want to buy it. The only way the holder of the bond could unload it would be to lower the price. On the other hand, if one said they would sell the bond for $750, there would be a rush into the market to buy the bond. Thus, demand would be greater than supply and the price of the bond would rise. To how much? To $878.78, all other things being equal. Thus the $878.78 is the equilibrium priceEquilibrium Price:Price securities sell for in efficient market, which is the discounted value of cash flows. for the bond until market conditions change. is maintained by Dr. Sharon Garrison
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