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Valuation of Fixed Income Securities: Loan stocks and debentures

Valuation of Fixed Income Securities: Loan stocks and debentures. P o = Interest x PVIFA k%,n + M x PVIF k%,n

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Valuation of Fixed Income Securities: Loan stocks and debentures

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  1. Valuation of Fixed Income Securities: Loan stocks and debentures • Po = Interest x PVIFAk%,n + M x PVIFk%,n • Example: XYZ is planning to issue a 15 years loan stock with RM100 par value and a coupon rate of of 9%. Interest rate is to paid annually. If the prevailing market interest rate is 9% for a loan stock with similar risk class, what would be value (issue price) of XYZ loan stock be? • Solution: Po = Interest x PVIFAk%,n + M x PVIFk%,n • Po = 9% x 100 x PVIFA9%,15 + 100 x PVIF9%, 15 • = 9 x 8.061 + 100 x 0.275 • = RM100 1

  2. Valuation of Fixed Income Securities: Loan stocks and debentures • If coupon rate r = market interest rate (k) then Po = M • Example: What would be the market value of XYZ loan stock after (a) 1 year, (b) 7 year and (c) 14 year if coupon rate = market interest rate? • (a) Po = 9 * PVIFA9%,14 + 100 * PVIF9%,14 • = 9 * 7.786 + 100 * 0.299 = RM100 • (b) Po = 9 * PVIFA9%,8 + 100 * PVIF9%,8 • = 9 * 5.535 + 100 * 0.502 = RM100 • (c) Po = 9 * PVIFA9%,1 + 100 * PVIF9%,1 • = 9 * 0.917 + 100 * 0.917 = RM100 2

  3. Valuation of Fixed Income Securities: Loan stocks and debentures • Discount and Premium: If r < k , then loan stock will be trading at a discount. • Example: What would be the market value if (a) k = 10% after 1 year (b) k = 12% after 1 year • Solution • (a) Po = 9 * PVIFA10%,14 + 100 * PVIF10%,14 • = 9 * 7.367 + 100 * 0.263 = RM92.6 • (b) Po = 9 * PVIFA12%,14 + 100 * PVIF12%,14 • = 9 * 6.628 + 100 * 0.257 = RM85.35 3

  4. Valuation of Fixed Income Securities: Loan stocks and debentures • The discount on a loan stock would gradually diminishes when maturity date approaches and on maturity Po = M • Example: Suppose k remains 10% after one year. What is the value of the loan stock after (a) 2 years and (b) 14 years • Solution • (a) Po = 9 * PVIFA10%,13 + 100 PVIF10%,13 • = 9 * 7.103 + 100 * 0.29 = RM92.93 • (b) Po = 9 * PVIFA10%,1 + 100 PVIF10%,1 • = 9 * 0.909 + 100 * 0.909 = RM99.08 4

  5. Valuation of Fixed Income Securities: Loan stocks and debentures • Premium: If r > k, then loan stock will be trading at a premium. • Example: What would be the market value if (a) k = 8% after 1 year (b) k = 6% after 1 year • Solution • (a) Po = 9 * PVIFA8%,14 + 100 * PVIF8%,14 • = 9 * 8.244 + 100 * 0.341 = RM108.3 • (b) Po = 9 * PVIFA6%,14 + 100 * PVIF6%,14 • = 9 * 9.30 + 100 * 0.442 = RM127 5

  6. Valuation of Fixed Income Securities: Loan stocks and debentures • The premium on a loan stock would gradually diminishes when maturity date approaches and on maturity Po = M • Example: Suppose k remains 8% after one year. What is the value of the loan stock after (a) 2 years and (b) 14 years • Solution • (a) Po = 9 * PVIFA8%,13 + 100 PVIF8%,13 • = 9 * 7.904 + 100 * 0.368 = RM107.94 • (b) Po = 9 * PVIFA8%,1 + 100 PVIF8%,1 • = 9 * 0.926 + 100 * 0.926 = RM100.93 6

  7. Valuation of Fixed Income Securities: Loan stocks and debentures • 5 Rules • If r = k, then Po = M • If k > r, then Po <M (selling at discount) • If k<r, then Po > M (selling at a premium) • The greater the increase in k, the greater the fall in Po (and vice versa) • Po approaches M as maturity date approaches. 7

  8. Rating Agency Malaysia (RAM) Malaysian Rating Corporation (MARC) Bonds Trust Performances Term structure of interest rates Malaysian Government Securities (MGS) Private Debt Securities (PDS) KLIBORs TB3 Interest rate futures (MDEX) Money market instruments in Malaysia Group assignment (40% = 30% report + 10% presentation 8

  9. Loan stocks/debentures with semi annual payments • Po = I/2 * PVIFAr%/2 n*2 + M * PVIF r%/2, n*2 • Example: Syarikat Maju is planning to issue a 15 year unsecured debenture with RM100 par value and a coupon rate of 9% per annum. Interest is paid semi-annually. Find the issue price if the prevailing market interest rate is 8%. • Solution: RM9/2 * PVIFA4%, 30 + RM100 * PVIF4%, 30 • = 4.5 * 17.29 + 100 * 0.308 = RM 108.6 • Redo for previous example. (Homework) 9

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