Fundamentals of Finance: In-depth Project Report on Bond Valuation

This report provides a comprehensive overview of bond valuation within the context of fundamental finance principles. It covers key concepts such as call provisions, discount and premium bonds, and the inverse relationship between market interest rates and bond prices. The report includes calculations for zero-coupon bond prices and explains the rationale behind steep discounts. It also demonstrates how to calculate bond prices and determine whether a bond is trading at a discount or premium. Furthermore, the report details the calculation of yield to maturity (YTM) and discusses the impact of sales price changes on YTM. The analysis is supported by relevant academic references, offering a solid foundation for understanding bond valuation techniques and their practical implications. Desklib provides access to this and many other solved assignments for students.

Running Head: Fundamentals of Finance
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Project Report: Fundamentals of Finance

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Contents
Question 1.........................................................................................................................3
i. Call provisions...........................................................................................................3
ii. Additional compensation in bond.............................................................................3
Question 2.........................................................................................................................3
i. Discount bond and premium bond.............................................................................3
ii. Reasons that why bond prices are changed..............................................................3
Question 3.........................................................................................................................4
i. Differences in interest payment and bond prices.......................................................4
ii. Coupon paying bond and zero coupon bond............................................................4
Question 4.........................................................................................................................4
i. Zero coupon bond price calculations.........................................................................4
ii. Reasons behind steep discounts................................................................................5
Question 5.........................................................................................................................5
i. Calculation of bond prices.........................................................................................5
ii. Why bond is either discount or premium bond........................................................6
Question 6.........................................................................................................................6
i. Calculation of yield to maturity.................................................................................6
ii. Yield to maturity effect............................................................................................6
References.........................................................................................................................7

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Question 1:
i. Call provisions:
Call provision allows a bond issuer to retire and repurchase the bonds. If a bond is with
the call provisions than in a particular time period, it could be called against a particular [rice
which would be paid to the bondholders and any other situated accrued interest would be
defined as provisions.
ii. Additional compensation in bond:
In addition to the bond principle, premium amount is paid by the issuer to the
bondholders at time of bond called. Normally, a common call premium is total worth of one
year’s interest rate. Though, sometimes call premium could be reduced as the bond’s age.
Question 2:
i. Discount bond and premium bond:
Discount bond is the bond which is selling in lower price than its par value such as a
bond is worth of $ 100 but it is traded in $ 90 in the market than this bond would be called
discount bond. On the other hand, the premium bond is the bond which would be sold by the
bondholder in greater price than its par value such as a bond is worth of $ 100 but it is traded
in $ 110 in the market than this bond would be called premium bond.
ii. Reasons that why bond prices are changed:
According to Cornett, Adair & Nofsinger (2016), Market interest rate changes and the
price of bond are inversely connected to each other. Bond’s coupon rate and bond maturity
period is always fixed by the issuer at the initial stage so the interest rate and economy
changes do not make an impact over the bond prices. Though, with the interest rate

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increment, new bonds price would be higher than the existing share price. The existing bonds
are required to be sold in a different amount to carry the ROI in same line with new bonds.
Question 3:
i. Differences in interest payment and bond prices:
The 6% coupon bond depicts about the annual interest of 6% of bond on its par value.
For instance, for a bond worth $ 100, the interest amount would be $6 per year. So, the price
of the coupon bonds would be near to the par value of the bond. Whereas, the zero coupon
bond does not pay the interest amount. The bondholders get the return from increment of the
market price of the bond. Initially, the price of the zero coupon bond is much lower and at the
time of mature, the par value is given (Becker & Ivashina, 2015).
ii. Coupon paying bond and zero coupon bond:
In case of changing in the market interest rate, the 6% coupon bond would remain near
to the par value as the market changes does not make more impact on the interest bonds
whereas the zero coupon bond prices would fluctuate more.
Question 4:
i. Zero coupon bond price calculations:
Given,
Future value = $ 100
Interest rate = 4%
Compounding = Semi annually
Time = 20 years

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PV= FV/ (1+i)^n (Tanaka, 2015)
PV = 100 / (1+0.04/2)^20*2
PV = 100/ (1.02)^40
PV = 100/ 2.20
PV = $ 45.29
ii. Reasons behind steep discounts:
Zero coupon bonds are sold at steep discount due to the reason that no interest amount
is paid on the zero coupon bonds so that in the given time period, investors make enough
profits and returns for the foregone of interest payments. Steep discounts make it easy for the
investors to choose zero coupon bonds over interest coupon bonds.
Question 5:
i. Calculation of bond prices:
Coupon rate = 0.038
Time period = 18 years
Market interest rate = 7%
Solution,
PMT = 0.038* 100/2 = 1.9
Time = 18*2 = 36
Interest rate = 7% /2 =3.5%
Future value = 100

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PV = PMT * [1-1/(1+i)^n/i]+FV/(1+i)^n (Brooks, 2015)
PV = 1.9 * [1-1/(1+0.035)^36/0.05]+100(1+0.035)^36
PV = $ 67.54
ii. Why bond is either discount or premium bond:
The above calculations express that the bond is a discount bond as the par value of the
bond is quite higher than the present value of the bond.
Question 6:
i. Calculation of yield to maturity:
Given,
Present value = $ 1035.25
PMT = 0.065 * 100/2 = 3.25
N = 2*18 = 36
FV = $ 100
Calculations of Yield to maturity
FV 1000
PMT 32.5
NPER 36
PV -1035.25
RATE(H6,H5,H7,H4,0)*2
6.17%
ii. Yield to maturity effect:
The yield to maturity (YTM) of the bond would be 6.17%. A decrement in the offered
sales price will make an impact on increment in the yield to maturity.

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References:
Becker, B., & Ivashina, V. (2015). Reaching for yield in the bond market. The Journal of
Finance, 70(5), 1863-1902.
Brooks, R. (2015). Financial management: core concepts. Pearson.
Cornett, M. M., Adair, T. A., & Nofsinger J. (2016).M: Finance(3rd ed.). New York, NY:
McGraw-Hill.
Tanaka, T. (2015). Managerial discretion and the maturity structure of corporate public debt:
Evidence from Japan. Working paper, Ritsumeikan University.