Dear Aspirants,
Today we will be discussing an important topic of RBI Grade B.This topic is part of Finance in phase II and questions upto 6 marks have been asked from this chapter. On Tuesday will be discussing it further try questions related to the same concept today at 6.30 p.m. Let's begin now:-
What is Bond?
From Companies or Government point of view: -
A bond or debenture is an instrument of debt issued by a business or government. In easy words, Bond is an instrument through which a company can raise funds (loan)
From an Investor point of view: -
A bond is fixed income investment in which an investor lends money to an entity (corporate or government) for a definite period of time at a fixed rate of interest.
Some basic terms related to Bonds
Par Value: Value stated on the face of bond It is the amount which firms borrow and promises to repay at time of maturity.
Coupon Rate: A bond carries a specific interest rate known as coupon rate. It is calculated on the face value of Bond.
Maturity Period: Corporate bonds have a maturity period of 3 to 10 years, while government bonds can have maturity periods upto 30 years.
Redemption: Repayment of principal
Bond Valuation Method
The value of Bond is
V = I (PVIFAkd, n) + F (PVIFkd, n)
Where,
V = value of bond
I = annual interest payable
F = par value or principal amount of bond at the time of maturity
N = maturity period of the bond.
Kd = required rate of return
Example on above:
- A bond of Rs. 1000 as par value bearing a coupon rate of 14 % matures after 5 years, the required rate of return on this bond is 13%. Calculate the value of the bond. [Given (PVIFA 13%, 5 = 3.517) and (PVIFkd, n = .543).
Solution:
Given
- I = 1000 x 14 % = 140
- Kd = 13%
- F = 1000
- N = 5 years
The value of the bond is
V = I (PVIFAkd, n) + F (PVIFkd, n)
= 140 (PVIFA 13%, 5) + 1000 (PVIF 13%, 5)
= 140 (3.517) + 1000 (.543)
= Rs. 1035.4
Bond Value Theorems
Some basic rules with regards to bonds are: -
CAUSE | EFFECT |
The required rate of return = coupon rate | Bonds sells at par value |
The required rate of return > coupon rate | Bonds sells at a discount |
The required rate of return < coupon rate | Bonds sells at a premium |
Longer the maturity of a bond | Greater the bond price change with a given change in the required rate of return. |
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On Tuesday we will discuss ahead on YTM, duration of bond and other related concepts.
Happy Reading!
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All the best for your exam
Team gradeup
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