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Organizational history, mission and vision
A bond is a debt security. A bond is defined as an instrument of indebtedness by the bond issuer to any bondholder. Under some agreed terms, the bond issuer is said to owe the investor a particular debt. This essay analyses different aspects of bond evaluation. These elements include the types of bonds, bond evaluation methods, factors affecting bond valuation and relevant terminologies in bond valuation.
Analysis of the types of bonds
The types of bonds include government bonds. Government bonds are also referred to as treasury bonds and are issued by the government to raise money (Chandra 172-173). Municipal bonds are other types of bonds issued by cities in order to raise funds (OHara 1). Zero-coupon bonds are types of bonds that do not pay regular interests but usually traded at deep discounts. Convertible bonds are bonds exchangeable at the holders option for issuance of a companys common stock (Agrawal 221). Corporate bonds are issued by companies to cater for their debt capital. Fixed coupon bonds pay same interest amount for the whole period.
Proposed goals of bond valuation
Time value of money; this process involves two types of cash flows that are face value and coupon payments. The bonds value is calculated by adding the present value of the principal amount to the present value of coupon payments. Through this method, bonds can be evaluated annually, semi-annually and quarterly (Fabozzi 169). The other method of price valuation is the relative price approach. Investors who use these techniques buy bonds after detecting that these bonds were under-priced. Investors of these bonds use this method to detect over-priced bonds and then sell them later (Drake and Fabozzi 398). The third method of bond valuation is the stochastic calculus approach. This technique is used in the evaluation of risk-free bonds with quantities that are continuously adjusted. Valuation using this method is achieved by constructing a stochastic differential equation. The stochastic and non-stochastic differential equations governing the bond price must be known in order to compute the bonds value (Danthine and Donaldson 455). Finally, the arbitrage-free pricing approach is another method used in bond evaluation. This method values a bond considering the series of cash flows. Each cash flow is taken to be a zero-coupon bond. In this case, each cash flow is discounted at a unique discount rate of its own (Fabozzi and Mann 110).
The different factors affecting bond valuation are as follows. Firstly, interest rate and the rate of return affect bond prices. Interest rates are determined by the real risk-free rate, the expected rate of inflation and the risk premium. When interests rate are high, the bond prices increases and vice versa (Madura 207). Secondly, the rate of inflation may also affect bond valuation. When the inflation rate is high, the value of bonds decreases. A low rate of inflation increases the value of bonds. The various terminologies used in bond valuation include yield to maturity, yield to call and realized yield. Yield to call measures the return rate that investors receive for holding a bond till it reaches the call date. Realized yield computes the expected return rate of a bond that investors expect to sell prior to the bonds maturity. Yield to maturity indicates the fully compounded return rate promised to investors who buy bonds at prevailing prices.
Works Cited
Agrawal, Neeraj. Management of Working Capital. New Delhi: Sterling Publisher Private Limited, 2003. Print.
Chandra, Prasanna. Fundamentals of Financial Management. New Delhi: Tata McGraw-Hill Education, 2010. Print.
Danthine, Jean-Pierre, and John B. Donaldson. Intermediate Financial Theory. 2nd ed. Amsterdam: Elsevier, 2005. Print.
Drake, Pamela, and Frank J. Fabozzi. Foundations and Applications of the Time Value of Money. Hoboken, N.J.: John Wiley & Sons, 2009. Print.
Fabozzi, Frank J. Fixed Income Analysis Workbook. 2nd ed. Hoboken, N.J.: J. Wiley, 2007. Print.
Fabozzi, Frank J., and Steven V. Mann. Introduction to Fixed Income Analytics: Relative Value Analysis, Risk Measures, and Valuation. 2nd ed. Hoboken, N.J: Wiley, 2010. Print.
Madura, Jeff. Financial Markets and Institutions. Cincinnati: South-Western College Pub, 2001. Print.
OHara, Neil. The Fundamentals of Municipal Bonds. Hoboken, NJ: John Wiley & Sons, Inc., 2012. Print.
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