SFM COMPILER Bond Analysis & Valuation

CHP - 2 BOND ANALYSIS AND VALUATION

Years May Nov

RTP Paper RTP Paper
2008 NA NA Yes Yes
2009 Yes Yes Yes Yes
2010 Yes Yes Yes Yes
2011 Yes No Yes Yes
2012 Yes No Yes Yes
2013 Yes Yes No Yes
2014 Yes Yes No No
2015 Yes Yes Yes Yes
2016 Yes Yes Yes Yes
2017 Yes Yes Yes No
2018 (Old) Yes Yes Yes Yes
2018 (New) Yes Yes No Yes
2019 (Old) Yes No No No
2019 (New) Yes No No No

2008
Question 1 Nov RTP 2008
The following data are available for a bond
Face value Rs. 1,000
Coupon Rate 15%
Years to Maturity 6
Redemption value Rs.1,000
Yield to maturity 17%
What is the current market price, duration and volatility of this bond? Calculate the expected market
price, if increase in required yield is by 75 basis points.

Solution :
(1) Current Market Price = PV of Coupons + PV of Redemption
= 150 (PVIFA 17%) + 1,000 (PVIFA 17,6)
= 150 (3.589) + 1,000 (0.390)
= 538.35 +390 = 928.35
(2) Duration

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Year Cash flow P.V. @ 17% wx

(x) (w)
1 150 .855 128.25 128.25
2 150 .731 109.65 219.3
3 150 .624 93.60 280.8
4 150 .534 80.10 320.4
5 150 .456 68.40 342
6 1150 .390 448.50 2691
928.50 3981.75

D=
 wx = 3981.75 = 4.288 yrs.
 w 928.50
Duration 4.288
3. Volatility = YTM Factor = 1.17 = 3.67
4. The expected market price if increase in required yield is by 75 basis points.
= Rs.928.35 – (3.67  0.75%) = Rs.902.797
Note : Yield increase market rise decreases.

Question 2 Nov 2008 – RTP

The Investment portfolio of a REG EPF Trust is as follows:
Government Bond Coupon Rate Purchase rate Duration
(F.V. Rs.100 per Bond) (Years)
G.O.I. 2008 11.68 106.50 3.50
G.O.I. 2012 7.55 105.00 6.50
G.O.I. 2017 7.38 105.00 7.50
G.O.I. 2024 8.35 110.00 8.75
G.O.I. 2034 7.95 101.00 13.00
Face value of total Investment is Rs.5 crores in each Government Bond.
Calculate actual Investment in portfolio.
What is a suitable action to churn out investment portfolio in the following scenario?
1. Interest rates are expected to lower by 25 basis points.
2. Interest rates are expected to raise by 75 basis points.
Also calculate the revised duration of investment portfolio in each scenario.

Solution :
Calculation of Actual investment of Portfolio

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Security Purchase price Investment

(Rs. in lakhs)
G.O.I. 2008 106.50 532.50*
G.O.I. 2012 105.00 525.00
G.O.I. 2017 105.00 525.00
G.O.I. 2024 110.00 550.00
G.O.I. 2034 101.00 505.00
Total 2,637.50
5  106.5 = 532.50
3.5  6.5  7.5  8.75  13.00
Average Duration = = 7.85
5
Suitable action to churn out investment portfolio in following scenario.
To reduce risk and to maximize profit or minimize losses.
(1) Interest rates are expected to be lower by 25 basis points in such case increase the average
duration by purchasing GOI 2034 and Disposing of GOI 2008.
39.25  3.5  13.00
Revised Average Duration shall be = = 9.75 years
5
(2) Interest rates are expected to rise by 75 basis points in such case reduce the average duration
by (*) Purchasing GOI 2012 and disposing of GOI 2034.
39.25  13.00  3.50
Revised Average Duration shall be = = 6.55 years
5
(*) Purchasing of GOI 2008 is not beneficial as maturity period is very short and 75 basis points is
comparatively higher change.

Question 3 Nov 2008 Paper – 4 Marks

The following is the Yield structure of AAA rated debenture:
Period Yield (%)
3 months 8.5%
6 months 9.25
1 year 10.50
2 years 11.25
3 years and above 12.00
(i) Based on the expectation theory calculate the implicit one-year forward rates in year 2 and
year 3.
(ii) If the interest rate increases by 50 basis points, what will be the percentage change in the
price of the bond having a maturity of 5 years? Assume that the bond is fairly priced at the
moment at Rs.1,000.

Solution :
(i) Implicit rate of Interest for Year 2 and Year 3

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(1 + r2)2
For Year 2 = (1 + r1) – 1
(1.1125)2
= (1.1050) - 1 = 12%
(1 + r3) 3
For Year 3 = (1 + r1) (1 + f2) – 1
(1.12)3
= (1.1125)2 – 1 = 13.52%
(ii) If fairly priced at Rs.1000 and rate of interest increases to 12.5% the percentage charge will
be as follows:
1000(1 12)5
Price = (1.125) 5 = Rs.978
1000 – 978
% Change = x 100 = 2.2%
1000

Question 4 Nov 2008 Paper – 6 Marks

XL Ispat Ltd. Has made an issue of 14 % non – convertible debentures on Jan 1, 2007. These
debentures have a face value of Rs.100 and is currently traded in the market at a price of Rs.90.
Interest on these NCDs will be paid through post-dated cheques dated June 30 and December 31.
Interest payments for the first 3 years will be paid in advance through post-dated cheques while for
the last 2 years post-dated cheques will be issued at the third year. The bond is redeemable at par
on December 31, 2011 at the end of 5 years.
Required
i. Estimate the current yield at the YTM of the Bond.
ii. Calculate the duration of the NCD
iii. Assuming that intermediate coupon payments are, not available for reinvestment calculate
the realized yield on the NCD.

Solution :
Coupon 14
1) A) Cy = = = 15.56%
MP 90
1  FV  P  / n
B) YTM =
FV  P  / 2
14  100  90 / 5
= = 16.84%
100  90 / 2
2) Duration
Yr. CF PV @ 16.84% wx
1 14 11.98 11.98
2 14 10.255 20.51
3 14 8.777 26.331
4 14 7.51 30.04

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5 114 52.35 261.768

90.87 350.63

D=
 wx =
350.63
= 3.86 yrs.
w 90.87
3) If intermediate coupon are not available for reinvestment then the total will be available at
end of 5 yr. it will be like a 2CB bond

90 14  5 + 100
100(1 + r)5 = 170
1
 170  5
r=   – 1 = 13.565%
 90 

Question 5 Nov 2008 Paper – 8 Marks

The data given below relates to a convertible bond :
Face value Rs.250
Coupon rate 12%
No. of shares per bond 20
Market price of share Rs.12
Straight value of bond Rs.235
Market price of convertible bond Rs.265
Calculate :
(i) Stock value of bond. (ii) The percentage of downside risk.
(iii) The conversion premium (iv) The conversion parity price of the stock.

Solution :
(i) Stock value or conversion value of bond 12 × 20
= Rs.240
(ii) percentage of the downside risk
265 – 235
= x 100 = 12.77%
235
This ratio gives the percentage price decline experienced by the bond if the stock becomes
worthless.
(iii) Conversion Premium
Market Price – Converion Value
= x 100
Conversion Value
265 – 240
= x 100 = 10.42%
240
(iv) Conversion Parity Price
Bond Price
= No of shares on Conversion
= 265 / 20 = Rs.13.25

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This indicates that if the price of shares rises to Rs.13.25 from Rs.12 the investor will neither
gain nor lose on buying the bond and exercising it. Observe that Rs.1.25 (13.25– 12.00) is
10.42% of Rs.12, the Conversion Premium.

2009
Question 6 May 2009 RTP
A 9% 5 years bond is issued in the market at Rs.90 and redemption price Rs.105. For an investor with
marginal income tax rate of 30% and capital gain tax 10% (assuming no indexation), what is the post-
tax yield to maturity ?

Solution :
I = 100  9%  0.7 = 6.3
CGT = (105 – 90)  10% = 1.5
F = 105 – 1.5 = 103.5
F–P 103.5 – 90
I+ n 6.3 + 5
YTM = F + P = 103.5 + 90 = 9.30%
2 2

Question 7 May 2009 Paper – 6 Marks

ABC Ltd. has Rs.300 million, 12 per cent bonds outstanding with six years remaining to maturity. Since
interest rates are falling, ABC Ltd. is contemplating of refunding these bonds with a Rs.300 million
issue of 6 year bonds carrying a coupon rate of 10 per cent. Issue cost of the new bond will be Rs.6
million and the call premium is 4 per cent. Rs.9 million being the unamortized portion of issue cost
of old bonds can be written off no sooner the old bonds are called off. Marginal tax rate of ABC Ltd.
is 30 per cent. You are required to analyse the bond refunding decision.

Solution :
Initial Cash Movements
A) Net proceeds of fresh issue (300 – 6) 294
B) Redemption of old bonds (312)
C) Tax shield on bond premium (12  30%) 3.6
D) Tax shield on unamortised portion of issue cost (9  0.3) 2.7
(11.7)
Recurring cash flows
Old New
A) Post tax coupon 25.2 21
B) Tax shield on unamortized 0.45 0.3
1 1
discount, floating cost (9   0.3) (6   0.3)
6 6
24.75 20.7

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4.05
= 4.05  PVIFA (7%, 6)
= 4.05  4.767
= 19.30
Net Savings = 19.3
– 11.7
7.6
Since the decision is Positive we should go ahead with bond refunding decision

Question 8 May 2009 Paper – 20 Marks

(a) Consider two bonds, one with 5 years to maturity and the other with 20 years to maturity.
Both the bonds have a face value of Rs.1,000 and coupon rate of 8% (with annual interest
payments) and both are selling at par. Assume that the yields of both the bonds fall to 6%,
whether the price of bond will increase or decrease? What percentage of this
increase/decrease comes from a change in the present value of bond’s principal amount and
what percentage of this increase/decrease comes from a change in the present value of
bond’s interest payments?
(b) Consider a bond selling at its par value of As. 1.000, with 6 years to maturity and a 7% coupon
rate (with annual interest payment), what is bond’s duration?
(c) If the YTM of the bond in (b) above increases to 10%, how it affects the bond’s duration?
And why?
(d) Why should the duration of a coupon carrying bond always be less than the time to its
maturity?

Solution :
A) Since bond is trading at par, redeemable at pat
CY = YTM = Coupon = 8%
5 Yr. Bond
Yield P.V. of coupon + P.V. of redemption = Bond
8% 319.42 + 680.88 = 1000
(80  3.99) (1000  0.681)
6% 336.99 + 747 = 1089.99
(80  4.212) (1000  0.747)
Change 17.57 66.42 83.99
% 20.92% 79.08% 100%
20 Yr Bond
Yield P.V. of coupon + P.V. of redemption = Bond
8% 786 + 214 = 1000
(80  9.818) (1000  0.214)
6% 917.6 + 312 = 1229.6

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(80  11.47) (1000  0.312)

Change 131.6 98 229.6
% 57.32% 42.68% 100%
CY
B) D = YR  AF  YTM Factor + (1 – YR)n  YTM = 1

= 4.767  1.07 = 5.1 yrs.

C) D = 4.8 yrs. = 4.356  1.1

Question 9 Nov 2009 RTP – Similar to - Question 3 - Nov 2008 Paper – 4 Marks

Question 10 Nov 2009 RTP – Similar t0 - Question 4 - Nov 2008 Paper – 6 Marks

Question 11 Nov 2009 Paper - 4 Marks

An investors is considering the purchase of the following Bond:
Face value Rs.100
Coupon rate 11%
Maturity 3 years
(i) If he wants a yield of 13% what is the maximum price he should be ready to pay for?
(ii) If the Bond is selling for Rs.97.60, what would be his yield?

Solution :
Value of bond = P.V. of coupons + P.V. of redemption
= 11  PVIFA (13%, 3) + 100  PVIF (13%, 3)
= Rs.95.27/-
F–P 100 – 97.6
I+ n 11 + 3
YTM = F+P = 100 + 97.6 = 11.94%
2 2
2010
Question 12 May 2010 RTP
Phototech plc has in issue 9% bonds which are redeemable at their par value of £100 in five years’
time. Alternatively, each bond may be converted on that date into 20 ordinary shares of the
company. The current ordinary share price of Phototech plc is £4·45 and this is expected to grow at
a rate of 6·5% per year for the foreseeable future. Phototech plc has a cost of debt of 7% per year.
Required:
Calculate the following current values for each £ 100 convertible bond:
(i) market value; (ii) floor value; (iii) conversion premium.

Solution :
(a) Calculation of market value of each convertible bond
Expected share price in five years’ time = £4·45 x(1·065)5 =£6·10

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Conversion value = £6·10 x 20 =£122

Compared with redemption at par value of £100, conversion will be preferred
The current market value will be the present value of future interest payments, plus the
present value of the conversion value, discounted at the cost of debt of 7% per year.
Market value of each convertible bond = (£ 9 x 4·100) + (£ 122 x 0·713)
= £123·89
(b) Calculation of floor value of each convertible bond
The current floor value will be the present value of future interest payments, plus the present
value of the redemption value, discounted at the cost of debt of 7% per year.
Floor value of each convertible bond = (£ 9 x 4·100) + (£ 100 x 0·713)
= £108·20
(c) Calculation of conversion premium of each convertible bond
Current conversion value = £ 4·45 x 20 =£89·00
Conversion premium = £123·89–£89·00 =£34·89
This is often expressed on a per share basis,
i.e.£34·89/20 =£1·75 per share

Question 13 May 2010 RTP

On 1 June 2003 the financial manager of Gadgets Corporation’s Pension Fund Trust is reviewing
strategy regarding the fund. Over 60% of the fund is invested in fixed rate long-term bonds. Interest
rates are expected to be quite volatile for the next few years.
Among the pension fund’s current investments are two AAA rated bonds:
1) Zero coupon June 2018
2) 12% Gilt June 2018 (interest is payable semi-annually)
The current annual redemption yield (yield to maturity) on both bonds is 6%. The semi-annual yield
may be assumed to be 3%. Both bonds have a par value and redemption value of $100.
Required:
Estimate the market price of each of the bonds if interest rates (yields):
(i) increase by 1%; (ii) decrease by 1%.
[Given PVF (2.5%, 30) = 0.4767, PVF (3%, 30) = 0.412, PVF (3.5%,30) = 0.3563]

Solution :
The current market prices of the two bonds may be estimated to be:
$100
Zero coupon = (1.06)15 = $ 41.73
12% gilt with a semi-annual coupon
1 – (1.03)– 30
Present value of an annuity for 30 periods at 3% is = 9.6004 $
0.03
Present value of interest payments $6×19·6004 = 117·60
Present value of redemption using PVF (3%, 30) [$100×0·4120] = 41·20
158·80

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(i) If interest rates increase by 1%

$100
Zero coupon = (1.07)15 = $ 36.25 a decrease of$5·48 or 13·1%
12% gilt
1 – (1.025)– 30
Present value of an annuity for 30 periods at 3.5% is = 18.3920 $
0.035
Present value of interest payments$6×18·3920 = 110·35
Present value of redemption using PVF (3.5%, 30) [$100 × 0·3563] = 35·63
145·98
This is a decrease of $12·82 or 8·1%

(ii) If interest rates decrease by 1%

$100
Zero coupon = (1.05)15 = $ 48.10 an increase of$6·37 or 15·3%
12% gilt
1 – (1.025)– 30
Present value of an annuity for 30 periods at 2.5% is = 20.9303 $
0.025
Present value of interest payments $6 × 20·9303 = 125·58
Present value of redemption using PVF (2.5%, 30) [$100 × 0·4767] = 47·67
173·25
This is a decrease of $14·45 or 9·1%

Question 14 May 2010 Paper – 8 Marks

Consider the following data for government securities
Face value Interest (Rate %) Maturity (Years) Current Price (Rs.)
1,00,000 0 1 90,000
1,00,000 10.5 2 98,000
1,00,000 11.0 3 98,500
1,00,000 11.5 4 98,900
Calculate the forward interest rates.

Solution :
100000
Bond A 90000 = (1 + r )
01

100000
r01 = 90000 – 1 = 11.11%
10500 110500
Bond B 98000 = + +
(1 + r01) (1 + r02)2
110500
98000 – 9450.1 = (1 + r )2
02

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1
 110500 
r02 =  88549.9 2 – 1 = 11.71%
 
11000 11000 11000
Bond C 98500 = (1 + r ) + (1 + r )2 + (1 + r )3
01 02 03

11000
98500 – 9900.1 – 8814.72 = (1 + r )3
03
1
 111000 
r03 =  79785.183 1 = 11.64%
 
11500 11500 11500 111500
Bond D 98900 = (1 + r ) + (1 + r )2 + (1 + r )3 + (1 + r )4
01 02 03 04

111500
98900 – 10350.1 – 9215.39 – 8264.91 = (1 + r )4
04

 111500 1
r04 =  71069.64 – 1
 
= 11.92%
Term Structure
Bond Maturity Rate
A 1 11.11
B 2 11.71
C 3 11.64
D 4 11.92
(1.1171)2
f12 = ) – 1 = 12.31%
1.1111
(1.1164)3
f13 =  1.1171  – 1 = 11.90%
 
4 1
(1.1192) 
f14 =  1.1111  3 – 1 = 12.19%
 
3
(111.64)
f23 = (111.71)2 – 1 = 11.5%
1
 (1.1192)4 
f24 =  (1.1171)2  2 – 1 = 12.13%
 
4
(1.1192)
f34 = – 1 = 12.76%
(1.1164)3

Question 15 Nov 2010 RTP

NewChem Corporation has issued a fully convertible 10% debenture of Rs.10,000 face value,
convertible into 20 equity shares. The current market price of the debenture is Rs.10,800, whereas
the current market price of equity share price is Rs.480.
You are required to calculate (i) the conversion premium and (ii) the conversion value.

Solution :

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As per the conversion terms 1 Debenture = 20 equity share (known as the conversion ratio.)
The conversion terms can also be expressed as: 1 Debenture of Rs.500 = 1 equity share.
(i) The conversion premium measures how much more expensive it is to buy the convertible
debenture than the underlying equity share.
(ii) The cost of buying Rs.500 debenture (one equity share) is:
108
Rs.500 x 100 = Rs.540
Comparing this with the cost of buying one equity share from market at Rs.480.
Thus, conversion premium is therefore:
540 – 480
480 x 100 = 12.5%
Therefore, it is more expensive to buy the debenture and get it converted, than to purchase
one equity share directly.
(iii) The conversion value is calculated as the market value of equity shares that is equivalent to
one unit of the convertible debenture.
Conversion value = conversion ratio X MPS (equity shares)
= 20 x Rs.480
= Rs.9,600
From this calculation of conversion value, the conversion premium may also be calculated as
below:
10800 – 9600
x 100 = 12.5%
9600

Question 16 - Nov 2010 Paper – 5 Marks

Calculate Market Price of:
(i) 10% Government of India security currently quoted at 110 but interest rate is expected to go
up by 1 %.
(ii) A bond with 7.5% coupon interest. Face Value 10,000 & term to maturity of 2 years, presently
yielding 6% interest payable half yearly.

Solution :
Assuming Bond to be perpetual
Coupen
i) Yield = MP
10
 = 110
= 0.09%
New Yield = 9.09 + 1 = 10.09%
10
New Price = 10.09%
= Rs.99.11/-

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ii) Value = P.V. of coupons + P.V. of redemption

= 375  PVIFA (3%, 4) + 10000  PVIF(3%, 4)
= 10278.78

2011
Question 17 May 2011 RTP
ABC Ltd. has the following outstanding Bonds.
Bond Coupon Maturity
Series X 8% 10 Years
Series Y Variable changes annually comparable 10 Years
To prevailing rate
Initially these bonds were issued at face value of Rs.10,000 with yield to maturity of 8%.
Assuming that:
(i) After 2 years from the date of issue, interest on comparable bonds is 10%, then what should
be the price of each bond?
(ii) If after two additional years, the interest rate on comparable bond is 7%, then what should
be the price of each bond?
(iii) What conclusions you can draw from the prices of Bonds, computed above.

Solution :
Here we shall compare two bonds, one with fixed copoun rate and another as per with prevailing
interest rate.
(i) After 2 Years passed (8 years remaining) Value of Bond Series – X
= Rs.800 PVIAF (10% ,8) + Rs.10,000 PVIF (10%, 8)
= Rs.4,268 + Rs.4,665 = Rs.8,933
Since Bond-Series Y has a variable interest rates, so the interest amount will increase and
decrease with the movement of interest rates. As given presently rate of interest is 10%, the
value of Bond will be:
= Rs.1,000 PVIAF (10%, 8) + Rs.10,000 PVIF (10%, 8)
= Rs.5,335 + Rs.4,665 = Rs.10,000
(ii) After 2 additional years at the yield rate of 7%, the value of Bond shall be as follows:
Bond-Series X
= Rs.800 PVIAF (7%, 6) + Rs.10,000 PVIF (7%, 6)
= Rs.3,813 + Rs.6,663
= Rs.10,476
Bond-Series Y
= Rs.700 PVIF (7%, 6) + Rs.10,000 PVIF (7%, 6)
= Rs.700 x 4.767 + Rs.10,000 x 0.666
= Rs.3,337 + Rs.6,663 = Rs.10,000

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(iii) From above prices it can be concluded that price of Bond-Series X moves inversely with
change in interest rate. Whereas, the price of Bond Series Y does not fluctuate, reason being
its interest (coupon) adjusted according to change in interest rates.

Question 18 May 2011 RTP

Pet feed plc has outstanding, a high yield Bond with following features:
Face Value £ 10,000
Coupon 10%
Maturity Period 6 Years
Special Feature Company can extend the life of Bond to 12 years.
Presently the interest rate on equivalent Bond is 8%.
(a) If an investor expects that interest will be 8%, six years from now then how much he should
pay for this bond now.
(b) Now suppose, on the basis of that expectation, he invests in the Bond, but interest rate turns
out to be 12%, six years from now, then what will be his potential loss/gain.

Solution :
(i) If the current interest rate is 8%, the company will not extent the duration of Bond and the
maximum amount the investor would ready to pay will be:
= £ 1,000 PVIAF (8%, 6) + £ 10,000 PVIF (8%, 6)
= £ 1,000 x 4.623 + £ 10,000 x 0.630
= 4,623 + 6,300
= £ 10,925
(ii) If the current interest rate is 12%, the company will extent the duration of Bond. After six
years the value of Bond will be
= £ 1,000 PVIAF (12%, 6) + £ 10,000 PVIF (12%, 6)
= 4,111 + 5,070
= £ 9,177
Thus, potential loss will be £ 9,177 - £ 10,925 = £1,748

Question 19 Nov 2011 RTP – Similar to - Question 1 - Nov RTP 2008

Question 20 Nov 2011 RTP

M Ltd. has to make a payment on 30th January, 2011 of Rs.80 lakhs. It has surplus cash today, i.e.
31st October, 2010; and has decided to invest sufficient cash in a bank's Certificate of Deposit
scheme offering an yield of 8% p.a. on simple interest basis. What is the amount to be invested now?

Solution :
Calculation of Investment Amount
Amount required for making payment on 30th January, 2011= Rs.80,00,000
Investment in Certificates of Deposit (CDs) on 31st October, 2010

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Rate of interest = 8% p.a.

No. of days to maturity = 91 days
Interest on Rs.1 of 91 days
(Rs.1 × 0.08 × 91/365) = 0.0199452
Amount to be received for Re. 1
(Rs.1.00 + Rs.0.0199452) = 1.0199452
Calculation of amount to be invested now to get Rs.80 lakhs after 91 days:
Rs.80,00,000
= Rs.1.0199452
= Rs.78,43,558.65

Question 21 Nov 2011 RTP – Similar to Question 6 - May 2009 Paper 6 Marks

Question 22 Nov 2011 Paper – 5 Marks

The six months forward price of a security is Rs.208.18. The rate of borrowing is 8 percent per annum
payable at monthly rates. What will be the spot price?
Solution
Calculation of spot price
 r
The formula for calculating forward price is: A = P 1 + nmn
 
Using the above formula,
208.18
P= = 200
1.0067 6
8
r= = 0.67% per month.
12
Hence, the spot price should be Rs.200.

Question 23 Nov 2011 Paper – 6 Marks

Pineapple Ltd has issued fully convertible 12 percent debentures of Rs. 5,000 face value, convertible
into 10 equity shares. The current market price of the debentures is Rs.5,400. The present market
price of equity shares is Rs. 430.
Calculate:
(i) the conversion percentage premium, and
(ii) the conversion value
Solution
(i) The conversion value can be calculated as follows:
Conversion value = Conversion ratio X Market Price of Equity Shares
= 10 × Rs.430 = Rs.4300
(ii) Conversion Premium %
5400  4300
=  100
4300
= 25.58%

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Question 24 Nov 2011 Paper – 8 Marks

Based on the credit rating of bonds, Mr. Z has decided to apply the following discount rates for valuing
bonds:
Credit Rating Discount Rate
AAA 364 T Bill rate + 3% Spread
AA AAA + 2% Spread
A AAA + 3% Spread
He is considering to invest in AA rated, Rs.1,000 face value bond currently selling at Rs.1,025.86. The
bond has five years to maturity and the coupon rate on the bond is 15% p.a. payable annually. The
next interest payment is due one year from today and the bond is redeemable at par. (Assume the
384 day T-bill rate to be 9%).
You are required to calculate the intrinsic value of the bond for Mr. Z Should he invest in the bond?
Also calculate the current yield and the Yield to Maturity (YTM) of the bond.

Solution :
AA Rated yield 9 + 3 + 2 = 14%
1) Value of bond = P.V. of coupons + P.V. of redemption
= 150  PVIFA (14%, 5) + 1000  PVIF(14%, 5)
= 150  3.433 + 1000  0.519
= Rs.1034.36/-
Current MP = Rs.1025.86/-
2) The bond is trading cheap, therefore the investor should go long.
Coupen
CY = MP  100
150
= 1025.86  100
= 14.62%
F–P
I+ n
3) YTM = F+P
2
1000 – 1025.86
150 + 5 144.828
= =
1000 + 1025.86 1012.93
2
= 14.3%

2012
Question 25 May 2012 RTP – Similar to - Question 4 - Nov 2008 Paper – 6 Marks

Question 26 Nov 2012 RTP

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 SFM COMPILER Bond Analysis & Valuation

The following data is related to 8.5% Fully Convertible (into Equity shares) Debentures issued by JAC
Ltd. at Rs.1000.
Market Price of Debenture Rs.900
Conversion Ratio 30
Straight Value of Debenture Rs.700
Market Price of Equity share on the date of Conversion Rs.25
Expected Dividend Per Share Rs.1
You are required to calculate:
(a) Conversion Value of Debenture
(b) Market Conversion Price
(c) Conversion Premium per share
(d) Ratio of Conversion Premium
(e) Premium over Straight Value of Debenture
(f) Favourable income differential per share
(g) Premium pay back period
Solution :
(a) Conversion Value of Debenture
= Market Price of one Equity Share X Conversion Ratio
= Rs.25 X 30 = Rs.750
(b) Market Conversion Price
Market Price of Convertible Debenture 900
= = 30 = Rs.30
Convertion Ratio
(c) Conversion Premium per share
= Market Conversion Price – Market Price of Equity Share
= Rs.30 – Rs.25 = Rs.5
(d) Ratio of Conversion Premium
Conversion Premium Per Share 5
= = = 20%
Market Price of Equity Share 25
(e) Premium over Straight Value of Debenture
Market Price of Convertible Bond 900
= - 1 =
Straight Value of Bond 700 - 1 = 28.6%
(f) Favourable income differential per share
Coupon Interest from Debenture – Convertion Ratio – Dividend Per Share
= Convertion Ratio
85 – 30 – 1
= = Rs.1.833
30
(g) Premium pay back period
Conversion Premium Per Share 5
= Favaourable Income Differential Per Share = 1.833 = 2.73 years

Question 27 Nov 2012 RTP – Similar to - Question 1 - Nov RTP 2008

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Question 28 Nov 2012 Paper – 5 Marks

Calculate the Current price and the Bond equivalent yield (using simple compounding) of a money
market instrument with face value of Rs.100 and discount yield of 8% in 90 days. Take 1 year 360
days.
Solution :
1) Current price
100
IV =
1.08
= 92.59
2) Bond Equivalent Yield
100 – V 300
BEY = x
V Days of Maturity
100 – 92.59 360
BEY = x 90 = 32%
92.59

2013
Question 29 May 2013 RTP –Similar to-Question 26 - Nov 2012 RTP

Question 30 May 2013 Paper – 6 Marks

M/s. Earth Limited has 11% bond worth of Rs.2 crores outstanding with 10 years remaining to
maturity.
The company is contemplating the issue of a Rs.2 crores 10 year bond carring the coupon rate of 9%
and use the proceeds to liquidate the old bonds.
The unamortized portion of issue cost on the old bonds is Rs.3 lakhs which can be written off no
sooner the old bonds are called. The company is paying 30% tax and it's after tax cost of debt is 7%.
Should Earth Limited liquidate the old bonds?
You may assume that the issue cost of the new bonds will be Rs.2.5 lakhs and the call premium is 5%.

Solution :
1. Initial outlay
A) Redemption of old Bonds (2,00,00,000  1.05) (2,10,00,000)
B) Tax shield on POR (2,00,00,000  0.5  30%) 3,00,000
C) Issue of New Bonds (2,00,00,000 – 2,50,000) 1,97,50,000
D) Tax on unamortised portion of issue cost of old bonds.
(3,00,000  30%) 90,000
Net (8,60,000)
2. Future Cash Flows
New Old
Post tax Interest (12,60,000) (15,40,000)
(18,00,000  70%) (22,00,000  70%)

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 SFM COMPILER Bond Analysis & Valuation

Amortisation of Issue Cost 7,500 9,000

(2,50,000 / 10  30%) (3,00,000 / 10  30%)
Net 12,52,500 15,31,000

Saving 2,78,500
 PVI FA (7% 10 yrs) – 19,56,068
3. Net Savings = 19,56,068 – 8,60,000 = 10,96,068

Question 31 Nov 2013 Paper – 5 Marks

ABC Ltd. issued 9%, 5 year bonds of Rs.1,000/- each having a maturity of 3 years. The present rate of
interest is 12% for one year tenure. It is expected that Forward rate of interest for one year tenure is
going to fall by 75 basis points and further by 50 basis points for every next year in further for the
same tenure. This bond has a beta value of 1.02 and is more popular in the market due to less credit
risk.
Calculate
(i) Intrinsic value of bond
(ii) Expected price of bond in the market

Solution :
(i) Intrinsic Value of Bond = Pv of Coupon + Pv of Redemption
Forward rate of interests
1st Year 12%
2nd Year 11.25%
3rd Year 10.75%
90 90 90
PV of Interest = 1 + 0.12 + (1 + 0.12) (1 + 0.1125) + (1+ 0.12) (1 + 0.1125) (1 + 0.1075)
= Rs.217.81
1000
PV of Redemption = (1 + 0.12) (1 + 0.1125) ( 1+ 0.1075) = Rs. 724.67
IV = 217.81 + 724.67 = Rs. 942.48
(ii) Expected Price = Intrinsic Value x Beta Value
= Rs.948.48 x 1.02 = Rs.961.33

2014
Question 32 May 2014 RTP
Mr. A is planning for making investment in bonds of one of the two companies X Ltd. and Y Ltd. The
detail of these bonds is as follows:
Company Face Value Coupon Rate Maturity Period
X Ltd. Rs.10,000 6% 5 Years
Y Ltd. Rs.10,000 4% 5 Years

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 Bond Analysis & Valuation SFM COMPILER

The current market price of X Ltd.’s bond is Rs.10,796.80 and both bonds have same Yield To Maturity
(YTM). Since Mr. A considers duration of bonds as the basis of decision making, you are required to
calculate the duration of each bond and you decision.

Solution :
To calculate duration of bond we need YTM.
i + (FV - P)/n
YTM =
(FV + P)/2
600+(10,000 - 10796.80)/5
=
(10,000 + 10796.80)/2
600  159.36
=
10398.4
= 4.2%

Duration of X Ltd.’ s Bond

Year Cash Flows P.V @ 4.2% Wx

1 600 575.82 575.82

2 600 552.60 1105.20
3 600 530.34 1591.02
4 600 508.98 2035.92
5 10600 8,629.46 43147.30
Total 10,797.20 48455.26

D =
 wx =
48455.26
= 4.49 Yrs.
w 10797.20

Duration of Y Ltd.’s Bond

Year Cash Flows P.V @ 4.2% Wx
1 400 383.88 383.88
2 400 368.40 736.8
3 400 353.56 1060.68
4 400 339.32 1357.28
5 10400 8466.64 42333.2
Total 9,911.80 45871.84

D =
 wx =
45871.84
= 4.628 Yrs.
w 9911.8

Decision: Since the duration of Bond of X Ltd. is lower hence it should be preferred.

Question 33 May 2014 Paper – 8 Marks

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 SFM COMPILER Bond Analysis & Valuation

GHI Ltd, AAA rated company has fully convertible bonds on the following terms, a year ago
Face Value of Bond : Rs.1000
Coupon Rate : 8.5%
Time of Maturity : 3 years.
Interest Payment : Annual, at the end of year
Principle Repayment : At the end of bond Maturity
Conversion Ratio : Number of shares per bond : 25
Current Market Price Per Share : Rs.45
Market Price of Convertible Bond : Rs.1175
AAA rated company can issue plain vanilla bonds without conversion option at an interest rate of
9.5%
Calculate as of today
1. Straight value of Bond
2. Conversion value of Bond
3. Conversion Premium
4. Percentage of Downside Risk
5. Conversion Parity Price.

Solution :
(i) Straight Value of Bond
= Rs.85 x 0.9132 + Rs.85 x 0.8340 + Rs.1085 x 0.7617 = Rs.974.96
(ii) Conversion Value
= Conversion Ratio x Market Price of Equity Share
= Rs.45 x 25 = Rs.1,125
(iii) Conversion Premium
Conversion Premium = Market Conversion Price - Market Price of Equity Share
1175
= – Rs.45 = Rs.2
25
(iv) Percentage of Downside Risk
1,175 – 974.96
= x 100 = 20.52%
974.96
(v) Conversion Parity Price
Bond Price
= No of shares on Conversion
1175
= 25 = Rs.47

2015
Question 34 May 2015 RTP – Similar to - Question 26 - Nov 2012 RTP

Question 35 May 2015 Paper – 8 Marks

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On 31st March, 2013, the following information about Bonds is available

Name of Security Face Value Maturity Date Coupon Rate Coupon Date
st
Zero Coupon 10,000 31 March, 2023 N.A N.A
th
T – Bill 1,00,000 20 June, 2013 N.A N.A
st st
10.71% GOI 2023 100 31 March, 2023 10.71 31 March
10% GOI 2018 100 31st March, 2018 10.00 31st March & 31st October
Calculate
1. If 10 years yield is 7.5% p.a. What price the Zero coupon Bond would fetch on 31 st March,
2013?
2. What will be the annualized yield if the T – bill is traded @98,500?
3. If 10.71% GOI 2023 Bond having yield to maturity is 8%, what price would it fetch on April 1,
2013 (after coupon payment on 31st March?
4. If 10% GOI 2018 Bond having yield to maturity is 8%, what price would it fetch on April 1, 2013
(after coupon payment on 31st March?

Solution :
1. Value of Zero Coupon Bond for 10 years yield @ 7.5%
10,000
(1.075)10 = Rs.4,852
2. Annualized yield
(FV – P) 360
BEY = x Days of Maturity
P
10000 – 98500 361
BEY = x 81 = 6.86%
98500
3. Value of GOI 2023 Bond
= PV of Coupons + PV of Redemption
= 10.71 PVAF (8%, 10) + 100 PVF (8%, 10)
= 10.71 x 6.71 + 100 x 0.4632
= Rs.118.18
4. Value of GOI 2018 Bond
= PV of Coupons + PV of Redemption
= 5 PVAF (4%, 10) + 100 PVF (4%, 10)
= 5 x 8.11 + 100 x 0.6756 = Rs.108.11

Question 36 Nov 2015 – RTP – Similar to - Question 5 - Nov 2008 Paper – 8 Marks

Question 37 Nov 2015 Paper – 5 Marks

The following data is available for a Bond
Face Value Rs.1000
Coupon Rate 11%
Years to Maturity 6

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 SFM COMPILER Bond Analysis & Valuation

Redemption Value Rs.1,000

Yield to Maturity 15%
(Round of your answers to 3 decimals)
Calculate the following with respect to the Bond
1. Current Market Price
2. Duration of Bond
3. Volatility of Bond
4. Expected market price if increase in required yield is by 100 basis points.
5. Expected market price if decrease in required yield is by 75 basis points.

Solution :
1. Current Price of the Bond
= PV of Coupon + PV of Redemption
= 110 x PVAF (15%, 6) + 1,000 x PVF (15%, 6)
= 110 x 3.7845 + 1,000 x 0.4323
= 416.29 + 432.3 = 848.59
2. Duration of the Bond
Year Cash Flows P.V @ 15% Wx
1 110 95.70 95.70
2 110 83.16 166.32
3 110 72.38 217.14
4 110 62.92 251.68
5 110 54.67 273.35
6 1110 479.52 2877.12
Total 848.35 3881.31

D =
 wx =
3881.31
= 4.575 Yrs.
w 848.35

3. Volatility of the Bond

Duration 4.570
= YTM Factor = 1.15 = 3.974 yrs.
4 Expected market price if increase in required yield is by 100 basis points.
= 848.35 x 3.974% = 33.162
Market Price will decrease as Market price and yield are inversely related.
Hence the expected market price = 848.35 – 33.162 = Rs.801.318
5. Expected market price if decrease in required yield is by 75 basis points.
= 848.35 x 75% of (3.974) = 24.87
Market Price will increase as Market price and yield are inversely related.
Hence the expected market price = 848.35 + 24.87 = Rs.859.35

Question 38 Nov 2015 Paper – 6 Marks

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 Bond Analysis & Valuation SFM COMPILER

Mr A will need Rs.1,00,000 after 2 years for which he wants to make one time necessary investment
now. He has choice of 2 types of bonds. The details of which are as follows.
Bond X Bond Y
Face Value Rs.1000 Rs.1000
Coupon 7% Payable annually 8% Payable annually
Years to maturity 1 4
Current Price Rs.972.73 Rs.936.52
Current Yield 10% 10%
Advice Mr. A whether he should all his money in one type of bond or he should buy both the bonds
and if so, in which quantity?
Assume that there will be no call risk or default risk?

Solution :
Duration of Bond X
Year Cash Flows P.V @ 10% Wx
1 1070 .909 972.63 972.63
Total 972.63 972.63

D =
 wx =
972.63
= 1 yrs.
w 972.63

Duration of Bond Y
Year Cash Flows P.V @ 10% Wx
1 80 72.72 72.72
2 80 66.08 132.16
3 80 60.08 180.24
4 1080 737.64 2950.56
Total 936.52 3335.68

D =
 wx =
3335.68
= 3.56 yrs.
w 936.52

Let a be the investment in bond X and therefore investment in Bond Y will be (1-a)
Since the required duration is 2 years, the proportion of investment in each security shall be
calculated as follows
2 = a x 1 + (1-a) 3.563
A = 0.61
B = 1 – 0.61 = 0.39
Therefore, the proportion of investment shall be 61% in X and 39% in Y
Amount of Investments
1, 00, 000
Bond X = = 82,644.63
1.12

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 SFM COMPILER Bond Analysis & Valuation

= 82,644.63  0.61
= Rs.50,413
Bond y = 82,644.63 – 50413
= Rs.32,232

Question 39 Extra Question

Note : This Question is Included because author thinks that it is important for students to solve this
M/s. Transindia Ltd. is contemplating calling As. 3 crores of 30 years, 1,000 bond issued 5 years ago
with a coupon interest rate of 14 percent. The bonds have a call price of 1,140 and had initially
collected proceeds of 2.91 crores due to a discount of 30 per bond. The initial floating cost was
3,60,000. The Company intends to sell 3 crores of 12 per cent coupon rate, 25 years bonds to raise
funds for retiring the old bonds. It proposes to sell the new bonds at their par value of 1,000. The
estimated floatation cost is 4,00,000. The company is paying 40% tax and its after cost of debt is 8
per cent. As the new bonds must first be sold and their proceeds, then used to retire old bonds, the
company expects a two months period of overlapping interest during which interest must be paid on
both the old and new bonds.
What is the feasibility of refunding bonds?
Solution
Initial Cash Movements
a) Net proceeds of new issue (3cr – 0.04) 2.96 Inflow
b) Redemption of old bonds (3  1.4) (3.42) Outflow
c) Interest (Post tax period) for overlapping
2
(3  14%  12  60%) (0.042) Outflow
d) Tax shield of unamortized floating cost & discount
25
(0.09 +0.036  30  40%) 0.042 Inflow
e) Tax shield on premium on redemption
(3  0.14  40%) 0.168 Inflow
(0.292)
Recurring Cash Flows
Old New
1) Post tax coupon 2520000 2160000
(3  14%  60%) (3  12%  60%)
2) Tax shield on amortization,
Discount, Cost (16800) (6400)
 25 
30000 x 30 + + 360000 x 30  400000
   
x 40% x 40% 
 25   25 
25,03,200 21,53,600
349600  PVIFA (8%, 25)

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= 349600  10.675
= 3731901
Net savings = 3731901
–2920000
811901

Question 40 May 2016 RTP

The following data are available for a Bond
Face Value Rs.1,000
Coupon Rate 16%
Years to Maturity 6
Redemption value Rs.1,000
Yield to maturity 17%
Calculate the duration and volatility of this bond?

Solution :
1. Duration
Year Cash Flow PV @ 17% Wx
1 160 136.80 136.80
2 160 116.96 233.92
3 160 99.84 299.52
4 160 85.44 341.76
5 160 72.96 364.8
6 1160 452.40 2714.4
964.40 4091.2

Duration of the Bond =

 wx =
4091.2
= 4.24 yrs.
w 964.4

2. Volatility
Duration 4.243
Volatility of the bonds = (1+YTM) = = 3.63 yrs.
1.17

Question 41 May 2016 Paper

Bright Computers Limited is planning to issue a debenture series with a face value of Rs.1,000 each
for a term of 10 years with the following coupon rates:
Years Rates
1–4 8%
5–8 9%
9 – 10 13%
The current market rate on similar debenture is 15% p.a. The company proposes to price the issue
in such a way that a yield of 16% compounded rate of return is received by the investors. The

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redeemable price of the debenture will be at 10% premium on maturity. What should be the issue
price of debenture?
PV @ 16% for 1 to 10 years are: .862, .743, .641, .552, .476, .410, .354, .305, .263, .227 respectively.

Solution :
Present Value of Debenture
Year Cash Outflow (Rs.) PVF @ 16% Present Value (Rs.)
1–4 80 2.798 223.84
5–8 90 1.545 139.05
9 – 10 130 0.490 63.70
10 1100 0.227 249.70
676.29

Question 42 Nov 2016 RTP

The following data is related to 8.5% Fully Convertible (into Equity shares) Debentures issued by JAC
Ltd. at Rs.1000.
Market Price of Debenture Rs.900
Conversion Ratio 30
Straight Value of Debenture Rs.700
Market Price of Equity share on the date of Conversion Rs.25
Expected Dividend Per Share Rs.1
You are required to calculate:
(a) Conversion Value of Debenture
(b) Market Conversion Price
(c) Conversion Premium per share
(d) Ratio of Conversion Premium
(e) Premium over Straight Value of Debenture
(f) Favourable income differential per share
(g) Premium pay back period

Solution :
(a) Conversion Value of Debenture
= Market Price of one Equity Share X Conversion Ratio
= Rs.25 x 30 = Rs.750

(b) Market Conversion Price

Market Price of Convertible Debentures Rs.900
= = = Rs.30
Conversion Ratio 30

(c) Conversion Premium per share

Market Conversion Price – Market Price of Equity Share
= Rs.30 – Rs.25 = Rs.5

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(d) Ratio of Conversion Premium

Conversion premium per share Rs.5
= = = 20%
Market Price of Equity Share 25
(e) Premium over Straight Value of Debenture
Market Price of Convertible Bond Rs.900
= -1 = Rs.700 - 1 = 28.6%
Straight Value of Bond
(f) Favourable income differential per share
Coupon Interest from Debenture−Conversion Ratio x Dividend per share
= Conversion Ratio
85−30 x 1
= = Rs.1.833
30
(g) Premium pay back period
Conversion premium per share Rs.5
= Favourable income deifferential pre share = Rs.1.833 = 2.73 years

Question 43 Nov 2016 RTP

The following is the Yield structure of AAA rated debenture:
Period Yield (%)
3 months 8.5%
6 months 9.25
1 year 10.50
2 years 11.25
3 years and above 12.00
(i) Based on the expectation theory calculate the implicit one-year forward rates in year 2 and
year 3.
(ii) If the interest rate increases by 50 basis points, what will be the percentage change in the
price of the bond having a maturity of 5 years? Assume that the bond is fairly priced at the
moment at Rs.1,000.

Solution :
(i) Implicit rates for year 2 and year 3
(1+ r2)2
For year 2 𝑓2 = –1
1+ r1
(1.1125)2
= -1
(1.1050)
= 12%
(1+ r3)3
For year 3 𝑓3 = (1+ r –1
1)(1+ f1 )

1.12 
3

= –1
1.1125 2
= 13.52%
(ii) If fairly priced at Rs.1000 and rate of interest increases to 12.5% the percentage charge will
be as follows:
1000(1.12)5
Price = (1.125)5

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1762.34168
= 1.8020
= Rs.977.99 or Rs.987
1000−978
% Change = x 100
1000
22
= 1000 x 100 = 2.2%

Question 44 Nov 2016 RTP – Similar to Question 39

Question 45 Nov 2016 Paper

A Ltd. has issued convertible bonds, which carries a coupon rate of 14%. Each bond is convertible into
20 equity shares of the company A Ltd. The prevailing interest rate for similar credit rating bond is
8%. The convertible bond has 5 years maturity. It is redeemable at par at Rs.100.
The relevant present value table is as follows.
Present Value 𝒕𝟏 𝒕𝟐 𝒕𝟑 𝒕𝟒 𝒕𝟓
PVIF0.14,t 0.877 0.769 0.675 0.592 0.519
PVIF0.08,t 0.926 0.857 0.794 0.735 0.681
You are required to estimate:
(Calculations be made upto 3 decimal places)
(i) Current market price of the bond, assuming it being equal to its fundamental value,
(ii) Minimum market price of equity share at which bond holder should exercise conversion
option; and
(iii) Duration of the bond.

Solution :
(i) Current Market Price of Bond
Time CF PVIF *% PV (CF) PV (CF)
1 14 0.926 12.964
2 14 0.857 11.998
3 14 0.794 11.116
4 14 0.735 10.290
5 114 0.681 77.634
ƩPV (CF) i.e. P0 = 124.002
Say Rs.124.00
(ii) Minimum Market Price of Equity shares at which Bondholder should exercise conversion
option:
124.00
= Rs.6.20
20.00
(iii) Duration of the Bond
Year Cash Flow PV @ 8% Wx
1 14 12.964 12.964
2 14 11.998 23.996

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3 14 11.116 33.348
4 14 10.290 41.16
5 114 77.634 388.17
124.002 499.638

D=  Wx =
499.638
= 4.029 yrs.
W 124.002

Question 46 May 2017 RTP

G holds securities as detailed herein below:
Security Face Value Numbers Coupon Maturity Annual
(Rs.) Rate (%) Years Yield (%)
Bonds A 1,000 100 9 3 12
Bond B 1,000 100 10 5 12
Preference shares C 100 1,000 11 * 13*
Preference shares C 100 1,000 12 * 13*
* Likelihood of being called (redeemed) at a premium over par.
Compute the current value of G’s portfolio.

Solution :
Computation of current value of G’s portfolio
(i) 100 Nos. Bond A, Rs.1,000 par value, 9% Bonds maturity 3 years:
Rs.
Current value of interest on bond A
1-3 years: Rs.9000 × Cumulative P.V. @ 12% (1-3 years) 21,618
= Rs.9000 × 2.402

Add: Current value of amount received on maturity of Bond A

End of 3rd year: Rs.1,000 × 100 × P.V. @ 12% (3rd year) 71,200
= Rs.1,00,000 × 0.712
92,818

(ii) 100 Nos. Bond B, Rs.1,000 par value, 10% Bonds maturity 5 years: Current value of interest
on bond B
1-5 years: Rs.10,000 × Cumulative P.V. @ 12% (1-5 years)
= Rs.10,000 × 3.605 36,050

Add: Current value of amount received on maturity of Bond B

End of 5th year: Rs.1,000 × 100 × P.V. @ 12% (5th year) 56,700
= Rs.1,00,000 × 0.567 92,750

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(iii) 100 Preference shares C, Rs.1,000 par value, 11% coupon

11% x 1000Nos.x Rs.100 11,000
= Rs.84,615
13% 0.13

(iv) 100 Preference shares D, Rs.1,000 par value, 12% coupon

12% x 1000Nos.x Rs.100 12,000
= Rs.92,308
13% 0.13

Total current value of his portfolio [(i) + (ii) + (iii) + (iv)] 3,62,491

Question 47 May 2017 RTP

GHI Ltd., AAA rated company has issued, fully convertible bonds on the following terms, a year ago:
Face value of bond Rs.1,000
Coupon (interest rate) 8.5%
Time to Maturity (remaining) 3 years
Interest Payment Annual, at the end of year
Principal Repayment At the end of bond maturity
Conversion ratio (Number of shares per bond) 25
Current market price per share Rs.45
Market price of convertible bond Rs.1175
AAA rated company can issue plain vanilla bonds without conversion option at an interest rate of
9.5%.
Required: Calculate as of today:
(i) Straight Value of bond.
(ii) Conversion Value of the bond.
(iii) Conversion Premium.
(iv) Percentage of downside risk.
(v) Conversion Parity Price.
t 1 2 3
PVIF0.095,t 0.9132 0.8340 0.7617

Solution :
(i) Straight Value of Bond
= Rs.85 x 0.9132 + Rs.85 x 0.8340 + Rs.1085 x 0.7617
= Rs.974.96
(ii) Conversion Value
= Conversion Ration x Market Price of Equity Share
= Rs.45 x 25 = Rs.1,125
(iii) Conversion Premium
= Market Conversion Price - Market Price of Equity Share
= Rs.2
(iv) Percentage of Downside Risk

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Rs.1,175−Rs.974.96
= x 100 = 20.52%
Rs.974.96
(v) Conversion Parity Price
Base Price Rs.1,175
= No. = = Rs.47
of share on conversion 25

Question 48 May 2017 Paper

Bank A enter into a Repo for 14 days with Bank B in 10% Government of India Bonds 2018 @ 5.65%
for Rs.8 crore. Assuming that clean price be Rs.99.42 and initial Margin be 2% and days of accrued
interest be 262 days. You are required to determine
(i) Dirty Price
(ii) Repayment at maturity (consider 360 days in a year)

Solution :
(a) Dirty Price
Clean price + Interest accrued
10 262
= 99.42 + 100 x 100 x 360
= 106.70
(b) First leg (Start Proceed)
Dirty Price 100−Initial Margin
= Nominal Value x x
100 100
106.70 100−2
= Rs.8,00,00,000 x x
100 100
= Rs.8,36,52,800 or, rounded off to Rs.8,36,53,000
(c) Second leg (Repayment at Maturity)
No.of days
= Start Proceed x (1 + Repo rate x )
360
14
= Rs.8,36,53,800 x (1 + 0.0565 x )
360
= Rs.8,38,36,804

Question 49 May 2017 Paper

RC Ltd. is able to issue commercial paper of Rs.50,00,000 every 4 months at a rate of 15% p.a. The
cost of placement of commercial paper issue is Rs.2,000 per issue. RC Ltd. is required to maintain line
of credit Rs.2,00,000 in bank balance. The applicable income tax rate for RC Ltd. is 30%. What is the
cost of funds (after taxes) to RC Ltd. for commercial paper issue? The maturity of commercial paper
is four months.

Solution :
Rs.
Issue Price 50,00,000
Less: Interest @ 15% for 4 months 2,50,000
Issue Expenses 2,000
Minimum Balance 2,00,000

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45,48,000
2,52,000(1−0.30) 12
Cost of Funds = x x 100
45,48,000 4

5,29,200
= 45,48,000 x 100 = 11.636%
Question 50 May 2017 Paper
P Ltd. has current earnings of Rs.6 per share with 10,00,000 shares outstanding. The company plans
to issue 80,000, 8% convertible preference shares of Rs.100 each at par. The preference shares are
convertible into 2 equity shares for each preference share held. The equity share has a current market
price of Rs.42 per share.
Calculate:
(i) What is preference share's conversion value?
(ii) What is conversion premium?
(iii) Assuming that total earnings remain the same, calculate the effect of the issue on the basic
earnings per share (A) before conversion (B) after conversion.
(iv) If profits after tax increases by Rs.20 Lakhs what will be the basic EPS, (A) before conversion
and (B) on a fully diluted basis?

Solution :
(i) Conversion value of preference share
Conversion Ratio x Market Price
2 × Rs.42
= Rs.84
(Or Rs.67,20,000)
(ii) Conversion Premium
(Rs.100/Rs84)–1 = 19.05%
(Or Rs.12,80,000 or Rs.16 per share)
(iii) Effect of the issue on basic EPS
Rs.
Before Conversion
Total (after tax) earnings Rs.6 x 10,00,000 60,00,000
Dividend on Preference Shares 6,40,000
Earnings available to equity holders 53,60,000
No. of shares 10,00,000
EPS 5:36
On diluted Basis
Earnings 60,00,000
No. of shares (10,00,000 + 1,60,000) 11,60,000
EPS 5:17

(iv) EPS with increase in Profit

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Rs.
Before Conversion
Earnings 80,00,000
Dividend on Preference Shares 6,40,000
Earnings for equity shareholders 73,60,000
No. of shares 10,00,000
EPS 7:36
On diluted Basis
Earnings 80,00,000
No. of shares 11,60,000
EPS 6:90

Question 51 May 2017 Paper

The following information are available with respect of Krishna Ltd.
Year Krishna Ltd. Dividend per Average Dividend Yield Return on
Average Share share Market Index Govt. bonds
Price
2012 245 20 2013 4% 7%
2013 253 22 2130 5% 6%
2014 310 25 2350 6% 6%
2015 330 30 2580 7% 6%
Compute Beta Value of the Krishna Ltd. at the end of 2015 and state your observation.

Solution :
Computation of Beta Value
Calculation of Return
D1 +(P1− P0 )
Returns = x 100
P0
Year Returns
2012 – 13 22+(253−245) = 12.24%
x 100
245
2013 – 14 25+(310−253) = 32.41%
x 100
253
2014 - 15 30+(330−310) = 16.13%
x 100
310

Calculation of Returns from market Index

Year % of Index Appreciation Dividend Total Return %
Yield %
2012 – 13 (2130−2013) 5% = 10.81%
x 100 = 5.81%
2013
2013 – 14 (2350−2130) 6% = 16.33%
x 100 = 10.33%
2130
2014 - 15 (2580−2350) 7% = 16.79%
x 100 = 9.79%
2350

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Computation of Beta
Year Krishna Ltd. (X) Market Index (Y) XY Y2
2012 - 13 12.24% 10.81% 132.31 116.86
2013 - 14 32.41% 16.33% 529.25 266.67
2014 – 15 16.13% 16.79% 270.82 281.90
Total 60.78% 43.93% 932.38 665.43
60.78
Average Return of Krishna Ltd. = = 20.26%
3
43.93
Average Market Return = = 14.64%
3
̅Y
ƩXY−nX ̅ 932.38−3 x 20.26 x 14.64
Beta (β) 2 ̅ )2
= = 14.64%
ƩY −n(Y 665.45−3(14.64)2
Observation
Expected Return (%) Actual Return Action
(%)
2012 - 13 6% + 1.897(10.81% - 6%) = 15.12% 12.24% Sell
2013 - 14 6% + 1.897(16.33% - 6%) = 25.60% 32.41% Buy
2014 – 15 6% + 1.897(10.79% - 6%) = 26.47% 16.13% Sell

Question 52 Nov 2017 RTP

The data given below relates to a convertible bond:
Face Value Rs.250
Coupon Rate 12%
No. of shares per bond 20
Market price of share Rs.12
Straight value of bond Rs.235
Market price of convertible bond Rs.265
Calculate:
(i) Stock value of bond.
(ii) The percentage of downside risk.
(iii) The conversion premium
(iv) The conversion parity price of the stock

Solution :
(i) Stock value or conversion value of bond
= 12 × 20 = Rs.240
(ii) Percentage of the downside risk
Rs.265−Rs.235 Rs.265−Rs.235
= 0.1277 or 12.77% or = 0.1132 or 11.32%
Rs.235 Rs.235
This ratio gives the percentage price decline experienced by the bond if the stock becomes
worthless.
(iii) Conversion Premium

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Market price−Conversion value

= × 100
Conversion value

Rs.265−Rs.240
= × 100 = 10.42%
Rs.240
(iv) Conversion Parity Price
Bond Price Rs.265
= No.of shares on conversion = = 13.25%
20
This indicates that if the price of shares rises to Rs.13.25 from Rs.12 the investor will neither gain nor
lose on buying the bond and exercising it. Observe that Rs.1.25 (Rs.13.25 – Rs.12.00) is 10.42% of
Rs.12, the Conversion Premium.

Question 53 May 2018 – RTP – Similar to - Question 37 - Nov 2015 Paper – 5 Marks

Question 54 May 2018 Paper

Constant Engineering Ltd. has developed a high tech product which has reduced the Carbon emission
from the burning of the fossil fuel. The product is in high demand. The product has been patented
and has a market value of Rs.100 Crore, which is not recorded in the books. The Net Worth (NW) of
Constant Engineering Ltd. is Rs.200 Crore. Long term debt is Rs.400 Crore. The product generates a
revenue of Rs.84 Crore. The rate on 365 days Government bond is 10 percent per annum. Bond
portfolio generates a return of 12 percent per annum. The stock of the company moves in tandem
with the market. Calculate Economic Value added of the company.

Solution :
Note: Lot of things are missing in the question, so I have made necessary assumptions to complete
the question
1. Tax rate is not given
2. Re and Kd are not specified

EVA = NOPAT – Kc.

1. NOPAT = EBIT – Tax
= 84 (Note - Tax rate is not given, so 84 is assumed as NOPAT)
2. Total Funds
Net Worth = 200 + 100 = 300 Re = 12% (Assumed)
Debt = 400 Kd = 10% (Assumed)

Kc = 300 × 12% = 36
Kd = 400 × 10% = 40
76
EVA = 84-76 = 8 EVA

Question 55 May 2018 Paper

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The following is the data related to 9% fully convertible (into Equity Shares) debentures issued by
Delta Ltd. at Rs.1000.
Market Price of 9% Debenture 1,000
Conversion Ratio (No. of shares) 25
Straight Value of 9% Debentures 800
Market price of equity share on the date of conversion 30
Expected Dividend per share 1
Calculate:
(a) Conversion value of Debenture;
(b) Market Conversion Price;
(c) Conversion Premium per share;
(d) Ratio of Conversion Premium;
(e) Premium over straight Value of Debenture;
(f) Favourable Income Differential per share; and
(g) Premium pay back period

Solution :
1. Conversion Ratio = 25 shares

2. Conversion value of Debenture / Stock Value of Bond

= 25 × 30 = Rs.750

3. Market Conversion Price / Conversion Parity Price

= Market Value of Debenture/Conversion Ratio
= 1000/25 = Rs.40

4. Ratio of Conversion Premium

Conversion Premium
= Conversion Parity Price – Market Price of Share
= 40-30
= 10

Conversion Premium Ratio

40−30
= × 100 = 33.33%
30

5. Premium over Straight value of Debenture

= Market Price of Debenture – Straight value of Debenture
= 1000 – 800 = Rs.200

6. Favourable Income differential per share

Interest = 1000 × 9% = 90.

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Dividend/share per debenture = 25 × 1 = 25

90−25
i.e. = Rs.2.6/share
25

7. Premium pay back period

Conversion Premium = MP of Debenture – Stock value of Bond
= 1000-750 = 250
Income differential = 90-25 = 65
Pay back period = 250/65 = 3.846 years

Question 56 May 2018 Paper

A bond is held for a period of 45 days. The current discount yield is 6 per cent per annum. It is
expected that current yield will increase by 200 basis points and current market price will come down
by Rs.2.50.
Calculate:
(i) Face value of the Bond and
(ii) Bond Equivalent Yield

Solution :
1. Bond with discount yield of 6% matures in 45 days
45
Therefore, yield of 45 days = 6 x 365 = 0.7397%

So the Present value of the bond today

PV = 𝑥/1.007397 = 0.9927x

2. If yield increases by 2% price falls by Rs.2.5

A. So at 8% yield price will be 0.9927x – 2.5
B. Also with discount yield of 8% maturing in 45 days
45
The yield for 45 days shall be = 8 x 365 = 0.9863%

So the Present value of the bond today

PV = 𝑥/1.009863 = 0.9902x

3. So 0.9927x – 2.5 = 0.9902x

Therefore x = 1000 ------- Face Value = 1000

Question 57 May 2018 (New) – RTP

XL Ispat Ltd. has made an issue of 14 per cent non-convertible debentures on January 1, 2007. These
debentures have a face value of Rs.100 and is currently traded in the market at a price of Rs.90.
Interest on these NCDs will be paid through post-dated cheques dated June 30 and December 31.
Interest payments for the first 3 years will be paid in advance through post-dated cheques while for

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the last 2 years post-dated cheques will be issued at the third year. The bond is redeemable at par
on December 31, 2011 at the end of 5 years.
Required:
(i) CALCULATE the current yield and YTM of the bond.
(ii) CALCULATE the duration of the NCD.
(iii) CALCULATE the realized yield on the NCD assuming that intermediate coupon payments are,
not available for reinvestment calculate.

Solution :
(i) Current yield
Coupon
=
MP
7
= = 73785 Semi Annually
90
i.e. 7.78  2 = 15.56% Annually
i  FV - P /n
(ii) YTM =
(FV  P)/2
7100 - 90 / 10
= = 8.42 % Semi Annually
100  90 / 2
= 16.84% Annually
(iii) Duration
Period CF PV @ 8.42% Wx
1 7 6.46 6.46
2 7 5.95 11.9
3 7 5.49 16.47
4 7 5.07 20.28
5 7 4.67 23.35
6 7 4.31 25.86
7 7 3.97 27.79
8 7 3.67 29.36
9 7 3.38 30.42
10 107 47.67 476.75
90.64 668.64

D=
 Wx = 668.64 = 7.377 periods of 6 months
 W 90.64
i.e. 3.69 yrs.
(iv) If intermediate coupon are not available then the Bond will be ZCB.
90(1 + r)5 = 170

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1
 170  5
r=   – 1 = 13.565%.
 90 

Question 58 May 2018 (New) – Paper

Sabanam Ltd. has issued convertible debentures with coupon rate 11%. Each debenture has an
option to convert to 16 equity shares at any time until the date of maturity. Debentures will be
redeemed at Rs.100 on maturity of 5 years. An investor generally requires a rate of return of 8% p.a.
on a 5-year security. As an advisor, when will you advise the investor to exercise conversion for given
market prices of the equity share of
(i) Rs.5,
(ii) Rs.6
(iii) Rs.7.10.
Cumulative PV factor for 8% for 5 years : 3.993
PV factor for 8% for year 5 : 0.681
Solution
Investor wants a return of 8%
On Investment
‫؞‬IV of Bond
= PV of coupon + PV of Redemption
= 11 × PVIFA (8%, 5) + 100 × PVIFA (8%, 5)
= 112.023
For investor to break even and convert share the price would be
= 112.023 / 16 = Rs.7.
The Investor should convert at price of Rs.7.10/share

Question 59 Nov 2018 – RTP

Pet feed plc has outstanding, a high yield Bond with following features:
Face Value £ 10,000
Coupon 10%
Maturity Period 6 Years
Special Feature Company can extend the life of Bond to 12 years
Presently the interest rate on equivalent Bond is 8%.
(a) If an investor expects that interest will be 8%, six years from now then how much he should
pay for this bond now.
(b) Now suppose, on the basis of that expectation, he invests in the Bond, but interest rate turns
out to be 12%, six years from now, then what will be his potential loss/ gain if company
extends the life of bond by another 6 years.

Solution :
(a) If the current interest rate is 8%, the company will not extent the duration of Bond and the
maximum amount the investor would ready to pay will be:

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= £1,000 PVIAF (8%, 6) + £10,000 PVIF (8%, 6)

= £1,000 x 4.623 + £10,000 x 0.630
= £4,623 + £ 6,300
= £ 10,923
(b) If the current interest rate is 12%, the company will extent the duration of Bond. After six
years the value of Bond will be
= £1,000 PVIAF (12%, 6) + £10,000 PVIF (12%, 6)
= £1,000 x 4.111 + £10,000 x 0.507
= £4,111 + £5,070
= £9,181
Thus, potential loss will be £9,181 - £10,923 = £1,742

Question 60 Nov 2018 – Paper

Sonic Ltd. issued 8% 5 year bonds of Rs.1,000 each having a maturity of 3 years. The present rate of
interest is 12% for one year tenure. It is expected that forward rate of interest for one year tenure is
going to fall by 75 basis points and further by 50 basis points for next year. This bond has a beta value
of 1.02 and is more popular in the market due to less credit risk.
Calculate:
(i) Intrinsic Value of bond
(ii) Expected price of bond in the market

Solution :
Discounting rates
Year Forward Rate
1 12%
2 11.25%
3 10.75%

A. IV of Bond = PV of future cash flow

Year CF PV
1 80 71.43 -@12%
2 80 64.21 -@12%, 11.25%
3 1080 782.64 -@12%, 11.25%, 10.75%
918.28

B. Expected value of Bond = 918.20 x 1.02 = Rs.936.6456

Question 61 Nov 2018 (New) - Paper

Tangent Ltd. is considering calling Rs.3 crores of 30 years, Rs 1,000 bond issued 5 years ago with a
coupon interest rate of 14 per cent. The bonds have a call price of Rs 1,150 and had initially collected
proceeds of Rs.2.91 crores since a discount of Rs 30 per bond was offered. The initial floating cost

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was Rs.3,90,000. The Company intends to sell Rs.3 crores of 12 per cent coupon rate, 25 years bonds
to raise funds for retiring the old bonds. It proposes to sell the new bonds at their par value of
Rs.1,000. The estimated floatation cost is Rs.4,25,000. The company is paying 40% tax and its after
tax cost of debt is 8 per cent. , As the new bonds must first be sold and then their proceeds to be
used to retire the old bonds, the company expects a two months period of overlapping interest during
which interest must be paid on both the old and the new bonds. You are required to evaluate the
bond retiring decision. [PVIFA 8%,25= 10.675]

Solution :
Part 1 : Initial Cash Flows
1 Redemption of Old Bonds 3,45,00,000 Outflow
(30000000 / 1000 x 1150)
2 Tax Shield on POR of OLD Bonds 18,00,000 Inflow
(45,00,000 x 40%)
3 Issue of New Bonds 2,95,75,000 Inflow
(3,00,00,000 - 4,25,000)
4 Tax shield on unamortised floatation cost on old bonds 4,30,000 Inflow
(9,00,000 + 3,90,000) x 25/30 x 40%)
5 Post tax overlapping interest 4,20,000 Outflow
(3,00,00,000 x 14% x 2/12 x 60%)
NET -31,15,000

Part 2 : Recurring Cash Flows

OLD NEW
1 Post Tax Coupon 25,20,000 21,60,000
OLD = 30000000 x 14% x 60%
New = 30000000 x 12% x 60%
2 Tax Shield on Amortization 17,200 6800
of floatation cost/Discount
OLD = (900000 + 390000)/30 )x40%
New = 425000 / 25 x 40%
NET 25,02,800 21,53,200

Difference of Old and New 3,49,600

PVIFA for 25 years 37,31,980
NET Cash flows of Part 1 and Part 2 6,16,980
Since the cash flows are positive we should go ahead with the project.

Question 62 Nov 2018 (New) - Paper

The following data are available for three bonds A, B and C. These bonds are used by a bold portfolio
manager to fund an outflow scheduled in 6 years. Current yield is 9%. All bonds have face value of
Rs.100 each and will be redeemed at par. Interest is payable annually.

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Bond Maturity (Years) Coupon Rate

A 10 10%
B 8 11%
C 5 9%
(i) Calculate the duration of each bond.
(ii) The bond portfolio manager has been asked to keep 45% of the portfolio money in Bond A.
Calculate the percentage amount to be invested in bonds B and C that need to be purchased
to immunize the portfolio.
(iii) After the portfolio has been formulated, an interest rate change occurs, increasing the yield
to 11%. The new duration of these bonds are : Bond A = 7.15 Years, Bond B = 6.03 Years and
Bond C = 4.27 years.
Is the portfolio still immunized ? Why or why not ?
(iv) Determine the new percentage of B and C bonds that are needed to immunize the portfolio.
Bond A remaining at 45% of the portfolio.
Present values be used as follows :
PV T1 T2 T3 T4 T5
PVIF0.09 0.917 0.842 0.772 0.708 0.650

PV T6 T7 T8 T9 T10
PVIF0.09 0.596 0.547 0.502 0.460 0.4224

Solution :
1. Duration A = 6.94 / B = 5.94 / C = 4.24
2. DA = DL
Wa x Da x Wb x Db x Wc x Dc =6
(0.45 x 6.94) + (Wb x 4.94) + (0.55 - Wb) x 4.24
3.123 + 5.94Wb + 2.33 – 4.24Wb = 6%
1.7Wb + 5.453 =6
Wb = 0.32
Wc = 0.55 – 0.32 = 0.23
Wa = 0.45
3. If Yield = 11%
Duration
= 7.15 for A / 6.03 for B / 4.27 for C
= (7.15 x 0.45) + (6.03 x 0.32) + (4.27 x 0.23)
= 6.13 years
Note : if the yield changes, the duration changes and therefore the portfolio is not immunized.

Question 63 May 2019 (New) - RTP

Based on the credit rating of bonds, Mr. Z has decided to apply the following discount rates for valuing
bonds:

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Credit Rating Discount Rate

AAA 364 day T bill rate + 3% spread
AA AAA + 2% spread
A AAA + 3% spread
He is considering to invest in AA rated, Rs.1,000 face value bond currently selling at Rs.1,025.86. The
bond has five years to maturity and the coupon rate on the bond is 15% p.a. payable annually. The
next interest payment is due one year from today and the bond is redeemable at par. (Assume the
364 day T-bill rate to be 9%).
You are required to calculate the intrinsic value of the bond for Mr. Z. Should he invests in the bond?
Also calculate the current yield and the Yield to Maturity (YTM) of the bond.

Solution :
AA Rated yield 9 + 3 + 2 = 14%
1) Value of bond = P.V. of coupons + P.V. of redemption
= 150  PVIFA (14%, 5) + 1000  PVIF(14%, 5)
= 150  3.433 + 1000  0.519
= Rs.1034.36/-
Current MP = Rs.1025.86/-
2) The bond is trading cheap, therefore the investor should go long.
Coupen
CY = MP  100
150
=  100
1025.86
= 14.62%
F–P
I+ n
3) YTM = F+P
2
1000 – 1025.86
150 + 5 144.828
= =
1000 + 1025.86 1012.93
2
= 14.3%

Question 64 May 2019 (Old) - RTP

The data given below relates to a convertible bond:
Face value Rs.250
Coupon rate 12%
No. of shares per bond 20
Market price of share Rs.12
Straight value of bond Rs.235

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Market price of convertible bond Rs.265

Calculate:
(i) Stock value of bond.
(ii) The percentage of downside risk.
(iii) The conversion premium
(iv) The conversion parity price of the stock.

Solution :
(i) Stock value of Bond
= Conversion Rates  M.P. of share
= 20  12 = Rs.240
(ii) Conversation premium
= M.P. of Bond – Stock value of Bond
= 265 – 240 = Rs.25
(iii) Conversion parity price
M.P.of Bond 265
= = = 13.25
Conversion Ratio 20
(iv) % downside risk
265 - 235
=  100 = 12.766%
235

Question 65 May 2019 (Old) - RTP

A Ltd. has issued convertible bonds, which carries a coupon rate of 14%. Each bond is convertible into
20 equity shares of the company A Ltd. The prevailing interest rate for similar credit rating bond is
8%. The convertible bond has 5 years maturity. It is redeemable at par at Rs.100.
The relevant present value table is as follows.
Present values t1 t2 t3 t4 t5
PVIF0.14, t 0.877 0.769 0.675 0.592 0.519
PVIF0.08, t 0.926 0.857 0.794 0.735 0.681
You are required to estimate:
(Calculations be made upto 3 decimal places)
(i) current market price of the bond, assuming it being equal to its fundamental value,
(ii) minimum market price of equity share at which bond holder should exercise conversion
option; and
(iii) duration of the bond.

Solution :
(i) Current Price
= PV of Coupon + PV of Red.
= 14  PVIFA(8%, 5) + 100  PVIF (8%, 5)
= 55.90 + 68.1 = Rs.124

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(ii) Conversion Parity Price

M.P. of Bond 124
= = = Rs.6.20
Conversion Parity 20
(iii) Duration
Years CF PVIF PV Wx
1 14 0.926 12.96 12.96
2 14 0.857 12 24
3 14 0.794 11.12 33.36
4 14 0.735 10.29 41.16
5 114 0.681 77.63 388.15
124 499.63

D=
 Wx = 499.63
= 4.029 Yrs.
W 124



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