Unit 3: Valuation Of Fixed Income Securities

Transcript:Unit 3: Valuation Of Fixed Income Securities:
Unit 3: Valuation Of Fixed Income Securities Prepared by: Arjun Yadav (Research Scholar) Guided by: Dr. Ambrish (Assitant Professor) Characteristics Of Fixed Income Securities (Debt And Preferred Stock) Meaning: Fixed income securities are financial claim with promised cash flows of fixed amount paid at fixed dates. Unlike variable income securities, where payments change based on short term interest rates, payments of a fixed income securities are known in advance. Features: Fixed income securities have lowest risk. Fixed rate of return. These fixed income securities are n0t for the capital appreciation. These securities are liquid in nature. Capitalization of cash flows from the asset and risk free rate When a security is to be valued on the capitalised value, we need to first derive the required rate of return at which investor value its security. The minimum rate of return that the investor wishes to earn is known as required rate. It consists of: The risk free rate(equal for each security) The risk premium(adjusted according to the risk) Req. rate of return(k)=Ir + rp ,where Ir=risk free rate ,rp=risk premium, k=the required rate of return Capitalisation of cash flows When we calculating the value of security we apply the discounting technique to find the capitalised value. PVs=CF/(1+k)+CF/(1+k)2 +…….CF/(1+k)n where, PVs= present value of security, CF= cash flow at the end of an year, k=discount rate, n=life span of security(in years) At different point of risk the discounting rate is fluctuating, higher the risk high discount rate and vice-versa. Valuation of bonds Meaning of Bond: It is a agreement between investor and Govt. or company or Financial institution, where investor lend a certain amount at a certain rate. It is a financial instrument which creates liability over the institution, bonds rate of return is based on its risk associated. Features of bonds: Face value Redemption value Maturity period Rate of Interest Market value Bonds Value and Yields Bonds are classified into three types: Bonds with finite maturity date Yield to maturity Perpetual bond/ Perpetuity Bonds with finite maturity date: PVB= I/(1+kd)t + m/(1+kd)n Where, PVB= present value of bond I= interest paid M= maturity value n= no. of years kd= required rate of return on bond / market interest rate t= time period of payment receipt 2. Yield to maturity bond: YTM is the total return anticipated on a bond if the bond is held until its matures. YTM is considered a