Security Analysis

Bonds/Debentures
1. Bonds are securities that establish a creditor relationship between the purchaser (creditor) and the issuer (debtor).bonds are also called fixed income securities. 2. A straight bond is one where the purchaser pays a fixed amount of money to buy the bond. At regular periods, she receives an interest payments, called the coupon payment. The final interest payment and principal are paid at a specific date of maturity. Issuers of bonds: Bonds are issued by many different entities, including corporations, government and government agencies.

Features of a Bond
The main features of a bond or debenture are I. Face Value: Face value is called par value. A bond is generally issued at a par value of Rs. 100 or Rs. 1,000 and interest is paid on face value. II. Interest rate: Interest rate is fixed and known to bondholders (debenture-holders). Interest paid on a bond/debenture is tax deductible. The interest rate is also called coupon rate. III. Maturity: A bond (debenture) is generally issued for a specific period of time. It is repaid on maturity. IV. Redemption value: The value that a bondholder will get on maturity is called redemption, or maturity value. A bond may be redeemed at par or at premium or at discount. V. Market Value: A bond may be treaded in a stock exchange. The price at which it is currently sold or bought is called the market value of the bond. Market value may be different from par value or redemption value

Bond Value Theorems

Some basic rules which should be remembered with regard to bonds are: a) When the required rate of return is equal to coupon rate, the bond sells at par value. b) When required rate of return exceeds the coupon rate, the bond sells at a discount. The discount declines as maturity approaches. c) When required rate of return is less than the coupon rate, the bond sells at a premium. The premium declines as maturity approaches. d) The longer the maturity of a bond, the greater is its price changes with a given change in the required rate of return.

Treasuries: There are three major types of treasury issues.

Treasury Bills: T-bills have maturities of up to 12 months. They are zero coupon bonds, so the only cash flow is the face value received at maturity. Treasury Notes: Notes have maturities between one year and ten years. They are straight bonds and pay coupons twice per year, which the principal paid full at maturity. Treasury bonds: T-bonds may be issued with any maturity , but usually have maturities of ten years or more.

Corporate Bonds We will consider three major type of corporate bonds: Mortgage Bonds: These bonds are secured by real property such as real estate or buildings. In the event of default, the property can be sold and the bondholders repaid. Debenture: These are the normal types of bonds. It is unsecured debt, backed only by the name and goodwill of the corporation. In the event of the liquidation of the corporation, holders of debentures are paid before stockholders, but after holders of mortgage bonds. Convertible Bonds: These are bonds that can be exchanged for stock in the corporation. Deep Discount Bonds: It is a form of zero interest bonds. These are sold at a discount value and on the maturity face value is paid to investors. In such bonds there is no interest pay-out during in lock in period.

Basic Valuation Model

Capitalized value of financial assets is defined as the sum of present value of cash flows from as asset discounted at the required rate of return. In order to find out the capitalized value the future expected benefits are discounted for time value of money. It the most relevant concept of valuation in valuation of financial assets. 1. Cash flows: the value of an asset is contained in its ability produce cash flows over a given period of time interval. The financial assets represent a claim in future in terms of interests or dividends receivable or in terms of maturity/ sales price. Since the financial assets produce these cash flows, therefore, the value of such assets should be based upon these future cash flows. 2. Timing: since the cash flows may occur over a period of time, the value of financial assets should consider the time value of money also. In general, the sooner the cash flows, the higher is its present value. Thus, the financial assets are valued by compounding the present values of their future cash flows. 3. Risk: the risks of primary concern at this stage are business risk, financial risk, interest rate risk and inflation risk. The risk associated with cash flow can be incorporated in the valuation process by using a proper and sufficient discount rate. on the basis of these considerations, the C. V. concept of valuation of financial assets seems to be most appropriate criterion. An investor values financial assets in terms of its present value. The discount rate to be sued for this purpose is required rate of return of the investors.

Valuation
The value of the a financial asset is determined by discounting the expected cash flows to their present value, at a discount rate commensurate with the risk-return perspective of the investor. So utilizing the present value technique, the value of a financial asset can be expressed as follows: 1. Bond Valuation Model (with a maturity period) 2. Bond value with Semi- Annual Interest. 3. Yield to Maturity (YTM) (the rate of return one earns is called the yield to maturity)