Valuation of Debt
Understanding the Debt Instrument
◼What is debt and who issues it?
It is a financial claim issued by borrower of funds for whom it is a liability.
◼Who holds it?
The lender of funds for whom it is an asset
◼What is the difference between debt and equity?
Equity confer ownership rights where as debt does not.
Debt promises to pay interest at periodic intervals and to repay the
principal itself at a pre-specified maturity date, where as equity gives
right to the surplus generated by the organization without any promise
Debt usually has a finite life span where as equity has infinite life
The interest payments are contractual obligations borrowers are required
to make payments irrespective of their financial performance
◼In the event of liquidation
The claims of debt holders must be settled first, Only then can equity
holders be paid.
Terminology Associate with Debt Instrument
Face Value
◼It is the principal value and the amount payable by the borrower to
the lender at maturity.
◼Periodic interest payments are calculated on this amount
Term to Maturity
◼It is the time remaining for the bond to mature and time remaining for
which interest has to be paid as promised.
The Coupon Rate and the Coupon Value
◼Periodic interest rate (coupon rate) need to paid by the borrower.
◼The value of the coupon can be calculated by multiplying the face
value with the coupon rate.
Yield to Maturity (YTM)
◼YTM is the rate of return an investor will get if held to maturity and all
coupon received before maturity must be reinvested at the YTM
Discount Bonds
◼If the price of the bond is less than the face value at the time of issue then it
is a discount bond
◼If the bond is trading at lower than face value then also is called discount
bond
This will happen when the YTM is higher than the coupon rate.
Par Bonds
◼If the price of the bond is equal to the face value at the time of issue then it is
a par bond
◼If the bond is trading at face value then also is called par bond
Terminology Associate with Debt Instrument
