Valuation¶
Debt¶
It is the rate of return the firm’s lenders demand when they loan money to the firm.
Forms of Borrowing¶
| Type | |
|---|---|
| Private | Bank Loan |
| Public | Bond/Debenture |
Bond¶
Certificate of
| Term | Fixed? | Meaning | Formula | Unit |
|---|---|---|---|---|
| Face/PAR/Book Value | ✅ | Listing price of the security | \(\text{PAR } = \frac{\text{Total Amount}}{\text{No of bonds}}\) | Currency |
| Coupon Rate | ✅ | Interest rate | % of face value | |
| Time to Maturity/ Time to Expiry | ✅ | Bounding time period by which face value will be repayed (at every payment instant, we only pay the coupon amount) | ||
| Credit Rating | Partially | |||
| YTM (Yield-to-Maturity) | IRR of the bond Actual return for the buyer of the bond |
| Bond Traded at | Purchase | Returns |
|---|---|---|
| PAR | Market Value = Face Value | YTM = Coupon rate |
| Premium | Market Value > Face Value | YTM < Coupon rate |
| Discount | Market Value < Face Value | YTM > Coupon rate |
Bond Price¶
\[ \text{Bond Price} = \sum_{t=1}^T \frac{\text{Coupon } t}{(1+\text{YTM})^t} + \frac{\text{PAR}}{(1+\text{YTM})^T} \]
\[ \text{Bond Price } \propto \frac{1}{\text{Interest Rate}} \]
This is because, if interest rate increases, lenders will go to loan market, and everyone will sell their bonds.
Misc¶
Run-on-the-bank¶
Banks should have minimum liquidity, to ensure that
- If a private bank falls show on SLR, they can request from government, using Rapport
- If a govt bank falls show on SLR, they can request from government, using Reverse Rapport
Rapport¶
Repurchase agreement
Reverse Rapport¶
Why are Govt Bonds Risk-Free?¶
Chance of default is lowest.
Preference Shares¶
- Hybrid of debt and common shares
- Fixed dividends
- Deferrable dividends
- They don’t have voting rights
- There is no expiration date
- It is the only real example of perpetuity
- Usually higher return than bonds
\[ k_p = \frac{d_p}{p_p} \quad \left(\frac{c}{r} \text{ from Perpetuity} \right) \]