Valuing semi-annual cash flows, Financial Management

Assignment Help:

In all previous illustrations, we assumed that coupon payments are paid on annual basis. However, most of the bonds carry interest payment semi-annually. Semi-annual coupon payments can be calculated by dividing the annual coupon payment and discount rate by 2. The time period n in the present value formula is treated in terms of 6-month period rather than years.

For example consider a 7%, 5-year bond with a discount rate of 6% and a maturity value of Rs.100. The cash flow, in the form of interest, for the first four and half years will be Rs.3.50 (Rs. 7/2) and last cash flow will be Rs.103.50, i.e., interest of Rs.3.50 and a principal of Rs.100.

The annual discount rate is 6% so semi-annual discount rate will be 3% (6% / 2). 

When coupon rate is 7%, the semi-annual coupon rate is 3.5%. Then PV of cash flow will be:

Table 1: Calculation of PV of 7% Bond when Cash Flows are Semi-annual

Year

Cash Flow (in Rs.)

PV (in Rs.)

  I half 2007

    3.5

  3.40

II half 2007

    3.5

  3.30

  I half 2008

    3.5

  3.20

II half 2008

    3.5

  3.11

  I half 2009

    3.5

  3.02

II half 2009

    3.5

  2.93

  I half 2010

    3.5

  2.85

II half 2010

    3.5

  2.76

  I half 2011

    3.5

  2.68

II half 2011

103.5

77.01

 

Present Value =

104.27

If we compare the PV of table 1 then we find that PV of table 1 is greater by Rs.0.06. This is because one-half the annual coupon payment is received six months sooner than when payments are annual. 

We can divide the value of non-amortizing bond into two parts, first is PV of coupon payment and second is PV of maturity value. For fixed coupon rate, coupon payments represent an annuity. A short-cut formula for computing the value of bond when coupon rate is fixed and single discount rate is set for discounting the coupon payments, is to compute the PV of the annuity and then add the PV of maturity value.  We can represent it in formula as follows:

 

         V0      =       335_valuing semi annual cash flows.png

 

                   =       I ¤ 2 (PVIFAkd ¤ 2,2n) + F(PVIFkd/2, 2n)                                           ... Eq. (3)

Where,     

                   V        =    value of the bond

                   I/2      =    semi-annual interest payment

                   F         =    par value of the bond payable at maturity

                    kd/2    =     required rate of return for the half-year period

                   2n        =     maturity period expressed in half-yearly periods.


Related Discussions:- Valuing semi-annual cash flows

Explain about routine functions, Q. Explain about Routine Functions? Ro...

Q. Explain about Routine Functions? Routine Functions: - The routine functions are Supervision of cash receipts and payments. Opening Bank Accounts as well as managing them Saf

Relevant and irrelevant cost, The first involved the creation of spreadshee...

The first involved the creation of spreadsheets to resolve some problems for an organization. You will need to model the problem roughly before you start to spreadsheet and you wil

Settlement mechanism, Settlement Mechanism: Nifty index futures and opt...

Settlement Mechanism: Nifty index futures and option contracts are cash settled. All CMs are required to open a separate bank account with NSCCL designated clearing banks. T

Floating-rate securities that have constant quoted margin, Let us look into...

Let us look into few floaters that have constant quoted margin. 1. De-leveraged Floaters 2.  Inverse Floaters 3.  Dual-Indexed Flo

Calculate rate of return on investment in terms of us dollar, Mr. James K. ...

Mr. James K. Silber, an avid international investor, just sold a share of a French company, for FF50. The share was bought for FF42 a year ago. The exchange rate is FF5.80 each U.S

Income statement, Income Statement A formal statement of the parts...

Income Statement A formal statement of the parts used in determining an organization net income that is called profit and loss statement. The several categories reported

Sollution the problem, VK Ltd a multi-product Company, furnishes you the fo...

VK Ltd a multi-product Company, furnishes you the following data relating to theyear 2000.First Half of the year Second Half of the yearSales Rs. 45,000 Rs. 50,000 Total Cost Rs. 4

Analysis of company position, Analysis of Company Position Associated ...

Analysis of Company Position Associated International Supplies Ltd Circulation: Associated International Supplies Ltd (AIS Ltd.) Author: A. Consultant, AXY Consultin

Determine the circumstances is a warrant’s value high, Under what circumsta...

Under what circumstances is a warrant’s value high?  Explain. A warrant’s value would be high while the stock prices, time to expiration, and/or expected stock price volatility a

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd