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

Calculate the acid test ratio, FIXED ASSETS                          200 00...

FIXED ASSETS                          200 000                       LONG TERM LIABILITIES CURRENT ASSETS CASH             40 000                       LOAN

Treasury auction process, All treasury securities are issued on the b...

All treasury securities are issued on the basis of auction. The auction process is computerized and hence qualified broker-dealers can access it electronically. T

Financial position as assets, One of the well-known soccer clubs in Austral...

One of the well-known soccer clubs in Australia, Sydney, has made a decision to include its players on the club's statement of financial position as assets. These players are signe

Method to find seasonal variation in time series, Method to Identify the Co...

Method to Identify the Component of Seasonal Variation in a Time Series This technique is called as Ratio to Moving Average Method. In this technique, we construct an index wh

Average collection period ratio, What is Average Collection Period Ratio? P...

What is Average Collection Period Ratio? Please provide me report on Average Collection Period Ratio.

Chi square test as a test of independence, Chi Square Test as a Test of Ind...

Chi Square Test as a Test of Independence In real life decision making, managers often have to know whether the differences between the proportions observed from a number of sa

Organizational structure of pension funds, Organizational Structure of pens...

Organizational Structure of pension funds In an investment organization such as pension funds, endowments, life and casualty insurance companies, the central bank's investment

Define the risk of cost of capital, Risk of cost of capital A straight...

Risk of cost of capital A straightforward assumption of traditional cost of capital analysis is that firm's business and financial risk are unaffected by acceptance and financ

Aggressive approach of financial management, Q. Aggressive Approach of fina...

Q. Aggressive Approach of financial management? A -firm may be aggressive in financing its assets. An aggressive policy is said to be followed by the firm when it uses short-te

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