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

Determine primary variables being balanced in the eoq, What are the primary...

What are the primary variables being balanced in the EOQ (Economic Order Quantity) inventory model?  Explain The primary variables being balanced in the EOQ (Economic Order Quant

Defien the term ension funds, Pension funds Pension funds offers retire...

Pension funds Pension funds offers retirement income in the form of annuities to employees covered by a pension plan. They obtain contributions from employers or employees and

Determine the method of credit rating, Determine the method of Credit Ratin...

Determine the method of Credit Rating It is obligatory for the issuing companies to get credit rating done on debt securities issues. Credit ratings are also required for Comme

Portfolio management a financial tool for a firm''net worth, I need your...

I need your assistance on how to group the relevant data so as to help me in the data analysis

What is trustworthy collateral from the lenders'' perspective, What is trus...

What is trustworthy collateral from the lenders' perspective?Explain whether accounts receivable and inventory are trustworthy collateral. Assets that are readily marketable of

Beta, Beta Beta is a measure of the market risk, or methodical risk, o...

Beta Beta is a measure of the market risk, or methodical risk, of a particular privacy or portfolio. Systematic risk defines any risk that influences the value of a huge numbe

Financial leverage, paid-up equty 100000 earning of the company 10000 praic...

paid-up equty 100000 earning of the company 10000 praice - earning ratio(PIE) 20 no.of equty share

Categorization of management risk , Categorization of management risk: ...

Categorization of management risk: Once each event has been evaluated, and been classified as to its probability and impact, the next step is to categorise those events. To do

Calculate super normal profit, The economic analysis is done for Schlumberg...

The economic analysis is done for Schlumberger, oilfield service company. They are # 1 in terms of market caps, revenue and employees globally. If any references are used / outside

What are the negative consequences of a company holding, What are the negat...

What are the negative consequences of a company holding too much cash? A company holding in excess of cash would be giving up the opportunity to invest more in income producing

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