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

Operating cycle, discuss the applicability of an operating cycle of a veget...

discuss the applicability of an operating cycle of a vegetable growing business

Portfolio construction based on a factor model, Bond management evolution t...

Bond management evolution to some extent is linked to the increased volatility of the interest rate term structures which is in existence since seventies. Bond valuatio

Show the marketing issues, a) Cultural exports are the commercial transfer ...

a) Cultural exports are the commercial transfer of values and ideas from one country to another. Canned crab meat is a popular local fragility in Thailand and Viya Crab Products Co

Define the term shareholders, Shareholders Shareholders are usually ass...

Shareholders Shareholders are usually assumed to be interested in wealth maximisation. This though involves consideration of potential return and risk. Where a company is liste

Evaluation of money-market hedge, Evaluation of money-market hedge Expe...

Evaluation of money-market hedge Expected receipt after 3 months = $300000 Dollar interest rate over three months = 5.4/ 4 = 1.35% Dollars to borrow now to have $300000 l

Cost of capital, The Nu-Nu Brothers Inc. (NNBI) has the following capital s...

The Nu-Nu Brothers Inc. (NNBI) has the following capital structure, which it considers to be optional: Debt 25% Preferred Stock 15% Common Equity 60% NNBI''''s expected net income

Calculate the break-even point, A Video Rental store has two employees. The...

A Video Rental store has two employees. The Supervisor is paid $2,200 per month. The other employee, Mark is paid $1,200 per month. In addition, Mark is paid a commission of 20 cen

Explain about the investment decision- financial management, Explain about ...

Explain about the investment decision- financial management The investment decision relates to selection of assets in which funds would be invested by a firm. Assets which can

Extendible reset bonds, Extendible reset bonds are floaters in which ...

Extendible reset bonds are floaters in which the issuer is required to reset the coupon rate so that the issue will trade at a predetermined price (usually above

BUS 430 Finance Seminar, Image Storage Corporation has 1,000,000 shares out...

Image Storage Corporation has 1,000,000 shares outstanding. It wishes to issue 500,000 new shares using a (North American) rights issue. If the current stock price is $50 and the s

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