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The valuation of debt finance, and duration (part 1) – ACCA (AFM) lectures

VIVA

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  1. in example 2 under the redemption yield, to calculate the redemption yield you are using internal rate of return method. is it necessary to provide teh workings or the final answer only would be sufficient.
    you can enter the variable in teh scientific calculator and get the value of the variable, the variable being the redemption yeield investors expect.
    (1+X)^-10X110 + 8x(1-(1+X)^-10)/X=91.61
    wiht this and click the solve function, it would giv ehte value of variable X. is it possible to do such working

  2. Dear Sir,
    I have read the ACCA technical articles on the annual spot yield curve and I need a further help to understand it.

    In example 4 of the ACCA technical article “Bond valuation and bond yields”, in order to determine the yield curve, each bond C鈥檚 annual cash flows is discounted with a different discount rate e.g. 3.88% for year one, 4.96% for year two and 5.80% for year three)

    However, according to the example in the article “Determining interest rate forwards and their application to swap valuation” the interest rate quoted by the bank based on the annual spot yield curve is the same for both years for a two year bond e.g. it is 4.6% in year one and 4.6% in year two.

    Could you possibly clarify?
    Thank you.

  3. Hello Sir,

    Thank you for the lecture, your explanations were spot on!

    I have only one doubt, regarding one point you made regarding the MV of bonds falling after we have bought them. Since the interest and the face value is fixed when we buy them at the current market price, why do we care if the MV falls in the future? Is it because we might want to sell them before their maturity date? This is the only logical explanation I can think of at the moment!

    Thank you!
    Georgios

  4. Hello,

    I have a quick question regarding example 3.

    You mentioned we could by all means use the annuity but you did it year by year. Slightly confused as to when we can just use the annuity as oppose to the year by year d.f. (additionally if using the annuity is much quicker why would we use the d.f year by year)

    Thank you!

  5. Hello Sir, (This might sound a little silly, but) Why is this sensitivity important to the investor? The said investor will be getting a fixed return and the redemption rate is fixed and known. How would the changes in the MV or its sensitivity effect them– Is it if they decide to sell the bond to a third party before the duration or is it just a notional consideration?

  7. Hello sir,
    Practically the yield, i.e. return required by investors would be higher for longer term of investment. In the example its just theoratically the same return for both bonds, but practically investor would require a higher return for the ten year bond, given the concept of yield curve. Is my understanding correct?

  8. Hello sir ,
    Thank you for the fantastic explanation , it’s really helpful !
    I have one doubt though –
    In example 2 , you mentioned that corporate tax is irrelevant as our concern is investors required rate and not the cost to company , which i completely understand .

    But , how would the answer be different if we were asked to calculate the cost to company for the same question and if the corporate tax rate was mentioned ? ( Is cost to company = investors required rate – corporate tax ?)
    Thanks !

    • The calculation of the cost of debt to the company was all explained in earlier lectures (the lectures on Chapter 6 of the lecture notes).

      If debt is irredeemable then it is return to investors x (1 – T).
      If the debt is redeemable then it is the IRR of the after tax flows.

      • Sir, the cost of debt should be the IRR of post tax cash flows. But in the answer of march/june 2019 Q3, examiner has directly calculated the cost of debt by multiplying pre-tax cost by (1-T), for a redeemable bond of 5 year maturity, which is then used in the calculation of WACC.

      • So we can do it too in the exam? Unless it is specifically a bond valuation question. Like if we have to calculate bond’s value to use in WACC calculation, we can use this shortcut right?

  9. Hello!

    I have a question from past paper: dec ’09 – Alaska Salvage.

    In part b) it required to determine the coupon rate, where we can work on it by stating it as “x” (unknown figure) to the amounts given.

    My question is why do we have to add the call value in year 0 and what does it mean putting it there?

    Thank you.

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