hi, i would like to clarify for me this”500,000 10% irredeemable debentures” mean. beacause i thought it was 500,000 *10%=50000 then divide 0.08 to get market value of debt. instead ur using 100 *10%=10. is it assumption that ur using 100 instead of 500000 issued debentures

I make it clear in the earlier lectures that debt is always quoted on the stock exchange in units of $100 nominal (unless specifically told otherwise in the exam). The $125 is the market value of one unit ($125 p.c.). The total market value of all the debt is therefore $500,000 x 125/100 = $625,000 (which is the same as what you are doing).

Exam questions will make it clear whether they want the total market value of all the debt, or whether they want the market value that will be quoted on the stock exchange i.e. the value per $100 nominal.

please confirm if i am correct in my understanding ?

1) A market value higher than the nominal value would mean that a lower interest rate would be paid to the investor as because a higher market value is a compensation for the lower rate and vice versa ??

2) let suppose that i initially bought a debenture for a nominal value of $ 100 from a company last year . Currently the market value of the same debenture is worth $ 120 which would mean that the company would offer a lower return rate as the market value is greater than the nominal value . my question is that why would a person buy that debenture on the stock exchange from me when he has nothing to gain by purchasing it ??

firstly he would buy that debenture from me for $ 120 and secondly he would be paid a lower rate of interest . both of these are financially not in his favor …

1. Correct – assuming you are referring to the return to the investor (as opposed to the coupon rate, which would stay unchanged).

2. Firstly, the interest paid by the company (the coupon rate) is not changing. Whatone investor chooses to pay to another investor to take over the debenture is nothing to do with the company. As far as it not being financially in the investors favour – why not? If I have $120 to invest I will look to see what returns I can get on the money. If banks are paying (say) 1% a year interest, then I will be quite happy to pay $120 for the debenture is I end up getting a return of more than 1%! As I explain in the lecture, it is investors who determine the market value – not the company – and it depends on the interest they will get each year and the rate of return that they require.

At 16.25 in the video, (example 12) you take the discount factors for only years 1-3 thereby treating it as it was redeemable by 2010. However, in the lecture notes in example 12 it says they’ll be redeemable by 2020. Please correct me if I’m wrong.

please donot amend the year 2007 to 2017 . change 2020 to 2010 because as per your words in the video u have used 2010 as the maturity year . so altering the maturity year would get the lecture in line with the notes 馃檪

Sir, in example 12 (chapter 15) it was better as of today to convert it to shares and therefore we calculated current m.v and parity value based on it but say if today it was better to take money at maturity would we calculate m.v based on $100 nominal in 3 years time. Also will parity value be $100 ? Please help

In example 12 your answer says investors are looking for a return of 10%. This isn’t stated in the question. Where do you get this assumed required rate of return or have I missed it?

We have certain assumptions and limitations in dividend valuation model, do the same applies to i.e., irredeemable debt as well?

Dividend valuation model formula = D/Re if there is no growth Irredeemable debt formula = Interest/kd

1. We assume that dividends/interest are paid once in a year and there is not interim dividend or semi annual interest 2. We assume that we have constant dividends or interest payments till infinity.

I have done some further work on question # 9. The investor required rate of return is 12%.

The interest rate that the investor will be getting is 8%. If we add the discount % and the premium % on this interest rate then it will also be around 12% which is equal to investor required rate of return.

Breakup: Interest rate getting 8% Discount (100-91.21)/5 years 1.76% Premium 10/5 years 2% TOTAL 11.76%

My question is: If the investor can easily get 12% bank interest then why he would buy traded debts which has the same fixed interest (even lower 11.76% in this question than 12%)? I think the risk is almost the same.

Can you please correct me if I am wrong? and provide explanations to understand the main ideas.

Firstly, your calculation (of 11.76%) is only an approximation. The correct return the investor is getting is the IRR, which is exactly 12%. (Although this is explained in a later chapter – the cost of capital – if you think about it, the return must be the IRR because that is the rate of interest that gives a NPV of zero).

Secondly, if bank interest is 12% then an investor in bonds will almost certainly want more than 12% and therefore the market value will end up being lower. The interest given by the bank may well be a starting point, but the exact return required by investors will depend on the level of risk, and again this is dealt with in a later chapter. It is impossible to explain everything at once – this chapter is dealing with the fact that in theory the market value will be the present value of future expected receipts discounted at the investor required rate of return. What determines the rate of return they require is a separate issue.

For the purposes of the exam will MV of Debt = MV of ALL debentures? I just want to ensure that I don’t stop at the working that gives the nominal pv and miss any points.

Dear John, Is it possible to be asked to calculate the share price at a given point in time in the future, using the dividend growth model? I get the idea that the dividends being discounted are full year dividends. So is it okay to apportion the dividend growth half way through? Say for 6 months, as in (D_0 (1+g)^(6/12))/(K_e-g)^(6/12) .

These are two separate questions (and in future they are better asked in the Ask the Tutor Forum rather than as a comment on a lecture).

First – if you know the market value now, and you want an estimate of the share price in the future, then you multiply the current share price by (1+g)^n (where n is the number of years in the future).

Second – you will not be asked to deal with 6 monthly dividends. In practice some companies certainly do pay dividends twice a year, but the interim dividend is usually much smaller that the final dividend, which means you would have to use the formula twice (once on the interim dividends and then on the final dividends).

Hi, In example 10 it says issued $1000,000 , 7% debentures are redeemable in four years time at par?invester required rate ov return is 10 %. Calculate the m.v ov the debt? in last question it says on premium is there any difference in par and premium if yeah how to solve this example .?

Have you watched all of our lectures? Debentures (and bonds and loan stock) are usually (in the exam) redeemed at a premium and the premium is always by reference to the nominal value. In which case the redemption amount is higher than the nominal (or par – which means the same thing) value.

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rishabbohra98 says

Sir for redeemable debt if there is tax at 30% then should we deduct tax from the interest and find after tax interest

John Moffat says

Not if calculating the market value.

It is investors who fix the market value and they are not affected by company tax.

hadi245 says

hi,

i would like to clarify for me this”500,000 10% irredeemable debentures” mean. beacause

i thought it was 500,000 *10%=50000 then divide 0.08 to get market value of debt.

instead ur using 100 *10%=10. is it assumption that ur using 100 instead of 500000 issued debentures

John Moffat says

I make it clear in the earlier lectures that debt is always quoted on the stock exchange in units of $100 nominal (unless specifically told otherwise in the exam). The $125 is the market value of one unit ($125 p.c.). The total market value of all the debt is therefore $500,000 x 125/100 = $625,000 (which is the same as what you are doing).

Exam questions will make it clear whether they want the total market value of all the debt, or whether they want the market value that will be quoted on the stock exchange i.e. the value per $100 nominal.

ahonanuga says

Hi John

In the example 12 where you cal the PV of the interest payments for 3 year…

You say $8 * 2.487 = 18.90

this is not correct as 8* 2.487 =19.896 or am I missing something.

John Moffat says

You are correct – it was a silly mistake and I should have said 19.90.

I will rerecord the lecture at some stage. However the answer in the lecture notes is correct 馃檪

kirill009 says

Great lecture, thank you!

John Moffat says

Thank you for your comment 馃檪

kellykhan99 says

In example 12 how did you know to use the df of 10%. It does not state what investors require of return should be.

kellykhan99 says

just read the comments i can see it was just not added!!!

John Moffat says

馃檪

fola94 says

In Example 12, how did you get to know it is 1-3 years? The questions says nothing about three years, so I do not seem to understand. Thank you.

John Moffat says

Please read the comment from mracca11 below, and my reply.

usama93 says

please confirm if i am correct in my understanding ?

1) A market value higher than the nominal value would mean that a lower interest rate would be paid to the investor as because a higher market value is a compensation for the lower rate and vice versa ??

2) let suppose that i initially bought a debenture for a nominal value of $ 100 from a company last year . Currently the market value of the same debenture is worth $ 120 which would mean that the company would offer a lower return rate as the market value is greater than the nominal value . my question is that why would a person buy that debenture on the stock exchange from me when he has nothing to gain by purchasing it ??

firstly he would buy that debenture from me for $ 120 and secondly he would be paid a lower rate of interest . both of these are financially not in his favor …

kindly guide me in that please !

John Moffat says

1. Correct – assuming you are referring to the return to the investor (as opposed to the coupon rate, which would stay unchanged).

2. Firstly, the interest paid by the company (the coupon rate) is not changing. Whatone investor chooses to pay to another investor to take over the debenture is nothing to do with the company.

As far as it not being financially in the investors favour – why not? If I have $120 to invest I will look to see what returns I can get on the money. If banks are paying (say) 1% a year interest, then I will be quite happy to pay $120 for the debenture is I end up getting a return of more than 1%!

As I explain in the lecture, it is investors who determine the market value – not the company – and it depends on the interest they will get each year and the rate of return that they require.

mracca11 says

Hello Sir,

At 16.25 in the video, (example 12) you take the discount factors for only years 1-3 thereby treating it as it was redeemable by 2010. However, in the lecture notes in example 12 it says they’ll be redeemable by 2020. Please correct me if I’m wrong.

Thankyou 馃檪

John Moffat says

Oops! It is a typing mistake – it should say that ‘now’ is 2017.

Thank you for spotting it. I will have it corrected 馃檪

usama93 says

please donot amend the year 2007 to 2017 . change 2020 to 2010 because as per your words in the video u have used 2010 as the maturity year . so altering the maturity year would get the lecture in line with the notes 馃檪

John Moffat says

Good point – thanks 馃檪

rakhi2rakhi says

Sir, in example 12 (chapter 15) it was better as of today to convert it to shares and therefore we calculated current m.v and parity value based on it but say if today it was better to take money at maturity would we calculate m.v based on $100 nominal in 3 years time. Also will parity value be $100 ? Please help

John Moffat says

Yes to both questions 馃檪

tree38 says

HI

In example 12 your answer says investors are looking for a return of 10%. This isn’t stated in the question. Where do you get this assumed required rate of return or have I missed it?

John Moffat says

You are quite right – thank you for spotting it.

I will have it added to the example in the notes immediately.

Libin Jacob ACCA says

hi John Sir, 10% is not in the question so can you kindly tell me how did you get that 10 %.Many thanks 馃檪

John Moffat says

Have you not read the previous post here? It is a mistake – it should be in the question.

mktaguba says

Hi John,

In example 12 of the new lecture notes, is the “8% debentures 2020” suppose to say its repayable in 2010 and why is did we discount at 10%?

Thanks

madihakhan18 says

Hi,

are these lectures still valid??

John Moffat says

Of course they are otherwise they would not be here 馃檪

salman7 says

Dear sir,

We have certain assumptions and limitations in dividend valuation model, do the same applies to i.e., irredeemable debt as well?

Dividend valuation model formula = D/Re if there is no growth

Irredeemable debt formula = Interest/kd

1. We assume that dividends/interest are paid once in a year and there is not interim dividend or semi annual interest

2. We assume that we have constant dividends or interest payments till infinity.

You comment needed pls. Thanks,

John Moffat says

We assume that interest is paid annually.

Interest payments are constant, but that is not an assumption – it is a fact. If the coupon rate is (say 8%) then it is fixed at 8% per year.

salman7 says

Hi Mr. John,

I have done some further work on question # 9. The investor required rate of return is 12%.

The interest rate that the investor will be getting is 8%. If we add the discount % and the premium % on this interest rate then it will also be around 12% which is equal to investor required rate of return.

Breakup:

Interest rate getting 8%

Discount (100-91.21)/5 years 1.76%

Premium 10/5 years 2%

TOTAL 11.76%

My question is: If the investor can easily get 12% bank interest then why he would buy traded debts which has the same fixed interest (even lower 11.76% in this question than 12%)? I think the risk is almost the same.

Can you please correct me if I am wrong? and provide explanations to understand the main ideas.

John Moffat says

Firstly, your calculation (of 11.76%) is only an approximation. The correct return the investor is getting is the IRR, which is exactly 12%. (Although this is explained in a later chapter – the cost of capital – if you think about it, the return must be the IRR because that is the rate of interest that gives a NPV of zero).

Secondly, if bank interest is 12% then an investor in bonds will almost certainly want more than 12% and therefore the market value will end up being lower. The interest given by the bank may well be a starting point, but the exact return required by investors will depend on the level of risk, and again this is dealt with in a later chapter. It is impossible to explain everything at once – this chapter is dealing with the fact that in theory the market value will be the present value of future expected receipts discounted at the investor required rate of return. What determines the rate of return they require is a separate issue.

matekane1113 says

OMG! these lectures are so overwhelming, thank you so much sir John

kc09 says

For the purposes of the exam will MV of Debt = MV of ALL debentures? I just want to ensure that I don’t stop at the working that gives the nominal pv and miss any points.

John Moffat says

Yes 馃檪

sophierayner says

Is the answer to LE10, $90.49?

$7 x 3.170 (DF @ 10% for T1-T4) = $22.19

$100 x 0.683 (DF @ 10% for T4) = $68.30

$22.19 + $68.30 = $90.49?

sophierayner says

Oops, just seen your answer at the start of the next lecture.. I got it right, yay! 馃檪

John Moffat says

Great 馃檪

samson says

Dear John,

Is it possible to be asked to calculate the share price at a given point in time in the future, using the dividend growth model? I get the idea that the dividends being discounted are full year dividends. So is it okay to apportion the dividend growth half way through? Say for 6 months, as in

(D_0 (1+g)^(6/12))/(K_e-g)^(6/12) .

Kind regards

John Moffat says

These are two separate questions (and in future they are better asked in the Ask the Tutor Forum rather than as a comment on a lecture).

First – if you know the market value now, and you want an estimate of the share price in the future, then you multiply the current share price by (1+g)^n (where n is the number of years in the future).

Second – you will not be asked to deal with 6 monthly dividends. In practice some companies certainly do pay dividends twice a year, but the interim dividend is usually much smaller that the final dividend, which means you would have to use the formula twice (once on the interim dividends and then on the final dividends).

samson says

Dear John,

Thank you very much for the clarification.

The comment is well noted as well.

Regards

John Moffat says

You are welcome 馃檪

uzma1111 says

Hi,

In example 10 it says issued $1000,000 , 7% debentures are redeemable in four years time at par?invester required rate ov return is 10 %.

Calculate the m.v ov the debt?

in last question it says on premium is there any difference in par and premium if yeah how to solve this example .?

John Moffat says

Have you watched all of our lectures?

Debentures (and bonds and loan stock) are usually (in the exam) redeemed at a premium and the premium is always by reference to the nominal value. In which case the redemption amount is higher than the nominal (or par – which means the same thing) value.

uzma1111 says

yes i did but after this lecture

thank u so much 馃檪

John Moffat says

You are welcome 馃檪

mansoor says

the required rate of return … are we assuming its pre tax rate of return?

John Moffat says

It is not an assumption, it is a fact.

It is only the company that gets tax relief on the interest payments, not the investor.

You really should watch our free lectures because this is all explained in detail – I cannot (and will not) simply type out the lectures here 馃檪

mansoor says

thank u

… with 20 things to consider i tend to ask the stupidest questions..:) .. thank u again …

John Moffat says

No problem 馃檪