INVESTMENT ANALYSIS – AREAS OF CONCENTRATION (TOPIC: BOND AND EQUITY )

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 DETERMINATION OF RETURNS FROM BOND AND EQUITY BOND

BOND

 Under bond, we have the following:

1. Coupon Rate
2. Current Yield
3. Yield to Maturity

 COUPON RATE – this refers to the normal rate of interest that is charged on the nominal value of a bond.  Coupon is therefore the product of the Coupon rate which denote by small letter (i) and the face value of the bond which symbolically is written fcv.  The amount of Coupon on the bond issued is represented as i(fcv).  Where i is the Coupon weight or the nominal interest of the bond.  Fcv is the face value of the bond.

THE CURRENT YIELD – this refers to the actual rate of return on the bond issued and it is calculated as Y=C

                                     Po 

Where y is the current yield of the bond issued, c is the annual coupon.  Then Po is the market value or price of the bond.

YIELD TO MATURITY – this represent the rate of return on the nominal value of the bond adjusted for the amortization of premium i.e. the discount rate that equates the future cash flow from the bond issued with the current market price of the bond.  Note that, if the market price is higher than the nominal value, then it means that the bond issued is selling at a premium. But if the market price is lower than the nominal value, then the bond is selling at a discount.  Yield to maturity can be calculated thus:

YTM = C + FCV – Po

                     N_____

           ½ (FCV + Po)

Where:

YTM is yield to maturity

C = annual coupon

FCV = the face value of the bond

Po = Market value of the bond

N = holding period or number of years to maturity

 ILLUSTRATION:

Suppose a 10% bond with a face value of N100,000 is currently selling for N80,000, what is the current yield and the approximate yield to maturity if it is due to mature in 20 years?

SOLUTION:

First of all, we need to the Coupon rate before we can calculate for Yield to Maturity.

So, Coupon Rate is i (fcv) = 10% (100,000) = N10,000.

 Hope we all know how I got that. i, is the 10% in the question, fcv is the face value of the bond which is 100,000.  10%x100,000 = N10,000.  Now that we know our Coupon Rate, we can go ahead to solve.

The Current Yield of the bond is Y=  C

                                                      Po

 Y =  10,000

        80,000 = 0.125 or 12.5%

While the yield to maturity is:

YTM = C + FCV – Po

                     N_____

           ½ (FCV + Po)

YTM = 10,000 + (100,000 – 80,000)

                                   20_______

                  ½ (100,000 + 80,000)

YTM = 10,000 + 1,000

           ½ (180,000)

YTM = 11,000

           90,000 

YTM = 0.122 or 12.2%

Pls, if you don’t understand this, just call for 07069373637 for clarification.  I would have love to explain a little.

From the formula

YTM = C + FCV – Po

                     N_____

           ½ (FCV + Po)

You have to calculate the figure of FCV – Po then divide them by N.  which is like this 100,000 – 80,000 = 20,000 divide by n which is 20. You will get 1,000.

Then C is 10,000.  10,000 of C added to the 1,000 that you have calculated out of FCV-Po/N will give you 11,000.

Finally, you have 11,000 at the top and you still have to calculate for ½ (FCV +Po) which will give you 100,000 FCV + 80,000 of Po =180,000. ½ multiply by 180,000 will give you 90,000.  So we have 11,000 at the top and 90,000 below.  So divide 11,000/90,000.  That is how we got 0.122. if you multiply 0.122 you will get 12.2%.  You answer have to be in percentage that is why we have to multiply by 100.