BOND VALUATION

BOND VALUATION

Bonds are long-term fixed income securities. Debentures are also long-term fixed income securities. Both of these are debt securities. In India, debt securities issued by the government and public sector units are generally referred to as bonds, while debt securities issued by private sector joint stock companies are called debentures. The two terms, however, are often used interchangeably. The term ‘bond’ is used in this chapter to include debentures also.

The two major categories of bonds are government bonds and corporate bonds. Government bonds represent the borrowings of the government. Since they are backed by the government, they are considered free from default risk. Corporate bonds represent debt obligations of private sector companies. Corporate bonds are backed by the credit of the issuing companies. It is the company’s ability to earn money and meet the debt obligations that determines the bond’s default risk.

Bond valuation is less glamorous than stock valuation for two reasons. First, the returns from investing in bonds are less impressive and fixed. Second, bond prices fluctuate less than equity prices. As the uncertainty associated with the cash flows occurring to a bond holder is less, the emphasis is more on fine-turned calculations and analysis. An investor in bonds should be on the look out for even small differentials in prices and returns.