What is Debenture & Bond? How to calculate Bond Yield at Maturity?

Debenture: It is a loan certificate which

 is issued by company to the general public. The debenture holders have a right to get interest on it. It is not a secured loan.

Bond: It is similar to debenture, but it acts as a secured loan issued by government and big corporations. The interest rates are low, but paid before the debentures.                                                                                      

Bond Yield at Maturity: The bond holders can ascertain how much amount they earn on their investments annually.

Formula: (Annual Interest + [(par value-market value)/number of years of maturity]/ ((par value+ market value) / 2)



Types of debentures:

Convertible debenture	A debenture which can be convertible into equity shares.
Non-convertible debenture	A debenture which cannot be converted into equity shares.
Registered debenture	Only registered debenture holders get interest amount and principal amount.
Bearer debenture	Anyone who bears the debenture certificate get interest amount.
Redeemable debenture	A debenture issued for a fixed period. After a fixed period debenture holders get their principal amount.
Irredeemable debenture	A debenture which is not matured until the winding up of a company.
Secured debenture	It is secured by the assets of a company. If company is not able to pay principal amount to debenture holders then company has to sell their assets.

Type of Bonds

Corporate Bonds:
Callable Bonds	These bonds are paid off before the maturity date at a specified price
Zero coupon bonds	These bonds doesn't carry any interest,but issued at discount.
Mortgage Bond	It is secured by specified property or assets like land.
Government Bond:
Municipal Bond	It issues for development in school, road etc by state or Local government.
Revenue Bond	It pays off when it earns income for which it issues.
Federal Government Bond	It issued by federal government like treasury bond for 10 to 30, treasury bill and treasury notes.
Foreign Bond:
Dollar Bond (External Bond)	When Indian government issues bond for investors in US investors.
Internal Bond	When bond issues in native currency.

Bond Current Yield:

Example: Suppose M. Chopra has invested in 20 years bond and the interest rate is 9% and required rate of return is 7%. Find out the current yield if market value of bond is Rs. 9, 88,000 and the face value is Rs. 10, 00,000.

Solution: Current Yield = Annual Interest / Market value

= 90,000 / 9, 88,000

= 9.10%

Bond Yield at Maturity (YTM):

Example: Mr. Sharma has invested in a bond for 10 years. The interest rate is 6.3% annually. The market price of bond is Rs. 980 and the face value of a bond is Rs. 1000. Find out the yield at maturity.

Solution: (Annual Interest + [(par value-market value)/number of years of maturity]/ ((par value+ market value) / 2)

Or

C*[1-(1/ (1+YTM) ⁿ)/I] + FV/ (1+YTM) ⁿ

= [63 + (1000- 980 /10)/ (1000+980 / 2)

=65/990

=6.56 %

Yield at Maturity of Zero Coupon Bond:

Example: Mrs. Nisha has invested in a zero coupon bond for 8 years whose current price is Rs.8, 756 and face value is Rs.10, 000. Find out the Yield at maturity.

Solution: Yield at maturity = (Face Value / Current price) -1

= (10,000 / 8, 756) – 1

= 14.20%

Bond Yield at Call (YTC): Bondholders earn interest on bond when it calls before maturity. These bond are known as Callable bonds. The issuer buy back their bond when market interest rate is lower than the stated rate in bonds.

Example: Suppose you invested in a bond for 20 years and the interest rate is 5.3%. The face value of a bond is Rs. 1000 and the market value is Rs.856. The issuer buy back the bond before the maturity from bond holders at premium of Rs.1090 in 10 years. Find out the yield at call.

Solution: (Annual Interest + [(call price-market value)/number of years until call]/ ((call price+ market value) / 2)

= [(53 + (1090- 856 /10))/ (1090+856 / 2)

= 76.4/973

= 7.85 %

Note: If bond is issue at premium then the required rate of return is lower than the coupon rate and if issue at discount then the required rate of return is higher than the coupon rate.