Financial Institutions and

Markets
Prof. Manisha Sanghvi
Examination Marks
Final Examination 60

Mid Term Examination 20

Presentation 10

Attendance / Class Participation 10

Total 100
 Course Contents
 Introduction to Financial markets and Institutions
 Bond Market
 Money Market
 Capital Market
 Mutual Funds
 Foreign Exchange
 Investment Banking
 Commercial Banking
Indian Financial System
 The economic development of a nation is reflected by the progress of
the various economic units, broadly classified into corporate sector,
government and household sector. While performing their activities
these units will be placed in a surplus/deficit/balanced budgetary
situations.
 There are areas or people with surplus funds and there are those with a
deficit. A financial system or financial sector functions as an
intermediary and facilitates the flow of funds from the areas of surplus
to the areas of deficit. A Financial System is a composition of various
institutions, markets, regulations and laws, practices, money manager,
analysts, transactions and claims and liabilities.
 Financial System;
The word "system", in the term "financial system", implies a set
of complex and closely connected or interlined institutions,
agents, practices, markets, transactions, claims, and liabilities in
the economy. The financial system is concerned about money,
credit and finance-the three terms are intimately related yet are
somewhat different from each other. Indian financial system
consists of financial market, financial instruments and financial
intermediation. These are briefly discussed below
Financial Institutions
 Includes institutions and mechanisms which
 Affect generation of savings by the community
 Mobilisation of savings
 Effective distribution of savings

 Institutions are banks, insurance companies,

mutual funds- promote/mobilise savings
 Individual investors, industrial and trading
companies- borrowers
Financial market
 Defined as the market in which financial assets are created or transferred
 These assets represent a claim to the payment of a sum of money
sometime in the future and/or periodic payment in the form of interest or
dividend.
 Classification
 Money market
 (Short term instrument)
 Organized (Banks)
 Unorganized (money lenders, chit funds, etc.)

 Capital markets
 (Long term instrument)
 Primary Issues Market
 Stock Market
 Bond Market
 The most important distinction between the two????
Financial markets facilitate:

 The raising of capital

 The transfer of risk
 International trade

They are used to match those who want capital to those who have it. Typically a
borrower issues a receipt to the lender promising to pay back the capital. These
receipts are securities which may be freely bought or sold. In return for lending money
to the borrower, the lender will expect some compensation in the form of interest or
dividends.
Financial markets could mean:

 Organizations that facilitate the trade in financial products. i.e. Stock exchanges
facilitate the trade in stocks, bonds and warrants.

 The coming together of buyers and sellers to trade financial products. i.e. stocks and
shares are traded between buyers and sellers in a number of ways including: the use
of stock exchanges; directly between buyers and sellers etc.
Financial Markets
 OTC
 Auction Market
 Organized Market
 Intermediation financial market
Types of Financial markets
 Capital markets
 Stock markets, which provide financing through the issuance of
shares or common stock, and enable the subsequent trading
thereof.
 Bond markets, which provide financing through the issuance of
Bonds, and enable the subsequent trading thereof.
 Commodity markets
 Money markets
 which provide short term debt financing and investment.
 Derivatives markets
 which provide instruments for the management of financial risk.
 Futures
 Forward
 Options .
 Insurance markets
 which facilitate the redistribution of various risks.
 Foreign exchange markets
 which facilitate the trading of foreign exchange.
 Credit market
 where banks, FIs and NBFCs purvey short, medium and
long-term loans to corporate and individuals.

The capital markets consist of primary markets and

secondary markets. Newly formed (issued) securities are
bought or sold in primary markets. Secondary markets
allow investors to sell securities that they hold or buy
existing securities.
Purpose of Financial Markets
Purpose:
 To facilitate the transfer of funds between borrowers and
lenders
 Trade TIME & RISK

 Price discovery: Trading on secondary markets provides public

information on asset prices (market price = last traded price of
an asset)

 Lower search costs: Since all trading parties converge to the

same location, matching is made easier

 Provides liquidity: investors can sell assets prior to maturity on

secondary markets to satisfy their time preference for
consumption and diversification needs.
FM Participants

 Firms - Net Borrowers

 Households (Individuals/Consumers)- Net Savers
 Financial Institutions -Borrowers and Savers
 Government (Federal/State/Local)
Money Market
 Main Function
•To channelize savings into short term productive
investments like working capital .

 Instruments in Money Market

•Call money market
•Treasury bills market
•Markets for commercial paper
•Certificate of deposits
•Bills of Exchange
•Money market mutual funds
•Promissory Note
Capital Markets
Provided resources needed by medium and
large scale industries.

Purpose for these resources

 Expansion
 Capacity Expansion
 Investments
 Mergers and Acquisitions

Deals in long term instruments and sources of

funds
Main Activity

 Functioning as an institutional mechanism to channelize

funds from those who save to those who needed for
productive purpose.

 Provides opportunities to various class of individuals and

entities.
 Primary Markets Secondary Markets
When companies need financial resources for its The place where such securities are traded by these
expansion, they borrow money from investors investors is known as the secondary market.
through issue of securities.

Securities issued Securities like Preference Shares and Debentures

b)Preference Shares cannot be traded in the secondary market.
c)Equity Shares
d)Debentures

Equity shares is issued by the under writers and Equity shares are tradable through a private broker
merchant bankers on behalf of the company. or a brokerage house.

People who apply for these securities are: Securities that are traded are traded by the retail
b)High networth individual investors,FI’s,MF’s etc
c)Retail investors
d)Employees
e)Financial Institutions
f)Mutual Fund Houses
g)Banks

One time activity by the company. Helps in mobilising the funds for the investors in
the short run.
The Indian Capital Market
 Market for long-term capital. Demand comes
from the industrial, service sector and
government
 Supply comes from individuals, corporates,
banks, financial institutions, etc.
 Can be classified into:
 Gilt-edged market
 Industrial securities market (new issues and stock
market)
Major Reforms in
Indian Capital Market
 Setting up of SEBI
 Introduction of free pricing in the primary capital market and abolition of
capital control
 Standardization of disclosures in public issue
 Permission to FIIs to operate in the Indian capital market.
Modernisation of trading infrastructure – on-line screen based
electronic trading system
 Shift from account period settlement to (14 days) to rolling settlement
(T+2)
 Safety and Integrity Measures – margining system, intra-day trading
limit, exposure limit and setting up of trade/settlement guarantee fund
 Clearing of transactions through the clearing house
 Dematerialization of securities –Two depositories in the country
 Reconstitution of Governing Boards of Stock Exchanges
 Introduction of trading in equity derivative products
 Indian corporate allowed to access
 International capital markets through
 American Depository Receipts
 Global Depository Receipts
 Foreign Currency Convertible Bonds
 External Commercial Borrowings
 Financial Institutions
Specialize in market activities that help facilitate the
 Transfer of funds between borrowers and lenders. They are frequently referred to as
Financial Intermediaries (ie. act in the capacity as a go-between when financial
markets are insufficient by themselves)
Types of Financial Institutions:
 Depository: Commercial Banks, Thrifts, Credit Unions, Savings and Loan
 Non Depository: Investment companies (mutual funds), Pension funds,
Insurance
 Finance companies: Corporations that have financial arms such as, LIC
housing finance, IDBI
 Government Sponsored Enterprises (GSE)
 Information collectors: Analysts, Rating agencies, Auditors
 Market makers & dealers: Brokers, Specialist firms
Bond Market
Session 2
 Making money:
Interest and capital gains
There are two ways to make money from a bond –
either by earning interest or capital gains.
Let's say that you have a Rs 1,000 bond that pays
6% interest for five years. If you hold that bond until
the very end of this term (known as the maturity
date), you’ll collect five interest payments of Rs 60
for a total of Rs 300.
Total principal and
Principal Year 1 (6% interest Year 2 (6% interest Year 3 (6% interest Year 4 (6% Year 5 (6% interest (at maturity
amount on 1,000) on 1,000) on 1,000) interest on 1,000) interest on 1,000) date of 5 years)

Rs 1000.00 60.00 60.00 60.00 60.00 60.00 1,300.00

•You could also decide to sell that
bond to someone else for $1,100. In
that case you’d earn a capital gain of
$100 (plus whatever interest
payments you had received in the
meantime).

•Now, why would someone pay you

$1,100 for a bond that only cost you
$1,000?
 Selling bonds
•Your $1,000 bond pays 6% interest. Since you
bought that bond, however, interest rates have gone
down. Similar companies are now only offering a 5%
interest rate on their bonds. Your original rate looks
pretty good to another investor. So you can sell that
6% bond at a higher cost than you paid for it, which
is called selling for a premium.
•However, if interest rates have gone up, and similar
companies are now offering 8%, you may have to
sell your bond for less – which is known as selling at
a discount.
•Interest rates and bond prices, then, are like a see-
saw – when interest rates go down, bond prices go
Bond Issuers
 Government Bonds
 Municipal Bonds
 Corporate Bonds
 International Bonds
 Eurobond
 Foreign bonds
 Global Bonds
Bonds terminology
 Issuer
A bond is a debt security, similar to an I.O.U. When you
purchase a bond, you are lending money to a government,
municipality, corporation, federal agency or other entity known
as the issuer.
 Par Value
 It is the value stated on the face of the bond.
 It represents the amount the firm borrows and promises to repay
at the time of the maturity.
 It is also known as the principal, face value, or par value.
 Par value will vary depending on the type of bond. Most
corporate bonds have a Rs 100 face value, sometimes it can be
Rs 1000.
 It is important to remember that bonds are not always sold at par
value. In the secondary market, a bond's price fluctuates with
interest rates. If interest rates are higher than the coupon rate on
a bond, the bond will have to be sold below par value (at a
 Maturity
 Maturity is the length of time before the principal is returned
on a bond. It is also called term-to-maturity. At the time of
maturity, the issuer is no longer obligated to make interest
payments.
 Maturities range significantly, from 1 year to 40+ years for
some corporate bonds.
 The bonds of different maturities will behave somewhat
differently. For example, bonds with long-term maturities will
be more sensitive to changes in interest rates. Shorter term
bonds are more stable and, because you are more likely to
hold it to maturity, are more predictable. There are some
circumstances where a bond will be "called" before maturity.
 Short-term notes: maturities of up to 4 years; Medium-term
notes/bonds: maturities of five to 12 years; Long-term bonds: maturities
of 12 or more years.
 Coupon
 The coupon rate is the interest rate that is paid out to the bond holder.
 The name derives from the old system of payment, in which bond holders
would need to send in coupons in order to receive payment.
 The coupon is set when the bond is issued and is usually expressed as an
annual percentage of the par value of the bond.
 Payments usually occur every six months, but this can vary. If there is a 5%
coupon on a Rs 1000 face value bond, the bondholder will receive Rs 50
every year.
 If two bonds with equal maturities and face values pay out different
coupons, the prices of these bonds will behave differently in the secondary
market. For example, the bond with a lower coupon rate will be less
expensive because the bondholder is going to be getting more of his/her
return from the return of principal at maturity than will the holder of a bond
with a higher coupon.
 There are some bonds that do not pay out any coupons; these are called
zero-coupon bonds .
CREDIT RATINGS
 Each of the agencies assigns its ratings based on an in-depth analysis of the issuer's financial
condition and management, economic and debt characteristics, and the specific revenue sources
securing the bond.

Credit Ratings
Standard and
Credit Risk Moody's Poor's Fitch
Prime Aaa AAA AAA
Excellent Aa AA AA
Upper Medium A A A
Lower Medium Baa BBB BBB
Speculative Ba BB BB
Very Speculative B, Caa B, CCC, CC B, CCC, CC, C
Default Ca, C D DDD, DD, D
Types of Bonds
I. Classification on the basis of Variability of Coupon
 Zero Coupon Bonds
 Zero Coupon Bonds are issued at a discount to their face value and at the
time of maturity, the principal/face value is repaid to the holders. No interest
(coupon) is paid to the holders and hence, there are no cash inflows in zero
coupon bonds.
 The difference between issue price (discounted price) and redeemable price
(face value) itself acts as interest to holders. The issue price of Zero
Coupon Bonds is inversely related to their maturity period, i.e. longer the
maturity period lesser would be the issue price and vice-versa. These types
of bonds are also known as Deep Discount Bonds.
Floating Rate Bonds
 In some bonds, fixed coupon rate to be provided to the

holders is not specified. Instead, the coupon rate keeps

fluctuating from time to time, with reference to a
benchmark rate. Such types of bonds are referred to as
Floating Rate Bonds.
For better understanding let us consider an example of
one such bond from IDBI in 1997. The maturity period of
this floating rate bond from IDBI was 5 years. The coupon
for this bond used to be reset half-yearly on a 50 basis
point mark-up, with reference to the 10 year yield on
Central Government securities (as the benchmark). This
means that if the benchmark rate was set at “X” %, then
coupon for IDBI’s floating rate bond was set at “(X + 0.50)”
%.
 Coupon rate in some of these bonds also have floors
and caps. For example, this feature was present in the
same case of IDBI’s floating rate bond wherein there
was a floor of 13.50% (which ensured that bond
holders received a minimum of 13.50% irrespective of
the benchmark rate).
 On the other hand, a cap (or a ceiling) feature signifies
the maximum coupon that the bonds issuer will pay
(irrespective of the benchmark rate). These bonds are
also known as Range Notes.
More frequently used in the housing loan markets
where coupon rates are reset at longer time intervals
(after one year or more), these are well known as
Variable Rate Bonds and Adjustable Rate Bonds.
Coupon rates of some bonds may even move in an
opposite direction to benchmark rates. These bonds
 Fixed
 Stays same until maturity; ie: buy a Rs 1000 bond with 8%
fixed interest rate and you will receive Rs 80 every year until
maturity and at maturity you will receive the Rs 1000 back.

 Payable at Maturity
 Receive no payments until maturity and at that time you
receive principal plus the total interest earned compounded
semi-annually at the initial interest rate.
II. Classification on the Basis of Variability
of Maturity
 Callable Bonds
 The issuer of a callable bond has the right (but not the
obligation) to change the tenor of a bond (call option). The issuer
may redeem a bond fully or partly before the actual maturity
date. These options are present in the bond from the time of
original bond issue and are known as embedded options.
 This embedded option helps issuer to reduce the costs when
interest rates are falling, and when the interest rates are rising it
is helpful for the holders.
 Puttable Bonds
 The holder of a puttable bond has the right (but not an
obligation) to seek redemption (sell) from the issuer at any
time before the maturity date.
 In riding interest rate scenario, the bond holder may sell a
bond with low coupon rate and switch over to a bond that
offers higher coupon rate. Consequently, the issuer will have
to resell these bonds at lower prices to investors.
 Therefore, an increase in the interest rates poses additional
risk to the issuer of bonds with put option (which are
redeemed at par) as he will have to lower the re-issue price
of the bond to attract investors.
 Convertible Bonds
 The holder of a convertible bond has the option to convert
the bond into equity (in the same value as of the bond) of the
issuing firm (borrowing firm) on pre-specified terms.
 This results in an automatic redemption of the bond before
the maturity date. The conversion ratio (number of equity of
shares in lieu of a convertible bond) and the conversion
price (determined at the time of conversion) are pre-
specified at the time of bonds issue.
 Convertible bonds may be fully or partly convertible. For the
part of the convertible bond which is redeemed, the investor
receives equity shares and the non-converted part remains
as a bond.
III. Classification on the basis of Principal
Repayment

 Amortizing Bonds
 Amortizing Bonds are those types of bonds in which the
borrower (issuer) repays the principal along with the coupon
over the life of the bond.
 The amortizing schedule (repayment of principal) is prepared in
such a manner that whole of the principle is repaid by the
maturity date of the bond and the last payment is done on the
maturity date. For example - auto loans, home loans, consumer
loans, etc.
Debt Instruments
Type
Central Government Securities
State Government Securities
Government – Guaranteed Bonds
PSU
Corporate
Typical Features
Medium – long term bonds issued by RBI on
behalf of GOI.
Coupon payment are semi annually
Medium – long term bonds issued by RBI on
behalf of state govt.
Coupon payment are semi annually
Medium – long term bonds issued by govt
agencies and guaranteed by central or
state govt.
Coupon payment are semi annually
Medium – long term bonds issued by PSU.
51% govt equity stake
Short - Medium term bonds issued by
private companies.
Coupon payment are semi annually
Risk Associated with Investing in
Bonds
 Interest Rate Risk
 The price of the bond will change in the opposite

direction from the change in interest rate. As interst

rate rises the bond price decreases and vice versa.
 If an investor has to sell a bond prior to the maturity

date, it means the realisation of capital loss.

 This risk depends on the type of the bond; callable

puttable etc????

 Reinvestment Income or Reinvestment Risk

 The additional income from such reinvestment called

interest on interest, depends on the prevailing interest

rate levels at the time of reinvestment.
 Call Risk
 The issuer usually retains this right in order to have

flexibility to refinance the bond in the future is market

interest rate drops below the coupon rate
 Disadvantage for investors for callable bond: cash flow

pattern not known with certainty, interest rate drop,

capital appreciation will reduce.
 Credit Risk
 If the issuer of a bond will fail to satisfy the terms of
the obligation with respect to the timely payment of
interest and repayment of the amount borrowed.
 Yield = market yield + risk associated with credit risk
 Inflation Risk
 Purchasing power risk arises because of the
variation in the value of cash flow from the
security due to inflation.
 Eg: ???
 Exchange Rate Risk
 Risk associated with the currency value for non-
rupee denominated bonds. Eg: US treasury bond
 Liquidity Risk
 Its depends on the size of the spread between bid and

ask price quoted. Wider the spread is risky.

 For investors keeping till maturity, this is uminportant.

 Market to market should be calculated portfolio value.

 Volatility Risk
 Value of bond will increase when expected interest
rate volatility increases.
 Risk Risk
 Natural uncertainty.

 Avoid securities in which knowledge is less.

Time value of Money
 Present value of money
PV = Pn 1
(1+r)n
Present value of an Ordinary Annuity
 When the same amount of rupees is received
each year or paid each year is referred to as
an annuity.
 When the first payment is received one
period from now is called as an ordinary
annuity.
PV = 1
1-

A (1+r)n
r
Question
 Suppose that an investor expects to receive
Rs 100 at the end of each year for the next
eight year. Interest rate 9%
 When the first payment is received one
period from now is called as an ordinary
annuity.
PV = 1
1-

100 (1.09)8
0.09
100 [5.534811] = Rs 533.48
Bond Pricing
 Reason –
 Indicate the yield received
 Should the bond be purchased

 Priced at – Premium, Discount, or at Par

Calculating Bond Price
 Sum of the present values of all expected
coupon payments plus the present value of the
par value at maturity.

C = coupon payment, ordinary annuity

n = number of payments
i = interest rate, or required yield
M = value at maturity, or par value
Session 3
Yield YTM Duration
Question 1
 Calculate the Bond price for a 20 year 10%
coupon bond with a par value of Rs 1000.
Lets suppose the yield on this bond is 11%.
The cash flows for this bond are as follows:
 40 semi anually coupon payment of Rs 50
 Rs 1000 to be received 40 six month period
from now.
Solution
50 1 1000
1-

(1.055)40 + (1.055)40
0.055

 Rs 50 1- 0.117463 + Rs 100
0.055 8.51332

= Rs 802.31 + 117.46
= Rs 919.77
Question 2
 Calculate the Bond price for a 20 year 10%
coupon bond with a par value of Rs 1000.
Lets suppose the yield on this bond is 6.8%.
The cash flows for this bond are as follows:
 40 semi anually coupon payment of Rs 50
 Rs 1000 to be received 40 six month period
from now.
Solution
50 1 1000
1-

(1.034)40 + (1.034)40
0.034

= Rs 1084.51 + 262.53
= Rs 1,347.04
 Calculate the Bond price for a 20 year 10%
coupon bond with a par value of Rs 1000.
Lets suppose the yield on this bond is 10%.
The cash flows for this bond are as follows:
 40 semi anually coupon payment of Rs 50
 Rs 1000 to be received 40 six month period
from now.
Ans Rs 1000
Price Yield Relationship
 When yield increases, investor would not buy
the issue because it offers a below market
yield; the resulting lack of demand would
cause the price to fall.
 When yield decreases ??????
 This is how bond price falls below its par
value.
 When bond sells below its par value, it is said
to be selling at a discount
 Coupon rate is less than the required yield
Price is less than the par ( Discount Bond)
 Coupon rate is equal to the required yield
Price is equal to the par
 Coupon rate is more than the required yield
Price is more than the par ( premium
Bond)
 A fundamental property of a bond is that its
price changes in the opposite direction from
the change in the required yield
 As the required yield increases, the present
value of cash flow decreases; hence the price
decreases.
 As the required yield decreases, the present
value of cash flow increases; hence the price
price

yield
Premium and Discount Bonds
Pricing Zero-Coupon Bonds
 No coupon payment until maturity. Because of this,
the present value of annuity formula is unnecessary.
 Calculate the price of a zero-coupon bond that is
maturing in 5 years, has a par value of $1,000 and
required yield of 6%....?
 Determine the Number of Periods
 Determine the Yield
Determining Interest Accrued
 Accrued interest is the fraction of coupon payment
that the bond seller earns for holding the bond for a
period of time between bond payments
 The amount that the buyer pays the seller is
the agreed upon the price plus accrued
interest. This is referred as a Dirty bond
prices
 The price of a bond without accrued interest
is called the Clean bond prices
Eg: On March 1, 2003, X is selling a corporate bond
with a face value of $1,000 and 7% coupon paid
semi-annually. The next coupon payment after March
1, 2003, is expected on June 30, 2003.
What is the interest accrued on the bond?
Bond Basics
 Two basic yield measures for a bond are its coupon
rate and its current yield.

Annual coupon
Coupon rate =
Par value

Annual coupon
Current yield =
Bond price

10-64
Yield
 Yield is the return you actually earn on the
bond--based on the price you paid and the
interest payment you receive
 Two Types of Yields:
 Current Yield: annual return on the dollar amount paid
for the bond and is derived by dividing the bond's
interest payment by its purchase price
 Yield To Maturity: total return you will receive by
holding the bond until it matures or is called.
Yield
n Current yield:
Annual coupon receipts/ Market price of the bond

 It does not consider:

 Time value of money
 Complete series of future cash flow

 It compares a pre-specified coupon with the current

market price, it is called as current yield.
Example
 The current yield for a 15 years 7% coupon
bond with a par value of Rs 1000, selling for
Rs 769.40

Current yield = Rs 70 = 9.10%

Rs769.40
Yield to Maturity
 Given a pre-specified set of cash flows and a price,
the YTM of a bond is that rate which equates the
discounted value of the future cash flows to the
present price of the bond.
YTM
 Yield to maturity (YTM) is the interest rate (i) that equates the
present value of cash flow payments received from a debt
instrument with its value today.
 It is the most accurate measure of interest rates.
 The yield to maturity is the annual return annual rate
(discounted) earned over a bond kept until maturity.
 The yield to maturity is the discount rate estimated
mathematically that equals the cash flow of payment of interest
and principal received with the purchasing price of the bond.
 This term is also referred to as internal rate of return or as the
expected rate of return of the bond and it is the yield in which
most bond investors are interested in.
YTM
n

P=Σ C + M
t=1
(1+y)n (1+y)n

P= Price of the bond

C = coupon payment
N = No. of years left to maturity
M = Maturity value
Y = yield to maturity
Yield of Bond
Eg: You hold a bond whose par value is $100 but has a current
yield of 5.21% because the bond is priced at $95.92. The bond
matures in 30 months and pays a semi-annual coupon of 5%.
 The yield is the interest rate that will make the
present value of cash flow equals to the bond
price.
 YTM is calculated same way as IRR, the cash
flows are those that the investor would
realized by holding the bond till maturity.
 To compute the YTM requires a trial and error
method
Example
 Calculate the YTM for a 15 years 7% coupon
bond with a par value of Rs 1000. Lets
suppose the bond price is Rs 769.42. The
cash flows for this bond are as follows:
 30 semi anually coupon payment of Rs 35
 Rs 1000 to be received 30 six month period
from now.
769.42 = Rs 35 1 1000 1
1-
30 30
(1+y) + (1+y)

y
 Trial and error method

Annual Interest PV of 30 PV of Rs 1000 30 PV of cash flows

rate payments of Rs periods from
35 now
9% 570.11 267 837.11

9.5% 553.71 248.53 802.24

10% 538.04 231.38 769.42

11.5 % 532.04 215.45 738.49

11 % 508.68 200.64 709.32

Would you prefer to buy a 10-year, 10% annual
coupon bond or a 10-year, 10% semiannual coupon
bond, all else equal?
The semiannual bond’s effective rate is:

m 2
 iNom   0.10
EFF% =  1 +  − 1 = 1+  − 1 = 10.25%
 m  2 
10.25% > 10% (the annual bond’s effective
rate), so you would prefer the semiannual bond.
Calculating Yield for Callable
and Puttable Bonds
 A callable bond's valuations must account for the
issuer's ability to call the bond on the call date
 The puttable bond's valuation must include the
buyer's ability to sell the bond at the pre-specified
put date.
 The yield for callable bonds is referred to as
yield-to-call, and the yield for puttable bonds is
referred to as yield-to-put.
Yield to Call (YTC)
 Yield to call (YTC) is the interest rate that
investors would receive if they held the bond until
the call date. The period until the first call is
referred to as the call protection period.
 Yield to call is the rate that would make the
bond's present value equal to the full price of the
bond. Essentially, its calculation requires two
simple modifications to the yield-to-maturity
formula:
YTC
 When the bond may be called and at what
price are specified at the time the bond is
issued.
 The price at which bond may be called is
referred to as the call price.
Example
 Consider an 18 years 11% coupon bond
payable semi annually with a maturity value
of Rs 1000 selling at Rs 1169. suppose that
the first call date is 8 years from now and that
the call price is Rs 1055.
 Call price = 1055
 N = 8*2 = 16 m
 C = 1000*11%/2 = 55
 Bond price = 1169
Solution
1169 = Rs 55 1 1055 1
1-
16 16
(1+y) + (1+y)

 8.54% is the yield to first call

Yield to Put (YTP)
 This mean that the bond holder can force the issuer
to buy the issue at a specified price.
 Yield to put (YTP) is the interest rate that investors
would receive if they held the bond until its put date.
 To calculate yield to put, the same modified equation
for yield to call is used except the bond put price
replaces the bond call value and the time until put
date replaces the time until call date.
 M = put price
 n = number of periods until assumed put date.
Example of YTP
 Consider an 18 years 11% coupon bond
payable semi annually issue selling Rs 1169.
assume that issue is putable at par (Rs 1000)
in five years.
 Put price = 1000
 N = 5*2 = 10 m
 C = 1000*11%/2 = 55
Solution
1169 = Rs 55 1 1000 1
1-
10 10
(1+y) + (1+y)

 6.94% ≈ 7% is the yield to put