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

Commodity markets
Money 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.

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 expansion, they borrow money from
investors through issue of securities.

The place where such securities are traded

by these investors is known as the
secondary market.

Securities issued
a)Preference Shares
b)Equity Shares
c)Debentures

Securities like Preference Shares and

Debentures cannot be traded in the
secondary market.

Equity shares is issued by the under writers

and merchant bankers on behalf of the
company.

Equity shares are tradable through a private

broker or a brokerage house.

People who apply for these securities are:

a)High networth individual
b)Retail investors
c)Employees
d)Financial Institutions
e)Mutual Fund Houses
f)Banks

Securities that are traded are traded by the

retail investors,FIs,MFs etc

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), youll collect five interest payments of Rs 60
for a total of Rs 300.
Principal
amount
Rs 1000.00

Year 1 (6% interest

on 1,000)
60.00

Year 2 (6% interest

on 1,000)
60.00

Year 3 (6% interest

on 1,000)
60.00

Year 4 (6%
interest on 1,000)
60.00

Year 5 (6%
interest on 1,000)
60.00

Total principal and

interest (at maturity
date of 5 years)
1,300.00

You could also decide to sell that

bond to someone else for $1,100. In
that case youd 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 seesaw 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 "discount"). If interest rates have fallen, the price will be higher.

 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 zerocoupon 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
Credit Risk

Moody's

Standard and
Poor's

Prime

Aaa

AAA

AAA

Excellent

Aa

AA

AA

Upper Medium

Lower Medium

Baa

BBB

BBB

Speculative

Ba

BB

BB

Very Speculative

B, Caa

B, CCC, CC

B, CCC, CC, C

Default

Ca, C

DDD, DD, D

Fitch

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 IDBIs 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 IDBIs
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 are known as
Inverse Floaters and are common in developed markets.

 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

Typical Features

Central Government Securities

Medium long term bonds issued by RBI on

behalf of GOI.
Coupon payment are semi annually

State Government Securities

Medium long term bonds issued by RBI on

behalf of state govt.
Coupon payment are semi annually

Government Guaranteed Bonds

Medium long term bonds issued by govt

agencies and guaranteed by central or
state govt.
Coupon payment are semi annually

PSU

Medium long term bonds issued by PSU.

51% govt equity stake

Corporate

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 nonrupee 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-

1
(1.055)40
0.055

Rs 50 1- 0.117463

0.055
= Rs 802.31 + 117.46
= Rs 919.77

1000

(1.055)40

Rs 100
8.51332

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-

1
(1.034)40

1000

0.034

= Rs 1084.51 + 262.53
= Rs 1,347.04

(1.034)40

 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
1.

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
Rs769.40

= 9.10%

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=
t=1

C
(1+y)n

M
(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-

1
(1+y)30
y

1000
+

1
(1+y)30

 Trial and error method

Annual Interest
rate

PV of 30
payments of Rs
35

PV of Rs 1000 30
periods from
now

PV of cash flows

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 bonds effective rate is:

iNom
EFF% 1

0.10
1 1
1 10.25%
2

10.25% > 10% (the annual bonds 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-

1
(1+y)16

1055
+

8.54% is the yield to first call

1
(1+y)16

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-

1
(1+y)10

1000
+

6.94% 7% is the yield to put

1
(1+y)10