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Emerging Market Finance Lecture 14: Valuation of Corporate Bonds. Corporate Bond. B T = X if V T > X or = V T if V T < X where V T is the value of the firm at bond maturity T, and X the face value of a zero-coupon bond. Example. Company ABC: Vt = $ 1 billion，
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Emerging Market FinanceLecture 14: Valuation of Corporate Bonds
Corporate Bond BT = X if VT > X or = VT if VT < Xwhere VT is the value of the firm at bond maturity T, and X the face value of a zero-coupon bond.
Example • Company ABC: • Vt = $1 billion， • ROA = 10%， • Volatility(ROA) = 30%。 • Consider a 5-yr zero-coupon bond with $500 million face value。 • Then, the probability of bankruptcy in yr. 5 = 21.32%。
Relationship between Bond Maturity and Probability of Bankruptcy Years to Maturity
Standard Textbook Calculation • According to standard textbook,Bt = {500*p + E(VT) * (1-p) }/(1+r)^(T-t)where p = prob of No bankruptcy in yr 5 and E(VT) = the expected value of the firm if bankruptcy occurs • If r=2%，then Bt = $450.6 million • and 5-yr corporate bond yield =3.53%
If no recovery of value at bankruptcy, then the picture differs • Bt = 500*p /(1+r)^(T-t) • Bt = $407.6 million And the 5-yr bond yield = 7.05%。
No recovery vs. full recovery No recovery assumed Bond Yi e l d Actual corp. bond yields in China (2002) Based on Textbook Years to Maturity
Spread between Corporate and Government Bond Yields Yield Spread No recovery assumed Actual Spread (2002) Years to Maturity
