How compounding bonds should be estimated? A realistic approach
by Safdar Hussain Tahir; Hazoor Muhammad Sabir; Nadeem Nazir
International Journal of Bonds and Derivatives (IJBD), Vol. 1, No. 4, 2015

Abstract: The main objective of this article is to propose a new approach for the evaluation of compounding bonds. The prevailing approach as indicated in different books proves to be falsified through examples. According to the said present value approach, the compounding is used on both determinants, i.e., coupon payments as well as maturity value without any sound argument. The study provides evidences regarding inappropriate use of compounding through analysing the two difference cases with illustrations. In line with value maximisation principle, the investors prefer bonds having more compounding. But the fact as is revealed that the compounding on maturity eats up the benefits of early payments of coupon rate which overall decrease the value of bonds instead of increasing. Therefore, the prevailing approach is concluded misleading. Thus, it needs to be modified immediately. A new realistic approach is recommended.

Online publication date: Tue, 22-Dec-2015

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