Amortized Cost
Also written Amortised cost
A debt security's purchase cost adjusted for the purchase discount or premium over its maturity — how a Category III AIF values unlisted securities with no ascertainable market, plus accrued interest.
In plain language
Some securities simply have no market price. An unlisted bond held by a Category III AIF may not trade for months. The fund still has to strike a NAV on every Valuation Day, so it needs a rule.
For unlisted securities for which there is no ascertainable market, the rule is amortized cost plus interest accrued from the date of purchase.
Amortized cost starts from what the fund paid and moves it gradually toward the bond's face value. If the bond was bought at a discount to face value, the carrying value rises over the remaining life; if at a premium, it falls. By maturity the two meet. The workbook describes it as the purchase cost, after adjusting the discount or premium on purchase throughout the maturity period of the bond.
How it works
Where it sits among valuation rules (as on the Valuation Day):
| Security | Basis |
|---|---|
| Listed securities | Closing price |
| Unlisted equity | Cost, then fair market value by independent valuer |
| Unlisted non-equity with an ascertainable market | Closing price on that market |
| Unlisted, no ascertainable market | Amortized cost + interest accrued since purchase |
Versus mark-to-market. For money market instruments and long-term debt the workbook prefers mark-to-market, using prices from FBIL, CCIL, FIMMDA and similar agencies, exchange closing prices and VWAY. It says that, instead of the amortized cost approach, mark-to-market is more reliable and transparent, although it may reduce managers' discretion, and that using mark-to-market reduces the potential default risk arising from a downgrade in credit rating.
The method is not prescribed. The workbook does not say whether the discount or premium is spread evenly or by an effective-interest calculation. The example below spreads it evenly only to show the idea.
The formula
Value on Valuation Day = Amortized cost + Interest accrued since purchase
Amortized cost = Purchase cost ± portion of discount/premium amortized to date
A worked example
Illustrative figures, straight-line amortization. On 1 April, a Category III AIF buys 10,000 unlisted 8% bonds, face value Rs 1,000, at Rs 960 each, with 4 years to maturity. There is no ascertainable market.
Discount on purchase = Rs 1,000 − Rs 960 = Rs 40 per bond
Amortized per year = Rs 40 ÷ 4 = Rs 10
Amortized per half-year = Rs 5
Valuation Day, 30 September (six months):
Amortized cost = Rs 960 + Rs 5 = Rs 965
Interest accrued (6 months) = 8% × Rs 1,000 × 6/12 = Rs 40
Value per bond = Rs 1,005
Holding value = 10,000 × Rs 1,005 = Rs 1,00,50,000
A year later the amortized cost would be Rs 975, and at maturity Rs 1,000. None of these figures moves because interest rates or the issuer's credit changed — which is exactly the workbook's reason for preferring mark-to-market wherever a market exists.
Why NISM asks about it
Chapter 8 (Valuation) introduces amortized cost in section 8.1's valuation rules, applies it to the unlisted corporate bonds of RCE Ltd in the Fund INC NAV examples, and contrasts it with mark-to-market in section 8.2.3. Expect questions on which holdings are valued at amortized cost, whether accrued interest is added, and why the workbook prefers mark-to-market for traded debt.
Common exam traps
- Amortized cost is for unlisted securities with no ascertainable market. An unlisted security that does have a market is valued at its closing price.
- Unlisted equity is not at amortized cost — it is valued at cost initially and then at fair market value by the independent valuer.
- Add interest accrued from the date of purchase. The workbook's Fund INC example assumes none accrued, so it values the bond at amortized cost alone.
- Mark-to-market is described as more reliable and transparent than amortized cost.
- A workbook arithmetic slip. Fund INC's RCE Ltd holding shows 1,000 bonds of face value Rs 10,000 at a rate of 105 valued at Rs 10,50,00,000. At those inputs the face value is Rs 1 crore and 105% of it is Rs 1.05 crore, not Rs 10.50 crore. The NAV totals use Rs 10.50 crore; do not reproduce the line as a method.
Check yourself
1.A Category III AIF holds unlisted debentures for which there is no ascertainable market. How are they valued on a Valuation Day?
- a)At amortised cost, plus any interest accrued from the date of purchase
- b)At the closing price of the most comparable listed debenture
- c)Initially at cost and thereafter at Fair Market Value determined by an independent valuer
- d)At face value until maturity
Show the answer
Answer: (a) At amortised cost, plus any interest accrued from the date of purchase
The workbook's rule: ‘For unlisted securities for which there is no ascertainable market, valuation will be done at amortized cost of such security, plus interest (if any) accrued from the date of such purchase’. In the Fund INC example, the unlisted RCE Ltd. bonds are carried at amortised cost.
- Where an unlisted non-equity security does have an ascertainable market, the rule is ‘the closing price dealt on the market on which the securities are traded’ — on that market, not on a comparable security.
- Initially at cost, then Fair Market Value by the independent valuer is the rule for unlisted equity.
- Face value appears nowhere in the valuation rules.
Where this is taught
- Series XIX-B · Chapter 8: Valuationintroduced here
- Series XIX-C · Chapter 14: Valuationintroduced here
Related terms
- Net Asset ValueThe net assets of a mutual fund scheme divided by the number of units outstanding — what one unit of the scheme is worth on a given day, after every liability except the unitholders' own.
- Fair valueThe theoretical futures price — spot plus the cost of carrying the commodity to expiry — at which a buyer is indifferent between buying today and buying forward.
- Mark to MarketThe daily settlement of a futures position at that day's closing price, so gains and losses are paid in cash every evening instead of accumulating until expiry.
- AmortisationThe repayment of borrowed capital over a fixed term through equal instalments, each of which is split between interest and principal in proportions that shift over the life of the loan.
- Independent ValuerThe valuer of a Category III AIF's unlisted holdings — not an associate of manager, sponsor or trustee, with 3 years' experience, and IBBI-registered with a professional membership or a CRA group entity.
- Valuation DayThe day, fixed in advance by a Category III AIF and disclosed in its offer documents, as on which its NAV is determined — at least monthly for open-ended funds and quarterly for close-ended ones.
- Volume Weighted Average YieldThe average yield of a debt security's trades, weighted by traded volume. Category III AIFs value T-bills and G-Secs on the VWAY of the last hour's trades, and other debt on the whole day's trades.
- FBILFinancial Benchmarks India Pvt. Ltd., one of the agencies a Category III AIF uses to obtain the security-level prices it needs to mark its money market and debt holdings to market.