Intrinsic value of a bond
The sum of the present values of all a bond's future cash flows, discounted at the investor's required rate of return. Buy if it exceeds the market price; sell if it is below.
In plain language
A bond promises a set of future payments: coupons along the way and the face value at maturity. What are those promises worth to you, today?
Discount each payment back to the present at the return you require, and add them up. That total is the bond's intrinsic value.
The workbook's definition: the intrinsic value of a bond is the sum of present value of all future cash flows of the bond discounted at a required rate of return.
The point of the calculation is a decision. Compare intrinsic value with the current market price. If intrinsic value is greater, the bond is undervalued for you and you could invest. If it is lower and you already hold the bond, you could sell.
How it works
The approach (Chapter 4, section 4.4). Because bonds generate pre-specified cash flows, they are valued by discounting cash flows at the investor's required rate of return, exactly as an equity share's intrinsic value is compared with its price.
Two equivalent decision rules.
| Compare | Buy if | Sell (if held) if |
|---|---|---|
| Intrinsic value vs market price | Intrinsic value > market price | Intrinsic value < market price |
| Yield at market price (YTM) vs required return | YTM > required return | YTM < required return |
In MS Excel (Illustration 4.1). The PRICE function takes settlement date, maturity date, coupon rate, "yield", redemption (per ₹100), frequency and day count basis. The workbook warns about a naming trap: in this function, "YIELD" means the investor's required rate of return, not the bond's YTM, and "PRICE" is the intrinsic value, not the current market price. The answer is per ₹100 of face value, so multiply by 10 for a ₹1,000 bond.
Day count basis. Basis 0 is 30/360, the convention the workbook says India follows for bonds; money market instruments use actual/365.
Price and rates move inversely. A higher required return lowers intrinsic value. When market rates are above the coupon, the bond sells at a discount; below the coupon, at a premium.
The formula
Intrinsic value = Σ [C ÷ (1 + r)^t] + F ÷ (1 + r)^n
C = coupon per period, F = face value, r = required return per period, n = number of periods.
For semi-annual coupons, halve the annual coupon and the annual required return, and double the number of years.
A worked example
The workbook's Illustration 4.1: a ₹1,000 face value bond, 12% coupon paid half-yearly, settlement 01-01-2022, maturity 01-01-2027 (5 years, 10 half-years).
Cash flows: ₹60 every six months for 10 periods, plus ₹1,000 at the end.
At a 15% required return (7.5% per half-year), as the illustration's input table shows:
- PV of coupons = ₹60 × [1 − 1.075^−10] ÷ 0.075 = ₹60 × 6.8641 = ₹411.85
- PV of face value = ₹1,000 ÷ 1.075^10 = ₹1,000 ÷ 2.0610 = ₹485.19
- Intrinsic value ≈ ₹897.04
The workbook prints the answer as ₹929.76. That figure is what the same bond is worth at a 14% required return (7% per half-year). See the traps below.
The decision. Illustration 4.2 gives the bond's market price as ₹975, with a YTM of 12.69%. Either way — intrinsic value of ₹897.04 or ₹929.76 — intrinsic value is below ₹975, and the YTM of 12.69% is below the required return. An investor requiring 14% or 15% should not buy; a holder could sell.
Why NISM asks about it
Chapter 4 (Investing in Fixed Income Securities), section 4.4.1, defines the intrinsic value of a bond and works it through in MS Excel; section 4.4.2 does the same for YTM on the same bond. The decision rules connect to Chapter 1's required rate of return and Chapter 3's intrinsic value of equity. Expect conceptual questions (what discount rate is used, what the Excel "YIELD" argument means) and comparisons of intrinsic value with market price.
Common exam traps
- The discount rate is the investor's required return, not the bond's YTM. YTM is the rate that equates cash flows to the market price.
- In Excel's PRICE function, "YIELD" is the required return and "PRICE" is intrinsic value — the workbook flags this confusion explicitly.
- The workbook's printed answer does not match its printed inputs. Illustration 4.1 lists a 15% required return and gives ₹929.76; ₹929.76 corresponds to 14%, and 15% gives about ₹897.04. The conclusion against a ₹975 market price is the same either way. If an exam option shows ₹929.76 for this illustration, it is the workbook's figure.
- Intrinsic value > price → buy; YTM > required return → buy. The two rules agree.
- Excel answers are per ₹100 of face value.
- Semi-annual bonds: halve the rate and coupon, double the periods.
Where this is taught
Free preparation for NISM Series XXI-BRelated terms
- Discounted Cash FlowA valuation method that estimates the cash a business will generate in future years and converts each year back to what it is worth today.
- Face valueThe denomination a company's capital is divided into and carried in its books — fixed, printed on the certificate, and the base on which dividend percentages and stock splits are computed.
- Intrinsic valueWhat an asset is actually worth — the present value of the cash it will generate over its remaining life, as against whatever price the market is quoting today.
- Yield to MaturityThe single discount rate at which a bond's future coupons and redemption amount add up to exactly its market price today — the return you actually earn if you hold it to maturity.
- Day count conventionThe rule for counting days in a holding period to calculate accrued interest. Indian bonds use 30/360; the Indian money market, including T-bills, uses actual/365.
- Required Rate of ReturnThe minimum return an investor expects before committing money: the nominal risk-free rate plus a risk premium. It is not a guaranteed, forecast or realised return.