You’ll learn about the book value vs market value vs face value of bonds in this tutorial, and you’ll understand how to calculate and project them in financial models.
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Table of Contents:
3:06 Excel Examples
11:04 Combined Example
14:46 Recap and Summary
Face Value is the amount of Debt that a company issues, pays interest on, and must repay upon maturity. It is affected ONLY by Debt issuances, principal repayments, and Accrued or “Paid-in-Kind” (PIK) Interest.
Book Value is the Debt that shows up on a company’s Balance Sheet under Liabilities & Equity, but it is NOT necessarily the amount it pays Interest on or what it must eventually repay.
It’s affected by everything above (issuances, repayments, and accrued interest), plus Issuance Fees, any Discount or Premium when the bond is first issued, and the amortization of both those items.
Market Value is what someone else would pay to buy the company’s Debt on the secondary market if it trades like that. It’s affected by interest payments, market interest rates on similar Debt, and future repayment upon maturity.
In practice, the bond’s coupon rate vs market rates, as well as the credit default risk of the issuer, make the biggest impact.
Toro is spending a lot and must issue additional Debt to fund operations in several years.
The Face Value of Debt goes up when new Debt is issued and down when there’s a repayment or maturity.
The Book Value of Debt also changes based on these, but we also must deduct the 2% financing fee on new issuances and add the amortization of these financing fees over 10 years.
We don’t know enough to determine the Market Value since it depends on current market rates vs the 6.1% coupon rate the company is currently paying.
In another example, Atlassian has issued a Convertible Bond that matures in 5 years, if it’s not converted into Equity before then.
Convertible Bonds are often separated into Equity and Debt components to reflect their dual nature, and the Book Value here equals the Face Value minus the Unamortized Issuance Fees minus the Debt Discount, which represents the difference in value between a traditional, non-convertible bond with a higher interest rate and the much-lower-rate convertible bond.
The Face Value here never changes until the end because there are no additional issuances, there’s no accrued interest, and there’s only the single maturity at the very end.
Cash Interest never changes since it’s always based on this constant Face Value and a constant interest rate.
The Book Value keeps increasing as the Debt Discount is amortized over time and as the Issuance Fees are also amortized, but it finally reaches $0 at the same time as the Face Value.
We don’t know enough to determine the Market Value, as we’d need to know the prevailing market interest rates on similar bonds and Atlassian’s default risk.
ONE EXAMPLE TO RULE THEM ALL:
Assume that a company issues a $1,000 10-year bond at a 5.00% coupon rate vs prevailing market rates of 6.35% on similar bonds. There are no principal repayments, and the interest is 100% Cash. There is a 2% issuance fee.
Due to the below-market rate, the bond is issued at a $100 Discount.
The Face Value is $1,000 initially, and it never changes until maturity. The Cash Interest is 5% * $1,000 = $50 per year until maturity.
The initial Book Value is the $1,000 Face Value – $100 Discount – $20 Issuance Fee = $880.
The Book Value will change according to the amortization of the Discount and the amortization of the Issuance Fees each year.
Book Value, Year 1: $880 + $100 / 10 + $20 / 10 = $892
Book Value, Year 2: $892 + $100 / 10 + $20 / 10 = $904
The Market Value is initially the $1,000 Face Value minus the $100 Discount (verify with the PRICE function in Excel), so $900.
We don’t know exactly how it will change over time because we don’t know future interest rates, but if rates go up, the Market Value will go down, and if credit default risk goes up, the Market Value will also go down (and vice versa for both of these).
Does Book Value vs Market Value vs Face Value for Bonds Matter?
In most cases, these distinctions don’t make a huge difference.
If you’re under time pressure, you can simplify all this and include only Issuances and Repayments to project Debt.
But interview questions on these topics could still come up, and if a company has a Convertible Bond or a normal bond issued at a big discount or premium, the Book Value vs Face Value distinction matters since interest is based on Face Value.