Valuation of debt uses NPV technique.
Discount rate used to find present value of loan notes. Market interest rate can be different from interest rate paid by the company. Interest rate offered on similar loan notes having same characteristics (size, duration, type etc) should be used for determining PV of loan notes. Interest rate offered on similar loan notes is known as redemption yield.
Market value of debt issued by the organization may not be same as par value. It is because of market interest rate higher or lower than interest rate offered on same debt issued by the organization.
If market interest rate is higher than interest rate on debt issued, then market value of the debt will be lower than redemption value. If market interest rate is lower than interest rate offered on debt issued, then market value of the debt will be higher than redemption value.
Market value of the debt can be determined on per unit basis or in total.
Redemption Value
Redemption value is the price which company is obliged to pay at maturity date of the loan notes. Redemption value can be par value or at premium or at discount to the par value.
Redemption Yield
Redemption yield is the rate of interest paid by the market on debts having similar characteristics such as risk and maturity period. Redemption yield is used as discount rate for the valuation of debt.
Floor Value
Floor value represents the minimum value, which will be certainly received by an investor from an investment or asset.
Floor value of convertible loan notes is the present value of interest and redemption price receivable from convertible loan notes, which loan notes holders, will certainly receive.
Market value should not fall below floor value, as investors will not be willing to sell their bonds below floor value. Floor value of convertible bonds represents minimum price to be paid to debt holders for the settlement of debt liability.
Value of conversion option attached with convertible loan notes will become $0. It is because conversion option represents the additional value, which will be received if share price will be higher than redemption value at maturity date. If share price will decrease to extent that conversion value becomes less than redemption value, then debt holders will reasonably choose redemption rather than conversion.
Conversion Premium
Conversion premium is the wealth (present value of cash flows) generated by investors on conversion into ordinary shares of the company than they would purchase ordinary share from stock market.
