A security (or secured) bond is one that uses a specific asset as a form of collateral against the amount being borrowed. In the event of the borrower defaulting on the loan, the asset is then passed on to the bondholders. A common type of secured loan is a mortgage bond, in which the loan is backed by the deeds to the borrower’s property and by the income stream of the mortgage payments.

Security bonds can also be secured with a predicted revenue stream from the business or project the bond was issued to finance. Because of this compensation, security bonds are generally considered less risky than other bonds.

Bond valuation is all about calculating the present value of the promised cash flows. In order to arrive at this value, a valuer must go through three steps:

  • Estimation of the expected cash flows over the life of the security.
  • Determination of the appropriate interest rate – this is based on the risk of the receipt of the estimated cash flows.
  • Calculation of the present value of the expected cash flow – this is done by multiplying the bond’s expected cash flows by the appropriate interest rate.

The valuation of a secured bond is based on the relationship between time and money. In other words, a Rand you receive today is worth more than a Rand promised to you at some time in the future. If someone promises to give you R10 million in 20 years’ time, you need to find the present value of that amount today. This is also sometimes referred to as discounting the future amounts.

There are certain features of bonds, such as convertibility, embedded options or floating rates that can make the estimation of future cash flows more uncertain, which adds another layer of complexity to the valuation of security bonds.

It’s also important to take the maturation date of the security bond into account as time goes by. If interest rates don’t change, a bond’s price will move toward its par value as the maturity date approaches. It then becomes necessary to calculate the change in value of the bond by revaluing it using a lesser number of periods to maturity.

The Property Partnership is a professional valuation company specialising in asset and bond valuations. We can help you ascertain the market or fair value of your security bond, so contact us today to speak to one of our experienced and qualified valuers.