Lecture 3 v2 – Bonds and Stock Valuation

7/26/2019 Lecture 3 v2 Bonds and Stock Valuation

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Lecture 3 BondsValuationFIN 2102 25 April 2016


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Agenda:

1. e!ision. "iscounting #actor$ FV$ %V$N%V$ annuities

2. &'at is a (ond)

3. "e*nitions: +oupon rate$ +urrent ,ieldn -ield to aturit,$ /aret "iscountInterest ate.

. "e*nitions: Face Value$ /aret Value$Fair !alue


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A4N"A 2

5. Valuation o# Bonds

6. &'at is 7toc 7'ares)

8. Valuation o# 7tocs.

9. /ain role o# stoc ec'ange

;. 4


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4VI7I>N7:

FV ? %V 1 @in

%V ?FV

11@in

Annuities:

%VA? A

1 1

1@ in

i

FVA ? A

1@ in 1

i


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&'at i# a copan, sells ,ou a certi*cate#or / 1$000 and proises to pa, t'e(u,er 5 o# / 1$000 i.e. /50 e!er,,ear #or 3 ,ears)

And proises to pa, (ac t'e 'ole /

1$000 at t'e end o# 3 ,ears.C'is is a DBondE

/ 1$000 is t'e Face Value 5 o# t'e Face Value / 1$000 is t'e

Coupon Rate


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&'at i#$ a#ter t'e copan, sells it to t'e

original (u,er #or / 1$000$ t'e original(u,er sells it #or / ;13)

Is t'e (ond !alue / 1$000 or / ;13)

Bot'. / 1$000 is t'e Face Value and

/ ;13 is t'e /aret ValueFace Value ill ala,s (e the same

#or t'e (ond.

Market Value is t'e price 'ere t'ere

is a illing (u,er and seller #or t'e(ond.


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C'e ne oner ill recei!e / 50 #or

t'e reaining 2 ,ears o# t'e (ond. i.e.up to aturit, o# t'e (ond

Is 'e getting 5 return on t'e (ond liet'e pre!ious oner)

No. =is return is /50 / ;13 ?0.059 or 5.9

Is t'e coupon rate still 5) C'en 'at is5.9)

+oupon rate 5 does not c'ange. It isdependent on Face Value.

C'is 5.9 is t'e +urrent -ield anddependent on /aret Value


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I# t'e ne oner (oug't t'e (ond at t'e

(eginning o# ,ear 2 i.e. end o# ,ear 1#or / ;13$ 'e ill still recei!e / 50#or t'e reaining 2 ,ears

AN" / 1$000 at aturit,

&'at is t'e pro*t return #or t'e neoner)

/ ;13?

/ 50

1 @ i

/ 50

1 @i2

/ 1$000

1 @i2

@ @

7ol!e #or i #or rate o#return


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i is #ound to (e 10. 7o 'at is t'is!alue) C'e ne coupon rate)

C'e ne current ,ield)

No. It is called D-ieldGtoGaturit,E or HustD-ieldE

It is t'e discount rate 'ere t'e price o#a (ond euates to t'e present !alue o#

all (ene*ts arising #ro t'e (ond.


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&'at i# t'e (ans outside are gi!ing

interest rates o# on deposits)C'is is t'e /aret "iscount Interest

ate

7o #ro t'is eapleJ. +oupon ate ? 5

+urrent ,ield ? 5.9

-ieldGtoGaturit, ? 10

"iscount rate ?

Face Value ? / 1$000

/aret Value ? / ;13


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VALK4 >F B>N"Co o(tain t'e Fair !alue o# (ond$ use

Ban interest rate

Ban interest rate #air !alue o# (ond!alue G in!erse relations'ip.

and t'e lengt' o# tie to aturit,.


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-ieldGtoG /aturit,

Ksuall, taen to e t'e rate o# return o#t'e (ond'older.

It is ade up o# :

C'e real rate of return t'e opportunit,cost or *nancial DrentE t'e in!estorc'arges #or using 'is #unds

Ination premium

Risk premium a special ris associatedit' t'e speci*c in!estent.


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I# t'e no oner is'es to 'a!e a

return o# sa, 12$ i.e. ,ield to aturit,o# 12 'at is t'e price 'e is ill topa, #or t'e (ond)

%rice o#t'e(ond

? / 50

1 @0.122

/ 50

1 @0.12

/ 1$000

1 @0.122

@ @


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Valuation o# stoc s'ares


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"IVI"4N" VALKACI>N />"4L

&ors on t'e preise t'at t'e !alue o# a

s'are to t'e s'are'older is t'e proise o#

recei!ing #uture di!idends.

7o i# t'e coon stoc pa,s a constant

di!idend eac' ,ear t'en t'e price o# t'e stoc

ill (e:

P0? D1

Ke'ere P0 = price o# t'e stoc toda,,D1 = "i!idend paid

Ke= euired rate o# return o# s'are


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"IVI"4N" VALKACI>N />"4L

I# di!idends are in constant grot' t'eprice o# t'e s'are is #ound (,:

D1

Ke g

'ere P0 = price o# t'e stoc toda,,

D1 = "i!idend paidKe= euired rate o# return o# s'are

g? +onstant grot' rate in di!idends

P0?


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7C>+ 4M+=AN4 Financial arets eist to allocate

capital #ro 'ouse'olds to corporations

and go!ernent units$ it' *nancial

institutions acting as interediaries.

7toc ec'anges is an eaple o#

*nancial arets.

4aples: N-74 NA7"A


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I/%>CAN+4 >F

7C>+ 4M+=AN4 %ro!ides liuidit, in twoa,s:

1. 4na(le corporations to raise #unds (,

selling ne issues o# securities at #air$copetiti!e prices.

2. Allos t'e in!estor 'o purc'ases

securities to sell t'e at relati!e easeand speed.


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/A4C 4FFI+I4N+-/arets are generall, said to (e e


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4FFI+I4NC /A4C=-%>C=47I7

7tates t'at i# stoc arets are e


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4FFI+I4NC /A4C

=-%>C=47I7Weak =ere past price in#oration is unrelated to

#uture prices

Crends cannot (e predicted and taenad!antage o# (, in!estors.

Semi-strong %rices currentl, reOect all pu(lic

in#oration

Strong All in#oration is iediatel, reOected in

stoc prices


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47KLC7 >F 7CK"I47

7toc ec'anges #ound to (e ainl,

ea and seiGstrong (ut not strong

%ri!ate$ insider in#oration is

!alua(le #or uic pro*ts (ut it is

illegal.


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+=AN47:

As counication s,stes ipro!e$

in#oration get disseinated #aster and

securities la are #orcing #ullerdisclosure o# corporate data.

7ecurities arets getting ore e


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4F44N+4 Bloc$ =irt and "anielson$ Foundations

o# Financial /anageent$ 15t'4dition $

/cra =ill 4ducation 2011 +'apters10 and 1

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Lecture 3 v2 – Bonds and Stock Valuation