Valuing paper assets stocks and bonds
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Valuing Paper Assets: Stocks and Bonds. What are Bonds, Preferred Stock, and Common Stock? How are they priced? How are they quoted and traded?. Debt (Bonds). Fixed or variable interest rate Secured or unsecured Fixed maturity date Sinking fund or periodic repayment Early retirement

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Valuing paper assets stocks and bonds l.jpg
Valuing Paper Assets:Stocks and Bonds

  • What are Bonds, Preferred Stock, and Common Stock?

  • How are they priced?

  • How are they quoted and traded?

Paper Assets


Debt bonds l.jpg
Debt (Bonds)

  • Fixed or variable interest rate

  • Secured or unsecured

  • Fixed maturity date

  • Sinking fund or periodic repayment

  • Early retirement

  • Interest tax deductible

  • Priority in liquidation

Paper Assets


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Preferred Stock

  • Fixed dividend payment (cumulative and non-cumulative)

  • No fixed maturity date

  • Flexibility to skip dividend payment

  • Possibility of call or conversion

  • Lower priority in liquidation

  • Priority in dividends

  • No tax deductibility of dividends

Paper Assets


Common stock l.jpg
Common Stock

  • No fixed dividend

  • Voting rights

  • Lowest priority in liquidation

  • Lowest priority in dividends

  • No fixed maturity

  • No tax deductibility of dividends

  • Residual risk and profits

Paper Assets



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Cash Flow for Bonds

Paper Assets


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Bond Value

= Price of the bond

= Interest payments

= Principal payments at maturity

= Number corresponding to a period; running from 1 to n

= Total number of periods

= Yield to maturity (or required rate of return)

Paper Assets


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A Premium Bond (Annual Compounding)

(face value)

(interest payment)

(years to maturity)

(market rate)

Present Value of Face Value

Present Value of Coupons

Total Bond Value

Paper Assets


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A Discount Bond (Annual Compounding)

(face value)

(interest payment)

(years to maturity)

(market rate)

Present Value of Face Value

Present Value of Coupons

Total Bond Value

Paper Assets


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Bond Price Table(10 Percent Interest Payment 20 Years to Maturity)

Paper Assets



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Impact of Time to Maturity on Bond Prices

Time PeriodBond Price withBond Price with

in Years8 Percent Yield12 Percent Yield

(of 10 percent bond)to Maturityto Maturity

  • 0 . . . . . . . . $1,000.00 $1,000.00

  • 1 . . . . . . . . 1,018.60 982.30

  • 5 . . . . . . . . 1,080.30 927.50

  • 10 . . . . . . . . 1,134.00 887.00

  • 15 . . . . . . . . 1,170.90 864.11

  • 20 . . . . . . . . 1,196.80 850.90

  • 25 . . . . . . . . 1,213.50 843.30

  • 30 . . . . . . . . 1,224.80 838.50

Paper Assets


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Relationship Between Time to Maturity and Bond Price

Bond Price ($)

Assumes 8% yield to maturity

1,300

1,200

1,100

1,000

900

800

700

10% bond, $1,000 par value

Assumes 12% yield to maturity

25

15

0

5

30

Number of years to maturity

* The relationship in the graph is not symmetrical in nature.

Paper Assets



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Required Return on a Bond(Annual Compounding)

Paper Assets


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Semi-Annual Coupons

Paper Assets


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Bond Concepts

  • 1. Bond prices and market interest rates move in opposite directions.

  • 2. When coupon rate = YTM, price = par value.

  • When coupon rate > YTM, price > par value (premium bond)

  • When coupon rate < YTM, price < par value (discount bond)

  • 3. A bond with longer maturity has higher relative (%) price change than one with shorter maturity when interest rate (YTM) changes. All other features are identical.

  • 4. A lower coupon bond has a higher relative price change than a higher coupon bond when YTM changes. All other features are identical.

Paper Assets



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Pricing Preferred Stock

Note: The book uses R

Paper Assets




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Common Stock Cash Flows

extending out forever

Paper Assets


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Constant Growth in Dividends(Gordon Growth Model)

Paper Assets


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Pricing Common Stock(Gordon Growth)

Paper Assets





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Pricing Common StockP/E Concept

= $10.00

= 5

=

= $10.00 X 5

= $50.00

Paper Assets


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P/E and DCF Models

Moral: P/E multiples are calculated by dividing Price by EPS. Price is NOT calculated by multiplying EPS by the P/E.

Paper Assets


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Summary

General:

Bonds:

Preferred Stock:

Common Stock:

Paper Assets


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Different Classes of Securities

Rate of Return (%)

H: Common Stock

G: Convertible Preferred

Risk

Premium

F: Preferred Stock

E: Income Bonds

D: Subordinated Debentures

C: Second Mortgage Bonds

B: First Mortgage Bonds

Riskless

Rate of

Return

A: U.S. Treasury Bonds

Risk to Investors

Paper Assets


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Stock Market Reporting

Gap pays a dividend of 9 cents/share

Gap has been as high as $52.75 in the last year.

Given the current price, the dividend yield is ½ %

Given the current price, the PE ratio is 15 times earnings

Gap has been as low as $19.06 in the last year.

6,517,200 shares traded hands in the last day’s trading

Gap ended trading at $19.25, down $1.75 from yesterday’s close

Paper Assets


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Stock Market Reporting

Gap Incorporated is having a tough year, trading near their 52-week low. Imagine how you would feel if within the past year you had paid $52.75 for a share of Gap and now had a share worth $19.25! That 9-cent dividend wouldn’t go very far in making amends.

Yesterday, Gap had another rough day in a rough year. Gap “opened the day down” beginning trading at $20.50, which was down from the previous close of $21.00 = $19.25 + $1.75

Looks like cargo pants aren’t the only things on sale at Gap.

Paper Assets



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Paper Assets


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Government Bond Reporting

Highlighted quote in Figure:

7.000 Jul 06n 100:13 100:14 4.78

Paper Assets



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