Group 06. Habiba Mustafa Sumaiya Nishan Muhammad Kashif Hafiz Aamir Sohail Altaf Hussain. BOND VALUATION. BOND: long term debt. A security that pays a stated amount of interest to the investor, period after period until its maturity. Face value Coupon maturity. BOND VALUE.
PV= PMT(1-1/(1+i)^n)/i + MV/(1+i)^n
Yield= coupon amount/price
**When prevailing interest rates rise, prices of outstanding bonds fall to bring the yield of older bonds into line with higher-interest new issues
**When prevailing prices fall, prices of outstanding bonds rise, until the yield of older bonds is low enough to match the lower interest rate on new issues.
The expectation theory says that:
“Bonds are priced so that an investor who holds a succession of short bonds can expect the same return as another investor who holds a long bond.”
In expectation theory risk factor must be considered. If predicted future level of interest rates, select strategy offering highest return.
“A change in the expected inflation rate will cause the same proportionate change in the nominal interest rate; no effect on the required real interest rate”.
In Real interest rate no inflation factor while in Nominal interest rate inflation factor exists.
Inflation rate higher real return will be lower.
Real cash flowt=nominal cash flowt/1+inflation rate)t
If u were to invest $1,000 in a 20-year bond with a 10% coupon, final payment would be $1,100.
if inflation rate=6% then real value would be
Bonds promised you a fixed nominal rate of interest.
Valuation of common stock
Trading through bank and OTC
Trading through Stock Exchange
The cash payoff to the owners of common stocks comes in two forms
Suppose Fledgling Electronics stock is selling for $100 a share (p0=100). Investors expect a $5 cash dividend over the next year (Div1=5). They also expect stock to sell for $110 a year (p1=110)
Expected return = r = 5+(110-100)/100
r = 0.15 or 15%
On the other hand, if you are given investors forecasts of dividend and price and the expected return is same then you can predict today’s price.
Price = po= Div1+p1/(1+r)
P0 = 5+110/1.15 =$100
That is, a year from now investor will be looking out at dividends in year 2 and price at the end of year 2. thus we can forecast p1 by forecasting DIV2 and p2 and we can express po in terms of DIV1, DIV2, and p2:
=DIV1/(1+r) + DIV2+p2/(1+r)*2
Suppose they are looking today for dividends of $5.5 in year 2 and subsequent price of $121. that implies a price at the end of the year 1 of
P1 = 5.50+121/1.15
P0 = 5/1.15 + 5.50+121/(1.15)*2
Expected return =dividend yield=earning-p ratio
If dividend is $10 a share and stock price is $100 then:
= 10/100 = .10
The price equals
P0= DIV1/r = EPS1/r = 10/.10 =100
EPS/Po= r ( 1- PVGO/Po)
It will underestimate r if PVGO is +ve and overestimate it if PVGO is -ve