Group 06

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## Group 06

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**Group 06**• Habiba Mustafa • Sumaiya Nishan • Muhammad Kashif • Hafiz Aamir Sohail • Altaf Hussain**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(bond)=PV(coupon payments)+PV(final payment) PV= PMT(1-1/(1+i)^n)/i + MV/(1+i)^n**Factors affecting Bond prices**• Credit Quality • Interest Rate • Yield • Tax Status**yield**• Yield is a figure that shows the return you get on a bond. Simplest version Yield= coupon amount/price**YIELD (Linking price and yield)**• Most important thing to remember!!!! **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.**BOND VOLATILITY**• Volatility refers to the amount of uncertainty or risk about the size of changes in security’s value. Volatility=Duration/1+yield**BOND DURATION**• Duration is a weighted measure of the length of time the bond will pay out. • Unlike maturity, duration takes into account interest payments that occur throughout the course of holding the bond.**Term structure/Yield Curve**• A "term structure of interest rates,“ also known as yield curve is a graph that plots the yield/spot rates of bonds against their maturities, ranging from shortest to longest.**EXPECTATION THEORY**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.”**INTRODUCING RISK**In expectation theory risk factor must be considered. If predicted future level of interest rates, select strategy offering highest return.**Inflation and Term structure**• Suppose u are saving for your retirement. which of the following strategies is the more risky? • Invest in one-year or invest in 20-year bond?**Inflation and nominal interest rates**• How does inflation affect the nominal rate of interest?**FISHER’S THEORY**“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”. 1+rnominal=(1+rreal)(1+i)**REAL & NOMINAL 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.**NOMINAL INTEREST RATE**Real cash flowt=nominal cash flowt/1+inflation rate)t FOR EXAMPLE: 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 =1,100/1.0620=$342.99**INDEXED BONDS**Bonds promised you a fixed nominal rate of interest.**How Common Stocks are Traded**• Primary Market Trading through bank and OTC • Secondary Market Trading through Stock Exchange**How Common Stocks are valued**• PV(stock) = PV(expected future dividends) • Today’s Price The cash payoff to the owners of common stocks comes in two forms • Cash dividends • Capital gains or losses**Conti…d**• Expected return = r = Divi1 + p1-p0/p0 Example 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)**Conti’d**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)**Conit’d**• If DIV1=5 and p1=110 and r=15%, then today's price should be 100: P0 = 5+110/1.15 =$100**But what determines the Next Year’s Price**• P1 = DIV2 + P2/(1+r) 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:**Conit…’d**• Po=1/1+r(DIV1+p1)=1/1+r(DIV1+DIV2+p2/1+r) =DIV1/(1+r) + DIV2+p2/(1+r)*2 Example 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 = $110**Conti…d**• From our expended formula P0 = 5/1.15 + 5.50+121/(1.15)*2 = $100**Estimating the Cost of Equity Capital**• Po = DIV1/ (r-g) • r = (DIV 1/p0) + g**Danger lurk in Constant-Growth formula**• Dividend growth rate = plowback ratio*ROE**The link between stock price and Earning per share**• Growth stock • Income stock Expected return =dividend yield=earning-p ratio If dividend is $10 a share and stock price is $100 then: Expected return=DIV1/P0 = 10/100 = .10**Conti..d**The price equals P0= DIV1/r = EPS1/r = 10/.10 =100 Po =EPS1/r+PVGO So, EPS/Po= r ( 1- PVGO/Po) It will underestimate r if PVGO is +ve and overestimate it if PVGO is -ve**Calculating PV of Growth Opportunities**• Po= DIV1/r-g • Payout ratio = DIV1/EPS1 • Growth rate= g = plowback ratio*ROE • Present value of level stream of earnings= EPS/r • PVGO = NPV1/r-g • Share price = EPS1/r +PVGO**Valuing a Business by Discounting Cash Flow**• In this you forecast dividend per share or total free cash flow of a business. • Value today always equals future cash flow discounted at the opportunity cost of capital**Valuing the Concatenator Business**• PV= FCF/1+r + FCF2/(1+r)^2 +….+FCF/(1+r)^H + PV/(1+r)^H**Estimating Horizon Value**• Forecasting reasonable horizon is particularly difficult. The usual assumption is moderate long rum growth after the horizon, which allow us to growing-perpatuityDCF formula. • It can also be calculated normal price-earnings or market-book ratios at the horizon date