9_Valuation_of_Bonds_PS_CS_1_1_1_ - FINANCE 300 VALUATION...

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FINANCE 300 VALUATION Interest, Valuation Model, Bonds, Preferred Stock, Common Stock REMEMBER Interest: %- price for borrowing and the $ is the cost. r = r* +IP + RP,Where:r is nominal interest rate, r* is real, IP is inflation premium and RP is risk premium, (composed of default risk, liquidity risk, maturity risk) Term Structure and yield curves VALUATION OF FINANCIAL INSTRUMENTS Basic Valuation Model V = CF1 / (1 + r) ^1 + CF2 / (1 + r) ^ 2 + … + CFn / (1 + r) ^ n Where: V is the value or worth of an investment CFs are the expected cash flows at period 1, 2 … n r is the required return (discount rate) which reflects the risk level of the expected cash flows BONDS : Corporate IOU. Bond Indenture-legal document spells out right of bond holders Restrictive Covenants:when bonds can be called, level of ratios before further issues, payment of dividends Mortgage Bonds-property pledged as security Debentures-unsecured bond (no lien) Ratings: Moody’s Aaa, Aa A Baa Ba B Caa S&P AAA AA A BBB BB B CCC THE BASIC BOND VALUATION MODEL: VB = PMT1 / (1 + rd) ^ 1 + PMT2 / (1 + rd) ^ 2 + … + PMTn / (1 + rd) ^ n + PAR / (1 + rd) ^ n Where: VB is the value of the bond PMT is the interest payment expected to be received at periods 1, 2…n PMT is found by Coupon Interest Rate (CIR)* PAR PAR is the face value of the bond which is what the holder receives at maturity rd is the required return n is the number of years until maturity KEY VARIABLES: Par Value, Coupon Interest Rate, Maturity Date, Required Yield (Rate of Return)
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9_Valuation_of_Bonds_PS_CS_1_1_1_ - FINANCE 300 VALUATION...

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