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 Indenturelegal document spells out right of bond holders
Restrictive Covenants:when bonds can be called, level of ratios before further issues, payment of dividends
Mortgage Bondsproperty pledged as security
Debenturesunsecured 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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 Spring '10
 BOUDREAUX
 Time Value Of Money, Interest, current required return

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