11S.04.Bonds_and_Stocks-student

11S.04.Bonds_and_Stocks-student - FIN 600 Lecture 4 Valuing...

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FIN 600 – Lecture 4 Valuing Bonds (fixed income securities) and Stocks Dr. Zhipeng (Alan) Yan
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Topics Covered ± Definitions and Example of a Bond ± How to Value Bonds ± Bond Concepts ± The Present Value of Common Stocks ± Estimates of Parameters in the Dividend-Discount Model ± Growth Opportunities ± The Dividend Growth Model and the NPVGO Model ± Stock Market Reporting
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Definition of a Bond ± A bond is a legally binding agreement between a borrower and a lender that specifies the: ² Par (face) value ² Coupon rate ² Coupon payment ² Maturity Date ± The yield to maturity is the required market interest rate on the bond.
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Bonds- types of issuer ± Corporations - public vs. private placement - collateralized vs. unsecured ± Municipal government - General Obligation (GOs): backed by the full faith, credit and taxing power of the governmental unit - Revenue Bonds: depends on the vitality and success of the particular entity (e.g. toll roads, hospitals, etc) within the municipal government. ± Federal gov. - Treasury; federal government agencies
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Coupon and Principal ± In U.S., coupon payment is made in semi- annual installment. Exception: MBS and ABS – deliver monthly CFs. ± Zero-coupon bonds: Treasury strips(Separate Trading of Registered Interest and principal Securities Program). ± Inflation-indexed bonds: Treasury Inflation- protection Securities (TIPS). ± Floating-rate/floater: coupon rate varies over the instrument’s life.
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Bonds WARNING WARNING The coupon rate IS NOT the discount rate used in the Present Value calculations. The coupon rate merely tells us what cash flow the bond will produce. Since the coupon rate is listed as a %, this misconception is quite common.
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Bond Yields ± Current Yield - Annual coupon payments divided by bond price. ± Yield To Maturity - Interest rate for which the present value of the bond’s payments equal the price.
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How to Value Bonds Primary Principle: ± Value of financial securities = PV of expected future cash flows ² Bond value is, therefore, determined by the present value of the coupon payments and par value. ² Interest rates are inversely related to present (i.e., bond) values.
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The Bond Pricing Equation T T ) (1 FV R R) (1 1 - 1 C Value Bond R + + + = PV cpn r r cpn par r t = + + + ++ + + () .... 11 1 12
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Bond Pricing Example What is the price of a 5.5 % annual coupon bond, with a $1,000 face value, which matures in 3 years? Assume a required return of 3.5%. 03 . 056 , 1 $ ) 035 . 1 ( 055 , 1 ) 035 . 1 ( 55 ) 035 . 1 ( 55 3 2 1 = + + = PV PV
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Bond Example: Calculator PMT I/Y FV PV N 55 =1,000*0.055 3.5 1,000 – 1,056.49 3 Find the present value (as of January 1, 2009), of a 5.5% coupon bond with annual payments, and a maturity date of December 2011 if the YTM is 3.5%.
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Bond Pricing Example (continued) What is the price of the bond if the required rate of return is 15 %?
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This note was uploaded on 03/18/2011 for the course FIN 615 taught by Professor Yan during the Spring '11 term at New York Institute of Technology-Westbury.

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11S.04.Bonds_and_Stocks-student - FIN 600 Lecture 4 Valuing...

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