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chaper 14 note

# chaper 14 note - Chapter14 By Dr M Metghalchi In chapter 13...

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1 Chapter 14 THE VALUATION OF FIXED INCOME SECURITIES By Dr. M. Metghalchi In chapter 13 we discussed various types of bonds; in this chapter we will discuss how a bond is valued. Perpetual Securities: These are securities with indefinite life, the buyer of these securities collect each year till infinity interest (In case of bonds) or dividend (In case of preferred stock). Bonds that pay interest for ever are usually called consoles. Consoles and preferred stocks are valued the same way If you buy a console or a preferred stock t you will get each year for ever a fixed payment (PMT) per year. PMT1=PMT2=PMT3= …… PMT4 = PMT n Using time value of money formula, the present value of a constant amount forever, is perpetuity, and we get: P = PMT/i P = Current price or Value of a console or Preferred stock and i is the required rate of return on the console or preferred stock. Example1: Assume Victoria Inc. ‘s last year dividend was \$2.0 and this dividend is expected to remain constant for the foreseeable future. If the required rate of return for VI is 10%, what is the value of VI’s preferred stock? P = PMT/ i = 2/.10 = \$20 Example 2: You buy a console that pay each year \$100 interest payment, if the required rate of return for this bond (Console) is 8%, what would be the price of this console? P = PMT/ i = 80/.08 = \$1000

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