Lec10 - Lecture 10 page 72 BOND AND STOCK VALUATION The...

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Lecture 10 page 72 BOND AND STOCK VALUATION The valuation (pricing) of bonds and stock is a straight forward application of the time value of money (TVM) concepts we have just studied. Bonds and stock are just series of cash flows. What kinds of cash flows are received from bonds? What kinds of cash flows are received from stock? Regardless of the assets name, the current value of any asset is the present value (today) of its cash flows. BOND VALUATION Bond Timeline: + + + - = N N M YTM VALUE FACE M YTM M YTM PMT COUPON Value Bond ) / 1 ( 1 / ) / 1 /( 1 1 $ You should note from the formula and timeline given above that bonds are simply a combination of an annuity (the coupon payment) with a lump sum (the face value). (Note: Coupon payment is an interest payment and YTM = r d ) For a typical bond, coupon payments are made on a semi-annual basis (i.e., M = 2).  - Richard T. Bliss, Babson University and Terry D. Nixon, Miami University
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Lecture 10 page 73 Example 1: You are interested in investing in a bond with an annual coupon rate of 14.5 percent. Coupon payments are made on a semi-annual basis. The bond has a face value of $1,000 and 7 years to maturity. Similar bonds are currently yielding 10 percent to their owners. How much should you be willing to pay for this bond? TIMELINE: FACE = COUPON PAYMENT = YTM = M = N = BOND PRICE = You are considering buying the bond listed above when suddenly, the yield on similar bonds jumps to 20 percent. Will the bond’s price increase or decrease? Why?  - Richard T. Bliss, Babson University and Terry D. Nixon, Miami University
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Lecture 10 page 74 Practice: What is the bond’s new price with the 20 percent yield? Lastly, the bond’s yield miraculously changes again when you are considering the purchase. What is the bond’s price if the yield on similar bonds becomes 14.5 percent? Things to note on bond pricing:
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This note was uploaded on 10/19/2011 for the course FINANCE 301 taught by Professor Nixon during the Fall '11 term at Miami University.

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Lec10 - Lecture 10 page 72 BOND AND STOCK VALUATION The...

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