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Unformatted text preview: Bond Valuation Stock Valuation Managerial Finance: Review Session 4 TA: Pablo Villanueva (using previous TAs notes) October 21, 2011 Bond Valuation Stock Valuation Agenda for Today 1. Valuation of Bonds Bond terminology Key pricing formulas Practice questions 2. Valuation of Stocks The dividenddiscount model Alternative methods Practice questions 3. Questions from Chapters 9 and 10 Bond Valuation Stock Valuation What is a Bond? Bond payments: Coupons: promised interest payments on a regular basis Face value: a large payment on the maturity date Example: what are the cash flows of a fiveyear bond with a $100 face value with 10% coupons paid semiannually? coupon payments: CPN = Coupon Rate Face Value Number of Coupon Payments per Year = . 1 100 2 Hence, the bond pays $5 every sixth months until the maturity date, at which it pays $105. Bond Valuation Stock Valuation Bonds: Key Definitions Yield to maturity : the discount rate that sets the PV of the promised bond payments equal to its market price P = CPN 1 + y + CPN (1 + y ) 2 + ... CPN (1 + y ) N + FV (1 + y ) N or equivalently P = CPN y 1 1 (1 + y ) N + FV (1 + y ) N Here, y is the yield to maturity per compounding period (e.g., 6 months, if the coupons are semiannual). We can annualize them. Bond Valuation Stock Valuation Bonds: Key Definitions Yield curve We can use prices of defaultfree zerocoupon bonds to determine their yieldtomaturity YTM n = FV P 1 / n 1 for an nyear zerocoupon bond The graph that plots YTM n for various maturities n is called the yield curve We can use the Law of One Price to value any defaultfree coupon bond: P = CPN 1 + YTM 1 + CPN (1 + YTM 2 ) 2 + ......
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This note was uploaded on 01/08/2012 for the course MS&E 245G taught by Professor Perezgonzalas during the Fall '11 term at Stanford.
 Fall '11
 PerezGonzalas

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