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11 10 21 Review Session 4 _Concept Review_

11 10 21 Review Session 4 _Concept Review_ - Bond Valuation...

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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 dividend-discount 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 five-year 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 default-free zero-coupon bonds to determine their yield-to-maturity YTM n = FV P 1 / n- 1 for an n-year zero-coupon 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 default-free coupon bond: P = CPN 1 + YTM 1 + CPN (1 + YTM 2 ) 2 + ......
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11 10 21 Review Session 4 _Concept Review_ - Bond Valuation...

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