Valuation of bond
General valuation model
The value of any asset can be found as the
PV of its expected future cash flows, Ct,
discounted at the rate r:
Value = C1 / (1+r) + C2 / (1+r)2 + -+ Ct / (1+r)t
Characteristics of bond valuation
Capital structure policy
What and why?
Capital structure is the mix of the long-term sources of
funds used by the firm.
The objective is to find optimal mixture of the permanent
sources of fund.
A capital structure is called optimal if it ma
Asset Pricing Model:
Risk and return: Risk and
Efficient Frontier: Portfolio choice
Investors should add securities into their portfolio
as long as the diversification benefits are worth it.
They do this because the new combination of
We have used observed market returns (i.e.,
market prices) data to obtain the required
This raises the question of how good the
market is at valuation.
This question is the same as asking whether
the market is
Risk and Return: Individual asset
Until now, we have developed valuation techniques assuming
that the risk-adjusted rate was known. We spoke about it
as the return one could earn on an equivalent investment, i.e.,
same amount of risk. N
Capital budgeting under uncertainty
Using the CAPM
The CAPM give us a measure of the investors
opportunity cost of capital (required rate of return).
The opportunity cost of capital tells us what
investors could earn on projects of similar risk:
What is the appropriate corporate payout
How much of the corporation's cash flow
should be paid out to investors?
Given the amount of the payout, what is the
best way to accomplish the payout?
How are dividends
Valuation of stocks
Characteristics of stock valuation
Cash flow : dividend (not fixed and fluctuate
depending on the firms profit each year and
Since dividend increases with the growth in
corporate earnings, th
Present value &
net present value
Single cash flow problems:
1. Present value (PV)
Suppose you need $1,050 one year from now.
How much would you have to put aside today
if you want to earn 5% on the money?
PV = ?
C1 = 1,050
Cash flow estimation: Investment
decisions with NPV
Only cash flow is relevant
1) Cash flows must be included when received,
not when earned.
2) Non-cash out expense (ex: depreciation
expense) should not be included in cash
flows. It is importan
Why net present value?
Capital budgeting is the process by which
long-term investment projects are
analyzed. It involves measuring the
incremental cash flows associated with
projects and evaluating the attrac
40%, 40%, Quiz
Random(3 check F ),
Some Basic Questions
(major financial decisions)
1. What should a firm invest in?
2. How should a firm finance its investments?
3. What to do with the profits