...Bond Valuation By Anuj Joshi Note 1 Bond Valuation Fixed income paying securities. 1. Theoretical price or value of bond depends upon. i. Coupon Payment : Fixed amount of interest to be received after prescribed frequency. ii. Maturity Value [Unless otherwise given is exam, we should take face value] iii. Discount Rate : It should always be market interest rate 2. What is market interest rate Market interest rate is derived from comparable listed bond. The comparison is based on risk and life of the bond. E.g. If we are valuing a bond which is unlisted and have 5 years of life, then we should look for a bond which is similar in risk profile (i.e. same credit rating)and having similar life. The YTM (Yield to Maturity) of listed bond is called market interest rate The YTM of a bond is nothing but IRR of the bond. 3. Value of a bond = PV of Coupon Amount + PV of Maturity Value [Remember CF and discount rate are before tax] Concept Point: i. Coupon rate is a historical rate and should never be used as a discount rate. In exam, if no other information is available, then only we should assume coupon rate of interest as market rate of interest. ii. Remember, Cost of Capital or Discount Rate is a future concept and it represents opportunity cost on the date of valuation. iii. YTM of a similar bond (i.e. current market interest rate) is the appropriate discount rate for bond valuation. How to value a bond which pays interest at a frequency lower than annually (e...
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...Financial Management Unit 4 Unit 4 4.1 Introduction 4.2 Valuation of Bonds Types of Bonds 4.2.1 Irredeemable or Perpetual Bonds Valuation Of Bonds And Shares 4.2.2 Redeemable or Bonds with Maturity Period 4.2.3 Zero Coupon Bond Bondyield Measures 4.2.1 Holding Period Rate of Return 4.2.2 Current Yield 4.2.3 Yield to Maturity (YTM) 4.2.4 Bond Value Theorems 4.3 Valuation of Shares 4.3.1 Valuation of Preference Shares 4.3.2 Valuation of Ordinary Shares 4.4 Summary Solved Problems Terminal Questions Answers to SAQs and TQs 4.1 Introduction Valuation is the process of linking risk with returns to determine the worth of an asset. Assets can be real or financial; securities are called financial assets, physical assets are real assets. The ultimate goal of any individual investor is maximization of profits. Investment management is a continuous process requiring constant monitoring. The value of an asset depends on the cash flow it is expected to provide over the holding period. The fact that as on date there is no method by which prices of shares and bonds can be accurately predicted should be kept in mind by an investor before he decides to take an investment decision. The present chapter will help us to know why some Sikkim Manipal University 50 Financial Management Unit 4 securities are priced higher than others. We can design our ...
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...1.0 Introduction Bond valuation is the determination of the fair price of a bond. As with any security or capital investment, the theoretical fair value of a bond is the present value of the stream of cash flows it is expected to generate. This essay is about different types of bonds and the instruction of the riskiness of bonds. Firstly, this essay will make a general overview of the types of bonds. Subsequently it will discuss the types of risks to which both bond investors and issuers are exposed. Finally it will make an analysis of the bond markets. 2.0 Basic information of bonds Bond is a form of long-term debt instrument. For example, a contractual liability, basically just a certificate showing that a borrower promises to repay interest and principal, on specific dates, to the holders of the bond. Bonds are one of the most important types of securities. There is a wide variety of these securities. It may seem confusing, but in actuality just a few characteristics distinguish the various types of bonds. 3.0 Various Types of Bonds Bonds are issued by both governments and corporations. Bonds are issued by public authorities, credit institutions, companies and supranational institutions in the primary markets. The most common process for issuing bonds is through underwriting. When a bond issue is underwritten, one or more securities firms or banks, forming a syndicate, buy the entire issue of bonds from the issuer and re-sell them to investors. The security firm...
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...Bond Valuation: * How do we use NPV to value bonds? One simply computes the present value of the cash flows at the appropriate rate of return. This corresponds approximately to the full price of the bond (as opposed to the listed price). * E.g.: a one period, $1000 bond, 10% coupon is valued at: $1037 (1100/1.06) if the market rate of return is 6%. The bond sells at a premium. * $1000 if the market rate of return is 10%. The bond sells at par. * $982 if the market rate of return is 12%. The bond sells at a discount. Tentative Conclusions * The higher the appropriate interest rate, the lower the price of the bond. * If the yield matches the coupon , then the bond sells at par. * If the yield is higher than the coupon, the bond sells at a discount. * If the yield is lower than the coupon, the bond sells at a premium Example: * Consider now an infinite bond, paying a 10% coupon, i.e. $100 forever. * Then if the market return is 10% the bond sells at 100/0.1 =1000. * If the market return is 6% the bond sells at 100/0.06 = 1667 * If the market return is 12% the bond sells at 100/0.12 = 833 * A tentative conclusion: it seems that longer maturity bonds are affected more by interest rate swings. * We will modify this conclusion later. Valuing a Bond * If today is October 1, 2010, what is the value of the following bond? An IBM Bond pays $115 every September 30 for 5 years. In September 2015 it pays...
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...BondBond Valuation Valuing the cash flows Chapter 7 (1) coupon payment (interest payment) = (coupon rate * principal) Bonds, Bond Valuation, and Interest Rates usually paid every 6 months (2) maturity value = principal or par value = $1000 Example (coupon rate = rd) Five year corp. bond pay coupons at 10% rate, market rate (discount rate) (required rate of return) is 10% Example (coupon rate = rd) Define Terms C rd = 10% 0 1 2 3 4 5 ├───────┼───────┼───────┼───────┼───────┤ P0 $100 $100 $100 $100 $100 $1,000 F n rd P0 = coupon payment = coupon rate x $1000 = 10% x $1,000 = $100 = face amount or maturity value = $1000 = payments to maturity = 5 = required rate of return = 10% = bond value = ? 1 Example (coupon rate = rd) P0 = PV of coupon annuity + PV of lump sum maturity value PV of coupon annuity = $379.08 PV of lump sum maturity value = $620.92 P0 = $379.08 + $620.92 = $1,000.00 Solve with Calculator PMT = C FV = F I/Y = rd N P0 PMT = C FV = F I/Y = rd N = 100 = 1000 = 10% =5 = PV = 1,000 In this case coupon = rd so P0 = F This Bonds sells at PAR Example (coupon rate > rd) Five year corp. bond pay coupons at 10% rate, market rate is 8% = 100 = 1000 = 10% =5 Example (coupon rate > rd) P0 = 399.27 + 680.58 = $1,079.85 Calculator: PMT = C FV = F I/Y = rd N P0 = 100 = 1000 = 8% =5 = PV = $1,079.85 2 Example (coupon rate...
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...is a problem if an asset or liability has to be liquidated immediately. If the asset or liability is held until maturity, then the reporting of book values does not pose a problem. For an FI, a major factor affecting asset and liability values is interest rate changes. If interest rates increase, the value of both loans (assets) and deposits and debt (liabilities) fall. If assets and liabilities are held until maturity, it does not affect the book valuation of the FI. However, if deposits or loans have to be refinanced, then market value accounting presents a better picture of the condition of the FI. The process by which changes in the economic value of assets and liabilities are accounted is called marking to market. The changes can be beneficial as well as detrimental to the total economic health of the FI. 6. Consider three Treasury bonds each of which has a 10 percent semiannual coupon and trades at par. a. Calculate the duration for a bond that has a maturity of four years, three years, and two years? Four-year Treasury Bond: Par value = $1,000 Coupon rate = 10% Semiannual payments R = 10% CF t 0.5 $50 1 $50 1.5 $50 2 $50 2.5...
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...Week 3 DQ 2 Forecasting Methods Read Problem 6 in Chapter 6 of your textbook. Calculate and answer parts a through d. Include all calculations and spreadsheets in your post. Explain why the moving average method was used instead of another forecasting method. What might be another forecasting method that could prove to be just as useful? Your initial post should be 200-250 words. Below see the number of mergers that took place over a 12-year period in the savings and loan industry. |Year | |Mergers | |Year | |2005 |61 |52.6 |8.4 |70.56 | |2006 |83 |55.6 |27.4 |750.76 | |2007 |123 |63 |60 |3,600 | |2008 |97 |75.2 |21.8 |475.24 | |2009 |186 |85.6 |100.4 |10,080.16 | |2010 |225 |110 |115 |13,225 | |2011 |240 |142.8 ...
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...Chapter 4 – Bond Price Volatility Extra Questions 1. Be sure you understand all the relationships shown in Exhibit 4-11 2. The price of a bond can be written as either as the sum of series of discounted CFs (Equation 4.1, page 63) or as the sum of the PV of an annuity and the discounted maturity value (Equation 4.9, page 67). Note that the PV of an annuity formula used in Equation 4.9 is derived from the difference between a perpetuity starting at time zero and a perpetuity starting at time n. The difference is an annuity starting at time 0 and ending at time n. Equation 4.3 is the first derivative of price w.r.t. yield (∂P/∂y) using equation 4.1. The numerator of equation 4.10 is first derivative of the price w.r.t. yield using equation 4.9. Consider either equation 4.3 or the numerator of 4.9. Determine only the sign of following second derivative and mixed partial derivatives: * ∂2P/∂y2 * ∂2P/∂y∂C * ∂2P/∂y∂n (a) Does duration increase or decrease as the initial yield increases?(decrease) (b) Does duration increase or decrease as the coupon increases?(decrease) (c) Does duration increase or decrease as the maturity increases?(increase) 3. (This is questions 2 and 4 from the text.) Consider semi-annual bonds A and B. | Bond A | Bond B | Coupon | 8% | 9% | Yield to maturity | 8% | 8% | Maturity (years) | 2 | 5 | Par | $100.00 | $100.00 | Price | $100.00 | $104.055 | Produce an Excel...
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...Introduction to Mathematics in Finance – HW 4 Swarna Ramineni sr3121 Answer 1) Value at risk: It is a statistical technique to measure the amount of potential loss, the probability of the loss, and the time frame. Value at risk is used by risk managers in order to measure and control the level of risk which the firm undertakes. The risk manager's job is to ensure that risks are not taken beyond the level at which the firm can absorb the losses of a probable worst outcome. For example, a financial firm may determine that it has a 5% one month value at risk of $100 million. This means that there is a 5% chance that the firm could lose more than $100 million in any given month. Conditional value at risk on the other hand is an extension of value at risk. It is derived by taking weighted average between the value at risk and losses exceeding the value at risk. The VaR model does allow managers to limit the likelihood of incurring losses caused by certain types of risk - but not all risks. The problem with relying solely on the VaR model is that the scope of risk assessed is limited, since the tail end of the distribution of loss is not typically assessed. Therefore, if losses are incurred, the amount of the losses will be substantial in value. Conditional value at risk does a better job at assessing the tail VaR and hence is a very useful tool for risk managers. Answer 2) NAV as of Nov 1, 2013 is $169,018 Gross Leverage is 1.744 and Net Leverage is 0.7017 The latest...
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...ICB Mutual Funds ICB Mutual Funds are also known as close ended Mutual Funds. The issued capital of a Mutual Fund is limited, that is, a Mutual Fund offers a limited number of certificates for sale to the public. The amount of capital and the number of certificates of each Mutual Fund remains unchanged. ICB Mutual Funds are independent of one another. A Mutual Fund being listed is traded on the Stock Exchanges. Price of Mutual Fund certificates after IPO is determined on the Stock Exchanges through interaction of supply and demand. The market price of a Mutual Fund certificates is available in Stock exchange quotations and in newspapers. Performances of ICB Mutual Fund The Considerations underlying the performance evaluation of mutual funds is a matter of concern to the fund managers, investors and researchers alike. The present paper attempts to answer two questions relating to mutual fund performance; 1. Whether the growth oriented Mutual Fund are earning higher returns than the benchmark returns (or market Portfolio/Index returns) in terms of risk. 2. Whether the growth oriented mutual funds are offering the advantages of Diversification, Market timing and Selectivity of Securities to their investors. This paper attempts to answer the questions raised, by initially describing some basic concepts and later by employing a methodology which was used by Sharpe (1966), Treynor (1965), and Jenson (1968) and finally given appropriate comments. ...
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...which time value of money can help corporate managers in general. The time valuation of money is the idea that money available now could be worth more than the same amount in the future, because that current money has the possibility of earning money in the future. Think if the expression, “It takes money to make money!” If you are guaranteed to have $100.00 now or $100.00 in 3 years, you would probably take the money now. However, the $100.00 you could have now can be utilized to make even more money in the future through investing. This concept is very important in the business world as corporations are always looking to increase investing opportunities that will prove profitable. Time valuation enables corporate managers to determine two major aspects of investments; How much to invest and the rate of return on that investment. A company needs to know how much they need for an initial investment and how much that investment will yield over a given period of time. This is also where compounded interest plays a major role, the more the interest is compounded the greater the yield. Examine the pros and cons of a sinking fund from the viewpoint of both a firm and its bondholders. Determine the fundamental manner in which this knowledge could be helpful to a financial manager. Provide a rationale for your response. Sinking funds are a method of repaying funds that were borrowed via a bond. A bond in simple terms is an IOU to individual persons or corporations that provided...
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...Financial Modelling – Session VII Email: jcadete@clsbe.lisboa.ucp.pt Financial Modelling Joaquim Joaquim Cadete Cadete 1 How your work is going to be scored? Svensson Model: IR Swaps: CIR Model: Modeling Formalization (6) Functions Efficiency Gains (3) Functions Efficiency Gains (3) Further Improvements (5) Efficiency Gains (3) User’s Perspective Your Grade Financial Modelling Joaquim Cadete 2 Risk Management: the main concern… Counterparty risk Credit risk Interest rate risk Capital risk and solvency Funding risk Risk Management Reputational risk Foreign exchange risk Off-balance sheet risk Operational risk Financial Modelling Market or trading risk Sovereign risk Regulatory risk Joaquim Cadete 3 Risk and Return Theories Diversification Standard deviation of portfolio return σ Unsystematic or diversifiable risk Systematic or Total risk market-related risk Number of holdings Financial Modelling Joaquim Cadete 4 Interest rate risk: the first layer of volatility… Operational Risk: Betas. Operational risk Systematic risk or nondiversifiable risk Unsystematic or diversifiable risk A Total Risk Shareholders’ risk A E E A E A= E Financial Modelling Joaquim Cadete 5 Interest rate risk: the first layer of volatility… Operational Risk: Betas. If A = E, then RA =...
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...ts/ For More Courses and Exams use this form ( http://hwguiders.com/contact-us/ ) Feel Free to Search your Class through Our Product Categories or From Our Search Bar (http://hwguiders.com/ ) FIN 571 W2 Ch 5 Problem A1 (Bond Valuation) FIN 571 W2 Ch 5 Problem A10 (Dividend discount model) FIN 571 W2 Ch 5 Problem A12 (Required return for a preferred stock) FIN 571 W2 Ch 5 Problem A14 (Stock Valuation) FIN 571 W2 Ch 5 Problem B16 (Interest-rate risk) FIN 571 W2 Ch 5 Problem B18 (Default risk) FIN 571 W2 Ch 5 Problem B20 (Constant growth model) FIN 571 W2 Ch 7 Problem C1 (Beta and required return) FIN 571 Week 2 Individual Assignment Text Problem Sets Get Tutorial by Clicking on the link below or Copy Paste Link in Your Browser https://hwguiders.com/downloads/fin-571-week-2-individual-assignment-text-problem-sets/ For More Courses and Exams use this form ( http://hwguiders.com/contact-us/ ) Feel Free to Search your Class through Our Product Categories or From Our Search Bar (http://hwguiders.com/ ) FIN 571 W2 Ch 5 Problem A1 (Bond Valuation) FIN 571 W2 Ch 5 Problem A10 (Dividend discount model) FIN 571 W2 Ch 5 Problem A12 (Required return for a preferred stock) FIN 571 W2 Ch 5 Problem A14 (Stock Valuation) FIN 571 W2 Ch 5 Problem B16 (Interest-rate risk) FIN 571 W2 Ch 5 Problem B18 (Default risk) FIN 571 W2 Ch 5 Problem B20 (Constant growth model) FIN 571 W2 Ch 7 Problem C1 (Beta and required return) FIN 571 Week 2 Individual Assignment...
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...11.3 THEORY OF VALUATION You may recall from your studies in accounting, economics, or corporate finance that the value of an asset is the present value of its expected returns. Specifically, you expect an asset to provide a stream of returns during the period of time you own it. To convert this estimated stream of returns to a value for the security, you must discount this stream at your required rate of return. This process of valuation requires estimates of (1) the stream of expected returns and (2) the required rate of return on the investment. 11.3.1 Stream of Expected Returns(Cash Flows) - An estimate of the expected returns from an investment encompasses not only the size but also the form, time pattern, and the uncertainty of returns, which affect the required rate of return. Form of Returns The returns from an investment can take many forms, including earnings, cash flows, dividends, interest payments, or capital gains (increases in value) during a period. We will consider several alternative valuation techniques that use different forms of returns. As an example, one common stock valuation model applies a multiplier to a firm’s earnings, whereas another valuation model computes the present value of a firm’s operating cash flows, and a third model estimates the present value of dividend payments. Returns or cash flows can come in many forms, and you must consider all of them to evaluate an investment accurately. Time Pattern and Growth Rate of Returns You...
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...FIN/571 April 13, 2015 Gurpreet Atwal Week 4 Learning Team Reflection Introduction Stock valuation is needed to ensuring the value of an organization’s stock and worth in the industry. There are various measuring methods that organizations can use to determining and establishing the value. Some of the methods and the reason for valuation have been identified below. Stock types and bonds: The stock valuation video covered the different types of stocks and well as bonds. There are common stocks and preferred stocks. Preferred stocks are considered to be a hybrid between a common stock and a bond. This form of stock will have no maturity and can be sometimes redeemable. A common stock is when an individual purchases a share of an organization and they own that share until they want to sell their share for the market value. A debt or a bond is another form of investment that private investors can use. A bond is a contract which has a set time period, as well as set cash flows. Once the bond is matured then the investor will receive their set return amount, although investors who have bonds will receive their return on investment before the stockholders. Assumptions and Indexes: Assumptions made on the valuation of a stock or company’s value in the future are crucial when determining the future value of a company based on its revenues. Many of the current stock values and valuations made on a company are based on the current or past performance of that company. The difficulties...
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