Successfully reported this slideshow.

Stock and bond valuation

371 views

Published on

Relationship between the yield to maturity (YTM) and the bond prices. Open markets are the places where the bonds are issued and are traded and the process as well as the yields is continually changing.
The investor gets the dividend as a compensation for investing some amount in the company. Hence, the dividends on the shares play a very crucial role in determining the value of the shares.

http://www.makemyassignments.com

  • Be the first to like this

Stock and bond valuation

  1. 1. qwertyuiopasdfghjklzxcvbnmqwertyui opasdfghjklzxcvbnmqwertyuiopasdfgh jklzxcvbnmqwertyuiopasdfghjklzxcvb nmqwertyuiopasdfghjklzxcvbnmqwer tyuiopasdfghjklzxcvbnmqwertyuiopas dfghjklzxcvbnmqwertyuiopasdfghjklzx cvbnmqwertyuiopasdfghjklzxcvbnmq wertyuiopasdfghjklzxcvbnmqwertyuio pasdfghjklzxcvbnmqwertyuiopasdfghj Stock & Bond Valuation
  2. 2. The relationship between a bond's price and the yield to maturity is an inverse relationship. Please explain; make sure you don't simply restate the inverse relationship, but explain the reasoning. Examples are encouraged. Ans. In order to understand the inverse relation between the yield to maturity (YTM) and the bond prices, the following example can be used: Suppose a bond has been purchased by Mr. X having a par value of $1000. The coupon over that bond is 6%, which means that a payment of $60 will be received annually as interest. However, in case the market rate of interest goes up to 7%, what will you do? A payment of $60 on that bond will be still received because you have locked-in rate. But the bond is sold into the open market, Mr. X will be asked to reduce the prices of the bond by which the buyer will get attracted towards the benefit that he may get due to the difference in the prices of the bond. No matter if the interest income (yield to maturity) over the life of the bond is less than the current market interest (Hamlett). So, with the rise in the price of the bond dropped to compensate for the lower return rate (yield to maturity) a buyer would receive from your bond vs. a newer bond at a higher rate. Open markets are the places where the bonds are issued and are traded and the process as well as the yields is continually changing (Kenny, 2010). As a result, yields converge to the point where investors are being paid approximately the same yield for the same level of risk.
  3. 3. Why are stock valuation models dependent upon expected future dividends, dividend growth and an appropriate discount rate? Ans. An investor purchases a stock in an expectation of:  To earn a return over his investment, in the form of dividends  In re-sell the stock after some time at a higher price when he himself would not likely to hold the bond any longer. The investor gets the dividend as a compensation for investing some amount in the company. Hence, the dividends on the shares play a very crucial role in determining the value of the shares (Rustagi, 2014). The value of the equity shares is considered as the sum of the present values of all the future cash inflows (in the form of dividends) discounted at the required rate of return of the investors. The growth rate of the dividends denotes that how will the company grow its profits or is planning to improve its profits. The reason being that the company only pays dividend when they are in the profitable conditions. Thus the growth rate should be taken into account because while determining the value of shares the growth rate plays an important role. It gives an idea that what would be the pattern of the dividends in the future. However, the growth rate is just an outcome of the planning of the company. The discount rate is the rate at which the future dividends will be discounted to determine the present values. The present values are calculated to reduce the uncertainty that may arise in the future. However, it is to be noted that the growth rate (g) should be less than the required rate of return (ke). Ke> g because while determining the price of the share following formula is used:
  4. 4. Dividend of the previous year (1 + growth rate) Required rate of return – Growth rate Thus, it is important to use the dividends, growth rate and discount rate while determining the values of the shares. Because if investors never received a payment for their security it wouldn’t be worth anything. Bibliography Hamlett, K. (n.d.). Relationship Between Bond Price & Yield to Maturity. Retrieved from The Nest: http://budgeting.thenest.com/relationship-between-bond-price-yield-maturity- 3681.html Kenny, T. (2010). Why Do Bond Prices and Yields Move in Opposite Directions? Retrieved from About.com: http://bonds.about.com/od/bonds101/a/Why-Do-Bond-Prices-And-Yields- Move-In-Opposite-Directions.htm Rustagi, R. (2014). Investment Management. Delhi: Sultan Chand & Sons.

×