Valuation of Bond and Stock
Valuation of Bond and Stock
Valuation of Bond and Stock
Valuation:
The process of determining the present
value of a financial asset by discounting
future cash flows to be generated by that
asset at an expected discount rate is called
valuation.
6-1
CHAPTER 6: Valuation of
Bond and Stock
Bond:
A long-term debt instrument in which a
borrower agrees to make payments of
principal and interest, on specific dates, to
the holder of the instrument by securing
sufficient collateral is called bond.
6-2
Key Features of a Bond
Par value – face amount of the bond, which
is paid at maturity (assume $1,000).
Coupon interest rate – stated interest rate
(generally fixed) paid by the issuer. Multiply
by par to get dollar payment of interest.
Maturity date – years until the bond must be
repaid.
Issue date – when the bond was issued.
Market rate of interest is the current interest
rate available at the market. (suppose, r)
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Valuation of Bond
Value of bond equals to the present value of all
future payments of interest and the principal
amounts. Since all the interest figures are equal so it
is the same as the present value of annuity and the
future value can be converted in the present value
as:
C 1 F
PV 1 T
r (1 r ) (1 r ) T
7-4
Example 1. Bond valuation
A 10%, Tk.1000, 10 year bond was issued that
pays interest on July 1 and December 1 every
year. Already 7 payments made. If the current
interest rate is 12%, what is the current price?
So, t=(20-7)=13
VB=$50 (PVIFA, n=13, i=6%)+PV(1000)
=[50*(8.8527)]+ 468.84=$ 911.47
7-5
Valuation of Stock
Method 1: Zero Growth
Share price is the present value of all future dividends.
Po PV ( D )
t 1
t
D1 D2 D3 D
....
1 k (1 k ) 2
(1 k ) 3
(1 k )
7-8
Case 3: No-constant Growth
The constant growth model is not applicable when ‘g’ is quite
high. No-constant growth or super growth model is then the
only choice to estimate stock price.
1. Calculate the present value of dividends of super growth
rate separately, sum it up,
2. Calculate the future price of the stock based on constant
growth rate,
3. Make the present value of the price,
4. Add the two streams of present value.
Example: If dividend grows at a super rate for 3 years and
then, at a constant rate for perpetuity, then:
Po=PV(D1)+PV(D2)+PV(D3)+PV(P3),
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where, P3=D4/(k-g)
Problem:
No-constant Growth model
Po=PV(D1)+PV(D2)+PV(D3)+PV(P3)
Where, P3=D4/(k-g)=39.156/(.15-.03)=326.304
and, PV(P3)=P3/(1+k)3=326.3/(1.15)3=214.55
P0=PV(D1)+PV(D2)+PV(D3)+PV(P3)=71.9+214.55=286.46
7-11
H.W.
Questions:
6-1, 6-2, 7-1, 7-2, 7-3, 7-4
Problems:
6-1, 6-3, 6-4, 6-9, 6-15, 7-3, 7-4, 7-5, 7-25
7-12