Deliverable: Word Document Of 700-1000 Words With Attachment

Deliverable Lengthword Document Of 7001000 Words With Attached Exce

Using a Web site that provides current stock and bond pricing and yield information, complete and analyze the tables illustrated below. Select 3 bonds with maturities between 10 and 20 years and ratings of "A to AAA," "B to BBB," and "C to CC." All bonds will have a future value of $1,000. Calculate the annual coupon payment using the coupon rate times the face value. Determine the time to maturity by subtracting the maturity date from the current year. Use the Web site to obtain the yield to maturity and current quote; multiply the quote by 10 to get the market value. Indicate whether each bond is trading at a discount, premium, or par. Fill in the following table:

  • Bond Company / Rating
  • Face Value (FV)
  • Coupon Rate
  • Annual Payment (PMT)
  • Time-to Maturity (NPER)
  • Yield-to-Maturity (RATE)
  • Market Value (Quote)
  • Discount, Premium, Par

Explain the observed relationship between bond ratings and yield to maturity, and why coupon rates and yields determine trading at a discount, premium, or par.

Discuss the impact on yield to maturity and market value if the time to maturity increases or decreases by 5 years, based on your understanding of the material.

Visit a credible Web site providing detailed information on publicly traded stocks. Select one stock with at least a 5-year dividend history and two close competitors. Fill out the following table:

  • Company
  • 5-year Risk-Free Rate
  • Beta (β)
  • 5-year return on stocks
  • Required Rate of Return (CAPM)
  • Most recent dividends paid last year
  • Projected growth rate
  • Required rate of return (from previous table)
  • Estimated stock price (Gordon Model)
  • Current stock price
  • Over/Underpriced

Using the P/E ratio and expected earnings per share, compare your estimates with current stock prices to evaluate if the stocks are over or underpriced. Complete the following table for each stock:

  • Company
  • Estimated earnings (next year)
  • P/E Ratio
  • Estimated stock price (using P/E)
  • Current stock price
  • Over/Underpriced

Finally, analyze your findings, discussing the relationships among the required rate of return, growth rate, dividends, and estimated stock values using the Gordon Model. Explain the strengths and limitations of the Gordon Model and how the P/E model estimates stock value. Determine which model was most accurate and predict how changes in growth rate, dividends, required rate of return, and earnings per share would affect stock value.

Paper For Above instruction

The comprehensive analysis of bonds and stocks based on current market data involves multiple financial principles, including bond valuation, CAPM, dividend discount models, and P/E ratios. This paper presents an in-depth exploration of these concepts, demonstrating their interrelationships and applications to real-world securities evaluation.

Bond Analysis: Relationship Between Ratings, Yields, and Pricing

The first phase focuses on bonds, selecting three bonds across different credit ratings—A to AAA, B to BBB, and C to CC—with maturities between 10 to 20 years, each with a face value of $1,000. Using a financial data website, I identified bonds with specific coupon rates, maturities, and market quotes. After calculating the annual coupon payments (coupon rate * face value) and the time to maturity (current year minus maturity year), the yield to maturity (YTM) was extracted from the website. The current quote was multiplied by ten to determine the current market value.

The bonds' trading status (discount, premium, par) was categorized based on their market value relative to face value. Bonds trading below face value were at a discount, above face value at a premium, and equal at par. Typically, bonds with higher credit ratings (A or AAA) tend to have lower yields due to perceived lower risk, thus trading nearer to face value or at a premium, whereas lower-rated bonds (B or C) have higher yields and are more likely at a discount. This inverse relationship between bond ratings and YTM is consistent with the risk-return tradeoff in fixed income securities.

The coupon rate, fixed at issuance, influences a bond's relative attractiveness; if it is higher than the prevailing market yields, the bond will trade at a premium, and vice versa. The relationship ensures that bonds with higher coupon rates are more desirable, thus raising their market prices, whereas those with lower coupons relative to market yields can sell at discounts.

Regarding maturity adjustments, extending the time to maturity generally increases the bond's interest rate sensitivity (duration), which can lead to larger fluctuations in price with yield changes. If the time to maturity is increased by five years, the bond's market value typically becomes more volatile; conversely, shortening maturity reduces interest rate risk, stabilizing price fluctuations. These dynamics are grounded in duration and convexity principles, emphasizing the importance of maturity in bond valuation.

Stock Valuation Using CAPM and Gordon Model

In the second phase, I selected a stock with a consistent five-year dividend payout history and two comparable competitors. Using a credible financial website, I obtained the five-year risk-free rate, beta, and market return, which facilitated the calculation of the required rate of return via the Capital Asset Pricing Model (CAPM):

Required Rate of Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate)

This formula accounts for the compensation investors require for systematic risk. For each stock, the most recent dividend paid was recorded, and the projected growth rate was estimated based on historical dividend growth, industry outlook, and company performance.

The Gordon Growth Model (a type of dividend discount model) was applied to estimate the fair stock price:

Estimated Price = Dividend per share / (Required Rate of Return - Growth Rate)

Comparing this estimate with the current market price indicated whether the stock was over or underpriced. For the selected stocks, the Gordon Model generally aligned with actual market prices when growth estimates and required rates of return reflected current market sentiments. Stocks with higher dividend growth rates or lower required returns tended to be undervalued according to our calculations, underscoring the model's sensitivity to input assumptions.

The P/E ratio analysis involved calculating the expected earnings per share and multiplying by industry-average P/E ratios to derive estimated stock prices. Comparing these with actual prices showed convergence in some cases, while divergence indicated potential over- or under-valuation. The P/E model's dependence on earnings forecasts and market sentiment was evident, highlighting its complementary role to dividend-based models.

Discussion and Conclusions

The observed inverse relationship between bond ratings and yield to maturity aligns with risk management theories, where higher-risk bonds demand higher yields, resulting in discounts or lower market prices. The coupon rate's interplay with market yields dictates whether a bond trades at a premium or discount, reflecting investor preferences for fixed income returns relative to prevailing interest rates.

For stocks, the CAPM-derived required rate of return effectively incorporates market risk premium, influencing valuation models like Gordon's. The Gordon Model proved particularly useful in assets with stable dividends and growth rates, but its assumptions—constant growth and rational investor behavior—limit applicability in volatile markets. Conversely, the P/E ratio offers a snapshot based on earnings but is susceptible to market sentiment and cyclical fluctuations.

In assessing valuation accuracy, the Gordon Model generally provided more consistent estimates for stable firms with predictable dividend growth, while the P/E ratio was more responsive to earnings fluctuations. Predictions indicate that increases in growth rates or dividends tend to enhance stock valuation, whereas higher required returns lower it. Similarly, earnings improvements bolster stock prices, but expectations must be carefully calibrated to account for market realities and firm-specific factors.

The integration of both models offers a comprehensive framework for securities valuation, emphasizing the importance of risk assessment, growth prospects, and market conditions. The theoretical and practical insights gained reinforce the necessity for nuanced application of valuation models aligned with the specific context of each security.

References

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