Part 1 Bonds Valuation Calculations Week 3 Assignment Templa

Part 1 Bonds Valuation Calcsbus3062 Week 3 Assignment Template

Part 1 - Bonds Valuation Calcs BUS3062 Week 3 Assignment Template

PART 1: Bond Valuation Solve the following problems and answer the last question. Example problems can be found on the "Bond Valuation Example" tab below. Create appropriate formulas using the supplied values in the corresponding cells so Excel can calculate the answer.

1. Compute the price of a 3.8 percent coupon bond with 18 years left to maturity and a market interest rate of 7 percent. Compute the price again if interest payments are paid semi-annually (solve using semi-annual compounding). Par value is $1000. [Annual Compounding Answer] [Semi-annual Compounding Answer]

2. A 6.50 percent coupon bond with 18 years left to maturity is offered for sale at $1,035.25. What yield to maturity [interest rate] is the bond offering? Assume interest payments are paid semi-annually, and solve using semi-annual compounding. Par value is $1000. [Annual Compounding Answer] [Semi-annual Compounding Answer]

3. You have just paid $1,135.90 for a bond, which has 10 years before it matures. It pays interest every six months. If you require an 8 percent return from this bond, what is the coupon rate on this bond? Par value is $1000. [Answer here]

4. A company XYZ issued 30 year bonds with 10% annual coupon rate at their par value of $1000 in 2010. The Bonds had a 7% call premium, with 5 years of call protection. Today XYZ called the bonds. Compute the realized rate of return for an investor who purchased the bonds when they were issued in 2010. Briefly explain why the investor should or should not be happy. [Answer here] [Explanation here]

5. ABC Corporation outstanding bonds have a par value of $1000, 8% coupon and 15 years to maturity and a 10% YTM. What is the bond's price? [Answer here]

6. What does a call provision [call feature] allow [bond] issuers to do and under what circumstances would they do it? [Answer here]

Part 2 - Stocks Valuation Calcs

PART 2: Stock Valuation Solve the following problems and answer the last question.Create appropriate formulas using the supplied values in the corresponding cells so Excel can calculate the answer. Example problems can be found on the "Stock Valuation Example" tab below. Show your work.

1. On March 5, 2013, the Dow Jones Industrial Average set a new high. The index closed at 14,253.77, which was up 125.95 that day. What was the return (in percent) of the stock market that day? [Answer here]

2. Your discount brokerage firm charges $9.50 per stock trade. How much money do you need to buy 300 shares of Time Warner, Inc. (TWX), which trades at 22.62? [Answer here]

3. Financial analysts forecast XYZ company's growth for the future to be a constant 8 percent. XYZ's recent dividend was $0.88. What is the value of XYZ stock when the required return is 12 percent? [Answer here]

4. A preferred stock from ABC pays $3.55 in annual dividends. If the required return on the preferred stock is 6.7 percent, what is the value of the stock? [Answer here]

5. QRST has earnings per share of $1.56 and a P/E ratio of 32.48. What's the stock price? [Answer here]

6. Explain why the Standard & Poor’s 500 Index might be a better measure of stock market performance than the Dow Jones Industrial Average. [Answer here]

Paper For Above instruction

The following comprehensive analysis addresses bond and stock valuation problems as outlined in Part 1 and Part 2 of the assignment instructions. It applies core financial principles, formulas, and real-world considerations to showcase mastery in valuing bonds and equities, interpret features such as call provisions, and analyze indices relevant for market performance measurement.

Bond Valuation

Bond valuation involves calculating the present value of future cash flows that a bond is expected to generate. These cash flows include periodic coupon payments and the repayment of par value at maturity. The computation adjusts for the frequency of interest payments, typically semi-annual in bond markets, and the prevailing market interest rate. The basic formula utilizes the present value of an annuity (coupon payments) and the present value of a lump sum (par value), discounted at the market rate of interest.

For instance, consider a bond with a 3.8% coupon rate, 18 years remaining to maturity, and a market interest rate of 7%. The par value is $1,000. To compute the bond’s price, first, convert the annual coupon rate into semi-annual payments: $38 per period. The semi-annual market rate is 3.5% (7% / 2). The total number of periods is 36 (18 years x 2). The two-step calculation involves discounting the coupon payments as an annuity and the par value as a lump sum, then summing these discounted values to find the bond price.

The formula in Excel would be: =PV(3.4%, 36, -40, -1000), which yields approximately $1,097.37. The negative signs indicate cash outflows in Excel’s PV function but are conventionally reversed for interpreting the bond price.

Similarly, if interest payments are semi-annual, the calculation adjusts for the payment frequency, affecting the interest rate and the total periods. This process exemplifies the importance of accurate periodic adjustments in financial valuations.

Zero-coupon bonds, which pay no periodic interest, are valued solely on the present value of their face value and are calculated similarly but with the interest payment set to zero. The price reflects the discounted future value discounted at the market rate compounded semi-annually over the bond’s remaining periods.

Yield to Maturity (YTM)

The yield to maturity is the internal rate of return (IRR) on a bond assuming it is held to maturity, considering the current market price, coupon payments, and face value. To solve for YTM, the typical approach involves iterative calculation or financial calculator functions like Excel’s RATE formula, adjusting inputs for semi-annual payments.

For example, a bond with a current price of $952.52, a 5% coupon rate, and nine years to maturity has a semi-annual cash flow of $25. The calculation reveals a semi-annual YTM of approximately 3%, translating to an annual YTM of 5.68% after doubling the semi-annual rate. Similar steps apply for bonds with different prices, coupons, and remaining durations, illustrating how market prices influence yield calculations.

Stock Valuation

Stock valuation primarily employs models such as the Dividend Discount Model (DDM) and Price/Earnings ratios. For a stock with expected dividends growing at a constant rate, the Gordon Growth Model provides the current stock value based on future dividends, the required rate of return, and the growth rate:

P0 = D1 / (i - g)

Here, D1 is the next year's dividend, i is the required return, and g is the growth rate. For example, with a recent dividend of $0.88, a growth rate of 8%, and a required return of 12%, D1 is calculated as $0.88 * (1 + 0.08) = $0.95. Plugging into the formula yields a stock value of approximately $10.24.

Preferred stocks with fixed dividends can be valued by dividing the annual dividend by the required return: $3.55 / 0.067 ≈ $53.02.

Market indices like the S&P 500 and Dow Jones are benchmarks for overall market performance. The S&P 500, comprising 500 large-cap stocks, is generally considered a more comprehensive and representative indicator compared to the Dow Jones, which includes only 30 large companies. The broader scope of the S&P 500 often provides a more accurate reflection of overall market trends and movements.

Call Provisions and Market Indices

A call provision grants bond issuers the right, but not the obligation, to redeem bonds before maturity, often at a premium and under specific conditions. Issuers typically invoke call provisions when prevailing interest rates decline, allowing them to refinance debt at lower costs, thus reducing their interest expense but potentially disadvantaging bondholders who face reinvestment risk.

Understanding these features is critical for investors because they influence bond prices and yields, adding an element of optionality to fixed-income investments.

Conclusion

Accurately valuing bonds and stocks is fundamental to prudent investment decision-making. Utilizing proper formulas, understanding market features such as call provisions, and recognizing the strengths and limitations of market indices enhance both theoretical understanding and practical investment strategies. This analysis demonstrates the integration of financial theory with real-world applications, emphasizing the significance of precision in valuation calculations.

References

  • Damodaran, A. (2012). Investment Valuation: Tools and Techniques for Determining the Value of Any Asset. Wiley Finance.
  • Fabozzi, F. J. (2016). Bond Markets, Analysis and Strategies. Pearson Education.
  • Ross, S. A., Westerfield, R., & Jaffe, J. (2019). Corporate Finance. McGraw-Hill Education.
  • Brealy, R. A., Myers, S. C., & Allen, F. (2021). Principles of Corporate Finance. McGraw-Hill Education.
  • Valuation: Measuring and Managing the Value of Companies (6th Edition). (2015). McKinsey & Company Inc.
  • Graham, B., & Dodd, D. L. (2008). Security Analysis: Sixth Edition. McGraw-Hill.
  • Investopedia. (2023). "Understanding Bond Valuation." https://www.investopedia.com/terms/b/bondvaluation.asp
  • Morningstar. (2023). "Comparison of Market Indices." https://www.morningstar.com/
  • Corporate Finance Institute. (2023). "Yield to Maturity (YTM)." https://corporatefinanceinstitute.com/resources/knowledge/finance/yield-to-maturity-ytm/
  • Standard & Poor’s. (2023). "Understanding Market Benchmarks." https://www.spglobal.com/spdji/en/

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