Bonds Bond valuation Stocks Stock valuation

Bonds and stocks

Gitman chapters 6 and 7

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Content

Bonds

Bond valuation

Stocks

Stock valuation

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Bond characteristics

• Maturity?
• How frequently is interest and principal paid?
• Risk and return

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Treasury bonds

• Issue through auctions, for large institutions

• Investment banks can repackage a Treasury bond cash flows
into STRIPS
• Some bonds protect investors against inflation (TIPS)

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Corporate bonds

• Placement: public or private

• Interest on bonds can be tax-deductible
• Special bonds
• Zero-coupon bond
• Variable-rate bonds
• Convertible bonds

• Requirements before issuing bonds in Vietnam Link

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Credit risk

• Interest rate depends on default risk

• Current capital structure and economic conditions can affect
default risk
• Bond can be secured by collateral

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Credit risk

• Credit rating

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Bond covenant

• Protect bondholders
• Limits on dividend payout
• Limits on management compensation
• Restricting new debts

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Using revenue from bond issuance

• Change capital structure

• Debt is cheaper than equity
• Buy back the company’s own stock
• What if debt/equity ratio is too high?

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Yield to maturity - YTM

• The average return an investor will earn if the bond is

purchased at the current market price and held until maturity

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Price zero-coupon bonds

Fn
P=
(1 + r )n

P: bond price
Fn : bond face value
n: years until maturity
r : YTM

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Application

• VNM issues zero-coupon with face value of $1000, 10 years in

maturity. YTM = 8%.
How much VNM will receive from the issuance?

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Price coupon bonds

C C C + Fn
P= + 2
+ ... +
1+r (1 + r ) (1 + r )n

P: bond price
Fn : bond face value
n: years until maturity
r : YTM
C = c × Fn : Coupon ($)

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Application

• Bond ACB is trading at YTM = 11%. The face value is

$1000, coupon rate c = 10%/year on face value (pay
annually). The remaining maturity is 2 years.
What is the current bond price?

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Bonds that pay coupon every six months

C C C
2 2 2 + Fn
P= r + r 2 + ... +
1+ 2 (1 + 2) (1 + 2r )2n
• YTM (r ) is an annual rate, so the formula has to be adjusted

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Application

• Bond VNG is trading at YTM = 8%. The face value is $1000,

coupon rate 12%/year (pays semiannually), the remaining
maturity is 20 years. .
What is the current bond price?

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The relationship between YTM and bond price

• If YTM increases, bond price will...

• The role of maturity
Treasurys Yield

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Stocks

• Owning a share means owning a small part of the company

• Shareholders have voting right
• Shareholders have residual claim on the company

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Return to shareholders

• Dividend when the company makes a profit in a given year

• Receive after the company has paid its current-period
obligations (wage, debt...)
• May receive nothing

• Capital gain from higher stock price

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Stock price
• Unlimited upside potential
• But price can crash to zero

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How shares are issued

• Private equity
• Venture capital
• Private equity funds
• Public equity
• Initial public offerings
• Secondary stock offerings

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Preferred stock

• Special: has priority over common stock in claiming assets of

the company
• Pay fixed dividend
• No voting right

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Stock valuation

• Discounted cash flow model

• Price multiples
• Asset-based method

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Dividend discount model

• If stock is bought then held for one year

• Sell after one year, receive
D1 + P1
V0 =
1+r
• So, similarly
D 2 + P2
P1 =
1+r
• Sell after n year of holding
n
X Dt Pn
V0 = t
+
(1 + r ) (1 + r )n
t=1

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Dividend discount model

• The company is assumed to last forever

• Stock value is the sum (in today’s value) of all future
dividends
∞
X Dt
V0 =
(1 + r )t
t=1

V0 : present value
Dt : dividend in year t
r : discount rate, what investors require from investing in the stock

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Constant dividend assumption

• Dividend does not change

D1
V0 =
r

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Gordon growth model

• Dividend grows with annual rate g indefinitely

D1 D0 (1 + g )
V0 = =
r −g r −g

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Application

• Stock VNM just paid $4 of annual dividend at the end of

2022. Dividend grows at a rate of 5%/year. Discount rate is
15%.
What should be the current value of stock?

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