STOCK

&
BOND VALUATION
FAISAL SARWAR
KEY FEATURES OF BOND
Par value: Face amount; paid at maturity.
Assume $1,000.

Coupon interest rate: Stated interest rate.

Multiply by par value to get dollars of interest.
Generally fixed.
 Maturity: Years until bond must be repaid.
Declines.

Issue date: Date when bond was issued.

Default risk: Risk that issuer will not make

interest or principal payments.
How does adding a call provision affect a
bond?
Issuer can refund if rates decline. That helps the
issuer but hurts the investor.
Therefore, borrowers are willing to pay more, and
lenders require more, on callable bonds.
Most bonds have a deferred call and a declining call
premium.
What’s a sinking fund?
Provision to pay off a loan over its life rather than all at
maturity.
Similar to amortization on a term loan.
Reduces risk to investor, shortens average maturity.
But not good for investors if rates decline after
issuance.
Difference in these terms
Difference between Bond and stock
Difference between Bank loan and Bond
Difference between Coupon rate and YTM
Difference between zero coupon bond and coupon
bond
Bond Value ($)
1,372
kd = 7%.
1,211

1,000
kd = 10%. M

837
kd = 13%.
775

30 25 20 15 10 5 0

Years remaining to Maturity

At maturity, the value of any bond must equal its
par value.
The value of a premium bond would decrease to
$1,000.
The value of a discount bond would increase to
$1,000.
A par bond stays at $1,000 if kd remains constant.
What’s “yield to maturity”?
YTM is the rate of return earned on a bond held to
maturity. Also called “promised yield.”
If coupon rate < kd, bond sells at a discount.
If coupon rate = kd, bond sells at its par value.
If coupon rate > kd, bond sells at a premium.
If kd rises, price falls.
Price = par at maturity.
YTM
1
A 10-year bond with 12.5% coupon rate and $1000 face
value yield to maturity is 14.5% . Assuming annual
coupon payment, calculate the price of the bond.
2
Suppose you want to offer zero coupon bond with a
face value of $1,000 maturing in twenty years. If the
yield to maturity (YTM) on the bond is 8.00%, what
will the price of the bond offered by your company?
The price of a bond is $920 with a face value of $1000
which is the face value of many bonds. Assume that
the annual coupons are $100, which is a 10% coupon
rate, and that there are 10 years remaining until
maturity
Stock valuation
Facts about Common Stock
Represents ownership.
Ownership implies control.
Stockholders elect directors.
Directors hire management.
Management’s goal: Maximize stock price.
When is a stock sale an initial public offering
(IPO)?
 A firm “goes public” through an IPO when the stock is
first offered to the public.
 Prior to an IPO, shares are typically owned by the
firm’s managers, key employees, and, in many
situations, venture capital providers.
Different Approaches for Valuing Common
Stock
Dividend growth model
Using the multiples of comparable firms
Free cash flow method
Difference in these terms

Par value/face value

Book value/Break up price per share
Market price
Fair/Intrinsic value
Multiple year Holding period
Dividend Discount Model
Preferred Stock Valuation
Constant growth model
example
Estimating the Value of G
Multistage DDM
Dividend discount model
D0 was $2.00 and g is a constant 6%. Find the
expected dividends for the next 3 years, and their PVs.
ks = 13%.
You own a stock that will start paying $0.50 annually at
the end of the year. It will then grow each year at a
constant annual rate of 5%. If the required rate of
return is 14%, what should you pay per share?
You are considering investing in ICI. Suppose ICI
currently paid $3 dividend and enjoying super growth
and expected to pay 30% more in dividends each
year for 3 years. After these three years the dividend
growth rate is expected to be 2% per year forever. If the
required return for ICI common stock is 11%, what is a
share worth today?