Bond and Stock Valuation

Question 1

Bond Duration

Answer 1

Weighted average maturity of a bonds cash flow on a present value basis

Price sensitivity to changes in interest rate

Used to compare price volatility. Higher duration = more volatile

Moment in time where investor is immune to interest rate and reinvestment risk

duration of portfolio should equal investors time horizon

Question 2

Bond Duration Principles

Answer 2

y= current yield on comparative bonds
( when market interest rate increases, duration decreases)

t = years to maturity

c= annual coupon rate

Increases Duration = longer YTM, Longer maturity, lower coupon, lower market interest rates

Question 3

Immunization

Answer 3

Duration of the bond portfolio equals time horizon of client.

Offsets interest rate risk and reinvestment risk

Question 4

Interest Rate Risk

Answer 4

Price risk - bond price and required rate of return

Reinvestment Risk- uncertainty about rate income can be reinvested at

Question 5

Zero’s - Duration

Answer 5

duration equals maturity

Price fluctuates MORE than coupon bonds with same maturity

Question 6

Duration- Bond interest rate changes

Answer 6

most important measure of risk

measures sensitivity to interest rate changes

Question 7

Convexity

Answer 7

allows us to improve the duration approximation for bond price changes
degree to which duration changes as YTM changes

convexity is largest for:
low coupon bonds
long maturity bonds
low YTM bonds

Question 8

Capitalized Earnings

Answer 8

based on estimates of issuers earning power X derived capitalization rate

Works well for established companies

Question 9

Zero Growth Model

Answer 9

Price = Dividend
——————
Required rate of return

preferred stock

Question 10

Constant Growth Model

Answer 10

Dividends grow at a constant rate

Price = Dividend (1+growth of dividend rate)
—————————————————-
required rate - growth rate of dividends

Question 11

Expected Return

Answer 11

Er = Dividend(1+growth rate of dividend) + growth rate
—————————————————–
Price

Question 12

Dividend Discount Model

Answer 12

market lowers the required rate of return, then the value of the stock will rise

expectations for higher dividend - the stock price will rise

6-9 FOR PROBLEMS
Does not work for co with no dividends or no dividend growth …use P/E

Question 13

Price to Earnings

Answer 13

P/E stock price has some relationship to earnings per share

Current Market Price = earnings X P/E

Determine if stock is undervalued or overvalued

Question 14

Price/Free Cash flow

Answer 14

Co pays no dividend
FCF (1+g)
————-
r -g