finance lec 6-7 - VALUING BONDS AND SHARES

Question 1

WHAT IS RELATIONSHIUP 1

Answer 1

value of bond inversley related to change in investors present ROR (based on mkt IR aka DR)

as amrket rate icnreases the bondholders required return increases
the coupon is fixed

the ytm = ror

value of bond

Question 2

why si the YTM most important

Answer 2

used to price bond

Question 3

what do investors have to pay any price after par value/when 1st issued

Answer 3

investors got to pay mkt price of bond

Question 4

cf associated w the repayment are

Answer 4

fixed

Question 5

price is not equal to

Answer 5

yield

Question 6

what happesn if yield increases

Answer 6

price decreases

bond mkt has had a terrible da

Question 7

what do yields determine * (* means check)

Answer 7

prices

Question 8

realtionship between prie and yield

Answer 8

inverse

Question 9

if the ror is 12% and the coupon rate is 12% what is the bond value

Answer 9

0

Question 10

relationship 2(hintc returns and dr)

Answer 10

mkt value of a bondwillbe

less than par value if the investors required rate of return is above the coupon rate (at a discount)

above par value if the investors ROR is below the coupon rate (@ a premium)

at par value if investors ROR is equal to coupon rate (@par)

Question 11

relationship 3 - change in IR will cause what changes in st and lt bonds ?

Answer 11

small change in ST cashflows(bonds)

larger impact on LT cashflows (bonds)

Question 12

which bonds are more affected by change in IR in terms of price and why

Answer 12

long term

more volatile and sensitive to changes in IR

more exposed to changes in IR and yields

subject to bigger swings in value as a result of the change in yield and IR

Question 13

Why are ST bonds less risky than LT bonds

Answer 13

extent to which £ an fluctuate are more restricted

Question 14

the higher the risk the higher the

Answer 14

return

Question 15

Relationship between risk and return is

Answer 15

+VE

Question 16

risks of facing bond holders

Question 17

upside of bonds capped why

Answer 17

cf are certain and we know how much we gonna get

but if money lent turns otu to make big profit your reward is capped - only get principala and coupon repayment regardless of what happens

Question 18

what are the 2 risks when it comes to bonds and whihc is the biggest

Answer 18

interest

default - biggest

Question 19

what is interest rate risk

Answer 19

if IR in mkt rises

value of bonds w fixed coupon will fall

Question 20

what is default risk

Answer 20

bond issuer may not pay coupon or unable to pay principal

Question 21

what provides reassuranve about default risk

Answer 21

bond ratings

Question 22

soveriegn/gov debts not risk free why do govs default on bonds issued in different currencies

Answer 22

can always print otu mroe of own money so can never default on own currency bonds but cant print out more of your own

Question 23

jsut because a bond is highly rated AAA this doesn’t mean

Answer 23

it’s risk free

Question 24

when does IR risk not matter

Answer 24

when plannig to hold bond till maturity

you know you’ll get principaland coupon repaytments

Question 25

why is IR risk signisfcnat for St bond holders

Answer 25

prices change due to changes in IR which changes ROR for investors which changes YTM which changes price of bond `

Question 26

the higher the credit rating

Answer 26

the lower the chance of default

Question 27

if we dont percieve someon as a high risk borrowe what dont we ask for

Answer 27

very high return

Question 28

as credit rating goes down e.g AAA to D borrowers are more liely to ... so we ask for

Answer 28

default higher return in exchange

Question 29

valuing shares

Question 30

what are the two types of shares

Answer 30

ordinary - OS preference - PS

Question 31

mkt value of share =

Answer 31

PV of future CF PV of future dividends

Question 32

future cf are

Answer 32

dividends

Question 33

what does the dividend growth model calculate

Answer 33

PV of a constantly increasing strwam of dividends thsu calcualting the mkt calue fo teh share

Question 34

market value of share =

Answer 34

pv of future dividends

Question 35

when can company pay dividend to ordinary SH

Answer 35

made a profit

Question 36

dividend

Answer 36

reward company pays to SH in return for their investment

Question 37

what is teh lwoeest value of dividend a shareholder can get and why

Answer 37

0 if company made loss they can cut dividend to 0

Question 38

ot in aggregate terms what happens ot teh totla amount of dividends on a graph

Answer 38

move upwards on sloping curve tend to increase OT increase slightly over GDP growth rate in the UK

Question 39

dividends sometimes described as uncertain why

Answer 39

copm can make prifit in one year or consistently anf hten a loss in the next year so no logner able to pay dividend

Question 40

differnce between dividend and bonds

Answer 40

- bonds youre certina w the cf/payment you gonna get but dividends go up and down - also dividends can grow but cf stays certain

Question 41

how do we work out dividend payments in PV

Answer 41

W/o dividend payments as relevant cf for shares then calc PV of payments

Question 42

dividends can be classified as

Answer 42

*growing* perpetuity

Question 43

why can dividends be classified as a growing perpetuity

Answer 43

not fixed and can go on *forever *

Question 44

the view of a growing perpetuity for dividends is quite siplitic what assumptions do we make

Answer 44

assume dividends grow at a constant rate ignore that company may not be able to pay as a result of loss

Question 45

perpetuity formula

Answer 45

cf/r-g

Question 46

how do we work out the market value of an ordinary share

Answer 46

next dividend payment (cf)/discount rate - growth rate) assume growth rate is constant*

Question 47

when working out the market value of an ordianry share why do we use the *next* dividend payment

Answer 47

formula gives us value when 1st payment a year from now so for formula to give us PV today we need to use next divident payment whih is a yar from now

Question 48

when working out the MV of an ordinary share if we know the current dividend and growth rate (*given*) what can we work out

Answer 48

next due dividend patment

Question 49

what is the other formula for MV of ordinary share

Answer 49

D0 (1+g)/(r-g) = D1/r-g d0 = divideedn onw d1 = dividend in one year g = growth rate r = discount rate/ROR

Question 49

MV of preference share MV = PV of future cf

Answer 49

preference dividend (fixed)(future cf) --------------------------------------- ror(dr) / D/R

Question 50

the differnece between ordinfary and preference shares is that dividends are .... (... means expand )

Answer 50

dividends are fixed - so regardless of how prifit of company are so somewhat like a bond as payments are known in advance slight risk - dont get paid if profits are not there but if profit is there payments are fixed and certain

Question 51

what is another differnce between bonds and sahres int erms of time

Answer 51

bonds got ltd life and preference dividends usually in eprpetuity and ordinary shre sin perpetuity as long as comp operates

Question 52

what is special about the preference share formula

Answer 52

preference dividend is equal yearly so no calculation of next dividend payment

Question 53

DR/ROR is not the same for ordinary shares as it is for dividend dividend payment why

Answer 53

cause level of risk is different i.e. with both shares you dont get paid if 0 profit but when theer eis profit preference shares fixed where as OS are vary preference paid first - if any leftover then ordinary share holders get dividends so rpeference risk lower hence why ROR preference share is lower