finance lec 6-7 - VALUING BONDS AND SHARES Flashcards
WHAT IS RELATIONSHIUP 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
why si the YTM most important
used to price bond
what do investors have to pay any price after par value/when 1st issued
investors got to pay mkt price of bond
cf associated w the repayment are
fixed
price is not equal to
yield
what happesn if yield increases
price decreases
bond mkt has had a terrible da
what do yields determine * (* means check)
prices
realtionship between prie and yield
inverse
if the ror is 12% and the coupon rate is 12% what is the bond value
0
relationship 2(hintc returns and dr)
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)
relationship 3 - change in IR will cause what changes in st and lt bonds ?
small change in ST cashflows(bonds)
larger impact on LT cashflows (bonds)
which bonds are more affected by change in IR in terms of price and why
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
Why are ST bonds less risky than LT bonds
extent to which £ an fluctuate are more restricted
the higher the risk the higher the
return
Relationship between risk and return is
+VE
risks of facing bond holders
upside of bonds capped why
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
what are the 2 risks when it comes to bonds and whihc is the biggest
interest
default - biggest
what is interest rate risk
if IR in mkt rises
value of bonds w fixed coupon will fall
what is default risk
bond issuer may not pay coupon or unable to pay principal
what provides reassuranve about default risk
bond ratings
soveriegn/gov debts not risk free why do govs default on bonds issued in different currencies
can always print otu mroe of own money so can never default on own currency bonds but cant print out more of your own
jsut because a bond is highly rated AAA this doesn’t mean
it’s risk free
when does IR risk not matter
when plannig to hold bond till maturity
you know you’ll get principaland coupon repaytments
why is IR risk signisfcnat for St bond holders
prices change due to changes in IR which changes ROR for investors which changes YTM which changes price of bond `
the higher the credit rating
the lower the chance of default
if we dont percieve someon as a high risk borrowe what dont we ask for
very high return
as credit rating goes down e.g AAA to D borrowers are more liely to … so we ask for
default
higher return in exchange
valuing shares
what are the two types of shares
ordinary - OS
preference - PS
mkt value of share =
PV of future CF
PV of future dividends
future cf are
dividends
what does the dividend growth model calculate
PV of a constantly increasing strwam of dividends
thsu calcualting the mkt calue fo teh share
market value of share =
pv of future dividends
when can company pay dividend to ordinary SH
made a profit
dividend
reward company pays to SH in return for their investment
what is teh lwoeest value of dividend a shareholder can get and why
0
if company made loss they can cut dividend to 0
ot in aggregate terms what happens ot teh totla amount of dividends on a graph
move upwards on sloping curve
tend to increase OT
increase slightly over GDP growth rate in the UK
dividends sometimes described as uncertain why
copm can make prifit in one year or consistently anf hten a loss in the next year so no logner able to pay dividend
differnce between dividend and bonds
- bonds youre certina w the cf/payment you gonna get
but dividends go up and down
- also dividends can grow but cf stays certain
how do we work out dividend payments in PV
W/o dividend payments as relevant cf for shares then calc PV of payments
dividends can be classified as
growing perpetuity
why can dividends be classified as a growing perpetuity
not fixed and can go on *forever *
the view of a growing perpetuity for dividends is quite siplitic what assumptions do we make
assume dividends grow at a constant rate
ignore that company may not be able to pay as a result of loss
perpetuity formula
cf/r-g
how do we work out the market value of an ordinary share
next dividend payment (cf)/discount rate - growth rate)
assume growth rate is constant*
when working out the market value of an ordianry share why do we use the next dividend payment
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
when working out the MV of an ordinary share if we know the current dividend and growth rate (given) what can we work out
next due dividend patment
what is the other formula for MV of ordinary share
D0 (1+g)/(r-g) = D1/r-g
d0 = divideedn onw
d1 = dividend in one year
g = growth rate
r = discount rate/ROR
MV of preference share
MV = PV of future cf
preference dividend (fixed)(future cf)
ror(dr)
/
D/R
the differnece between ordinfary and preference shares is that dividends are ….
(… means expand )
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
what is another differnce between bonds and sahres int erms of time
bonds got ltd life and
preference dividends usually in eprpetuity and ordinary shre sin perpetuity as long as comp operates
what is special about the preference share formula
preference dividend is equal yearly
so no calculation of next dividend payment
DR/ROR is not the same for ordinary shares as it is for dividend dividend payment why
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
