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Year 1 - Accounting and Finance > finance lec 6-7 - VALUING BONDS AND SHARES > Flashcards

finance lec 6-7 - VALUING BONDS AND SHARES Flashcards

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1
Q

WHAT IS RELATIONSHIUP 1

A

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

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2
Q

why si the YTM most important

A

used to price bond

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3
Q

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

A

investors got to pay mkt price of bond

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4
Q

cf associated w the repayment are

A

fixed

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5
Q

price is not equal to

A

yield

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6
Q

what happesn if yield increases

A

price decreases

bond mkt has had a terrible da

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7
Q

what do yields determine * (* means check)

A

prices

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8
Q

realtionship between prie and yield

A

inverse

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9
Q

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

A

0

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10
Q

relationship 2(hintc returns and dr)

A

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)

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11
Q

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

A

small change in ST cashflows(bonds)

larger impact on LT cashflows (bonds)

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12
Q

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

A

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

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13
Q

Why are ST bonds less risky than LT bonds

A

extent to which £ an fluctuate are more restricted

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14
Q

the higher the risk the higher the

A

return

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15
Q

Relationship between risk and return is

A

+VE

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16
Q

risks of facing bond holders

A
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17
Q

upside of bonds capped why

A

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

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18
Q

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

A

interest

default - biggest

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19
Q

what is interest rate risk

A

if IR in mkt rises

value of bonds w fixed coupon will fall

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20
Q

what is default risk

A

bond issuer may not pay coupon or unable to pay principal

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21
Q

what provides reassuranve about default risk

A

bond ratings

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22
Q

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

A

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

23
Q

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

A

it’s risk free

24
Q

when does IR risk not matter

A

when plannig to hold bond till maturity

you know you’ll get principaland coupon repaytments

25
Q

why is IR risk signisfcnat for St bond holders

A

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

26
Q

the higher the credit rating

A

the lower the chance of default

27
Q

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

A

very high return

28
Q

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

A

default

higher return in exchange

29
Q

valuing shares

A
30
Q

what are the two types of shares

A

ordinary - OS
preference - PS

31
Q

mkt value of share =

A

PV of future CF

PV of future dividends

32
Q

future cf are

A

dividends

33
Q

what does the dividend growth model calculate

A

PV of a constantly increasing strwam of dividends

thsu calcualting the mkt calue fo teh share

34
Q

market value of share =

A

pv of future dividends

35
Q

when can company pay dividend to ordinary SH

A

made a profit

36
Q

dividend

A

reward company pays to SH in return for their investment

37
Q

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

A

0

if company made loss they can cut dividend to 0

38
Q

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

A

move upwards on sloping curve

tend to increase OT

increase slightly over GDP growth rate in the UK

39
Q

dividends sometimes described as uncertain why

A

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

40
Q

differnce between dividend and bonds

A
  • bonds youre certina w the cf/payment you gonna get

but dividends go up and down

  • also dividends can grow but cf stays certain
41
Q

how do we work out dividend payments in PV

A

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

42
Q

dividends can be classified as

A

growing perpetuity

43
Q

why can dividends be classified as a growing perpetuity

A

not fixed and can go on *forever *

44
Q

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

A

assume dividends grow at a constant rate

ignore that company may not be able to pay as a result of loss

45
Q

perpetuity formula

A

cf/r-g

46
Q

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

A

next dividend payment (cf)/discount rate - growth rate)

assume growth rate is constant*

47
Q

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

A

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

48
Q

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

A

next due dividend patment

49
Q

what is the other formula for MV of ordinary share

A

D0 (1+g)/(r-g) = D1/r-g

d0 = divideedn onw

d1 = dividend in one year

g = growth rate

r = discount rate/ROR

49
Q

MV of preference share

MV = PV of future cf

A

preference dividend (fixed)(future cf)

ror(dr)

/

D/R

50
Q

the differnece between ordinfary and preference shares is that dividends are ….

(… means expand )

A

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

51
Q

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

A

bonds got ltd life and

preference dividends usually in eprpetuity and ordinary shre sin perpetuity as long as comp operates

52
Q

what is special about the preference share formula

A

preference dividend is equal yearly

so no calculation of next dividend payment

53
Q

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

A

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

Year 1 - Accounting and Finance (49 decks)

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