How to Value Bonds and Stocks Flashcards
A bond is a legally binding agreement between a
______ (bond ______) and a _____ (_______).
A bond is a legally binding agreement between a
borrower (bond issuer) and a lender (bondholder).
A bond specifies the ____ amount of the ____.
A bond specifies the principal amount of the loan.
A bond specifies the _____ and _____ of the ____ _____:
• In dollar terms (_____-rate borrowing)
• As a formula (______-rate borrowing)
A bond specifies the size and timing of the cash flows:
• In dollar terms (fixed-rate borrowing)
• As a formula (adjustable-rate borrowing)
First Principle:
Value of financial securities = ____ of ______ ______ cash
flows
First Principle:
Value of financial securities = PV of expected future cash
flows
To value bonds and stocks we need to:
– Estimate ___ ___ ___:
• ______
• ______
To value bonds and stocks we need to:
– Estimate future cash flows:
• Size (how much) and
• Timing (when)
To value bonds and stocks we need to:
– ________ future cash _____ at an appropriate rate.
• The rate should be appropriate to the _____ presented by the ______.
To value bonds and stocks we need to:
– Discount future cash flows at an appropriate rate.
• The rate should be appropriate to the risk presented by the security.
Bond value is determined by the present value of the
______ ____ and ____ ____.
Bond value is determined by the present value of the
coupon payments and face value.
Discount rates are ______ related to present (i.e., bond)
values.
Discount rates are inversely related to present (i.e., bond)
values.
If you know the price of a bond and the size and timing of cash flows, the yield to maturity (YTM) is the ______
rate.
If you know the price of a bond and the size and timing of cash flows, the yield to maturity (YTM) is the discount
rate.
Pure Discount Bonds:
Make ____ periodic _____ payments (coupon rate =
____%)
Pure Discount Bonds:
Make no periodic interest payments (coupon rate =
0%)
Pure Discount Bonds: The entire YTM comes from the difference between the _____ price and the ____ value.
Pure Discount Bonds: The entire YTM comes from the difference between the purchase price and the face value.
Pure Discount Bonds: Cannot sell for more than ____ value
Pure Discount Bonds: Cannot sell for more than face value
Pure Discount Bonds: Sometimes called _____, ____ discount bonds, or
_____ issue discount bonds (OIDs)
Pure Discount Bonds: Sometimes called zeroes, deep discount bonds, or
original issue discount bonds (OIDs)
Pure Discount Bonds: _____ Bills and _______-only Treasury strips are
good examples of zeroes.
Pure Discount Bonds: Treasury Bills and principal-only Treasury strips are
good examples of zeroes.
Pure Discount Bonds: Promise a _____ payment at a ____ future date.
Pure Discount Bonds: Promise a single payment at a fixed future date.
Information needed for valuing pure discount bonds:
– Time to maturity (T) = ___ - ____
– (F)
– (r)
Information needed for valuing pure discount bonds:
– Time to maturity (T) = Maturity date - today’s date
– Face value (F)
– Discount rate (r)
Level Coupon Bonds: Make _____ ____ payments in addition to the _____ value.
Level Coupon Bonds: Make periodic coupon payments in addition to the maturity value.
Level Coupon Bonds: The payments are ____ each period. Therefore, the
bond is just a combination of an _____ and a terminal (_____) value.
Level Coupon Bonds: The payments are equal each period. Therefore, the
bond is just a combination of an annuity and a terminal (maturity) value.
Level Coupon Bonds: Coupon payments are typically ______
Level Coupon Bonds: Coupon payments are typically semiannual
Information needed to value level-coupon bonds:
– (T)
– (C) and (F)
– _____ rate
Information needed to value level-coupon bonds:
– Coupon payment dates and time to maturity (T)
– Coupon payment (C) per period and Face value (F)
– Discount rate
Value of a Level-coupon bond
= PV of coupon payment _____ + PV of ____ value
Value of a Level-coupon bond
= PV of coupon payment annuity + PV of face value
Consols: bonds without a ____ _____.
Consols: bonds without a final maturity.
British consols pay a ____ amount (i.e., ___) every
period ____.
British consols pay a set amount (i.e., coupon) every
period forever.
Consols are an example of _____.
Consols are an example of perpetuity.
Bond prices and market interest rates move in
______ directions.
Bond prices and market interest rates move in
opposite directions.
A level-coupon bond trades in the following ways:
1. At the face value if the coupon rate is _____ to the
marketwide interest rate.
2. At a discount if the coupon rate is ____ than the
marketwide interest rate.
3. At a premium if the coupon rate is _____ than the
marketwide interest rate.
A level-coupon bond trades in the following ways:
1. At the face value if the coupon rate is equal to the
marketwide interest rate.
2. At a discount if the coupon rate is less than the
marketwide interest rate.
3. At a premium if the coupon rate is more than the
marketwide interest rate.
YTM is the rate the market is ______ for investing in that particular bond, considering the _______ of an asset.
YTM is the rate the market is demanding for investing in that particular bond, considering the riskiness of an asset.
Yield to maturity is the rate _____ by the current bond price.
Yield to maturity is the rate implied by the current bond price.
Coupon Rate (CR) is the rate at which an investor receives a ____ cash flow every ____ months.
Coupon Rate (CR) is the rate at which an investor receives a fixed cash flow every six months.
YTM is the ____ an investor would receive from his or her ____ investment.
YTM is the return an investor would receive from his or her entire investment.
When CR = YTM,
price = ____ value.
When CR = YTM,
price = face value.
CR > YTM,
price _ face value (premium bond)
CR > YTM,
price > face value (premium bond)
When CR < YTM,
price _ face value (discount bond)
When CR < YTM,
price < face value (discount bond)
Current yield is the annual _____ payment of a bond divided by its current _____.
Current yield is the annual coupon payment of a bond divided by its current price.
Holding Period Return (HPR) is the ____ ____ on an asset or investment portfolio over the period for which the asset or portfolio has been held.
Holding Period Return (HPR) is the total return on an asset or investment portfolio over the period for which the asset or portfolio has been held.
The value of any asset is the present value of its expected ____ ____ ____.
The value of any asset is the present value of its expected future cash flows.
Share ownership produces cash flows from:
– _____
– _____ _____
Share ownership produces cash flows from:
– Dividends
– Capital Gains
Valuation of Different Types of Shares:
– ___ Growth
– _____ Growth
– ______ Growth
Valuation of Different Types of Shares:
– Zero Growth
– Constant Growth
– Differential Growth
When future cash flows are constant, the value of a zero growth stock is the ___ ____ of a _____.
When future cash flows are constant, the value of a zero growth stock is the present value of a perpetuity.
Differential Growth: Assume that dividends will grow at _____ rates in the foreseeable future and then will grow at a _____ rate thereafter.
Differential Growth: Assume that dividends will grow at different rates in the foreseeable future and then will grow at a constant rate thereafter.
To value a Differential Growth Stock, we need to:
– Estimate _____ dividends in the foreseeable future.
– Estimate the future ____ price when the share becomes a _____ Growth Stock (case 2).
– Compute the total present value of the estimated future
dividends and future share price at the appropriate
_____ rate.
To value a Differential Growth Stock, we need to:
– Estimate future dividends in the foreseeable future.
– Estimate the future share price when the share becomes a Constant Growth Stock (case 2).
– Compute the total present value of the estimated future
dividends and future share price at the appropriate
discount rate.
Estimates of Parameters in the
Dividend-Discount Model:
The value of a firm depends upon its ____ rate, g, and its ____ rate, r.
Estimates of Parameters in the
Dividend-Discount Model:
The value of a firm depends upon its growth rate, g, and its discount rate, r.
The firm will experience earnings growth if its net
_____ ______ (total investment-depreciation) is
positive.
The firm will experience earnings growth if its net
capital investment (total investment-depreciation) is
positive.
To grow, the firm must ____ some of its earnings.
To grow, the firm must retain some of its earnings.
Growth Rate:
g = ____ ratio × _____
Growth Rate:
g = Retention ratio × Return on retained earnings
Growth Rate:
The return on retained earnings can be estimated
using the firm’s historical return on ____ (ROE)
Growth Rate:
The return on retained earnings can be estimated
using the firm’s historical return on equity (ROE)
The discount rate can be broken into two parts.
– The _____ yield
– The ____ rate (in dividends)
The discount rate can be broken into two parts.
– The dividend yield
– The growth rate (in dividends)
There is a great deal of _____ error involved in estimating r.
There is a great deal of estimation error involved in estimating r.
The previous approaches only estimate r and g based
on numerous assumptions.
– subject to ___
– r is ______ on g
The previous approaches only estimate r and g based
on numerous assumptions.
– subject to error
– r is dependent on g
Growth opportunities are opportunities to invest in
_____ NPV projects.
Growth opportunities are opportunities to invest in
positive NPV projects.
The value of a firm can be conceptualized as the sum
of the value of a firm that pays out _____-percent of its earnings as ____ (is a cash cow) and the net present value of the ____ opportunities.
The value of a firm can be conceptualized as the sum
of the value of a firm that pays out 100-percent of its earnings as dividends (is a cash cow) and the net present value of the growth opportunities.
Two conditions must be met in order to increase value:
– Earnings must be _____ so that projects can be funded.
– The projects must have ____ NPV – that is the return on the project must be greater than the firm’s discount rate
Two conditions must be met in order to increase value:
– Earnings must be retained so that projects can be funded.
– The projects must have positive NPV – that is the return on the project must be greater than the firm’s discount rate
A firm’s value increases when it invests in growth opportunities with ____ NPVs.
A firm’s value increases when it invests in growth
opportunities with positive NPVs.
No-Dividend Firm:
Firms that pay no dividends sell at ____ prices
(e.g., Amazon.com)
No-Dividend Firm:
Firms that pay no dividends sell at positive prices
(e.g., Amazon.com)
No-Dividend Firm:
These firms have many ____ opportunities and investors believe these firms will pay ___ at some point or they have invested for ____ ____ returns.
No-Dividend Firm:
These firms have many growth opportunities and investors believe these firms will pay dividends at some point or they have invested for capital gains returns.
No-Dividend Firm:
The model for ____ growth of dividends does not
apply.
No-Dividend Firm:
The model for constant growth of dividends does not
apply.
Dividend Growth Model and
the NPVGO Model (Advanced):
We have two ways to value a share:
– The dividend ___ model.
– The price of a share can be calculated as the ___ of its
price as a cash ___ plus the per-___ value of its growth
opportunities.
Dividend Growth Model and
the NPVGO Model (Advanced):
We have two ways to value a share:
– The dividend discount model.
– The price of a share can be calculated as the sum of its
price as a cash cow plus the per-share value of its growth
opportunities.
Comparables: Price-Earnings
Ratio:
Many analysts frequently relate earnings per share to
____.
Comparables: Price-Earnings
Ratio:
Many analysts frequently relate earnings per share to
price.
The price-earnings ratio is a.k.a the multiple
– Calculated as current share ____ divided by annual ____
– The National Post uses the last __ quarters’ earnings to
estimate EPS
The price-earnings ratio is a.k.a the multiple
– Calculated as current share price divided by annual EPS
– The National Post uses the last 4 quarters’ earnings to
estimate EPS
Comparables - Price-Earnings
Ratio:
Firms whose shares are “in fashion” sell at ____
multiples. ____ stocks for example.
Comparables - Price-Earnings
Ratio:
Firms whose shares are “in fashion” sell at high
multiples. Growth stocks for example.
Comparables - Price-Earnings
Ratio:
Firms whose shares are out of favour sell at ___ multiples. ____ stocks for example.
Comparables - Price-Earnings
Ratio:
Firms whose shares are out of favour sell at low multiples. Value stocks for example.
Comparables - Price-Earnings
Ratio:
PE multiple is _____ related to r.
As r increases,
the PE multiple ____.
Comparables - Price-Earnings
Ratio:
PE multiple is negatively related to r.
As r increases,
the PE multiple declines.
Comparables - Price-Earnings
Ratio:
PE multiple is ____ related to g. As g increases,
PE multiple _____.
Comparables - Price-Earnings
Ratio:
PE multiple is positively related to g. As g increases,
PE multiple increases.
Comparables - P-E
Ratio:
Accounting methods to determine EPS will impact
the ___ ratio for that company’s share.
– Generally accepted that companies with conservative
accounting practices will have ____ PE multiples
Comparables - Price-Earnings
Ratio:
Accounting methods to determine EPS will impact
the PE ratio for that company’s share.
– Generally accepted that companies with conservative
accounting practices will have higher PE multiples
Many analysts frequently relate price to variables other
than EPS, e.g.:
(3)
Many analysts frequently relate price to variables other
than EPS, e.g.:
- Price/Cash Flow per share Ratio
- Price/Sales
- Price/Book value per share (a.k.a. Market to Book Ratio)
The value of a firm can be calculated to be the PV of all _____ _____ flows that the firm will generate.
The value of a firm can be calculated to be the PV of all future cash flows that the firm will generate.
