Module 4: Bond and Stock Valuation Concepts Flashcards
Basic Bond PV Formula
PV = CF1/(1 + YTM)^! + CF2/(1+YTM)^2…
Entering in Calc Bond PV Formula
N = number of payments I/YR = semiannual yield for comparable bonds PMT = Semiannual coupon pmt FV = Par Value
Yield order when Bond trading at a premium
Current Yield > YTM > YTC
Yield order when bond trading at a discount
YTC>YTM>Current Yield
Duration Definition
The average time for a bondholder to receive the interest and principal payments from a bond in present value dollars.
Duration Goal
The duration of the bond should be equal to the time horizon of financial goals
Coupons Payments Affect on Duration
The larger the coupon payments, the lower the duration. Zero coupon bonds duration actually equals it’s maturity because their only payment is at the end of the holding period
How do market interest rates affect duration
A rise in the market interest rates decreases the duration, assuming all other factors are equal.
Duration Principals Summarized
Duration is inversly related to changes in market and coupon interest rates, and it is directly related to the changes in maturity.
Duration Formula
1+YTM/YTM - ((1+YTM) + T(COUPON-YTM))/COUPON((1+YTM)^T - 1) + YTM)
Convexity
A measurement that helps to measure the impact of interest rate changes that are greater than 1%. Using duration to compute price change assumes a linear relationship between YTM and change in price. As the expected YTM change gets greater, that linear relationship does not apply
Business Statement of Cashflows
Assists in the reconciliation of the business income statement to changes between two balance sheets. For a given period, it reflects the inflows and outflows of the business and the net changes in cash between two balance sheets.
The components of Business Statement of Cashflows
- cash flow from business operations
- cash flow from business investment activities
- cash flow from financing activities, such as the issuance of additional debt or equity
Pro forma Income Statement
Similar to a Business Statement of Cashflows except that it projects for the future rather than reporting the past. Important tool for planning future business operations. Created by first estimating gross profit and total expenses for the coming year or years and then accounting for the amount of taxes due on the net profit.
Book Value
The amount of equity available to it’s shareholders - or the amount that the shareholders have invested in the company.
Company Assets - Company Liabilities
Fundamental Analysis
The process of determining the fair market value, or intrinsic value, of a security and looking for mispricing.
Fundamental Analysis Factors
- Statistics gathered from the overall economy or economic environment
- interest rates and business cycle information
- monetary policy conducted by the Federal Reserve Board of Governors, including the current amount of the money
- Fiscal policy conducted by Congress
- Industry analysis
- Stock market tendencies
Top-Down Fundamental Analysis
Begins with researching the overall economy and the current state of the secondary market.
Economic Top-Down Analysis
Factors to Consider:
- Monetary Policy
- fiscal policy
- Inflation
- Political Environment
- Currency Stability
Industry Top-Down Analysis
Some industries do well in expanding economic environments and perform poorly in contracting environments. Industry ratios and financial statistics are computed for each industry by averaging out all the individual companies.
Company Top-Down Analysis
After determining that an industry’s outlook is positive, an investor can analyze and compare individual firms’ performances within the entire industry by using financial ratios and cash flow analysis.
Bottom-Up Fundamental Analysis
Essentially the analyst conducts the analysis in a manner opposite that of the top-down proponent. The bottom-up analyst first begins with an examination of the company fundamentals by using ratio analysis and then considers the financial prospects for the industry in which the company operates.
Current Ratio
current assets/current liabilities
Acid Test or Quick Ratio
Current assets - current liabilities / liabilities
Inventory turnover ratio
cost of goods sold / average inventory
Accounts receivable turnover ratio
sales / average account receivable
fixed-asset turnover
annual sales / fixed assets
operating profit margin
EBIT / sales