# Question Related To The Finance And Valuations

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Blog can be of any topic but here we would look into some of the question related to the finance and valuations.

Valuation of bonds

Redeemable bond – yield calculation

Exercise 1

A bond is redeemable in the year 2016.

The current price is £97 per £100

Interest rate is 5%

What is the current yield?

 Year Cash flows 5% discount 10% discount 2012 0 (97) 1.000 (97.00) 1.000 (97.00) 2013 1 5 0.952 4.76 0.909 4.55 2014 2 5 0.907 4.54 0.826 4.13 2015 3 5 0.864 4.32 0.751 3.76 2016 4 105 0.823 86.42 0.683 71.72 3.04 (12.84)

5% + (((3.04/(3.04+12.84)) x (10-5)) = 5 + 0.96 = 5.96%

Exercise 2

A bond is redeemable in the year 2015

The current price is £106 per £100

Interest is 8%

What is the current yield?

 Year Cash flows 8% discount 3% discount 2012 0 (106) 1.000 (106.00) 1.000 (106.00) 2013 1 8 0.926 7.41 0.971 7.77 2014 2 8 0.857 6.86 0.943 7.54 2015 3 108 0.794 85.75 0.915 98.82 (5.98) 8.13

3% + (((8.13/(8.13+5.98)) x (8-3) = 3 + 2.89 = 5.89%

Valuing bonds

As interest rates rise – the value of bonds reduces

As interest rates fall – the value of bonds increases

Example – what is the value of a 5% bond maturing in 4 years time if current interest rates are 4% and 6%?

 Year Cash flows 4% discount 6% discount 2012 0 2013 1 5 0.962 4.81 0.943 4.72 2014 2 5 0.925 4.63 0.890 4.45 2015 3 5 0.889 4.45 0.840 4.20 2016 4 105 0.855 89.78 0.792 83.16 103.67 96.53

5 x 2.775 = 13.875 5 x 2.673 = 13.365

105 x 0.8555 = 89.775 105 x 0.792 = 83.16

103.65 96.53

Risk

CAPM – Capital Asset Pricing Model

An investor requires a return of 14%

The market return is 10%

The return of treasury stock (government bonds) is 2%

What is the beta factor and measure of risk?

14 = 2 + B(10 – 2 )

14 – 2 = B(8)

12/8 = B

B = 1.5

Share valuation

The dividend growth model

(Di /P) + g

If Di is 5p

g = 10%

You expect a return of 15.75%

How much would you be prepared to pay for the share?

Di/p + g

5/P + 10% = 15.75%

5/P = 0.1575 – 0.10

5/P = 0.0575

5/0.0575 = 87p