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?

YearCash flows5% discount10% discount
20120(97)1.000(97.00)1.000(97.00)
2013150.9524.760.9094.55
2014250.9074.540.8264.13
2015350.8644.320.7513.76
201641050.82386.420.68371.72
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?

YearCash flows8% discount3% discount
20120(106)1.000(106.00)1.000(106.00)
2013180.9267.410.9717.77
2014280.8576.860.9437.54
201531080.79485.750.91598.82
(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%?

YearCash flows4% discount6% discount
20120
2013150.9624.810.9434.72
2014250.9254.630.8904.45
2015350.8894.450.8404.20
201641050.85589.780.79283.16
103.6796.53

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