## 03 Oct 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