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    Interest Rates and Security Valuation

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    HAZELMAE JEMINEZ
    * D0 = Current dividend = $2 * g = Growth rate = 5.50% * rs = Required rate of return = 9% * Time period (n) = 3 years Plugging into the formula: P3 = $2 * (1.055)^3 / (0.09 - 0.055) = $2.7075 = $27.08 Therefore, the expected stock price 3 years from today is $27.08.

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    Interest Rates and Security Valuation

    Uploaded by

    HAZELMAE JEMINEZ
    110 views19 pages
    * D0 = Current dividend = $2 * g = Growth rate = 5.50% * rs = Required rate of return = 9% * Time period (n) = 3 years Plugging into the formula: P3 = $2 * (1.055)^3 / (0.09 - 0.055) = $2.7075 = $27.08 Therefore, the expected stock price 3 years from today is $27.08.

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    Bjjhhi

    Original Title

    Chpt3.pptx

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    * D0 = Current dividend = $2 * g = Growth rate = 5.50% * rs = Required rate of return = 9% * Time period (n) = 3 years Plugging into the formula: P3 = $2 * (1.055)^3 / (0.09 - 0.055) = $2.7075 = $27.08 Therefore, the expected stock price 3 years from today is $27.08.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    110 views19 pages

    Interest Rates and Security Valuation

    Uploaded by

    HAZELMAE JEMINEZ
    * D0 = Current dividend = $2 * g = Growth rate = 5.50% * rs = Required rate of return = 9% * Time period (n) = 3 years Plugging into the formula: P3 = $2 * (1.055)^3 / (0.09 - 0.055) = $2.7075 = $27.08 Therefore, the expected stock price 3 years from today is $27.08.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    of 19

    Interest Rates and Security

    Valuation
    Various Interest
    Rate Measures
    01 Coupon Rate

    02 Required Rate of
    Return

    03 Expected Rate of
    Return

    04 Realized Rate of
    Return
    Defenition
    Required rate of return
    Coupon rate interest rate an investor
    interest rate on a bond should receive on a security
    instrument used to given its risk. Required rate of
    calculate the annual return is used to calculate the
    cash flows the bond fair present value on a
    issuer promises to pay security.
    the bond holder.
    Required Rate of
    Return
    FPV = CF1 + CF2 + CF3 +…+ CFn
    (1 + rrr)1 (1 + rrr)2 (1 + rrr)3 (1 + rrr)n

    Where: rrr = Required rate of return


    CF1 = Cash flow projected in period t (t = 1, …, n)
    ~ = Indicates that projected cash flow is uncertain
    (due to default and other risks)
    n = Number of periods in the investment horizon
    Example
    A bond you purchased two years ago for $890 is now
    selling for $925. The bond paid $100 per year in
    coupon interest on the last day of each year (the last
    payment made today). You intend to hold the bond for
    four more years and project that you will be able to sell
    it at the end of year 4 for $960. RRR is 11.25 per cent.
    b. 11.6O7
    c. 9.45
    d. 9.95
    Activity
    The bond paid $150 per year in coupon interest on the
    last day of each year (the last payment made today).
    You intend to hold the bond for three more years and
    project that you will be able to sell it at the end of year
    3 for $860. You also project that the bond will continue
    paying $150 in interest per year. Given the risk
    associated with the bond, its required rate of return ( r )
    over the next three years is 9.5O percent. Accordingly,
    the bond’s fair present value is
    Activity
    The Morrissey Company's bonds mature in
    7 years, have a par value of $1,000, and
    make an annual coupon payment of $70.
    The market interest rate for the bonds
    is 8.5%. What is the bond's price?

    a $923.22
    .
    b $946.30
    .
    c $969.96
    .
    Defenition

    Expected rate of return Realized rate of return


    interest rate an investor actual interest rate earned on
    expects to receive on a security an investment in a financial
    if he or she buys the security at security. Realized rate of
    its current market price, return is a historical (ex post)
    receives all expected measure of the interest rate.
    payments, and sells the
    security at the end of his or her
    investment horizon.
    Expected Rate of
    P = CF1 + CF
    Return
    + CF +…+ CF
    2 3 n
    (1 + Err)1 (1 + Err)2 (1 + Err)3 (1 + Err)n

    Where: Err = Expected rate of return


    CF1 = Cash flow projected in period t (t = 1, …, n)
    ~ = Indicates that projected cash flow is uncertain
    (due to default and other risks)
    n = Number of periods in the investment horizon
    Expected\Realized Rate
    of Return
    PP - BP
    Approx. YTM= AIP + N .
    .6(BP) + .4 (PP)
    Where: YTM = Yield to Maturity
    AIA = Annual Interest Payments
    PP = Principal Payments (Par Value of the Bond)
    BP = Bond Price (Current Price of the Bond)
    N = Number of periods in the investment horizon
    Activity
    A bond you purchased two years ago for $890 is now
    selling for $925. The bond paid $100 per year in
    coupon interest on the last day of each year (the last
    payment made today). You intend to hold the bond for
    four more years and project that you will be able to sell
    it at the end of year 4 for $960.
    b. 11.6O7
    c. 9.45
    d. 9.95
    Activity
    What is the approximate yield to maturity for
    a $1,000 par value bond selling for $1,120
    that matures in 6 years and pays 12 percent
    interest annually?
    (a) 8.5 percent
    (b) 9.4 percent
    (c) 12.0 percent
    (d) 13.2 percent
    Activity
    Mugwump Industries has issued a bond which has a
    $1,000 par value and a 15 percent annual coupon
    interest rate. The bond will mature in ten years and
    currently sells for $1,250. Using this information, the
    yield to maturity on Mugwump’s bond is _________.
    (a) 10.79 percent
    (b) 11.39 percent
    (c) 12.19 percent
    (d) 13.29 percent
    Activity
    Compute for the YTM given the following:

    Par Value of Bond: P1,OOO


    Ineterest Rate: 1O%
    Term: 1O years
    Current Price P9OO
    Stock with Zero Growth in Dividends
    Assignment
    Using the formula, compute for the current stock price:
    rs = D/P0 rs= rate of return
    D = Dividend
    Po= Stock Price
    A preferred stock you are evaluating is expected to pay a
    constant dividend of $1O per year each year into the
    future. The expected rate of return, E(r s ) , on the stock is
    15 percent.
    Stock with Constant Growth in
    Dividends

    rs= rate of return


    D = Dividend
    Po= Stock Price
    g= growth rate
    Stock with Constant Growth in
    Dividends
    A stock you are evaluating paid a dividend at the
    end of last year of $3.50. Dividends have grown at a
    constant rate of 2 percent per year over the last 20
    years, and this constant growth rate is expected to
    continue into the future. The required rate of return
    (r s ) on the stock is 10 percent. The fair present
    value (or price) of this stock is P44.63
    Stock with Constant Growth in
    Dividends

    NOTE: D1 is the value of the stock


    after one year.
    For the second formula, on the next
    slide, I will give you an example
    Stock with Constant Growth in
    Dividends
    Reddick Enterprises' stock currently sells for $35.50
    per share. The dividend is projected to increase at a
    constant rate of 5.50% per year. The required rate of
    return on the stock, rs, is 9.00%. What is the stock's
    expected price 3 years from today?

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