Business Finance 1 Dersi 5. Ünite Sorularla Öğrenelim

Unlike amortized loans, the issuer does not pay any part of par value during the life of the bond.

To find the value of the bond, you need to calculate present value of each future payment discounted at the current market interest rate (r). For example if the market interest rate for investments of this type is 13%, then the future cash flows will be discounted at 13%:

When the market interest rate is below the coupon interest rate, bonds sell above their par value and they are called premium bonds.

When the market interest rate exceeds the coupon interest rate, bonds sell below their par and are called discount bonds.

There is an inverse relationship between value of bonds and market interest rates. As market interest rates increase, the present value of future cash flows declines and the value of bond decreases. Conversely, if market interest rates decrease, the present value of future cash flows increases and the value of bond increases.

Bonds exhibit interest rate risk, which is the risk that the return from the bond will change according to changes in the interest rates. An increase in interest rates reduces bond values.

Bonds carry reinvestment rate risk, which is the risk that cash flows received may not be able to be reinvested at the expected rates if market rates have changed.

Yield-to-maturity is the average rate of return that will be earned on a bond if it is bought at the market price and held until it matures. It is the discount rate that makes the present value of its future cash flows equal to its market price. It is like an internal rate of return of a bond.

The interest rates you observe in the world around you are typically nominal rates.

The yield curve plots the relationship between bond yields and maturity.

According to Standard & Poors, AAA rated bonds are the safest, have lowest default risk whereas those that are rated BB or lower are expected to have high default risk and considered as junk bond. Junk bonds are required to provide very high yield in order to attract investors to invest in these bonds.

Stock ownership provides rights to vote, to receive dividends, to share in the residual in case of dissolution and a preemptive right to prevent undesired reduction of ownership share.

The difference between total assets and total liabilities is the book value of the company’s equity.

According to this model, the value of stock is equal to the present value of all future dividends that investors expect to get from that stock. This calculation is similar to bond valuation.

The simplest assumption is that the company will distribute same dividend forever. There is no change in dividend payments. It is same as assuming that there is zero growth in dividends.

Expected rate of return of stocks has two components. The first component is the return from dividends, called dividend yield (Div1/P0). The second component is the return from price appreciation, called capital gains yield ((P1-P0)/P0).