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ECON 2560 (29)
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ECON 2560

KEY POINTS THEORY FROM THEORY OF FINANCEZero Coupon Bonds Treasury Bills pay the market price Vo no interest payments are made at maturity you receive par value PoInterest is implicit in the difference between Vo and PCoupon Bearing Bonds Treasury Bonds Today you pay the market price Vo once every 6 months you receive coupon payments C at maturity you receive last coupon C plus par value PoInterest is explicit in coupon paymentsBOND VALUATIONHigher the Yield 004Lower the bond value oYour bond pays fixed amounts coupons plus par if market rates increase your bond becomes less attractive Higher the coupon rate R 009High the Bond ValueoDue to higher cash flowsLonger time to maturity10 vs 20 yearshigher sensitivity to yield changesoLonger you are locked into fixed interest stronger the effect of changing markets STOCK VALUATIONMarket Capitalization the current market price of a stock is given by its future valuewhich is expected resale price plus expected income discounted at rate KRisk Premium In order to take the risk inherent to the stock investors require a risk premium of KRfoWhy do we invest in risky stocks Typically expected return k is greater than Risk RfoIf there is excess return after KRf that is compensation for youCost of equity Capital when raising funds by issuing equity the firm incurs expected cost of K per dollar raisedEQUITY EVALUATION DIVIDENT DISCOUNT MODEL DDM I Constant Dividends perpetuity Pt DK
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