Lecture 10. Tuesday Mar 2 nd. Valuation of Financial Securities 2
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1 Lectue 10. Tuesday Ma 2 nd Valuation of Financial Secuities 2
2 nnouncements 1 Quiz #4 on OWL is cancelled Pactice Midtem available on OWL Pactice Midtem available as PDF on Couse Web Site Tuesday Ma 2nd Valuation of Financial Secuities 2 2
3 Fist Midtem The Fist Midtem is in class on Thusday. Remembe Calculatos (No shaing of Calculatos please Check you calculato s batteies Remembe you ID s Tuesday Ma 2nd Valuation of Financial Secuities 2 3
4 Fist Midtem Thee ae 5 vesions Red, Oange, Blue, Yellow and Beige Make sue people aound you have a diffeent coloed exam The vesions ae simila in content, but not the same in answe o in answe key, so be awae and put down you own answes Tuesday Ma 2nd Valuation of Financial Secuities 2 4
5 Fist Midtem Make-up Fiday 2:30 to 3:45 in oom 118 me if you have a eason to need to take the exam then Latecomes moe than 5 mins late to Thusday s exam will be equied to take the make-up Tuesday Ma 2nd Valuation of Financial Secuities 2 5
6 Fist Midtem Review Session Review session today 2:30 to 5:30 in oom 108 Come when you like Leave when you like Come with questions eady Tuesday Ma 2nd Valuation of Financial Secuities 2 6
7 Fist Midtem Coveage Pages 1 to 121 in the textbook Class mateials OWL Quizzes #1, #2 and #3 Tuesday Ma 2nd Valuation of Financial Secuities 2 7
8 Fist Midtem Coveage 7 Wod poblems 18 Numeical poblems Tuesday Ma 2nd Valuation of Financial Secuities 2 8
9 Fist Midtem 4 Pactice Midtems available on OWL Pactice Midtem available as PDF on Couse Web Site Tuesday Ma 2nd Valuation of Financial Secuities 2 9
10 Fist Midtem Office Hous today afte class in the Newman Cente Wednesday 11:30 to 1:00 in the Newman Cente by 8:00 this evening if you would like to see me befoe then on Wednesday Tuesday Ma 2nd Valuation of Financial Secuities 2 10
11 Fist Midtem me if you have questions Tuesday Ma 2nd Valuation of Financial Secuities 2 11
12 The Pesent Value of an nnuity n PV PV 1 1 = ( 1+ ) n Tuesday Ma 2nd Valuation of Financial Secuities 2 12
13 The Pesent Value of an nnuity 1 1 PV = n ( 1+ ) What happens as n gets bigge? 1 ( 1+ ) n = 1 Infinity 0 Tuesday Ma 2nd Valuation of Financial Secuities 2 13
14 The Pesent Value of an nnuity PV 1 = 0 Pepetuity is an annuity that goes on foeve. PVP = Fomula 4.2 Tuesday Ma 2nd Valuation of Financial Secuities 2 14
15 Zeo Gowth Dividend Model This model fo picing a shae assumes the dividend is constant and will be into the futue. Dividend P 0 = PVP = Fomula 4.2 Tuesday Ma 2nd Valuation of Financial Secuities 2 15
16 The PV of an nnuity Due n-1 PVn PV PV DUE DUE = PVn ( 1+ ) 1 1 = 1 + ( ) n ( 1+ ) Tuesday Ma 2nd Valuation of Financial Secuities 2 16
17 The Pesent Value of an nnuity 1 1 PV DUE 1 = + ( 1 ) n + What happens as n gets bigge? 1 ( 1+ ) n = 1 Infinity 0 Tuesday Ma 2nd Valuation of Financial Secuities 2 17
18 The Pesent Value of an nnuity PV DUE 1 = 0 ( 1+ ) PV DUE ( 1+ ) = = + = + So if the pepetuity is to stat immediately use PV DUE = + Tuesday Ma 2nd Valuation of Financial Secuities 2 18
19 Zeo Gowth Dividend Model with a Twist This model fo picing a shae assumes the dividend is constant and will be into the futue and the next one is due now. P = Dividend + Dividend 0 Tuesday Ma 2nd Valuation of Financial Secuities 2 19
20 Pepetual Bonds If a bond pays inteest in pepetuity, but neve the pays the face value P P 0 0 = BondCoupon o BondCoupon = + PVP Fomula 4.2 BondCoupon Tuesday Ma 2nd Valuation of Financial Secuities 2 20 =
21 Cashflow and Inteest Rates Timing of the Cashflow and The Inteest Rates Detemine the value placed on the Shaes o the Pepetual Bonds Tuesday Ma 2nd Valuation of Financial Secuities 2 21
22 Valuing Shaes if the Dividend Inceases If a Copoation does not pay out all of its pofit as a dividend Moe capital in the Cop Highe pofits, allowing Dividends to gow. Tuesday Ma 2nd Valuation of Financial Secuities 2 22
23 PV of Constant Gowth Pepetuity - PVCGP If g is the gowth ate (% expessed as a decimal) Then the PV of the cashflows is ( ) PVCGP = CF g 1 Tuesday Ma 2nd Valuation of Financial Secuities 2 23
24 Valuing Shaes if the Dividend Inceases DIV P = Fomula ( -g) Tuesday Ma 2nd Valuation of Financial Secuities 2 24
25 Valuing Shaes if the Dividend Inceases DIV P = Fomula ( -g) ( -g )*P ( ) P -g *DIV 0 1 = ( -g) P * 0 0 DIV P0 ( -g) = 1 Tuesday Ma 2nd Valuation of Financial Secuities 2 25
26 Valuing Shaes if the Dividend Inceases ( ) 1 -g = DIV P0 DIV P0 ( -g) 1 g + = + g DIV P0 ( -g) 1 = DIV1 = + P0 g g = DIV1 P0 Tuesday Ma 2nd Valuation of Financial Secuities 2 26
27 The PV of an nnuity Stating Late n-1. PVn-1 PV = n 1 ( ) ( 1+ ) Tuesday Ma 2nd Valuation of Financial Secuities 2 27
28 The PV of an nnuity Stating Late n-2. PV PVn-2 = ( ) n 2 1+ ( ) Tuesday Ma 2nd Valuation of Financial Secuities
29 The PV of a Pepetuity Stating Late PVP2 PVP 0 = 1+ ( ) 2 Tuesday Ma 2nd Valuation of Financial Secuities 2 29
30 T-Bills Sold at auction 13 weeks, 26 weeks o 52 weeks to matuity Repayment at Pa Value ) Piced at a discount Tuesday Ma 2nd Valuation of Financial Secuities 2 30
31 T-Bills Pa Value is Futue Value Cuent Pice is Pesent Value Inteest Rate () PV = FV n ( 1+ ) n Is the basic elationship.. Tuesday Ma 2nd Valuation of Financial Secuities 2 31
32 T-Bills Calculating the Inteest Rate If n is 0.5 yeas Pa Value is $10, Cuent Pice is $ 9, n ( PV) = FVn 1 ( 10, ,534.63) ( ) = 1 = 1 = = 0.10 = 10% Tuesday Ma 2nd Valuation of Financial Secuities 2 32
33 Bonds that pay inteest n. C C C C C PVCoupons C 1 n = t= 1 + ( ) t Pa Value PV = FV n ( 1+ ) n Tuesday Ma 2nd Valuation of Financial Secuities 2 33
34 Model fo Bond Valuation If the bond pays inteest (Coupons) annually. If it is exactly a yea to the next Coupon and n yeas to matuity, then ( ) { } { ( ) } + + Bond Value = C 1 + F 1 = 1, n Fomula 4.4 t n Tuesday Ma 2nd Valuation of Financial Secuities 2 34 t n
35 Valuing Financial Secuities We identify the cashflows fom the secuity Face Value, Coupons We apply TVM to the cashflows to establish a total pesent value of the cashflows. Tuesday Ma 2nd Valuation of Financial Secuities 2 35
36 Inteest Rates Used Fo U.S. Govenment debt which we conside to be isk-fee the inteest ate is set in the pimay and seconday maket fo such debt Fo Copoations we use balance sheet analysis o cedit atings to decide elative to isk-fee debt Tuesday Ma 2nd Valuation of Financial Secuities 2 36
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