What are bonds? How is the value of a bond calculated? What is the yield to maturity (YTM), and how is it used in bond valuation? Compare the Eurobond to US government bonds. Discuss how they are similar and how they differ. What are common stocks? How do common stocks differ from preferred stocks? How is the value of a common stock calculated?
What are bonds?
A bond is simply a loan. When you buy a bond, you lend the borrower (the issuer of the bond) your money for a while. The borrower could be a city or state, a company or the Government. In return for your loan, the borrower promises to pay you a specified rate of interest during the life of the bond, and to repay the face value of the bond at a specific time in the future (when the bond matures).
How is the value of a bond calculated?
The price of a bond is the sum of the present values of all expected coupon payments plus the present value of the par value at maturity. Calculating bond price is simple: all we are doing is discounting the known future cash flows. Remember that to calculate present value (PV) - which is based on the assumption that each payment is re-invested at some interest rate once it is received - we have to know the interest rate that would earn us a known future value.
Bonds can be priced at a premium, discount, or at par. If the bond's price is higher than its par value, it will sell at a premium because its interest rate is higher than current prevailing rates. If the bond's price is lower than its par value, the bond will sell at a discount because its interest rate is lower than current prevailing interest rates. When you calculate the price of a bond, you are calculating the maximum price you would want to pay for the bond, given the bond's coupon rate in comparison to the average rate most investors are currently receiving in the bond market. ...
This solution discusses bonds, how their value is calculated, yield to maturity, and a comparison of the Eurobond and US government bonds. Further, it discusses common stocks and preferred stocks and how value of a common stock is calculated. References are included in this 1,084 word response.