Relationship between bonds and interest rates
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What is the relationship between bonds and interest rates?
What are the calculations involved with pricing a bond and a stock?
Choose a stock that is publicly traded and explain how you think the future potential of the stock warrants the price it sells at today - please explain and support with terms and concepts.
Calculate the current return on a stock of your choice and compare it to returns on bonds. Which is better to invest in presently a stock or a bond in this company and why?
Cite and list all references used.
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Solution Summary
This solution discusses the relationship between bonds and interest rate. The solution also highlights the calculations involved with pricing a bond, and the calculations involved with valuing a stock. Additionally, the solution discusses how the future potential of The Boeing Company's stock warrants its current price. Finally, the solution shows a calculation of the current return of The Boeing Company's stock, and compares it to the returns on the company's bonds.
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The relationship between bonds and interest rate
Bonds have an inverse relationship with interest rates. When interest rates increase, the value of a bond decreases. Similarly, when interest rates decrease, the value of a bond increases. To illustrate this, suppose you buy a bond with a par value of $10,000 and a coupon rate of 7%. If interest rises to 8%, this bond would be less attractive to investors, thus you would need to discount it in order to sell, but if the interest rate dropped to 6% instead, the bond would be more attractive to investors, thus you would sell it at a price above its par value.
The calculations involved with pricing a bond and a stock
Valuing a bond involves the following three calculations:
(1) Estimating the expected cash flows
(2) Determining the suitable interest rate for discounting the cash flows
(3) Computing the PV (present value) of the expected cash flows using the interest rate calculated in ...
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