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Valuation of Bonds & Stocks

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1. Distinguish between the types of bonds. What factors determine their value? Explain three important relationships that exist in bond valuation.

2. Distinguish between preferred stock and common stock. Compare valuing preferred stock and common stock.

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Question 1

The different types of bonds are:
• Senior bonds which are secured obligations because they're backed by property that acts as collateral, for example Mortgage bonds (secured by real estate), equipment trust certificates (backed by equipment, popular with railroads and airlines).
• Junior bonds which are backed only with a promise by the issuer to pay timely interest and principal.
• Debenture bonds are unsecured bonds issued as notes (2-10 yr maturity), no collateral.
• Treasury bonds—aka Treasuries or governments. They are backed by the full faith and credit of the US government. Treasury notes have 2, 3, 5 or 10 yr maturities while Treasury bonds have 30 yr maturities.
• TIPS--Treasure Inflation-Protected Security, is a Treasury inflation-indexed bond. The maturity is 5, 10, or 20 yrs.
• Agency and Mortgage-Backed Bonds—issued by political subdivisions of the US government.
• Municipal bonds are issued by states, counties, cities, school districts. These ...

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The solution answers the valuation of bonds and stocks in 589 words with four sources cited.

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Finance: Analyze three investments, value of each security, rate of return

You are considering three investments.

The first is a bond selling for $1,100: it has $1,000 par value, coupon rate of 13%, and 15-year maturity. For bonds in this risk class, it should offer 14% yield to maturity (rate of return).

The second is a preferred stock with $100 par value selling for $90 per share, with a $13 annual cash dividend - you require a 15% rate of return on this preferred stock.

The third is a common stock with $25 par value that pays a cash dividend of $2; earnings per share for the company increased from $3 to $6 over 10 years, and the growth in dividends will be the same as the growth in earnings per share. The market price of the stock is $20 per share, and you think a
reasonable rate of return on it is 20%.

A. Explain how to calculate the value of each security based on the stated required rate of return.

B. Which investment would you buy? Explain.

C. If your required rate of return changed to 12% for the bond, 14% for the preferred
stock, and 18% for the common stock, how would your answers to parts a and b
change? Don't do the calculations - explain how to do them.

D. Repeat part c with required rates of return of 20% on the common stock, with
anticipated constant growth rate changes to 12%.

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