CPA #11 Notes
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This 2 page Class Notes was uploaded by Callie Lusk on Sunday October 2, 2016. The Class Notes belongs to FIN 330 at Western Kentucky University taught by Rhoades in Fall 2016. Since its upload, it has received 4 views. For similar materials see Print of finance management in Finance at Western Kentucky University.
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Date Created: 10/02/16
FIN 330 Exam #2 Preparation CPA #11 Notes Valuation Fundamentals Valuation is the process that links risk and return to determine the worth of an asset. o It can be applied to expected streams of benefits from bonds, stocks, income properties, oil wells, and so on. There are three inputs to the valuation process: o Cash flows It is expected to provide over the ownership period o Timing In addition to making cash flow estimates, you have to know the timing of the cash flows. o A measure of risk This determines the required return. The level of risk associated with a given cash flow can significantly affect the value. Basic Valuation Model The value of an asset is the present value of all future cash flows it is expected to provide over the relevant time period. o The time period can be any length. o The value of an asset is determined by discounting the expected cash flows back to their present value, using the required rate of return. Bond Valuation Bonds are long-term debt instruments used by businesses and government to raise large sums of money, typically from a diverse group of lenders. The value of a bond is the present value of the payments its issuer is contractually obligated to make, from the current time until it matures. Bond Value Behavior Whenever the required return on a bond differs from the bond’s coupon interest rate, the bond’s value will differ from its par value. o The required return is likely to differ from the coupon interest rate because either economic conditions have changed, causing a shift in the basic cost of long-term funds; or the firm’s risk has changed. Discount: the amount by which a bond sells at a value that is less than its par value. Premium: the amount by which a bonds sells at a value that is greater than its par value. Interest Rate Risk: The chance that interest rates will change and thereby change the required return and bond value. o Rising rates are a result in decreasing bond values and are great concern. Interest Rate Risk: The chance that interest rates will change and thereby change the required return and bond value. o Bondholders are typically more concerned with rising interest rates because a rise in interest rates, and therefore in the required return, causes a decrease in bond value. o Short maturities have less interest rate risk than long maturities when all other features (coupon interest rate, par value, and interest payment) are the same. Yield to Maturities When investors evaluate bonds, they commonly consider yield to maturity. o This is the compound annual rate of return earned on a debt security purchased on a given day and held to maturity. The current value, the interest rate, the par value, and the number of years to maturity are known and the required return must be found.
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