《L5 bond valuation》.pdf

HOW TO VALUE BONDS AND STOCKS Bo Sun 0 1 2 How to Value Bonds and Stocks? Use Net Present Value Approach (NPV) to value bonds and stocks. First Principles: • Value of financial securities = PV of expected future cash flows To value bonds and stocks we need to: • Estimate future cash flows: size (how much) and timing (when) • Discount future cash flows at an appropriate rate Bonds Stocks Dividends + Capital gains A bond is a certificate showing that a borrower owes a specified sum. • Zero-growth Fixed principal • • constant-growth Fixed future cash flows • differential growth 3 The essence of intrinsic value • In intrinsic valuation, you value an asset based upon its intrinsic characteristics. • For cash flow generating assets, the intrinsic value will be a function of the magnitude of the expected cash flows on the asset over its lifetime and the uncertainty about receiving those cash flows. • Discounted cash flow valuation is a tool for estimating intrinsic value, where the expected value of an asset is written as the present value of the expected cash flows on the asset, with either the cash flows or the discount r