In finance we say that the value of a financial asset can be calculated as the p
ID: 2614180 • Letter: I
Question
In finance we say that the value of a financial asset can be calculated as the present value of the future expected cash flows associated with that asset, list and describe the future expected cash flows associated with a bond.
How often do bonds typically pay coupon payments? As a result, which of the TVM components need to be adjusted (and how) when calculating the value of a bond?
Conduct some Internet research to answer the question: are bonds generally considered to be more or less risky than equity (i.e., stocks). Explain your opinion and be sure to explain how their risk level impacts their return relative to equities.
Explanation / Answer
1. The future Cash flows associated with a bond if held till maturity are:
a). The initial cash outflow of the price of the bond is given
b). In future Coupon Payments are received semi-annually or annually as specified in the bond document.(Coupon payment are like interest payment which are fixed through the term of the bond)
c) At the maturity the face value of the bond is received.
2. Bonds typically pay coupon payment at fixed time usually ate the end of year if coupon is annually or at the end of 6 months if coupon paid semi-annually. For calculating bond the yield till maturity will needs to be adjusted and coupon will also change .
Effective YTM = Ytm/No of times coupon paid in a year,
Coupon = Coupon rate * face value / ( No of times coupon paid in a year)
3. Bond are generally considered less risky than equities because the volatility involved in bond is quite less than equities. We know lower the volatility lower the risk and in case of liquidation of firm bond holders have the first right while equity holders will receive only after bond holders are paid off. Bond payments are fixed whereas dividend payments from stock are at the discretion of the company.
Since the bonds risk is lower their returns are fixed and sometimes lower than equities because equities have higher risk which might ring higher returns. At the same time bond return are less risky whereas equity returns might be negative in case of downturn ( i.e less than bond yields)
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