22/02
MN10500 Lecture 3: Valuation of Bonds & Stocks
Lecture Summary
● Characteristics of bonds
○ Interest-bearing, no ownership of the firm (issuer)
○ Government & corporate bonds
● Bond price as the present value of coupons and principal
● Characteristics of equity (stock)
○ Holders are owners of the firm (issuer)
○ Source of Income: dividend and capital appreciation
● Dividend Discount Model: Calculations and critiques
● Constant Dividend Growth Model: Calculations and critiques
Re-defining "Asset" From a Finance Perspective
● So the value of an asset is the value of all its future cash flows.
Debt Instruments
● Debt instruments are categorised by maturity:
○ Money Market Instruments: These are short-term issues that mature within
one year.
○ Notes: These are intermediate-term issues that mature between one and ten
years.
○ Bonds: These are long-term obligations which have a maturity period greater
than ten years.
Basic Features of a Bond
● A bond is a security that obligates the issuer to make specified payments to its
holder.
● Also known as Fixed Income Instruments.
● Bond holders do not 'own' the entity that issues the bond.
● Bonds are IOUs.
● The borrower (corporation, or government) pays a fixed amount of interest
periodically to the bond holder - normally every six months.
● The borrower (corporation, or government) repays the fixed amount of principal at the
date of maturity.
● When governments or companies issue bonds, they promise to make a series of
interest payments and then repay the debt.
International Bond Market by Size
, 22/02
Investors & Issuers of Bonds
● Participating Issuers
○ Government and government agencies
○ State and local political subdivisions (municipalities)
○ Corporations
○ International issuers
■ Eurobonds
■ Foreign bonds
● Participating Investors/Holders/Buyers
○ Individual Investors
○ Institutional Investors
■ Life Insurance Companies
■ Commercial Banks
■ Property & Liability Insurance Companies
■ Pension Funds
■ Mutual Funds
Types of Bonds Commonly Traded
● Government Bonds
○ Treasury Securities: Treasury bills (T-bills), notes, bonds
○ TIPS: Treasury Inflation-Protected Securities
○ Treasury Strips: Coupon/Principal Strips
○ Securities issued by government agencies
■ Government related institutions
■ Government sponsored enterprises
● Corporate Bonds
○ Carries the possibility of default (credit risk)
○ Secured (senior) bonds, which are secured by corporate assets
○ Unsecured bonds (debentures), which are not backed by assets of any
kind.
○ Subordinated (junior) debentures, which have lower priority in the event of
bankruptcy
MN10500 Lecture 3: Valuation of Bonds & Stocks
Lecture Summary
● Characteristics of bonds
○ Interest-bearing, no ownership of the firm (issuer)
○ Government & corporate bonds
● Bond price as the present value of coupons and principal
● Characteristics of equity (stock)
○ Holders are owners of the firm (issuer)
○ Source of Income: dividend and capital appreciation
● Dividend Discount Model: Calculations and critiques
● Constant Dividend Growth Model: Calculations and critiques
Re-defining "Asset" From a Finance Perspective
● So the value of an asset is the value of all its future cash flows.
Debt Instruments
● Debt instruments are categorised by maturity:
○ Money Market Instruments: These are short-term issues that mature within
one year.
○ Notes: These are intermediate-term issues that mature between one and ten
years.
○ Bonds: These are long-term obligations which have a maturity period greater
than ten years.
Basic Features of a Bond
● A bond is a security that obligates the issuer to make specified payments to its
holder.
● Also known as Fixed Income Instruments.
● Bond holders do not 'own' the entity that issues the bond.
● Bonds are IOUs.
● The borrower (corporation, or government) pays a fixed amount of interest
periodically to the bond holder - normally every six months.
● The borrower (corporation, or government) repays the fixed amount of principal at the
date of maturity.
● When governments or companies issue bonds, they promise to make a series of
interest payments and then repay the debt.
International Bond Market by Size
, 22/02
Investors & Issuers of Bonds
● Participating Issuers
○ Government and government agencies
○ State and local political subdivisions (municipalities)
○ Corporations
○ International issuers
■ Eurobonds
■ Foreign bonds
● Participating Investors/Holders/Buyers
○ Individual Investors
○ Institutional Investors
■ Life Insurance Companies
■ Commercial Banks
■ Property & Liability Insurance Companies
■ Pension Funds
■ Mutual Funds
Types of Bonds Commonly Traded
● Government Bonds
○ Treasury Securities: Treasury bills (T-bills), notes, bonds
○ TIPS: Treasury Inflation-Protected Securities
○ Treasury Strips: Coupon/Principal Strips
○ Securities issued by government agencies
■ Government related institutions
■ Government sponsored enterprises
● Corporate Bonds
○ Carries the possibility of default (credit risk)
○ Secured (senior) bonds, which are secured by corporate assets
○ Unsecured bonds (debentures), which are not backed by assets of any
kind.
○ Subordinated (junior) debentures, which have lower priority in the event of
bankruptcy
