2.1. Introduction – a simple way to value bonds and stocks

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Do curso por Moscow Institute of Physics and Technology

Principles of Corporate Finance – A Tale of Value

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Moscow Institute of Physics and Technology

Principles of Corporate Finance – A Tale of Value

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Curso 2 de 5 em Specialization Understanding Modern Finance

The study of Corporate Finance seems to be a very generic part of business education. Still, it either falls in the trap of intimidating formulas or is superficially journalistic. Both extremes preclude the understanding of the core finance ideas, concepts, and models. This Course is an attempt to avoid the above extremes. We discuss the core basis and mechanisms of modern corporate finance in a learner-friendly way. We will analyze the market’s most fundamental problems, realize the intrinsic interests and preferences of investors, reveal the true meaning of specific financial terms, and uncover important issues that are so often ignored in choosing and valuing investment projects. The learners will gain insight into the essence of corporate finance. They will be able to use the obtained knowledge and skills to successfully advance in their career at a financial institution, as well as in the area of financial management at non-financial businesses.

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Applications of NPV. Valuing Bonds and Stocks

Week 2 of the Course is devoted to the applications of NPV. In the first part of the week we use NPV to study riskless debt. Of special attention will be the challenges in valuing even riskless bonds. We discuss bond parameters and the special role of yield to maturity. Then we demonstrate how the NPV approach helps determine spot and forward interest rates. The second part of Week 2 deals with the core concepts in valuing equity. We introduce the idea of the common stock value as a function of its cash disbursements. Then we present some formulas that are used to value common stock on the basis of NPV. We focus on growth as a major contributor to the stock value. We analyze growth drivers and the mechanism of growth. On an example we reveal the influence of investments on the stock value. Finally, we pose some questions with respect to NPV approach.

2.1. Introduction – a simple way to value bonds and stocks3:07

2.2. Valuing riskless debt6:37

2.3. Bond cash flows and other parameters. Yield to maturity10:12

2.4. Calculating spot rates8:01

2.5. Forward rates – the idea and calculation8:53

2.6. Valuing common stocks – the expected rate of return5:13

2.7. The general stock valuation formula. The “tail”7:09

2.8. The model of growth. PVGO5:55

2.9. A constant growing company – an example10:05

2.10. – What’s ahead?2:41

Conheça os instrutores

Konstantin Kontor
Director and Professor of Finance and Strategy
American Institute of Business and Economics (AIBEc)

Welcome everyone to the second week of our corporate finance course.

In the last episode of the first week, we talked about the fact that now

we have to apply the NPV approach in our evaluation procedure to two special cases.

They're not cases, they're broad categories of cases.

One to fix the income instruments in which cash flows are sort of fixed or

at least contracted.

And the other area will be the equity instruments where cash flows are not

known but are only forecasted.

We start this week with the analysis of the first area.

This is the area of bonds.

A bond is the instrument that is used for financing.

It is issued by governments, by municipalities, by corporation.

And this is actually a way of issuing public debt.

So investors who buy bonds, they basically lend to issuers,

to the government, to corporations, to municipalities or whoever.

But this lending is organized in a special way.

First of all, this lending is kind of long term.

Well, maybe a very long time, up to 30 years similar to a mortgage.

Well, there are some bonds that are short term, too.

But this is not really in general a short term lending.

But what is more important,

this is the schedule of cash flows that are associated with the bond.

So normally bonds pay interest in

a regular payments that occur in the United States and some other countries.

Semi-annually in continental European countries, annually.

And then, so basically if this is the length or life of a bond,

you receive coupons in between and the bullet payment at the very end.

That includes the final coupon and the principle or the face or

the maturity value of all the bond.

Now, our main question is to what extend our approach based on NPV works here.

If it does, then we can except that the observed prices

of buns in the market will be close or I would say very close to

those that were calculated on the basis of the PV approach.

Namely, we would argue that if we have a forecast of interest rates,

because we have to unfortunately discount all the coupons

at their special rates, not at the same one.

And if we did so, we could expect that if the NPV approach holds, then the market

price of the bundle would be very close to the PV of all its cash flows.

In the next episode we will go further, we will introduce

some of the bond parameters and then we will indeed apply the NPV formula.

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