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INTRODUCTION
In Units One, Two, and Three, you learned some of the basics of financial markets, interest rates, and the time value of money. In this unit, you will apply these concepts to calculating the value of common financial assets. You will begin to learn how the market prices bonds, common stock, and preferred stock securities.
UNIT OBJECTIVES
When you complete this unit, you will be able to:
Recognize some terminology associated with bonds
Calculate the present value of a bond
Apply the dividend valuation model to find the present value of common stock
Calculate the present value of preferred stock
BONDS
Debt financing
There are two major types of debt financing:
Bank loans
Bonds
Bank loan:
agreement between lender and borrower
A bank loan is an agreement between a company and its bank. The bank provides a line of credit for the company to use, and the company pays the bank a rate of interest when it uses the credit line to borrow funds. Bank loans are priced so that the lending bank covers the cost of the funds and makes a profit.
Bond:
agreement between issuer
and investor
Bonds represent loans by investors to a company. In a bond contract, the investor purchases a certificate from the issuer in exchange for a stream of interest payments and the return of a principal amount at the end of the contract. In this section we will discuss the terminology of the bond market and the methodology for calculating the price (present value) of a bond.