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700 words plus excel, see attachment for more guidance, Valuation of Financial Instruments
finc_400.docx

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After engaging in a dialogue with your colleagues on valuation, you will now be given an opportunity to
apply principles that were presented in this phase. Using a Web site that provides current stock and
bond pricing and yield information, complete and analyze the tables illustrated below. Your mentor
suggests using a Web site similar to this one.
To fill out the first table, you will need to select 3 bonds with maturities between 10 and 20 years with
bond ratings of “A to AAA,” “B to BBB” and “C to CC” (you may want to use bond screener at the Web
site linked above). All of these bonds will have these values (future values) of \$1,000. You will need to
use a coupon rate of the bond times the face value to calculate the annual coupon payment. You should
subtract the maturity date from the current year to determine the time to maturity. The Web site
should provide you with the yield to maturity and the current quote for the bond. (Be sure to multiply
the bond quote by 10 to get the current market value.) You will then need to indicate whether the bond
is currently trading at a discount, premium, or par.
Bond
Company/
Rating
Face Value (FV)
Coupon Rate
Annual Payment (PMT)
Time-to Maturity (NPER)
Yield-to-Maturity (RATE)
Market Value (Quote)
A-Rated
\$1,000
B-Rated
\$1,000
C-Rated
\$1,000
Explain the relationship observed between ratings and yield to maturity.
Explain why the coupon rate and the yield to maturity determine why the bonds would trade at a
discount, premium, or par.
In this step, you have been asked to visit a credible Web site that provides detailed information on
publicly traded stocks and select 1 that has at least a 5-year history of paying dividends and 2 of its
closest competitors.
“To fill up the first table, you will need to gather information needed to calculate the required rate of
return for each of the 3 stocks (use the Capital Asset Pricing model). You will need to find the risk-free
rate online. It is the 5-year Treasury rate. You will need the market return which is just the return on the
S&P 500 Index, and it is available online. You should use an average over 5 years (find the historical
yearly returns for the S&P 500 Index and average them). You must research your stocks to find the
betas. You should be able to find them at finance.yahoo.com.”
Company
5-year Risk-Free Rate of Return
Beta (ß)
5-Year Return of S&P 500 Index
Required Rate of Return (CAPM)
“To complete the next table, you will need the most recent dividends paid over the past year for each
stock, next year’s expected dividends, the expected growth rate of the dividends (which you can
calculate by taking next year’s dividend subtracting off this year’s dividend and dividing the result by this
year’s dividend), and the required rate of return you calculated in the previous table. You will also need
to compare your results with the current value of each stock and determine whether the model suggests
that they are over- or underpriced.
Company
Current Dividend
Projected Growth Rate of Dividends
Next year’s Dividend
Required Rate of Return (CAPM)
Estimated Stock Price (Gordon Model) = Next year’s
dividend / (required rate of return – projected growth rate of dividends) Current Stock Price
Over/under Priced
In the third table, you will be using the price to earnings ratio (P/E) along with the average expected
earnings per share provided by the Web site. You will also need to compare your results with the
current value of each stock to determine whether or not the model suggests that the stocks are over- or
underpriced.
Company
Estimated Earning
(next year)
P/E Ratio
Estimated Stock Price (P/E)
Current Stock Price
Over/Under Priced
After completing the 3 tables, explain your findings and why your calculations coincide with the
principles related to bonds that were presented in the Phase. Be sure to address the following:
Explain the relationship observed between the required rate of return, growth rate and the dividend
paid, and the estimated value of the stock using the Gordon Model.
Explain the value and weaknesses of the Gordon model.
Explain the how the price-to-earnings model is used to estimate the value of the stocks.
Note: You can find information about the top 500 stocks at this Web site.
References
S&P 500 index chart. (2014). Retrieved from the Yahoo! Finance Web site:
http://finance.yahoo.com/echarts?s=%5egspc+interactive#symbol=^gspc;range=1y;compare=;indicator
=volume;charttype=area;crosshair=on;ohlcvalues=0;logscale=off;source=;