Differences Between Stock And Bond Valuation

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Differences Between Stock and Bond Valuations
This report will analyze the differences in how stocks and bonds are valued by investors. Their respective valuation processes will each be displayed separately followed by a condensed summary of their differences.

Bond Valuation process
Bonds are essentially debt instruments whereby the issuer of the bond is the recipient of a loan and the bondholder is an investor who receives interest payments for the duration of the bond and then receives principal repayment (Investopedia, 2017). A bond’s value to the bondholder is equal to the current value of its anticipated future cash flows (Investopedia 2017). To calculate a bond’s current market value
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The value of a stock that pays dividends to shareholders can be quantified using the dividend discount model. A stocks value is equal to the dividend per share divided by the required rate of return (Cleary & Jones 2013). The more risk related to a stock the higher the required rate of return an investor will expect to receive from their investment (Cleary & Jones 2013). For example, a stock which pays a 20$ dividend and which requires a 10% rate of return would be valued at 200. If the same stock required at 5% rate of return it would be valued at 400. A lower required rate of return means an investor is willing to pay a higher price for a share and the higher their required rate of return means a shareholder is willing to pay less for a share (Cleary & Jones 2013). Some stocks display steady growth and this must be taken into account as part of their valuation (Investopedia 2017). If a stock is expected to grow at a steady rate the value is equal to the dividend at the end of the year divided by the required rate of return minus the growth rate (Investopedia 2017). A stock which pays a 20 $ dividend when the required rate of return is 10% and is expected to grow at a constant rate of 5% would be valued at 420$. This figure was obtained by taking 20$ multiplied by 1.05 to find the expected dividend at the end of the year which equals 21$ per share. 21$ per share was divided by 0.05 which is the required rate of return of 10% minus the growth rate of 5% to obtain a value of 420$ per share. In the first example with a 20$ dividend and 10% required rate of return the stock was valued at 200$ per share. If dividends are expected to grow at a steady rate of 5% the value of the stock increase to 440$. The expectations of future growth will greatly impact the price per share as investors are willing to pay a higher price today if they expect dividends to

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