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

*…show more content…*

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