Review
Third Midterm
Investments chapter 11;13;17
Bond Yields and Prices
Interest Rates (Fisher Effect)
Bond Prices (Yield Curve)
Current Yield
Yield to Maturity
Yield to Call
Reinvestment Risk
Realized Yield
Yield Curve, Duration and
Convexity
 Measuring Bond Price Volatility:
 A measure that accounts for both size and
timing of cash flows
PV(CFt )
D
t
t 1Market Price
n
 Duration depends on three factors
 Maturity of the bond
 Coupon payments
 Yield to maturity
Duration Relationships
 Duration increases with time to maturity,
but at a decreasing rate


For coupon paying bonds, duration is always
less than maturity
For zero coupon-bonds, duration equals time to
maturity
 Duration increases with lower coupons
 Duration increases with lower yield to
maturity
Estimating Price Changes Using
Duration
 Modified Duration = D* = D/(1+r)
 D* can be used to calculate the bond’s
percentage price change for a given
change in interest rates
 It works well for “small” changes in
interest rates and parallel shifts in the
term structure of interest rates.
-D
%  in bond price 
r
(1  r)
Common Stock Valuation
 Fundamental Analysis
 Present value approach
Cash Flows
(1  k) t
t 1
n
Value of security  
 Multiple of earnings approach
 P/E multiplier remains popular for its ease of
use and the objections to the dividend
discount model
P/E Ratio Approach
 The higher the payout ratio, the higher the
justified P/E

Payout ratio is the proportion of earnings that
are paid out as dividends
 The higher the expected growth rate, g, the
higher the justified P/E
 The higher the required rate of return, k,
the lower the justified P/E
Which Approach Is Best?
 Complementary approaches?



P/E ratio can be derived from the constantgrowth version of the dividend discount
model
Dividends are paid out of earnings
Using both increases the likelihood of
obtaining reasonable results
 Dealing with uncertain future is always
subject to error
Other Valuation Techniques
 Market-to-book ratio (M/B)


Ratio of share price to per share shareholder’s
equity as measured on the balance sheet
Price paid for each $1 of equity
 Price-to-sales ratio (P/S)


Ratio of company’s market value (price times
number of shares) divided by sales
Market valuation of a firm’s revenues
Company Analysis
 Basic Financial Statements
 Balance Sheet
 Items listed in order of liquidity (assets) or in
order of payment (liabilities)
 Income Statement
DuPont Analysis
NI
EBT
EBIT Sales
TA





EBT EBIT Sales
TA
Eqty
Tax
Burden
Interest
Burden
EBIT
Efficiency
TA
Turnover
Leverage
Ratio
NI / Sales = Net Income Margin
NI / TA = ROA
TA
 ROA 
Equity
Leverage Ratio = TA / Equity
NI
NI
Sales
TA



Equity
SALES
TA
EQUITY
Net Profit
Margin
Asset
Turnover
Leverage
Ratio
TA
ROE  ROA 
EQUITY