Chapter 1-7 Notes: Bonds and Shares Concepts

Vocabulary flashcards covering key bond and stock valuation concepts, yields, and growth relationships discussed in the lecture.

Bond price

The present value of all future cash flows from a bond (coupon payments plus the face value at maturity) discounted at the appropriate yield.

Face value (par value)

The amount paid to the bondholder at maturity; typically 1,000 in examples.

Coupon payment

The periodic interest payment on a bond, usually equal to the coupon rate times the face value.

Coupon rate

The annual coupon payment expressed as a percentage of face value (e.g., 10% on a 1,000 face value yields 100 per year).

Premium bond

A bond whose price is above its face value (price > face value).

Discount bond

A bond whose price is below its face value (price < face value).

Par bond

A bond whose price equals its face value (price = face value).

Yield to Maturity (YTM)

The bond's total expected return if held to maturity; composed of capital gains yield and current yield.

Capital gains yield (CGY)

The portion of YTM arising from price changes over time; positive for discount bonds, negative for premium bonds.

Current yield (CY)

Annual coupon payment divided by the current price; a basic measure of return ignoring price changes.

YTM = CGY + CY

The relationship that the total yield equals the sum of capital gains yield and current yield.

Zero coupon bond

A bond with no periodic coupon payments; coupon rate = 0%; price rises toward face value; YTM comes from capital gains; no current yield.

Dividend (D1 and D0)

Cash paid to shareholders. D1 is the dividend in year 1; D0 is the current (today) dividend.

Share price valuation (P0)

Price today is the present value of expected future dividends plus the expected selling price, discounted at the required return.

Perpetuity

An endless series of equal payments; P0 = D1/r for a constant dividend, or P0 = D0(1+g)/(r−g) if dividends grow at rate g.

Growth rate (g)

The rate at which dividends (or cash flows) are expected to grow over time.

ROE (Return on Equity)

Net income divided by equity; a measure of profitability of shareholders’ equity.

Dividend payout ratio

Proportion of earnings paid out as dividends; retention ratio is 1 minus this amount.

Retention ratio

Proportion of earnings retained for reinvestment (1 − payout ratio).

Cost of equity (CAPM)

Ke = Rf + Beta × (RM − Rf); the required return on equity.

Beta

A measure of a stock’s sensitivity to overall market movements (systematic risk).

Risk-free rate (Rf)

Return on a risk-free asset, typically government securities.

Market return (Rm)

Expected return of the overall market.

Market Risk Premium (MRP)

Excess return of the market over the risk-free rate: MRP = RM − RF.

Gordon Growth Model (Dividend Discount Model with growth)

Valuation model for growing dividends: P0 = D1/(r−g) or P0 = D0(1+g)/(r−g).

D0 vs D1

D0 is the current dividend; D1 is the dividend expected next period.

Payout vs retention in growth

Growth in dividends can be driven by ROE and retention (growth = ROE × retention).