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Valuation of Financial Instruments

Deliverable Length: Word
document of 700–1,000 words with attached Excel Spreadsheet showing
calculations

Assignment Objectives

Apply the time value of money in making
financial decisions.

Determine the relationship between risk
and return by calculating stock and portfolio variance.

Apply valuation formulas to assess the
value of stocks and bonds.

Use effective communication, team and
problem-solving skills to collaborate on a project.

Weekly tasks or assignments (Individual or Group Projects) will
be due by Monday, and late submissions will be assigned a late penalty in
accordance with the late penalty policy found in the syllabus. NOTE: All
submission posting times are based on midnight Central Time.

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)	Discount, Premium, Par
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.
• Based on the material you
  learn in this Phase, what would you expect to happen to the yield to
  maturity and market value of the bonds if the time to maturity was
  increased or decreased by 5 years?

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. You
will need to calculate the risk-free rate for this assignment. You will need
the market return that was calculated in Phase 2, and the beta that you should
be able to find on the Web site.

Company	5-year Risk-Free Rate of Return	Beta (β)	5-Year Return on Top 500 Stocks	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, expected growth rate for the
stocks, 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 (next year)	Required Rate of Return (CAPM)	Estimated Stock Price (Gordon Model)	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.
• Explain which of the 2
  models seemed to be the most accurate in estimating the value of the
  stocks.
• Based on the material that
  you learn in this Phase, what would you expect to happen to the value of
  the stock if the growth rate, dividends, required rate of return, or the
  estimated earnings per share were to increase or decrease? Be sure to
  explain each case separately.

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=;

Yahoo! Finance. (n.d.). Retrieved from http://finance.yahoo.com/

Be sure to document your paper with in-text citations, credible
sources, and a list of references used in proper APA format.