Most financial decisions involve situations in which someone makes a payment at one point in time and receives money later. Dollars paid or received at two different points in time are different, and this difference is dealt with using the time value of monlyy. Each financing option with different interest rates, down payments, length of the loan, and other options The ability to understand these various options is the secret to financial success. When a corporation (or government) wishes to borrow money from the public on a long-term basis it usually does so by issuing or selling debt securities that are generally called bonds. Bonds are debt instruments issued by corporations or governments to raise capital. Some of the various types of bonds are treasury bonds, treasury bills, corporate bonds, municipal bonds, and foreign bonds. The market interest rate of a bond is determined by the risk-free rate, the inflation premium, the maturity risk premium, the default risk premium, and the liquidity premium. It is important to understand that a bond's price has an inverse relationship to the current market rate of interest, therefore, as interest rates rise, the value of the bond will fall. Stock prices are volatile, so it is difficult to estimate a stock's value. However, some analysts are better at it than others. Stocks are valued through the free cash flow valuation model, the Dividend Growth Model, and the Multistage Model. In this case analysis students will develop a loan amortization schedule by employing the concept of the time value of money. Students will also be able to calculate and discuss how bond prices are determined in the market and the relationship between interest rate and bond prices, and how a bond's price changes over time as it approaches maturity. In addition, students will determine how common stocks are valued; estimating the cost of equity capital; stock prices, and earnings per share. Time Value of Money You are ready to buy a house, and you have $20,000 for a down payment and closing costs. Closing costs are estimated to be 4% of the loan value. You have an annual salary of $36,000, and the bank is willing to allow your monthly mortgage payment to be equal to 28% of your monthly income. The interest rate on the loan is 6% per year with monthly compounding ( 5% per month) for a 30 -year fixed rate loan. How much money will the bank loan you? How much can you offer for the house? Bond Valuation Problem How is the value of a bond determined? What is the value of a 10 -year, $1,000 par value bond with a 10 percent annual coupon it its required rate of return is 10 percent? 1. What would be the value of the bond described in part 1 if, just after it had been issued the expected inflation rate rose by 3 percent points, causing investors to require a 13 percent return? Would we now have a discount or a premium bond? 2. What would happen to the bond's value if inflation fell, and rd declined to 7 percent? Would we now have a premium or a discount bond? 3. What would happen to the value of the 10 -year bond over time if the required rate of return remained at 13 percent, or if it remained at 7 percent? 4. Inflation has remained low for the past three years, but you have come to the conclusion that the trend is ending, and inflation will increase significantly over the next 18 months. Assume you have reached this conclusion prior to other investors reaching the same conclusion. What adjustments should you make to your bond portfolio considering your conclusions? Stock Valuation Problem 1. Assume that Abiproffy has a beta coefficient of 1.2, that the risk-free rate (the yield on T-bonds) is 7%, and that the market risk premium is 5%. What is the required rate of return on the firm's stock? 2. Assume that Abiproffy is a constant growth company whose last dividend (Do, which was paid yesterday) was $2.00 and whose dividend is expected to grow indefinitely at a 6% rate. What is the firm's current stock price? (Hint: use the answer from a to answer this question)