Need responses to these discussions:
Describe what happens to the present value of a cash flow stream when the discount rate increases?
1. Present value is what is required for an investor to put into a security today in order to receive the expected return. “Discounting is used to describe the process of calculating present values.” When the rate of discounting goes up it is a good thing for the present value since it means less is required to be put down in order to reach that final amount. For instance, in a scenario where the person wants to earn $400 in 1 year but has an option of either an interest rate of 6% or 8%, the person should choose the higher percentage since 8% would only mean they would need to put down $370.37 compared to $377.36. It isn’t a huge difference when looking at the example I gave but this could mean hundreds of dollars if the time is a longer maturity and/or larger amount they want to reach at the end of maturity.
2. Hello everyone
The yield difference between the corporate bonds and treasury bonds of the same maturities is known as yield spread. Treasuries are considered as risk free as they are backed by the government. The return on corporate bond is higher than the return on the treasury bond, as corporate bond is more risky and there is greater chances of company’s default. The higher the corporate bond’s credit rating, the lower the bond’s yield spread and the lower the rating the greater the yield spread. So, if the bond rating is high, its yield spread is low, and if the bond’s rating is low, then the yield spread is high.
The firm’s preferred stock is overvalued as its intrinsic value is $40 and current market value is $42, which shows that current market price is higher than the intrinsic value of the preferred stock. It is not favorable to buy that preferred stock as future cash flows are lower than expected. If this preferred stock is purchased, then in future this might return to its original price which is lower than the current market price and has to suffer a loss. So, Laissez-Faure’s preferred stock should not be purchased.
The general rule in economics is that the value of money today will not be equal to the same amount of money in the future. It is also know as time value of money, this is a central concept in the finance theory which takes into account, factors such as interest rates and inflation. When calculating returns over time, it is important to keep this in perspective and know the difference between nominal returns (returns on paper) and real returns (adjusted for today’s purchasing power). Investors are more concerned with the real returns than the nominal returns on their investments because a real rate o return is the annual percentage return realized on an investment which is adjusted for changes in prices due to inflation or other external effects. This keeps the purchasing power of a given level of capital constant over time. The investors are usually concerned about the after tax returns that they will get as the tax liability can vary substantially.