Question

1.)The relationship between a bond's price and the yield to maturity is an inverse relationship. Please explain; make sure you don't simply restate the inverse relationship, but explain the reasoning. If you can remember and understand the "why", you will never forget this important relationship.

2.)Examples are encouraged. Why are stock valuation models dependent upon expected dividends, future dividend growth and an appropriate discount rate? Please be sure to review how we value any financial asset which will help dissect this answer.

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Answer 1

1. Relationship between Bond price and yield to maturity will be having an inverse relationship because bonds which have already been issued into the secondary markets will be continuously readjusting their prices and Bond yields to stay in line with the current interest rate so there will always be an inverse relationship between yield to maturity and prices of the bond.

when the yield to maturity will be going up it means that the interest rate in the economy is also going up and it will hurt the value of the bond so that will lead to decrease in the prices of bonds, and when the yield to maturity will be going down it is a representative of interest rates in the market also going down, and it will mean that the bond prices will also go up in order to re adjust for the current interest rate.

2. Stock valuation models will be dependent upon expected dividend because it is assumed that, Dividend is a part of overall capital appreciation which has been paid out to them and various models like dividend discounting model will be considering the value of all the future dividend which will be paid in regards to the stock and they will be discounting those valuations at the fair value in order to derive the intrinsic value of the stock

the growth rate in dividend will be indicating that profits of the company have increased and growth rate in future dividend will be always reduced from the expected rate of return,(Ke-g), because it will provide lower denominator for dividing the current rate of dividend(D1) so it will be providing a higher valuation because those company who are having a growth rate in profits and dividend, and will be bound to receive a premium in respect of their peers.

So, it can be summarised that stock valuation models will be dependent upon expected dividend and growth rate of dividend along with discounting rate which will be expected rate of return of investor.