Question

Why is it important for financial managers to understand the valuation process? What are the 3 key inputs to the valuation process? What are typical maturities, denominations, and interest payments of a corporate bond? What mechanism protects bond holders?

Answer 1

Why is it important for financial managers to understand the valuation process?

To maximize value of stockholder wealth as reflected in the market price of the stock, Financial managers, should understand the valuation process. Financial decisions may influence a firm’s risk-return characteristics. Such decisions result in changes in both cash flows and the required rate of return, which in turn lead to changes in the price of the firm’s common stock. The failure of financial managers to understand the valuation process could lead to sub-optimal decisions and impede their ability to maximize firm value or shareholder wealth.

What are the 3 key inputs to the valuation process?

There are three key inputs to the valuation process which are following

1.Cash Flow-The value of any asset depends on the cash flows it is expected to provide over the ownership period

2.Timing- Time period is very important to determine the returns

3.Risk and Required return- Mesurement of risk is essential for decision. The level of risk associated with a given cash flow can significantly affect it value. that means, the greater the risk of a cash flow, the lower its value

What are typical maturities, denominations, and interest payments of a corporate bond?

Maturities -  maturity is the time between when the bond is issued and when it matures, known as its maturity date, at which time the issuer must redeem the bond by paying the principal or face value. Between the issue date and maturity date, the bond issuer will make coupon payments to the bond holder.

Denominations – Denomination is a classification for the stated or face value of financial instruments, including currency notes and coins, as well as bonds and other fixed-income investments. The denomination can also be the base currency in a transaction or the currency in which a financial asset is quoted. This further classification helps clarify acceptable payment options in transactions.

Interest payments – A payment amount determined by the interest rate on an account. As a borrower, an interest payment represents the rate charged for being lent funds. As an investor, interest payments represent income on earned on cash accounts or fixed and variable rate securities.

What mechanism protects bond holders?

The mechanism to protect bondholders is by make the bond secured. Among secured bonds are mortgage bond, collateral trust bond and equipment trust bond.

Mortagage Bond- A mortgage bond is a bond secured by a mortgage or pool of mortgages. These bonds are typically backed by real estate holdings and real property such as equipment. In a default situation, mortgage bondholders have a claim to the underlying property and could sell it off to compensate for the default.

A collateral trust bond is a bond that is secured by a financial asset - such as stock or other bonds - that is deposited and held by a trustee for the holders of the bond.

Equipment trust bond is a bond secured by tangible property, such as airplane, equipment or physical assets. It is usually issued by a transportation company such as a railroad or shipping line to secure payment, as the title for the equipment is held in trust for the holders of the issue. The trustee holds title to the equipment, which is leased to the issuer. When the debt is paid off, the equipment becomes the property of the issuer, as the title is transferred to the company