week 6 homework

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Week 6 Homework Chapter 7 4. Provide the definitions of a discount bond and a premium bond. Give examples A bond that is sold for less than its face value or par value is referred to as a discount bond. The bondholder's return or interest is calculating as the difference between the face value and the purchase cost. For instance, if a discount bond with a $1,000 face value is sold for $900, the investor will profit $100 because the bond is a discount bond and will be worth $1,000 when it develops. A premium bond, on the other hand, is one that is suggest for sale above its face value or par value. The bondholder's return or interest is reduced by the extra money paid over the face value (Choudhry, 2019). For occurrence, if a premium bond with a $1,000 face value is sold for $1,100 and the shareholder get $1,000 upon majority, there has been a $100 loss. 8. Explain how a bond's interest rate can change over time even if interest rates in the economy do not change . Due to several factors, such as changes in the issuer's creditworthiness, changes in the bond's risk profile, changes in market demand and supply dynamics, and changes in general financial conditions, a bond's interest rate may change over time even if interest rates in the economy do not change (WILD, 2017). These factors may alter how risky and enticing a bond is, which may change the bond's price, which may change the effective interest rate. For instance, if the bond issuer's creditworthiness declines, investors can request a higher yield to make up for the increased risk. The bond's price falls as a result of the increased yield, raising the interest rate in effect. On the other hand, if market circumstances or creditworthiness both improve, the bond's price may rise, lowering its effective interest rate. 10.What is the yield to call and why is it important to a bond investor? The yield or rate of return an investor would receive if the issuer called or redeemed a bond before the bond's maturity date is known as the yield to call (YTC). Bond investors should be aware of this since callable bonds allow the issuer the option to retire or "call" the bond prior to its maturity date (Rebonato, 2018). By taking into account both the normal interest payments and the possible call premium paid if the bond is called early, the YTC enables investors to assess the potential return if the bond is called. Investors can evaluate the possible risk and return profile of callable bonds and make better investment decisions by taking the yield to call into account.

12. Explain why high-income and wealthy people are more likely to buy a municipal bond than a corporate bond . For a number of reasons, more income and comfortable people are more likely to invest in municipal bonds than corporate bonds. Municipal bonds, are known as munis, are typically exempt from federal income taxes and are issued by state and municipal governments. If the investor lives in the municipality issuing the bond, they could in some situations also be except from state and local taxes. Municipal bonds are mainly appealing to more income people due to this tax benefit because they can benefit from tax-free income and possibly lower their overall tax burden (Corelli, 2018). Compared to corporate bonds, municipal bonds are often thought to have a lower risk. Tax revenue is a source of income that municipalities can use to fund debt repayment. Municipal bonds may be a more enticing choice for wealthy shareholders who value capital preserve and seek investments with lesser default risk. Municipal bonds are frequently used to finance public infrastructure initiatives including building roads, hospitals, schools, and utility companies. Wealthier people can be more inclined to give to causes that support their philanthropic objectives or their local communities. They can get financial benefits and support government efforts by investing in municipal bonds. In general, municipal bonds are more appealing to more income and wealthy people than corporate bonds because of the mix of tax benefits, reduced default risk perception, and the possibility for social effect. Investors should take into account their own financial status and contact with a financial advisor before making investment decisions because individual circumstances and investing objectives may differ. Chapter 8 5. Why might the Standard & Poor's 500 Index be a better measure of stock market performance than the Dow Jones Industrial Average? Why is the DJIA more popular than the S&P 500" For a number of reasons, the Standard & Poor's 500 Index (S&P 500) may be viewed as a more accurate indicator of stock market performance than the Dow Jones Industrial Average (DJIA). 500 large-cap corporations from different industries make up the S&P 500, which represents a more thorough cross-section of the American stock market. The DJIA, in contrast, only consists of 30 blue-chip businesses, mostly from the industrial sector. The S&P 500's wider representation provides a more diversified perspective of the market and lessens the effect of changes in one stock's price on the performance of the entire index.

Due to the market capitalization-based weighting of the S&P 500, the performance of larger companies is more strongly influenced. This method takes into account the relative importance of businesses based on their market share. The DJIA, on the other hand, is a price-weighted index, meaning that stocks with higher prices have a greater impact on the index. Since a stock with a greater price may not always be more significant or representational, this price weighting can mislead how the market is represented. In comparison to the DJIA, the S&P 500 often exhibits higher consistency and smoother performance over time because of its larger number of constituents and market capitalization weighting. Due to its diversification, the S&P 500 offers a more accurate indicator of market performance by reducing the effects of individual stock swings. Due to custom and history, the DJIA is more well-liked than the S&P 500. The earliest U.S. market index, it was founded in 1896. It grew well-known over time and was frequently covered by the media. It is also simpler to track and analyse due to its smaller number of elements. The S&P 500, however, rose to prominence as the investing environment changed because of its greater diversity and market capitalization weighting, giving it a more complete indicator of stock market performance. 6. Explain how it is possible for the DIIA to increase one day while the NASDAQ Composite decreases during the same day. The fluctuations of the major stock market indexes that measure distinct market segments, such as the Dow Jones Industrial Average (DJIA) and the NASDAQ Composite, might change for a variety of reasons. Here's how it's feasible for the DJIA to rise while the NASDAQ Composite falls on the same trading day. The DJIA displays the stock prices of 30 sizable, reputable businesses from diverse sectors. Even if other stocks in the market, such as those in the technology sector, are declining, the DJIA may gain on a given day if the stock prices of those 30 businesses rise together. Because the DJIA is price-weighted, stocks with higher prices have a bigger impact on the index's performance. The NASDAQ Composite, on the other hand, is a bigger index with thousands of stocks that is mostly concentrated on the technology and growth industries. Even though the DJIA is rising as a result of the success of other sectors, the NASDAQ Composite can fall if there is a sell-off or negative sentiment directly affecting the technology sector. The performance differences between the DJIA and the NASDAQ Composite highlight the fact that multiple factors can independently affect the movements of different indexes, each of which represents a different market segment. 8. Illustrate through examples how trading commission costs impact an investor's return. Investment returns might be impacted by commission fees since it makes trades less profitable overall. Trading commissions or fees are frequently charged as part of the cost of executing a trade when an investor uses a brokerage company to purchase or sell stocks or

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other assets. Suppose an stockholder wants to purchase 100 shares of a stock with a $50 per share pricing and the brokerage charges a $10 per trade commission. Without accounting for additional expenses, the price to buy the shares would be $5,010 ($50 per share multiplied by 100 shares + $10 commission). After deducting a further $10 commission for the trade, the investor would receive $5,990 ($60 per share x 100 shares) if they later decided to sell the shares when the price reached $60 per share. The trade's total gross profit in this instance would be $980 ($5,990 - $5,010) for the investor. The net profit, however, would be $960 ($980 - $20) after accounting for the trading commissions of $20 for both the purchase and sell transactions. The trading commission fees deduct $20 from the investor's return, or around 2% of the gross profit. Investors must therefore take these costs into account when assessing their prospective returns and include them into their investing plans. 9. Describe the difference in the timing of trade execution and the certainty of trade price between market orders and limit orders The timeframe of transaction execution and the degree of price certainty between market orders and limit orders are different. An instruction to purchase or sell a security at the best market price is known as a market order. A market order is executed instantly at the current market price when it is placed. Market orders provide the benefit of quick execution, which guarantees timely trade execution. The trade price is not guaranteed, though, as it is subject to the liquidity and market circumstances in effect at the time. Market orders give trade execution more weight than price stability. For instance, if a stockholder wishes to buy shares immediately, they can make a market order, which will be filled at the current market price, regardless of whether the price has changed since the order was made. A limit order is a directive to purchase or dispose of securities at a predetermined price or above. A limit order is not executed right away once it is placed. As an alternative, it hangs around the market until the desired price or a better one becomes available. The benefit of limit orders is that they offer assurance on the trade price. However, if the target price is not reached, the trade may not be immediately executed, and the order might not be filled. An investor can set a limit order at $100, for instance, if they wish to sell shares of a stock but only if the price reaches $100 per share. The order won't be executed until the stock price reaches or surpasses $100, at which point it will continue to be in effect. The order won't be filled if the stock price is below $100. In conclusion, limit orders prioritize a specific price but may not ensure immediate execution, whereas market orders prioritize trade execution over price certainty (Tyson, 2022). Investing when deciding between market orders and limit orders, investors should take their trading objectives, risk tolerance, and market conditions into account.

20. Describe the process for using the P/E ratio to estimate a future stock price. An estimate statistic used to predict a stock price is the price-to-earnings ratio (P/E ratio). It be of use to shareholders in decide if a stock is overvalued or undervalued by comparing a company's stock price to its earnings per share (EPS). These steps can be used to calculate a future stock price using the P/E ratio. Calculate the current P/E ratio Divide the current stock price by the EPS for the most recent 12-month period to arrive at the current P/E ratio. For instance, the P/E ratio would be 25 ($50 / $2) if the stock price was $50 and the EPS was $2. Estimate future earnings growth Investigate the business's prospects and projected earnings growth (Brigham, 2021). Determine the predicted growth rate of earnings by taking into account elements including market trends, competitive situation, and management's projections. Assume that the company's earnings are predicted to increase by 10% annually. Apply the P/E ratio to future earnings To calculate the expected stock price in the future, multiply the projected EPS by the predicted P/E ratio. Assuming the P/E ratio from the previous example, a predicted EPS growth rate of 10%, and a projected EPS of $2.20 for the next year, one can calculate the P/E ratio. EPS forecast: $2.20 P/E ratio projection: 25 Estimated future stock price = Projected EPS * Estimated P/E ratio Estimated future stock price = $2.20 * 25 = $55 To make informed investment decisions, it's crucial to keep in mind that the P/E ratio method is a streamlined method and should be used in concurrence with other fundamental and technical analysis tools. The P/E ratio estimate should be viewed as a guideline rather than an exact predict because changes in the market, company performance, and investor mood can all affect the actual stock price (Parameswaran, 2019). In order to better comprehend the target business's relative value, it's also essential to compare the P/E ratio of the target firm to that of its competitors and industry averages. Due to differences in growth rates, risk appetites, and market dynamics, certain industries may have varying average P/E ratios. Before making investment decisions based on the P/E ratio estimation, investors should perform extensive study and analysis taking into account a number of aspects.

References Brigham, E, F. & Ehrhardt, M, C. (2019). Financial management: theory & practice. Cengage learning. Brigham, E, F. & Houston, J, F. (2021). Fundamentals of financial management: concise. Cengage Learning. Choudhry, M. (2019). Analysing and interpreting the yield curve. Wiley. Corelli, A. (2018). Analytical corporate finance. Springer international publishing. Dor, A, B. & Desclee, A. (2020). Systematic investing in credit. Wiley. Maendel, J. & Mladjenovic, P. (2022). Factor investing for dummies. Wiley. Parameswaran, S, K. (2019). Fixed income securities concepts and applications. De Gruyter. Rebonato, R. (2018). Bond pricing and yield curve modeling a structural approach. Cambridge University Press. Tyson, E. (2022). Investing all-in-one for dummies. Wiley. WILD. (2017). EBOOK vitalsource: fundamental accounting principles. McGraw-hill education.

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