Posted: December 14th, 2022
Factors affecting bonds and shares valuation essay
Today, people and business entities across the globe use their money to make more money. Simply put, this is known as investing. When it comes to investing therefore, there are two key investment options that must be considered: bonds and shares. Bonds are more of loans from the investor to the bond issuer meant to raise capital for the company (Elton et al., 2003). On the other hand, shares are units of ownership in a company. Investors make profits from owning shares in form of dividends and capital gains. There are some elements or factors that affect the valuation or prices of bonds and shares as subsequently highlighted Factors affecting bonds and shares valuation essay.
Factors that affect the valuation of Bonds
First, bond prices may be affected by inflation. For instance, when inflation escalates, the prices of bonds fall and when inflation rates come down, bond prices rise. This can be understood by the fact that rising inflation inhibits the purchasing power of what people or business entities will earn on their investments (Elton et al., 2004).
Secondly, the valuations of bonds are affected by interest rates. In practice, when interest rates rise, the prices of bonds fall and when interest rates fall, the prices of bonds rise (Walter and Que, 2003). Investors are often attracted by bonds whose interest rates are low and discouraged or become less attractive to bonds with high interest rates.
Third, Elton et al., (2003) argue that credit ratings can affect the valuation of bonds. Credit ratings can provide information on an issuer’s ability to deliver interest payments and pay back the principal on a bond. If issuer’s credit ratings go up, bond prices will rise and if ratings fall, bond prices will be driven down too.
Fourth, the valuations of bonds are affected by a bond’s coupon. A bond’s coupon may be defined as interest rates that businesses must pay based on the bond’s face value. Even though coupons are generally fixed amounts, they can also be “indexed.” Here, interest rates are calculated by taking an established rate that fluctuates, such as a bank’s lending rate, and adding a “premium” percentage amount to calculate the bond’s coupon rate (Gabbi and Sironi, 2005).
Factors that affect the valuation of Shares
Just like bonds, there are some factors that can cause the prices of shares to either rise or fall. First, company news and performance are some of the factors that can affect the valuation of shares. A change of management, announcements of dividends, employee layoffs, accounting scandals and anticipated merger or takeover are some elements that may affect share prices (Kim, n.d).
Secondly, industry performance is another factor. Oftentimes, share prices of companies in the same industry –say banking industry- will move in tandem with each other. Prevailing market conditions generally affect companies in the same industry. However, share prices of one company will benefit from any piece of bad news coming from its competitor (Errunza and Ta, 2015).
Third, Kim (n.d) argues that investor sentiment or confidence may affect the prices or valuation of shares. Investor optimism may affect the prices of shares while a lack of investor confidence during recession or unemployment may affect valuation of shares.
Lastly, other economic factors such as the economic outlook, inflation, deflation, political shocks, the value of currency, changes in the economic policy, and interest rates are some of the factors that can affect the valuation of shares (Errunza and Ta, 2015).
The aforementioned factors are more of the direct factors that affect the valuation of bonds and shares. The prices of bonds and shares may also be affected indirectly. For instance, interest rates may be affected by current exchange rates, commodity prices, and wage inflation. Inflation may be affected by fast economic growth or increase in money supply among others all which may affect the valuation of bonds and shares (Kristina, 2010) Factors affecting bonds and shares valuation essay.
Elton, E., Gruber, M., Agrawal, D., & Mann, C. (2004). Factors affecting the valuation of corporate bonds. Journal Of Banking & Finance, 28(11), 2747-2767.
Errunza, V., & Ta, H. (2015). The Impact of Investability on Asset Valuation. Journal Of Financial & Quantitative Analysis, 50(5), 1135-1163.
Gabbi, G. & Sironi, A. (2005). Which factors affect corporate bonds pricing? Empirical evidence from Eurobonds primary market spreads. The European Journal Of Finance, 11(1), 59-74.
Kim, D. (n.d). Performance Shares: Valuation, Optimal Design, and Empirical Evidence. SSRN Electronic Journal.
Kristina, L. (2010).Investment Analysis and Portfolio Management. 1-166.
Walter, J. E., & Que, A. V. (2003). The Valuation of Convertible Bonds. Journal Of Finance, 28(3), 713-732.
You must complete this assignment individually.
The explanations to the discussion question should be aimed at one brief paragraph to multiple paragraphs depending on the question. If you use any articles, textbooks, journals etc. to support your decisions, you must use in-text referencing to properly acknowledge the work of the original author. The preferred referencing style is the Harvard referencing style (author-date).
This assignment is worth 20 marks and also counts towards 20 percent of the final grade. Marks will be allocated for this assignment for meeting the following requirements:
Completeness of submitted assignment – all required parts submitted – Factors affecting bonds and shares valuation essay
Presentation: clearly and neatly labeled answers to each question; no spelling, typing or grammatical errors; and appropriately referenced if required Factors affecting bonds and shares valuation essay.
TASK (10 marks for bonds and 10 marks for shares. 20 marks in total)
This task requires you to identify the various elements/factors that affect the valuation of bonds and shares.
Please note that you must segregate the factors for bond and shares separately – minimum four factors for each.
You are not only expected to identify the direct factors (the interest rate for example) but also the indirect factors (i.e. the various factors which affects the interest rate itself).
To simplify your discussion,you may choose a particular industry to answer this requirement.
If you use any articles, textbooks, journals etc. to support your decisions, you must use in-text referencing to properly acknowledge the work of the original author. The preferred referencing style is the Harvard referencing style (author-date). However, you are not expected to reference the formulae Factors affecting bonds and shares valuation essay.
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