Valuing Bonds and Stocks
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Various methods are used for valuation of stocks and bonds since different factors play a role in the value of these investments. Each has distinct method of valuation. Precisely, bond valuation is determined by several essential factors, which include coupon interest rate, time to maturity and interest rates fluctuations (Jarrow, Li, Liu, & Wu, 2010).
One of the methods of valuing callable bonds is reduced-form approach by describing the call probability through an intensity procedure. Callable bonds are more challenging to value and there no existing tractable and accurate suitable methods of valuation. However, reduced-form approach enables valuation of credit derivatives (Jarrow, Li, Liu, & Wu, 2010). Moreover, the use of this model makes it easier to evade the exposure mortgage alternative to different risk issues. Furthermore, the approach offers a simpler method of calculating the hedge ratios. More importantly, reduced-form approach is very important for pricing alternatives on callable bonds (Jarrow, Li, Liu, & Wu, 2010). Finally, the approach helps to infer a call decision of a firm from market prices.
On the other hand, valuing stocks can be done using the P/E methods. In this regard, the value of stocks can be done by matching the price (P) to the earnings of the company (E). An investor should understand the mean P/E ratio for a particular industry where the company belongs (Le Roux, 2010). Most of the financial places announce the apparent P/E ratio for every industry. The investor should then multiply the P/E ratio by the earnings per share (EPS) on his/her stock. Some of the financial sites also announce the figures of EPS for every stock. The product of the stocks EPS and industry P/E equals the price of the stock (Gottwald, 2012). An investor can also pay a premium in case the earnings per share can rise.
References
Gottwald, R. (2012). The use of the P/E Ratio to Stock Valuation. European Grants Projects Journals, 21-24.
Jarrow, R., Li, H., Liu, S., & Wu, C. (2010). Reduced-form valuation of callable corporate bonds: Theory and evidence. Journal of Financial Economics, 95(2), 227-248.
Le Roux, T. H. (2010). Investigating the relationship between the Price-Earning ratio and future stock returns in the South African Market (Doctoral dissertation, University of Cape Town).