Bond valuation tells us the intrinsic value of any bonds given its tenor, coupon rate, and market yield on similar assets. It is an important concept in determining the true value, or the intrinsic value of a bond. It tell us the most accurate price of the bond, because according to financial theory, the value of everything depends upon its future earning potential. For bonds, this future earning potential comes from the coupon payments that are made at predetermined time intervals. The last cash flow generated by the bonds is the redemption of the face value at its maturity. All of these cash flows are plugged in and discounted at the date of investment to get the real value or intrinsic value of a bond through the bond valuation formula. If the investor has bought the bond from the market, he will have a chance to make capital gain by selling the bond at any time , when he think that the price of the bond is higher than his price of purchase of the same bond.
A bond maturing at 15 Aug 2024, having a coupon of $2.375 is currently trading at 100.14 (Bonds online.com, 2014). We can use this information to find the bond price at to know whether the bond is trading at a discount or a premium. We will discount it with the discount rate today that is 2.36% for long term securities or similar bonds.
Dividend growth model is used to predict the correct market prices of the stock. It takes into account the future expected dividend growth and discounts by the risk premium in the market. It is done to give correct valuation of the equity stock in the market.
Apple is currently trading at $108.83 (investor.apple.com, 2014). If we know the expected dividend of the stock next year, we can be sure whether the market is trading efficiently, or whether the stock is overprice or underpriced?. Apple paid $7.26 (3.05+3.27+0.47+0.47) in dividends in the year 2014. If it is believed that Apple will increase its dividend by say 5% in the year 2014, its D1 will be $7.623 (1.05*7.26). If an investor wants to earn at least 12 percent on his investment in Apple, he will be willing to pay $108.9 (7.623/(0.12-0.05) for the Apple’s stock. This clearly shows that the market is expecting 5% growth in Apple and wants to earn at least 12 percent in Apple’s stock that is why the current value of Apple’s stock is near the investor’s expectation given that the growth rate for Apple comes to 5 percent.
Bondsonline.com, (2014). Bondsonline: Composite Bond Rates. [online] Available at: http://www.bondsonline.com/Todays_Market/Composite_Bond_Yields_table.php [Accessed 11 Nov. 2014].
Investor.apple.com, (2014). Apple - Investor Relations - Dividend History. [online] Available at: http://investor.apple.com/dividends.cfm [Accessed 11 Nov. 2014].