Discounted Cash Flow (DCF) approach explains that the value of any investment is

Question

Discounted Cash Flow (DCF) approach explains that the value of any investment is equal to the sum of present values of expected cash flows from the investment as defined below. where CF1, CF2, CF3 ... are expected cash flows, N is time to maturity, and r is the appropriate discount rate. Assume that you arc using this generic valuation equation to value a 5 year, annual coupon paying corporate bond. 1) How many expected cash flows are there? What are they? When do they occur respectively? Explain. 2) If this bond is callable in year 2, how will the ex cash flow change? How many expected cash flows are there? What arc they? When do t occur respectively? Explain. 3) In the valuation equation above, r is defined as the appropriate discount rate. In bon valuation, this r is called yield to maturity and in more plain terms, it is lair yield required yield investors think they can ask for. According to your text, perceived risk on bond issue by investors determines investors' fair yield on a bond. What kind of risk are talking about? Explain how they affect investors' fair yield on a bond.

Explanation / Answer

1. If the bond is annual coupon paying bond then there will be annual cash flow in terms of coupon at the end of each year till the maturity of the bond, and also at maturity the maturity value will be received. Here, 5 annual coupon payment at the end of each year till maturity and one maturity payment.

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