What is Cost of Equity? – Meaning, Concept and Formula
February 12, 2025
Investment bankers help their clients raise money by selling equity as well as bond securities on the securities markets. Investors know that equity securities are risky by their very design. However, when investors think about debt, they often think about secure investments, which are almost certain to pay a fixed rate of return. Debt is […]
Investment bankers play different types of roles when it comes to capital raising. Most of the time, they are middlemen who ensure that the requirements of both parties are met and that the deal goes through smoothly. However, often the acquiring party falls short of cash to complete the acquisition. In such cases, it is […]
In the previous article we studied that there are two types of deposits that banks use to fund their lending operations. We studied in detail about the different types of demand deposits. However, demand deposits are considered to be vulnerable sources of finance. Depositors are likely to pull out the funds that form a part […]
As asset class is a group of assets that have similar investment characteristics amongst themselves. At the same time, their investment characteristics are different from other asset classes. For instance, all stocks share certain characteristics amongst themselves, which they do not share with bonds. Similarly, there are certain characteristics that infrastructure also has as an […]
The Icelandic budget airline “Wow airline” became the latest airline to go bankrupt in Europe. Of late, Europe has seen a lot of airlines go bankrupt due to multiple reasons. No less than eight airlines have suspended their operations in Europe in the past year. Price wars, rise in fuel prices, and overcapacity have been […]
While calculating present values of bonds, one may observe that some of the information required to compute the present value is actually missing from the question. However, this is not an error. One needs to understand that the examiner is in a way testing your knowledge of how the bond market works. In the bond market, some of the information is considered to be implied i.e. it is not explicitly communicated. This is called the bond market convention. Here is a list of some of the commonly used conventions in the bond market:
Face Value Convention: If the face value of the bond is explicitly given, then the explicit face value must be used. However, if the face value is not explicitly given then the implied value is either $100 or $1000. Students can choose any of these values as the face values. They may state this in their assumptions for deriving the solution. But that too may not be required because bond market convention dictates that these values must be considered the face value in the absence of appropriate data.
Interest Rates Are Semi-Annual: Once again, a student needs to check if the frequency of the interest rates has been explicitly mentioned. In case it is, then we must use the interest rates that correspond to the frequency. However, in case they are not given, we need to use semi-annual interest rates. Most bond markets across the world pay interest twice a year. Hence, it is a reasonable assumption to make. Changing the annual interest rate into a semi-annual one has a huge change on the present value of the bond.
Day Count Conventions: Day count conventions specify the number of days that a year contains according to the bond market. The number of days in a year is important to the calculation of the interest that has been accrued on the bond. The day count convention, however, is not uniform in bond markets across the world. Each market has its own convention and the trader must be aware of the type of convention being used in the specific market that they are concerned about. However, day count conventions can be broadly classified into 3 categories:
Interest Payments: Another convention that we need to discuss about is when the interest payment actually gets made. Now, once again this depends on the specific bond that is being considered. However, there are terms like EOM which denote that interest will be paid at the end of every month. Any student of bond valuation must be well versed with these terms as well as the implications that using these terms has on the valuation of the bond.
This list of conventions is obviously not comprehensive. There are many more conventions that may apply to all the markets across the globe or maybe specific to a given market. However, this article was meant to indicate that sometimes there might be information implied in the question even though one does not explicitly see the information mentioned.
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