Valuation Please respond to the following: Review the valuation principle and ho
ID: 1143680 • Letter: V
Question
Valuation
Please respond to the following:
Review the valuation principle and how it helps a financial manager make decisions. In the early 1980s, inflation was in the double digits and the yield curve sloped sharply downward.
What did this yield curve suggest about the financial manager's / investor's expectations about future rates?
Explain how a downward sloping yield curve affects the prices of existing long-term bonds and stocks trading in the secondary market, assuming this change in the yield curve is the only change that occurs.
Would you characterize the change in the yield curve as a systematic or unsystematic risk?
Explanation / Answer
Answer : Valuation principle is making analysis of cost and benefits related to particular project. Cost benefit is a systematic process in which there is comparing benefit and cost of a project decision and policy of the government. It helps the financial manager in the following way such as :
Answer b : Yield curve shows that the relationship between the interest rate and time of maturity with respect to the inflation into an account. The slope of the yield curve tell us about the activity or position of an economy because the curve can shows that where investor think interest rate are headed in future it help in determing the expectations of an economy.
Sharply upward sloping yield curve indicates that yield on short term investment are lower than yield on long term investment where as inverted yield curve shows that higher interest rate on short term investment which shows that in future expected interest rate has been declined.
Answer c : Yield curve downward is a situation where short term interest rate exceed long term interest rate. This shows that economy entering into phase of recession
Impact in the stock market : When the yield curve is downward, profit of the company that take money at short term rate and lend to long term has been suffered such as commerical banks. There is long term capital management and hedge fund are created to over the risk of the company faced at downward yield curve.
Impact on bonds : When the yield curve is downward it resulted in purchasing of treasury backed securities provided a yield similar to the junk bonds. CD of 1 year are more attractive than long term bonds.
Answer d : Change in the yield curve is a part of systematic risk because it is market risk which causes change in the price of the stock which resulted changes in the interest rates. Systematic risk os the risk occured in all short term as well as long term securities of all companies.
It included such as :
It included such as interestrisk, market risk and inflation risk in an economy.
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