06 May Finance Discussion
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?
Part 2 respond
The valuation principle is an assertion that the value of a commodity or an asset to a firm or the investors is determined by its competitive market price. It is one of the roles of managers to make informed decisions on behalf of investors and shareholders and this is a used as a guide. This is used through breaking their ideas down and analyzing the costs and the benefits derived. For any competitive market, the value of a good is set by its price, therefore managers use the valuation principle first to know the market price of a good and thereafter using this, the benefits and costs are evaluated, in which the value of the benefit should exceed the value of costs.
The yield curve describes the relationship between the annual rate of return and the term to maturity. The yield curves reflect predominantly interest rate expectations. With the sharply downward sloping curves, the future expectations of the financial managers’ were expected short rates in the future.
Downward sloping yield curve occurs when short-term interest rates decline and is an indication of short term interest rates are expected to fall sharply.
Demand yield curve change is due to the change in the interest rates. It is a systematic risk. This is in that it is non-diversifiable and everyone in the market will experience it. The interest rate change affects stock prices, for example, rising rates affect the prices negatively since borrowing costs rise, making bonds more attractive because of the high returns.
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