The paper “ Financial Institutions and Markets ” is a meaningful example of an assignment on finance & accounting. The price of a bond is calculated by; In the above equation, P = bond price, C = annual coupon interest, M = value upon maturity and n = number of periods. = $519,860.41 If the Commonwealth Bank’ s credit rating increases from AA to AAA, the price of the bonds will go up. This is because rating agencies offer vital information to uninformed investors regarding bond ratings. The ratings are used to weigh up the credit value of particular bonds.
The rating agencies rate bonds on a scale of high to low, depending on the possibility of defaulting. Defaulting could either be by failure to pay the full principal amount on time or failure to pay full interest (coupons) on time. AAA is regarded as the highest quality rating followed by AA which is regarded as of high (very strong) quality. By and large, upgrading a bond’ s rating results in a higher bond price (Boot et al 2006). The price of the bonds would be; = 542,817.34 The number of funds Apple Inc.
will raise is given by; = = $48,796,791.44, but the acceptance fee will be deducted from this amount. Part 2: Investor Perspective According to the yahoo finance website (https: //au. finance. yahoo. com/), the Commonwealth Bank of Australia (CBA) has a market capitalization of AUD134.18 billion, McDonald's (MCD) has a market capitalization of AUD96.50 billion, and American Express (AXP) has a market capitalization of AUD82.65 billion. Therefore, in terms of market capitalization CBA is “ worth more” than MCD or AXP. Market capitalization refers to the aggregate market value of a company’ s number of outstanding shares. A high P/E ratio is linked to growth companies where investors expect earnings to keep increasing and therefore will pay more for the stocks.
However, a too high P/E ratio may indicate that a company’ s share price is overvalued such that investors will pay more but will not realize their expectations. The P/E ratio for CBA, MCD, and Westpac is 15.55, 22.60 and13.59 respectively. According to these figures, investors would expect MCD to post greater earnings into the future and will, therefore, buy more of these shares followed by CBA.
AXP has a comparatively low P/E ratio and therefore investors would not expect much growth of the company into the future. By means of the relative valuation model in estimating the share price of CBA, consider the P/E ratio for the other banking companies as indicated below; Company P/E Westpac 13.59 Australia and New Zealand Bank 12.22 Bendigo and Adelaide Bank 13.39 Auswide Bank 13.96 Average 13.29 From the figures above, the average P/E is. The EPS for CBA is 5.32, therefore, the company’ s share price ratio = 5.32 x 13.29 = AUD 70.70. This valuation is not correct given that different companies have different growth prospects.
The relative valuation takes into consideration the P/E ratio for different companies. Even though the companies are from the same industry/peers, each one stock is also affected by different factors, and therefore using that data to find the valuation of a different stock would be misleading. The applicable formula is; Where p = share price, Div = dividend per share, re = required rate of return, and g = growth rate. Where p = share price, Div = dividend per share, re = required rate of return, and g = growth rate. Therefore, the share price of CBA = 2.18 / (0.08 – 0.04) = $54.5.According to the article, a fall in the big banks’ EOS will lead to a fall in the share prices.
Share price contributes to the share capital, which is a key constituent of the company’ s capital structure. Ordinary share equity is a core component of tier 1 capital. Therefore, a fall in the share price will reduce the portion of the ordinary share equity capital and lead to a decline in the banks’ tier 1 capital.
Tier 1 capital is a key requirement for the bank since it can absorb losses without requiring the bank to stop operations. In the end, the bank’ s trading activities will be affected due to a falling capital base. Tier 1 capital is part of the capital adequacy ratio (CAR). Thus, a fall in tier 1 capital will lead to a declining CAR which is a key indicator for the bank’ s stability. To counter this effect the ban will have to boost tier 2 capital so as to have enough financial power.
Tier 2 capital is a risky capital component since it involves borrowing mainly through debt, convertible securities, and loan-loss reserves (Jackling et al. , 2010).
Boot A.W.A. Milbourn T.T. and Schmitz, A. 2006. Credit Ratings as Coordination Mechanisms, Review of Financial Studies, vol. 19, pp. 82-118.
Performance, B., 1997. Measuring and Managing Shareholder value creation, Montvale, NJ: Institute of Management Accountants.
Jackling, B. Raar, J. and McDowall, T. 2010, Accounting: A Framework for Decision Making, 3rd ed, McGraw-Hill.
Ryan, R. 2006, Corporate Finance and Valuation, Thomson Learning, London.