Prin of Finance

Market prices, Valuation Principle, Net present Value, Interest rates, and Bonds

Neicole L. Noel

Joseph Arbeiter

Principles of Finance – FIN 100 Section 014016

01/28/2011

1.

Explain why market prices are useful to a financial manager

By market prices, I take it to mean the market prices of financial instruments such as bonds, stocks and treasury bills traded in the financial markets. Financial instruments that are traded in the market have two prices (a) face value or par value, which are the prices at which these instruments are issued to the subscribers, initially, at the time of public offer by the organization such as the government or corporations and (b) the prices at which these instruments get traded daily in the market. There are primarily two types of instruments (a) debt or its variants and (b) equity. Debt instruments are contractual in nature between the issuer and the holder, are issued with a par value or face value, its maturity period and an interest rate including the periodicity of interest payments. Debt instruments carry a predefined rate of return called interest, which is calculated on the basis of its par value or face value and paid out to its holders at periodic intervals as determined by its terms of issue. In contrast, equity instruments are pure risk instruments, in the sense, the returns the equity holder gets is not assured (unlike a debt instrument that are fixed return instruments ) but varies depending on the performance of the company and the shareholders (board’s) decision on dividend payouts.

Both debt and equity are traded everyday in the recognized financial markets such as stock exchanges, where they are listed for trading. The price at which the instruments are traded, are different from the price at which they were originally issued. In the case of debt, the market prices are determined by the prevailing interest rates and the risk perception of those instruments determined by their latest ratings by...