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    Apologies if these questions sound very basic/trivial -- they're just bugging me a lot and I can't find a simple explanation anywhere (despite trying several internet sources and the books I have here).

    1) What is the yield to maturity on a bond? I understand that the cost of debt (Kd) used in the equation for calculating the weighted average cost of capital (WACC) is NOT simply the coupon rate on bonds/debentures...but why? Why is the yield to maturity different to the coupon rate?

    2) Apparently the market price of a bond goes up when the yield to maturity decreases, and the market price of a bond decreases when the yield to maturity increases? But again, why does that happen? What is the rationale behind lowering the bond price to investors when the yield to maturity for that bond is higher? To me this seems counter-intuitive -- I would have thought that companies would charge a higher market price for a bond if they know those investors will receive higher returns on their investment...where have I gone wrong here?

    3) This may seem rather silly, but how do shareholders make money? I understand that it's through dividend payments and also returns due to capital appreciation of the share price...but the latter makes little sense to me. Can someone put this into an example with an actual share (e.g. BMW) and explain how much money you would hypothetically make assuming a 10% appreciation in share price on a 1-year shareholding?

    Many thanks guys!
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    (Original post by ZetaMu)
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    1) Yield to maturity is simply a fancy term for the yield.. which is the rate of return expected if the bond is held till maturity.. this changes depending on supply/demand/futue expectations. Coupon rate is the periodic income generated as a result of ownership which is generally set at the beginning of the bond's life cycle.

    2) Think of the yield to maturity as a discount factor. The higher the discount rate the lower the price. So "Coupon rate/(1x)^n" > "Coupon rate/(2x)^n"

    Suppose x refers to the yield and n refers to the time period (which isn't relevant in the example). A higher yield means a higher expected rate of return but for that expected rate of return to increase, you have to understand more risk has to be involved. Higher risk = higher return, a fundamental principle to remember. For example take a look at GILTS or US Treasury bills, they have absolutely no default risk so the return is miniscule, however junk bonds offer much higher expected rates of returns so there prices are cheaper (if you were to standardise).

    3) Shareholders make money either through captal gains or dividends as you rightly pointed out. It's pretty simple really. Suppose I buy 10 shares worth £100 each at period n (where n is year 1) in BMW and over the course of the year, future expectations on the company have increased.. similar to bonds investors would discount the share at a lower rate thus increasing the share price. If the price of the share increased to £110 at n+1, and I sell all my shares I've made £110x10 = £1100 where I bought the shares for £1000.. so the difference is essentially gross profit. I think this is what you were getting at?
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    (Original post by Abdul-Karim)
    1) Yield to maturity is simply a fancy term for the yield.. which is the rate of return expected if the bond is held till maturity.. this changes depending on supply/demand/futue expectations. Coupon rate is the periodic income generated as a result of ownership which is generally set at the beginning of the bond's life cycle.

    2) Think of the yield to maturity as a discount factor. The higher the discount rate the lower the price. So "Coupon rate/(1x)^n" > "Coupon rate/(2x)^n"

    Suppose x refers to the yield and n refers to the time period (which isn't relevant in the example). A higher yield means a higher expected rate of return but for that expected rate of return to increase, you have to understand more risk has to be involved. Higher risk = higher return, a fundamental principle to remember. For example take a look at GILTS or US Treasury bills, they have absolutely no default risk so the return is miniscule, however junk bonds offer much higher expected rates of returns so there prices are cheaper (if you were to standardise).

    3) Shareholders make money either through captal gains or dividends as you rightly pointed out. It's pretty simple really. Suppose I buy 10 shares worth £100 each at period n (where n is year 1) in BMW and over the course of the year, future expectations on the company have increased.. similar to bonds investors would discount the share at a lower rate thus increasing the share price. If the price of the share increased to £110 at n+1, and I sell all my shares I've made £110x10 = £1100 where I bought the shares for £1000.. so the difference is essentially gross profit. I think this is what you were getting at?
    Really appreciate you taking the time out to explain all of that, so thank you!
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    (Original post by ZetaMu)
    Really appreciate you taking the time out to explain all of that, so thank you!
    You're very much welcome
 
 
 
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