This lesson applies the time value of money to the valuation of financial assets, with a focus on bonds and stocks.

3.1 Bond Valuation

A bond is a debt security that pays periodic interest (coupon) and repays principal at maturity. Its value is the present value of these expected cash flows, discounted at a rate reflecting the risk of the bond . The required rate of return incorporates the risk-free rate, a credit risk premium, and other factors such as liquidity risk . There is an inverse relationship between bond prices and yields: when required returns rise, bond prices fall.

3.2 Stock Valuation

The value of a stock is the present value of its expected future dividends . The dividend discount model is a foundational valuation approach. The Constant Growth Model (Gordon Growth Model) assumes dividends grow at a constant rate. The CAPM is used to estimate the required return on equity.