Question

Between share valuation and bond valuation, which one is easier to determine, and why? If you are an investor and you expect the interest rate to rise, will you invest in a long-term zero-coupon bond or a short-term coupon bond? Explain.

Answer 1

1.
It is easier to determine bond valuation because in case of bond the cash flows are certain and the timing is also certain. The required return on bond can also be easily found out from the market given the bond's rating.
But in case of equity, as equity has residual or leftover claim the timing and the amount of cash flows is not certain. Also, determining the required return is very difficult as no two companies are same.

2.
Invest in short term coupon bond as the price of a bond falls with rise in interest rates and the fall increases with increase in maturity. So, it is better to invest in short term coupon bonds and keep rolling them.