Question

what is the economic intuition behind the difference between the perpetual bond formula and the constant gordon growth model, ? stock and bond investors have homogeneous expectations for the two securities stock investors prefer diviend gains while bond investors prefer capital gains bond investors prefer cash flow with maturity while stock investors prefer perpetual cash flow stream stock and bond investors have different sets of interest with respect to the firm's future growth potentials

Answer 1

The economic intuition behind the difference between the perpetual bond formula and the constant Gordon growth model lies in the preferences and expectations of stock and bond investors. Stock investors prefer dividend gains and a perpetual cash flow stream, while bond investors prefer capital gains and a cash flow with maturity. These preferences reflect the different sets of interests that stock and bond investors have with respect to the firm's future growth potentials.

Step-by-step explanation:

The economic intuition behind the difference between the perpetual bond formula and the constant Gordon growth model lies in the preferences and expectations of stock and bond investors. Stock investors prefer dividend gains and a perpetual cash flow stream, while bond investors prefer capital gains and a cash flow with maturity. These preferences reflect the different sets of interests that stock and bond investors have with respect to the firm's future growth potentials.

Stock investors are more focused on the long-term growth potential of the company and are willing to forgo immediate cash flow in favor of perpetual dividends. On the other hand, bond investors prefer a fixed maturity date and are more concerned with capital gains that can be realized when interest rates fall after the bond is issued.

Overall, the difference in preferences and expectations of stock and bond investors drives the different formulas used to value perpetual bonds and stocks in the constant Gordon growth model.