14. Valuing investments

Question 1

Methods

Answer 1

• Market value
• Smoothed MV
• Fair value
• Historical book value
• Written up/down BV
• DCF
• Stochastic models
• Arbitrage value

Question 2

Smoothed MV

Answer 2

• Removes daily fluctuations&raquo_space;> less volatility
• No consistent valuation with liabilities
• Suitable if results will be communicated and interpreted

Question 3

HBV

Answer 3

• Purchase price is used for valuation
• No consistent valuation with liabilities
• Suited for fixed assets in published accounts

Question 4

Written up/down BV

Answer 4

• BV adjusted for value movements
• No consistent valuation with liabilities
• Suited for property re-evaluations

Question 5

DCF

Answer 5

• Pro: consistent basis between A and L valuations

- Con: assessment of RDR required

Question 6

Stochastic models

Answer 6

• Suitable for complicated scenarios where cashflows depend on the results
  e. g. decision on winding up a company during adverse financial circumstances

Question 7

Arbitrage value

Answer 7

• Proxy for market value of underlying is found by valuing a replicating portfolio and using condition that markets are efficient.
• Suited for derivatives

Question 8

Fair value

Answer 8

• No specifics on calculation method

Question 9

Advantages of market value

Answer 9

• Objective
• Realistic as its the realisable value on sale (if bid price is used)
• Easy
• Well understood and accepted
• Comparison with other methods to check price anomalies

Question 10

Disadvantages of market value

Answer 10

• May not be readily available
• Volatility
• May not reflect future proceeds
• Decision on whether to use bid, offer/mid prices
• Inconsistent valuation with liabilities
• Reflects marginal investor’s position
• May not be realisable value on sale

Question 11

Valuations according to asset class

Answer 11

Bonds: DCF

Equities:
  > MV
  > DCF: General dividend discount model/simplified model
  > NAV/share
  > EVA
  > Measurable key factors of business

Property: DCF

Derivatives: Arbitrage value

Question 12

Assumptions underlying the simplified model

Answer 12

• g < i
• g is constant
• g and i are defined consitently
• Dividends can be reinvested
• Tax and expenses ignored

Question 13

Other methods

Answer 13

• NAV/Share: what shareholders would receive - expenses if company was wound up, all assets sold and proceeds distributed to shareholders
• EVA: One years’s results - cost of servicing the capital that supports the rsults
• Measurable key factors of a company’s business