CH 13: Valuation of investments Flashcards

1
Q

8 Valuation methods

A

Smoothed market value
Historic book value
Adjusted book value
Market value

Fair value
Arbitrage value
Discounted cashflow
Stochastic modelling

SHAM FADS

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2
Q

Market Value

3,3

A

Market values are generally:
* easily available,
* objective
* well-understood
* Used for comparisonj

Problems using MV:
* Volatility: in ST
* No consistency to liability valuation
* Unlisted assets: difficult ot get MV

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3
Q

Smoothed Market value

3

A
  • Where market values are available, they can be smoothed to remove daily fluctuations.
  • Consistent valuation of liabilities as less volatile than MV
  • Requires judgement
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4
Q

Fair value

3

A
  • The amount for which an asset could be exchanged or a liability settled between KNOWLEDGEABLE, WILLING parties at ARM’S LENGTH.
  • FV~MV in most cases or proxy is used
  • Used when MV not available
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5
Q

Discounted cashflow

2

A
  • Involves discounting the expected future cashflows from an investment.
  • Can be made consistrnt with valuation of liabilities (same basis)
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6
Q

Stochastic models as a valuation method

2,3,2

A
  • They are an extension of the discounted cashflow
    method future cashflows, interest rates are treated as random variables.
  • The result of a stochastic valuation is a distribution of values from which the expected value and other statistics can be determined.

Advantages:
* Value derivatives with unceratin CF’s
* Generate distribution of results
* Consistent with liabilities

Disadvantage:
* Complex
* Results depend on assumptions made

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7
Q

Arbitrage value

3

A
  • Means of obtaining a proxy market value
  • Calculated by replicating the investment with a combination of other investments and applying the condition that in an efficient market the values must be equal.
  • Used to value derivatives
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8
Q

Book value

3

A
  • Price originally paid for the asset and is often used for fixed assets in published accounts.
  • Not consistent with liabilities

Advantages:
* Objective
* Conservative
* IFRS

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9
Q

Written up or written down book value

3

A
  • Book value adjusted periodically for movements in value.
  • Subjective
  • Not consistent with liabilities
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10
Q

Bond valuation

4

A
  • Discounted CF. PV of coupon and redemption payments

Each cashflow is discounted at the market spot rate of the appropriate term, adjusted for:
- Risk of default
- Marketability
- Additional option features should theoretically be valued using option pricing techniques

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11
Q

Bonds with options

2,2

A
  • Callable: bond that the borrower can choose to repay at any time.
  • Puttable: Investor can demand payment at any time

Value of bond w/Option:
* Puttable : MV bond no option + Value of option
* Callable: MV lower than normal bond due to uncertainty of repayment date.

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12
Q

Equity valuation methods
Discounted dividends

2,1

A
  • Start point is MV
  • Discounted CF to value shares, compare to MV =General model

Simplified model: assumptions about dividends. D/i-g
* i & g unknown
* i-g sensitive
* no taxes
* assume annual dividend

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13
Q

Equity valuation methods
NAV/EVA

2,3

A

NAV:
* Used to value comp with assets.
* Assetval(proxy) / #shares

Economic Value Added:
* Shareholder aims to get underlying value from investment
* Annual performance minus cost of services
* Metric for perf of management

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14
Q

Property valuation

2,2

A
  • True MV only known on sale.
  • Indicative value can be taken from similar transactions but will be subjective

Can use discounted cashflows:
* Explicit allowance for: rent frequency, increases, expenses
* Assume perpetuity

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15
Q

Options & futures valuation

2

A
  • Valued using the principle of no arbitrage, (option pricing methods)
  • Value taken is the vost to close out position.
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16
Q

Valuation of swaps

4

A
  • Valued by discounting the 2 component cashflows.
  • At inception, the value (at market rates of interest) of a swap to both parties will be zero
  • PV Inc = PV outgo
  • As market interest rates change, the value of the 2 cashflows will alter, leading to a positive net value for one party and a negative net value to the other.
17
Q

Purpose of Valuation

4

A
  • Method and basis used for valuation will depend on its purpose.
  • Regulatory,Discontinuance,ongoing

Needs to be consistent valuation bet assets and liabilities on the same set of assumptions.

18
Q

7 Criteria for assessing asset valuation methods

A
  • Readily available or not
  • Subjective / objective
  • Conservative / realistic
  • Simple to obtain or complex to calculate
  • How well is it understood
  • Volatile or not
  • Consistency with liability valuation
19
Q

Arbitrage

A

The simultaneous buying and selling of two economically equivalent, but differently priced portfolios so as to make an instant and risk-free profit.