CH 13: Valuation of investments Flashcards
8 Valuation methods
Smoothed market value
Historic book value
Adjusted book value
Market value
Fair value
Arbitrage value
Discounted cashflow
Stochastic modelling
SHAM FADS
Market Value
3,3
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
Smoothed Market value
3
- Where market values are available, they can be smoothed to remove daily fluctuations.
- Consistent valuation of liabilities as less volatile than MV
- Requires judgement
Fair value
3
- 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
Discounted cashflow
2
- Involves discounting the expected future cashflows from an investment.
- Can be made consistrnt with valuation of liabilities (same basis)
Stochastic models as a valuation method
2,3,2
- 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
Arbitrage value
3
- 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
Book value
3
- Price originally paid for the asset and is often used for fixed assets in published accounts.
- Not consistent with liabilities
Advantages:
* Objective
* Conservative
* IFRS
Written up or written down book value
3
- Book value adjusted periodically for movements in value.
- Subjective
- Not consistent with liabilities
Bond valuation
4
- 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
Bonds with options
2,2
- 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.
Equity valuation methods
Discounted dividends
2,1
- 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
Equity valuation methods
NAV/EVA
2,3
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
Property valuation
2,2
- 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
Options & futures valuation
2
- Valued using the principle of no arbitrage, (option pricing methods)
- Value taken is the vost to close out position.
Valuation of swaps
4
- 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.
Purpose of Valuation
4
- 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.
7 Criteria for assessing asset valuation methods
- 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
Arbitrage
The simultaneous buying and selling of two economically equivalent, but differently priced portfolios so as to make an instant and risk-free profit.
