Chapter 13 - Valuation of Investments

Question 1

Individual Asset valuation methods

Answer 1

Market value

Smoothed market value
- Where market values are available, they can be smoothed by taking some form of average over a specified period to remove daily fluctuations

Fair value
- is the amount for which an asset could be exchanged or a liability settled between knowledgeable, willing parties at arm’s length.
- This definition does not specify how such a value is calculated
- Most assets fair value is the market price

Discounted cashflow
- Discounting expected future cashflows from an investment using long term assumptions

Stochastic models
- extension of the discounted cashflow method in which the future cashflows, interest rates or both are treated as random variables.

Arbitrage value
- Arbitrage value is a means of obtaining a proxy market value and is 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.
- often used in the derivatives valuation

Historic book value
- This is the price originally paid for the asset and is often used for fixed assets in published accounts
- for most valuation purposes, book value has little merit, since it is historical

Written up and written down book value
- is historic book value adjusted periodically for movements in value

Question 2

Bond Valuations

Answer 2

Discounted cashflow approach
- Government or similar high-quality bonds can be valued by discounting cashflows at rates consistent with the market spot rate yield curve

Valuing bonds with option features
- Many bonds have option features (e.g. callable and puttable bonds).
- Such bonds should theoretically be valued using option pricing techniques, although this is not always done in practice.

Question 3

Equity Valuations

Answer 3

Market value is always the starting point for equity valuation if there is a suitable market

Discounted Dividend model
- value of a share equals discounted value of the estimated future dividend stream

Net Asset Value per share
- can be adopted for companies with significant tangible assets.
- A similar approach can be adopted to shares of a property investment company
- NAV = Net Assets / Number of Shares

Shareholder value
Economic Valued Added

Question 4

Property Valuations

Answer 4

• As with all investments, the true market value is only known when there is a transaction that equates a willing buyer with a willing seller.
• This happens frequently with stocks and shares that are actively traded on regulated markets, but real property changes hands infrequently.
• Indications of value can be taken from similar recent transactions but the uniqueness of each property means that considerable skill is needed to assess property market values.
• Such valuations must be regarded as a matter of the valuer’s opinion rather than fact.
• Property can be valued using an explicit discounted cashflow approach, but as with equities it is now more common to use a market-consistent valuation of liabilities.
• The cashflows discounted should be net of all outgoings and should make explicit allowances for expected rental increases

Question 5

Derivative Valuation

Answer 5

• Usually valued using techniques based on the principle of ‘no arbitrage’.
• The value taken is the cost of closing out the contract by buying an equal and opposite option or future on current term

Question 5

Derivative Valuation

Answer 5

• Usually valued using techniques based on the principle of ‘no arbitrage’.
• The value taken is the cost of closing out the contract by buying an equal and opposite option or future on current term

Question 6

Portfolio Valuation ( where liabilities exist )

Answer 6

The straightforward way of valuing a portfolio of investments is to sum the market values of the individual holdings, or if there is no active market, a proxy market value.

Most commonly , determining methods and bases for the valuation of liabilities that are consistent with a market value of assets are used. Other methods also still used are:

• Discontinuance valuation where the funds are valued assuming an immediate wind up
• Ongoing Valuation where valuation is done based on assumption that fund will be ongoing