Chapter 23: Valuation of individual investments Flashcards

1
Q

8 Valuation methods

A

BOOK VALUE

  • (historical) book value
  • written up or written down book value

MARKET VALUE

  • market value
  • smoothed market value
  • fair value
  • arbitrage value

DISCOUNTED CASHFLOW

  • discounted cashflow (deterministically calculated)
  • stochastic modelling
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2
Q

Fair value

A

the amount for which an asset could be exchanged or a liability settled between KNOWLEDGEABLE, WILLING parties at ARM’S LENGTH.

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3
Q

What are the characteristics of market value as a valuation proxy?

A

Market values are generally
…. easily available,
…. objective and
…. well-understood.

However, they can be volatile in the short-term.

It can also be difficult to value liabilities in a consistent, market-based manner.

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4
Q

Bond valuation

A

Present value 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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5
Q

Discounted dividend model

A

derives the value of a share as the discounted value of the estimated future dividend stream.

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6
Q

3 Equity valuation methods

A

• SHARE ANALYSIS

  • — P/E Ratios
  • — Other ratios - relevant and measurable

• VALUE ADDED MEASURES

  • — EVA
  • — PV[EVA]

• DISCOUNTED DIVIDEND MODEL

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7
Q

Property valuation

A

Discounted cashflow approach is mostly used

Explicit allowance for:

  • rent frequency
  • rental increases
  • expenses
  • possibility of voids
  • term of the lease
  • redevelopment / refurbishment costs
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8
Q

Options & futures valuation

A

Usually valued using techniques based upon the principle of no arbitrage, (option pricing methods)

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9
Q

Valuation of swaps

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, ignoring the market maker’s profit and expenses.

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.

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10
Q

Historic book value

A

Price originally paid for the asset and is often used for fixed assets in published accounts.

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11
Q

Favourability of the (historic) book value method

A

It is:

  • objective
  • conservative
  • well-understood
  • used for some accounting purposes
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12
Q

Written up or written down book value

A

Historic book value adjusted periodically for movements in value.

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13
Q

Smoothed Market value

A

Where market values are available, they can be smoothed to remove daily fluctuations.

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14
Q

Fair value calculation

A

For most assets, the fair value will simply be the market price.
If the market price of an asset is not readily available, then a proxy might be sought in the form of an alternative fair value.
- seek an indicative price from a broker or market maker
- use a stochastic asset model to determine a market-consistent value
- use most recent known price and adjust in line with the movement of an appropriate index.

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15
Q

Discounted cashflow

A

Involves discounting the expected future cashflows from an investment.

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16
Q

Arbitrage value

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.

17
Q

Callable bond

A

bond that the borrower can choose to repay at any time.

18
Q

puttable bond

A

the investor can demand repayment at any time.

19
Q

Value of a puttable bond to the investor

A

Equal to that of an otherwise identical bond that does not include an option, plus the time value of the choice provided by the option.

20
Q

Valuing portfolios of shares

A

The valuation of a portfolio of ordinary shares would be carried out by assuming the shares were swapped for a holding in an index.

21
Q

Appropriate valuation method depends on (3)

A
  • Objective of the investment
  • Reasons for valuation
  • Type of asset
22
Q

Valuation of assets make it possible to (2)

A
  • Identify “value for money” investments

- Monitor experience of the investment portfolio

23
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
24
Q

Alternative way of viewing a swaps contract

A

As a series of forward contracts.

If each of these forward agreements can be valued, then so can the swap.

25
Q

Stochastic models as a valuation method

A
  • They are an extension of the discounted cashflow
    method
  • The future cashflows, interest rates, or both 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.
26
Q

Disadvantages of stochastic models for valuation

A
  • they may be too complex for many applications
  • the results are dependent on the assumed distributions
    for the variables - these assumptions may be highly
    subjective
27
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.