Valuation Of Investments

Question 1

Common methods of valuing assets

Answer 1

(Historic) book value
Written up or written down book value
Market value
Smoothed market value (such as MA)
Fair value
Discount cashflow
Stochastic modeling
Arbitrage value

Question 2

Market values vs calculated values (Advantages)

Answer 2

Easily attainable

Realistic as realizable value on sale (assuming bid price used)

Easy as it does not require calculation

Well understood and accepted

Can be used as a comparison to other valuation methods to see whether an asset seems over- or under-priced

Question 3

Market values vs calculated values (Disadvantages)

Answer 3

May not be readily attainable (eg. unquoted instruments)

Volatile - values may fluctuate greatly even in the short term

May not reflect the value of future proceeds

A decision is required about whether bid, mid or offer price should be used

Difficult to ensure consistency of basis with that of the liability valuation

Value reflects the position of the marginal investor rather than the individual (eg. taxation)

May not be the realizable value on sale (eg. If dealing in large volumes or illiquid stocks)

Question 4

Bond valuations

Answer 4

Use DCF
The discount rate should be adjusted to reflect the riskiness of the payment and the marketability of the particular bond

Question 5

Equity valuations

Answer 5

Starting point: market value (if there is one)

Can use DCF

Other methods:
NAV
Value added methods, such as economic value added
Measurable key factors of a company’s business

Question 6

Property valuations

Answer 6

DCF

CFs should be net of all outgoings and should make explicit allowances for the expected rate of increase of rental income

Discount rate should depend on the riskiness of the investment and could be based on the yield on a bond of suitable term + margins for risk and lack of marketability

Question 7

Alternatives for placing a value in a portfolio of investments

Answer 7

Most widely used method for actuarial purposes is market value

Method and basis for any actuarial valuation will depend on purpose and type of liability. In some cases, method will be prescribed by regulation

Valuation of assets and liabilities need to be consistent

If a market value approach is used to value assets, then the liabilities must be valued using a market-based discount rate, which can be difficult to determine

Discounted cashflow methods for valuing assets can more easily be made both stable and consistent with the valuation of liabilities (which is typically done using a discounted cashflow approach)

Question 8

Allowing for the variability of asset prices

Answer 8

Volatility of asset prices is not a problem in itself as it may correctly reflect the underlying reality

However, in the context of the ongoing valuation of a long-term fund, comparing volatile asset values with a value of liabilities calculated using a stable interest rate is potentially misleading