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Valuation of Securities

Valuation of Securities

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Published by Ashish Roy

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Published by: Ashish Roy on Jan 08, 2013
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VALUATION OF SECURITIES
Learning objectives;
Basic valuation models to value bonds / debentures, preference shares, equityshares.
Apply the basic valuation model to bonds/Deb. To evaluate the relationshipbetween both return and time to maturity & bond values.
Understand YTM, its calculations and procedure to value Bonds that pay interestsemi-annually.
Learn the valuation of perpetual and redeemable preference shares.
Learn basic share valuation under each of three cases/. Zero growth model,constant growth model and variable growth model.
Understand and learn three other approaches- Book value, liquidation value andP/E /multiples-that are used to estimate share values.
Review the relationship between the impact of financial decision on both
expected return and risk and their combined effect on the value of the firm.
 
VALUATION
Valuation is the process that links risk and return to determine the worth of anasset. To value them, we have to use TV techniques and risk and return
framework.
The key inputs to the valuation process are
Expected returns in terms of cash flows together with their timings.
Risk in terms of required rate of return or return.
The value of an asset depends on the return (CFs) expected over theholding/ownership period.
The CFs can be annually, intermittent and even one time.
The level of risk associated with a given CF/ return has a significant bearing on itsvalue. The greater
the risk the lower the value & vice versa.
Higher risk can be incorporated into the valuation analysis by using a higherrequired / capitalization/discount rate to determine the PV.
While studying CAP,M model we found that greater the Beta, the higher the
required ROR.
It is against this back ground, the valuation of Bonds/ PS /ES is determined.
 
BONDS
Basic valuation model:
The value of an asset /security is the present/discounted values of all future CFs (return) associated with it over therelevant/specified period.
The expected return (CFs) are discounted
V= A1/ (1+k)
1
+ A2/ (1+k)
2
 
+ …+ A
n
/ (1+k)
n
 
V= Value of an asset / security
At = Cash streams expected at the end of year ‘t’
 
K = appropriate required /capitalization / discount rate.
Alternatively, if expected CF is a mixed stream, then
V = [(A1 x PVIF
(k, 1)
+ (A
2
x PVIF
(k, 2)
 
+……. + (An x PVIF
(k, n)
)]
If expected CF is an annuity, then
V= A x PVIFA
(k, n)
 

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