Security Valuation

Valuation is useful when trying to determine the fair value of a security, this could be
determined based on the willingness of the buyer to buy and the willingness of the seller to
sell.
When securities are traded, both sellers and buyers determined the market value of stock or
bonds

The intrinsic value refers to the perceived value of a security based on future earnings,
analysts do the valuation to determine if the financial instrument is overvalued or
undervalued by the market.
The fair value is the actual value (nominal) of an asset- a product, stock, or security that is
agreed upon by both seller and the buyer.
 Valuation of Bonds
Bonds form a significant portion of the financial market and are a key source of
capital for the corporate world.
Treasury bonds (T-bonds) are government debt securities issued by the federal
government that have maturities greater than 10 years.
A bond is a fixed income instrument that represents a loan made by an investor
to a borrower (corporate or government). A bond can be thought of as IOU
which mean a debt instrument.
T-bonds earn periodic interest until maturity, at which point the owner is also
paid a par amount equal to the principal.
A bond is a fixed income instrument that represents a loan made by an investor
to a borrower (corporate or government).
A bond can be thought of as IOU which mean a debt instrument.
Bonds are used by companies, municipalities, sovereign government to finance
projects or operations. Owners of bonds are debt holders or creditors of the
issuer.
Bond details include the end date when the principal of the loan is to be paid to
the bond owner and also the fixed interest payments by the borrower.
Bond prices are inversely related to interest, when interest rates go up, bond
prices fall and vice versa.
Bonds has maturity date on which the principal has to paid in full or risk default.
Default risk increases as a company moves closer toward bankruptcy.
Key Bond Characteristics includes:
a) Face Value
The face value (also known as the par value) of a bond is the price at which the
bond is sold to investors when first issued; it is also the price at which the bond
is redeemed at maturity.
b.)Coupon Rate
The periodic interest payments promised to bondholders are computed as fixed
percentage of the bond’s face value.
c.) Coupon
A bond’s coupon is the dollar value of the periodic interest payment promised to
bondholders; this equals the coupon rate times the face value of the bond. For
example, if a bond issuer promises to pay an annual coupon rate of 5% to bond
holders and the face value of the bond is $1,000, the bond holders are being
promised a coupon payment of (0.05)($1,000) = $50 per year.
d) Maturity
A bond’s maturity is the length of time unit the principal is scheduled to be
repaid.
e) Call Provisions
Many bonds contain a provision that enables the issuer to buy the bond back
from the bondholder at a pre-specified price prior to maturity known as the call
price.
It contains a provision that enables the issuer to buy the bond back from the
bondholder.
A bond containing a call provision is said to be callable.
f) Put Provisions
Some bonds contain a provision that enables the buyer to sell the bond back to
the issuer at a pre-specified price to maturity.
This provision enables bond holders to benefit from rising interest rates since the
bond can be sold and the proceeds reinvested at a higher yield than the original
bond.
g) Sinking Fund Provisions
Some bonds are issued with a provision that requires the issuer to repurchase a
fixed percentage of the outstanding bonds each year, regardless of the level of
interest rates.
A sinking fund reduces the possibility of default; default occurs when a bond
issuer is unable to make promised payments on the maturity date.
Government Treasury Bonds ( 1 SR)
 Boracay- Aklan Provincial
Bonds
Puerto Princesa Green Bonds
Corporate Bonds

Bond issued by a business entity is called a Corporate Bond. Corporations use

bonds as an alternative to stocks in raising capital. Examples of companies in the
Philippines regularly issuing corporate bonds include Ayala Corporation, Globe
Telecom, JG Summit Corporation, Filinvest Land, and many more.
Corporations can raise funds by issuing debt in the form of corporate bonds.
These bonds offer a higher promised coupon rate than Treasuries, but expose
investors to default risk.
The riskiest corporations offer the highest coupon rates to investors as
compensation for default risk. Default risk is a risk that a lender takes in the
chance that the borrower failed the required obligation. Credit extension of a
lender is applied whenever the financial health of a company is crucial.
Treasury bills- the maturity is one year or less; the currently available maturities are 4
weeks, 13 weeks, 26 weeks and 52 weeks.
Treasury notes – the maturity ranges between 1 and 10 years; currently available maturities
are 2,3,5,7 and 10 years.
Treasury bonds – the maturity ranges between 20 and 30 years; the currently available
maturity is 30 years.
Another key difference between these securities is that Treasury bills are sold at a discount
from their face value and redeemed at face value; Treasury notes and bonds are sold and
redeemed at face value and pay semi-annual coupons to investors.
Foreign Entities
Foreign bonds are issued by foreign governments and corporations and are denominated in
dollars. (If they are denominated in a foreign currency, they are known as eurobonds.)
Dollar-denominated bonds issued in the U.S. by foreign entities are known as Yankee Bonds.
Foreign bonds are mainly used to provide corporate or sovereign issuers with access to
another capital market outside their domestic market to raise capital. A foreign issuer who
wants access to the Japanese debt market would issue a bond referred to as Samurai bond.
How to calculate Bond Value?
A bond is a debt instrument that pays a fixed amount of interest until maturity.
When a bond matures, the principal amount of the bod is return to the
bondholder.
• Assume for example, that IBM issues a $1,000,000 6% bond due in 10 years.
The pays interest semi-annually.
• $1,000,000 is the face amount or the principal amount of the bond. That is the
amount that must be repaid by the issuer (IBM) at maturity.
• IBM (the issuer) must repay the $1,000,000 to the investors at the end of 10
years
• The bond pays interest of ($1,000,000 multiplied by 6%), or 60,000 per year.
Since the bond pays interest semiannually, the issuer must take two payments
of 30,000 semi-annually.
To calculate the bond price, we can use the basic present value (PV) formula:

Where C = coupon payment

I = interest rate, or required yield
M= value at maturity
n = number of payments
• F = $1000 for corporate bond
• Coupon rateannual = 5%, therefore, Coupon ratesemi-annual = 5%/2 = 2.5%
• C = 2.5% x $1000 = $25 per period
• t = 2 years x 2 = 4 periods for semi-annual coupon payments
• T = 4 periods
• Present value of semi-annual payments = 25/(1.03)1 + 25/(1.03)2 +
25/(1.03)3 + 25/(1.03)4
• = 24.27 + 23.56 + 22.88 + 22.21
• = 92.93
• Present value of face value = 1000/(1.03)4
• = 888.49
• Therefore, value of bond = $92.93 + $888.49 = $981
 Valuation of Stocks
Valuation of stocks is the process of determining the intrinsic value of a
share of common stock of a company.
The Dividend Discount model is used by investors to measure the value
of stock. Investors used the DDM to price stocks based on the sum of
future income flows dividends using the risk-adjusted required rate of
return.
The model states that the intrinsic value of the company’s future
dividends. This model is applicable only if the company distribute
dividend regularly.
Absolute Valuation
Absolute Valuation (discounted cash flow method) relies on the analysis
of company’s fundamental information derived from the financial
statement, primarily investigate the cash flow, dividend and growth
rate.
The DCF method calculates the intrinsic value of a stock is calculated by
discounting the company’s free cash flows to its present value.
DCF is a valuation method used to estimate the value of an investment
based on its expected future cash flow.
DCF Analysis attempts to figure out value of an investment today, based
on projections of how much money it will generate in the future.
Relative Valuation
Relative Valuation (also called the comparable approach) is a method
comparing investment with similar companies using ratio analysis of
similar companies targeting the same ratio for the target company.
Stock definition in Finance
A stock (also known as equity) is a security that represents the
ownership of a fraction of a corporation. This entitles the owner of the
stock to a proportion of the corporation’s assets and profits equal to
how mush stock they own.

Ownership of a small piece of company is called share and investors

purchase a stocks in companies as they are entitled to the earnings and
ownership of assets of the company, also they are responsible for the
risk involve in the investment.
Two Types of Stocks
COMMON STOCKS
Preemptive Right allows stockholders to subscribe to any new issue of
stock so that they can maintain their previous fraction of the total
number of authorized and issued shares.
Common Stocks ownership grants the stockholders the right to sell the
stock in the secondary market, either through a public exchange (PSE)
or in a private transaction.
Example: Mr. Forde owns 52% of the outstanding shares of the Forde
Corporation and is Chairman of the Board. If the Forde Corporation sells a
new stock issue that doubles the number of shares outstanding, Mr.
Forde’s share of ownership and control of the new larger number of
outstanding shares diminishes to what percent if he does not exercise a
preemptive right that allows him to buy 52 percent of the new issue?
Solution: Assume that the company has 100 shares outstanding. If the
number of shares double, then, 200 will exist. Mr. Forde owns 52 percent
of the original shares or 52 shares. This is 26% of the total shares after the
number of shares doubled (52/200 = .26 or 26%)
Cash Dividends - Common stockholders have the right to participate in
the profits of the company through dividends payment. Rapidly
growing corporations pay little or no cash dividends in order to retain
as much capital as possible to finance internal growth.
Voting Rights They have the right to vote at the annual company’s
meeting, they also have the power to vote against major issues (such as
mergers and expansion to a new product line). In case that they cannot
attend for the annual meeting they can send a proxy to vote the proxy
signer and they have the right to the company’s remaining assets if the
company goes out of bankruptcy.
The residual claim of the common stockholders that all bills ( such as
employees’ wages, suppliers bills, and bondholders’ interest) are paid
first before the common stockholders can claim of whatever assets
remain from the bankrupt operation.
PREFERRED STOCKS
Preferred stocks has characteristics of bond and common stocks; it
sometimes referred to as Hybrid Security, they receive preferential
treatment over common stockholders (but not over bondholders in
certain aspects)
Preferred stockholders receive two primary advantages over common
stockholders (1) after-tax earnings in the form of dividends cannot be
paid to common stockholders unless the preferred cash dividends have
already been paid.
Preferred stockholders receive a prior claim on the corporations assets
in the event of a bankruptcy . Preferred stockholders receive a greater
rate of return than bondholder as they assume a higher risk.
Preemptive Right
Common laws gives both common and preferred shareholders has the
right to subscribe additional shares to maintain their proportionate share
of ownership, however, the existence of preemptive rights depends on the
law of the state where the corporations is chartered and on the provisions
of the company’s articles of corporation.
Cash dividends from Preferred Stocks – Preferred Stockholders is entitled
to a dividend whether or not the firm earns called as cumulative cash
dividend clause. If corporations misses a part of a preferred dividend it
must be paid in the preceding year before common stockholders dividends
can be paid.
Example: The Baker Corporation was unable to meet its $6 per share preferred
dividend one year because of cash shortages. As a result, The Baker
Corporation’s cumulative preferred stocks in arrears for $6 per share. At the
end of its next year the Baker Corporation has $8 of earnings per share that it
can disperse as cash dividends, and all $8 must go to the preferred stock (rather
than $5 to preferred and $3 to common) After this $8 payment, how much will
the firm still be in arrears to its cumulative preferred stockholders?

Solution: The Baker Corporation must pay the $6 preferred dividend in arrears
plus the current dividend of $6 for a total of $12. Therefore, after the $8 to
preferred stockholders, it is still $4 in arrears.
Invest Intelligently: Are you really ready to take the plunge and invest in
shares of stocks?
In case of doubt or just to be doubly sure of your decision or goal,
take one step backward and analyze yourself again as well as the pros and
cons of your plan.
Managing investment portfolios and slowly growing them is one
approach to accumulate wealth. But how qualified or able are you to do so?
Do you know the risks you will face when you invest? Do you have the
tendency to make decisions based on impulse or gut feel? Will you invest
merely based on tips from your “deemed authoritative” or reliable relatives
and friends?
How much do you really know about yourself?
1. How is your personal lifestyle? Do you live in extravagance? Many
people would like to enjoy wearing expensive clothes, driving flashy cars, and
living in posh residences even to the extent of borrowing. They are conscious
of their image and take extreme pleasure hearing how people praise them.
There are people who would brag around that they would rather “live
rich, and die poor”. There are also those who are “flush with cash” and just
LOI –”live on inheritance” or “live on interest”
The above type of people consider investing as a second priority.
On the other hand, there are those who live in frugality. They are just
prudent in managing their personal and family income and expenditures , and
looking for opportunities to save is always on top of their priorities.
They are the compulsive savers who have the potential to become
wealthy and successful investors.
2. Are you in partnership in managing your finances?
Having common bank accounts and jointly managing finances may not
be a common practice for many married couples, bit there are advantages and
benefits accruing to those who adhere to this practice.
3. Are you typical of the following ordinary Filipinos?
a. sixty years old and above, living on earnings from retirement funds
b. Father of a family living below their means, who just won a million
pesos in a lottery
c. Fresh college graduate, still unemployed, living with and receiving
monthly allowances from parents.
d. Newly discharged employee who is given a reasonable termination
pay
e. Overseas foreign worker
4. Are you familiar with the Risk Profiling Questionnaire provided by banks for
new and existing bank clients?

The Risk Profiling Questionnaire is designed to introduce you to risks

associated with all types of investments and to help you determine your
attitude toward investment risks. It gives you a feel of what specific level of
risks you could be comfortable with or willing to accept in relation to the
amount of funds you would like to invest at the present time.
It discusses fluctuations in values of your investment portfolios,
percentage of your household income, and setting aside portion of your
monthly income for emergency purposes.
5. Have you or your family already set aside funds for emergency purposes and
children’s education funds?
Do not tap forced savings for investment purposes. Forced savings are
funds earmarked for emergencies, such as unexpected hospitalization costs and
financial impacts of fortuitous events, and for the children’s college education.
Providing for the children’s college education is one of the everlasting
investment options that parents could give their children.
6. Are you a stock trader, shareholder, or both?
If you are just interested in buying shares for regular buying and selling
purposes, you are merely trading in stocks.
If your intention is o hold the shares for the long-term primarily in
expectation of dividend income, then you are a stockholder. Owning a shares of
stocks has its inherent risks and rewards. If you pick the right company to invest
in then its earnings grow and assured of robust dividend yield. Worse if the
investee company goes bankrupt, you lose your investment.
Dividend Discount Model (DDM)
It is used to value stocks based on the net present value of the future
dividends.
• Example: Cuban Corporation will pay a dividend of $3.06 per share
next year. The company pledges to increase its dividend by 6 percent
per year indefinitely. If you require a return of 12% on your
investment, how much will you pay for the company’s stock today?
• Price per share = next dividend/(required return-growth rate)
• Price per share = $3.06/(12% - 6%)
• Price per share = $51
• Solution:
• Step 1 Find the present value of Dividends for year 1 and year 2
• PV (year 1) = $20/((1.15)^1)
• PV(year 2) = $20/((1.15)^2)
• PV is $17.4 and 16.3 respectively for first and second year dividend
• Step 2 Find the present value of future selling price after two years
• PV(Selling Price) $333.3/(1.15^2)
• $252.0
• Step 3
• Add the present value of the dividends and the present value of selling price
• $17.4 + $16.3 +252.0 = $285.8 (intrinsic value)
This method uses the concept of time value of money.
• For example, if the company’s cash flow in 2017 was $25 million, you can
compare that number to the cash flow in 2016 and determine how much it
grew by. You can use the growth rate from this comparison as an estimate of
how much the company will grow in the future.
• Let’s say the company is estimated to grow 5% in the first two years and then
2% in the following three years.
• You should also choose a percentage to calculate the terminal value. This
number represents the long-term growth of the company. Try to be a little
conservative with this; let’s say the long-term growth rate for the company is
3%
Calculate the projected cash flow each year?

Year1 =25 * 1.05 26.25

Year 2 =26.25 * 1.05 27.56

Year 3 =27.56 * 1.02 28.11

Year 4 =28.11 * 1.02 28.67

Year 5 =28.67 * 1.02 29.24

In this example, let’s say the company’s discount rate is 4%.
With these numbers, you can now plug them into the formula to complete a
Discounted Cash Flow analysis of the company:
Terminal Value: 2,393.72
(26.25 / 1.041)+(27.56 / 1.042)+(28.11 / 1.043)+(28.67 / 1.044)+
(29.24 / 1.045)+(2393.72 / 1.045)
= 25.24+25.48+24.99+24.51+24.03+1967.46
Discounted Cash Flow of the company = 2,091.71
Terminal Value is calculated by dividing the last cash flow forecast by the
difference between the discount rate and terminal growth rate.
Industry Analysis
Industry analysis is a function of businesses today completed by
business owners to assess the different economic scenario in the
business environment.
This analysis helps businesses understand how these economic
scenario directly or indirectly influence the goal of the company and
these can also be used to develop the competitive advantage of a
business in the market place.
An Industry analysis of Service Industry
The service industry is made up of professions that deliver services, or
intangible goods, to consumers.
Examples of this include accounting, education, health care and hospitality.
Unlike the manufacturing sector, which produces physical merchandise that is
sold to the public, the service industry does not create anything.
The individuals who make up this industry are hired simply to perform tasks.
Service Industry creates a large percentage of employment within the country.
• Industry Comparative Advantage
• Competitive advantage of an industry refers to factors that allow a
company to produce goods or services at a least cost than other
companies. It allows a company to generate more sales and superior
margins compared to its market rivals.
• They provide better benefits to consumers at a lower price with greater
value.
• Examples of Competitive advantage: Highly skilled manpower, access to
the source of raw materials that are restricted to competitors, unique
geographical location, used of a new technology, least cost of production,
brand image recognition.
• Competitive advantage is one of the company’s goal in today’s world that
defines the success of a business.
Competitive Forces Model ( Porter’s Five Forces)
• Intensity of industry rivalry
• The number of participants in the industry and their respective market
shares are a direct representation of the competitiveness of the industry.
Product differentiation reduced the intensity of competition, government
restrictions, labor unions can also be a barrier to entry.
• Threats of Potential Entrant
• Free entry of a new entrant to a particular industry, company face a constant
risk of new competitors. If new entry is difficult the company, company of
whichever industry enjoys competitive advantage and reaps the benefit for a
longer period.
• Bargaining Power of Suppliers
• If the industry relies to a limited number of suppliers, these suppliers has a
considerable amount of bargaining power, however it affects small
businesses as it affects the price of the final product as cost of production is
expensive.
• Bargaining Power of Buyers
• If consumers are sovereign, they are in a position to negotiate lower price,
better quality, and or additional service and discounts.
• Threat of Substitute
• Industry is always competing with another industry in producing similar
product. Substitute can take two form: Products with the same
function/quality but lesser price or product of the same price but of better
quality or providing more utility.