Chapter 13

Question 1

Reasons why different investors may use different methods of valuation: (3)

Answer 1

o Their general aims and objectives of investment differ.
o The reasons for valuing the investments differ.
o They type of assets (investment portfolio) being valued differ.

Question 2

Reasons why we value assets: (3)

Answer 2

o identifying whether a particular asset or asset class appears to be cheaper or dear and if we should include it in our portfolio in the first place.
o monitoring the ongoing performance of the individual asset to assess whether or not we should continue to hold it i.e., monitoring the experience of an investment portfolio.
o To achieve consistency with the method used to value the liabilities for which the assets support.

Question 3

Valuation methods

Answer 3

1. Market value
2. Smoothed market value
3. Fair value
4. Discounted cashflow
5. Stochastic models
6. Arbitrage value
7. Historic/book value
8. Written up or written down book value

Question 4

Why an investor may not always obtain the market value of an asset when selling the asset:

Answer 4

▪ ‘Market value’ may mean mid-market value or offer price rather than bid value.
▪ ‘Market value’ may mean yesterday’s market value.
▪ net proceeds from a sale will be reduced by dealing costs and possibly tax.
▪ if they sell a large holding of an asset, they may depress the price of the asset.
▪ if they own a strategic block of shares, they might receive more than the market value from a predator wishing to gain control of the company.

Question 5

Advantages of market value (6)

Answer 5

1. easy to obtain
2. objective
3. Suitable for Discontinuance Valuations: In the event of a scheme wind-up or company closure, market value represents the realisable value of assets.
4. Used with other valuation methods to determine if asset is over or under priced
5. well understood and accepted
6. may be required by regulation

Question 6

Disadvantages of market value method of valuation: (7)

Answer 6

1. may not be available (unquoted shares)
2. May not be the realisable value on sale (e.g., if dealing in large volumes or illiquid stocks - may need to lower the value at sale)
3. may not reflect the value of future proceeds
4. decision required on whether to use the bid, mid or offer price should be used
5. volatile - values fluctuate
6. difficult to ensure consistency with valuation of liabilities
7. Market prices are set based on what the average (marginal) investor is willing to pay.

Question 7

How do you get smoothed market value? (2)

Answer 7

1. smooth the market values over a specified period removing daily fluctuations
2. Moving average - value of the asset on any particular day is taken as the average of the market price over, say, previous three months.

many judgements needed:
-smoothing period
-smoothing method (simple or weighted average)

Question 8

what is historic book value and what are its advantages (4) and its disadvantage?

Answer 8

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

Advantages:
▪ Objective.
▪ conservative (but only if the value has risen since purchase)
▪ well understood.
▪ used for some accounting purposes.

Disadvantages:
-has little merit since it is historic
-cannot be consistent with liability valuation because it is hard to determine the discount rate to value liabilities

Question 9

Written up or written down book value:

Answer 9

-historic book value adjusted periodically for any movements in the price
-adjust using market value or discounted cashflow value

advantages:
-more sensible

disadvantages
-subjective
-cannot be consistent with liability valuation because it is hard to determine the discount rate to value liabilities

Question 10

fair value and how it can be calculated (3)

Answer 10

Fair value is the amount for which an asset could be exchanged, or a liability settled between knowledgeable, willing parties in an arm’s length.

1. An indicative price from a broker or market maker
2. using the most recent know price and adjusting in line with the movement in an appropriate index
3. using a stochastic asset model to determine a market-consistent value

Question 11

Arbitrage value

Answer 11

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.

Disadvantages:
-difficult to apply
-many assets difficult to replicate