valuations Flashcards
(34 cards)
valuation
process of determining how much an asset is worth
To determine whether an asset is overvalued or undervalued by the market, to determine the intrinsic value of a security & Discount all its future cash flow
gives us fair value & intrinsic value
market price vs instric price
market: ➢ Observed from the market
➢ Is the consensus price of all
traders
➢ Find it in newspaper
intrinsic: self-assigned value
➢ Varieties of models
used for estimation
MP and IP comparisons
MP < IP: buy, security is underpriced
MP>IP: sell, security is over priced
MP=IP, hold, security is correctly priced, market efficient
value investors
look for under-priced assets
prices that are unjustifiably low based on their intrinsic worth.
efficient markets
Market prices fully reflect all information, knowledge & expectations of all investors.
❖ Low costs and easy to transact (market participants are knowledgeable)
❖ If markets are efficient, investors have no reason to believe securities are not priced at or
near their true value their true value
MP=IP
inefficient market
Market prices deviate from the intrinsic prices by huge margins
Over and underpriced securities
secondary market
- Everyone selling
- Shares that have been sold more than once
types:
Direct search: Individuals bear the full cost of locating and negotiating. It is too costly to conduct
a thorough search to locate the best price. Securities that sell in direct market search markets
are normally bought and sold infrequently
b) Broker: Brokers bring buyers and sellers together and charge a commission fee that is less
than a cost of a direct search. The presence of active brokers increases market efficiency
c) Dealer: If the trading in security has sufficient volume, market efficiency is improved if there is
someone in the marketplace to provide continuous bidding for the security. Dealers earn profits
from the spread of the securities they trade. Difference between the bid price and the offer price
primary market
- Where shares are issued for the very first time by the company
- Company sells
Non-redeemable preference share
Preference share in perpetuity
A permanent form of financing with no obligation on the part of the company to repay the capital amount
Pay an infinite series of equal and periodic cash flows
PS0= Dp/i
valuate preference shares
Discount all the future cash flows (dividends) using the required rate of return (dividend yield for
similar preference) as the discount rate.
𝑃𝑆0 = 𝑃𝑉(𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑎𝑦𝑚𝑒𝑛𝑡𝑠 + 𝑝𝑎𝑟 𝑣𝑎𝑙𝑢𝑒)
redeemable pref shares
P= Dx(…) + Px(…)
𝐷= the annual preference share dividend payment
𝑃= the stated (par) value of the preference share
𝑖 = the yield to maturity of the preference share
𝑛 = the number of years to maturity
stock exchange market
Stock Exchange : stock exchange act as both primary and a
secondary market
IPO
(Initial Public Offer -selling shares to the public through a listing of the shares on a stock exchange
ordinary share 0 growth model
dividend will have a growth rate of zero
▪ The dividend payment pattern remains constant over time
P0 = D/R
𝑃0 = the current value, price or present value of the share
𝐷 = the constant cash dividend received in each time period
𝑅 = the required return on the shares or discount rate
ordinary share constant growth
assumes dividends grow at the same average rate from one period to the next period
forever (-ve/+ve)
▪ It is the appropriate assumption for mature companies with a history of stable growth
▪ We assume a constant growth in dividends to infinite. We apply the growing perpetuity formula.
P0 = D1/R-g
or
P0 = D0(1+g)/R-g
P0 = the current value, or price of the share
D1 = the next year’s dividend,
D0 = is the last dividend paid
R = required rate of return for ordinary shareholders,
g = the constant growth rate for dividends / estimated future growth rate in dividend
may be required to calculate the required rate of return for ordinary shares. Use the Capital Asset
pricing model (CAPM)
bond
long-term debt instrument used for raising finance.
issuer obligated to pay periodic interest and the principal amount at a specific date
▪ Interest paid is called a coupon payment
bond face value
Paid/received when bond matures. Principal amount owed to the bondholder
at maturity
▪ Determine coupon payment
▪ Set by company & fixed
coupon rate/payment
determines the coupon payments
▪ Coupon rate x face value
▪ Set by company and is fixed
time to maturity
Shows the lifespan of the bond
Set by the company & fixed
yield to maturity
Represents the return required by investors on the particular bond
▪ Used as a discount rate
▪ Fluctuates with market conditions Rate is determined from the market prices of
bonds that have features similar to those of the bond being valued
bond price
amount investor pays
par value
Bonds sell at face value – coupon rate is equal to the market rate of
interest on similar bond
discount bonds
Bond sells at below face value
ytm>coupon rate
