M P BHOJ (OPEN) UNIVERSITY, BHOPAL ASSIGNMENT QUESTION PAPER 2009-10. Explain the valuation theories of fixed & variable income securities.Investments which are 'fixed' for the community are thus made 'liquid' for the. Subject: Business Legislation Subject Code: CP 03. Day23 Valuation Theories of Fixed Income Securities Day24 Valuation Theories of Variable Income Securities. What does Security Valuation mean in finance? Dan and Kathleen will consider a number of factors for the fixed income portion of the Fund. Securities markets; Securities Subsidiary. 15.401 Part B Valuation Wehavelearnedthat. Theories of interest rates. Fixed income securities Valuation: Valuation of FI securities 1. Fixed Income Securities, Second Edition. Financial Modeling of the Equity Market: From CAPM to Cointegration. Dividend Discount and Residual Income Valuation Models 217. Graduate Course Descriptions. Company has preferred stock that promises its holders a fixed annual dividend of $8. Assuming a required return of 12.8%. This calibration, and subsequent valuation of bond options, swaptions and other interest rate derivatives, is typically performed via a binomial lattice based model. Closed form valuations of bonds. CFA Level 1 - Security Valuation. Discusses the top-down approach in valuing securities, and the different forms of investment returns. Fixed Income Investments; 15. Perspectives on value and valuation - Valuation. In finance, value is the firm value which consists of fundamental value and shareholder value. Firm value can be based on book value or market value. Market value is based on the stock market performance of a company. The strategic relevance of knowledge assets has led to the generation of new concepts and models for managing a company’s knowledge assets. Value creation is often perceived as the future value captured in the form of increased market capitalization. Valuation is used in functional areas of finance like corporate finance, investment analysis, and portfolio management. The three basic approaches to valuation are discounted cash flow valuation, relative valuation, and real option valuation. Value drivers should be directly linked to shareholder value creation. The determination of value drivers is a critical step in business process valuation since these drivers can either increase or reduce the value. The three main financial drivers of value creation are sales, costs, and investments. Earnings growth, cash flow growth, and return on invested capital are specific financial drivers. Profitability, growth, and capital intensity are considered as important drivers of free cash flow and value of a firm. Practitioners often view EPS as the most important part of value creation. Sales revenue and sales growth were also highly rated for measurement of performance. Value- based management focuses on the application of valuation principles. Stock price maximization is one of the significant factors for value maximization objectives. Maximization of shareholder wealth is the main objective of any value creating organization. The main value drivers for shareholder wealth creation are intangibles, operating, investment, and financial. The measures of shareholder value creation are Economic Value, Equity Spread, Implied Value, and CFROI. The major wealth creation measures are total shareholder returns, annual economic return, and market value added. Shared values are policies and operating practices which enhance the competitiveness of a company. In R& D organizations, intangible assets are key drivers of innovation and organizational value. These intangible assets generate shareholder value and corporate growth. The three methods to value proprietary technology are classified as the market approach, the cost approach, and the income approach. The major challenge in valuation is the development of reasonable assumptions for projections based on historical trends and the reasoning for assumption choices. An Introduction to Valuation. What. is. Valuation? The premise. of valuation is that we can make reasonable estimates of value for most assets. Some assets are easier to value than others. This introduction lays out some general insights. It also. examines the three basic approaches that can be used to value an asset. A philosophical basis for valuation A. This statement may seem logical and obvious, but it is. There are those who are disingenuous enough to argue that value is in. That is patently absurd. Perceptions. may be all that matter when the asset is a painting or a sculpture, but we do. Valuation models attempt to relate value to the level of. But there is one point on which there can be no disagreement. Asset. prices cannot be justified by merely using the argument that there will be. That is the. equivalent of playing a very expensive game of musical chairs, where every. The problem with investing with the expectation that. Inside the Valuation Process There. At one end are those who. At the other are those who feel that. The truth does lies somewhere in the middle. Value first, Valuation to follow: Bias in Valuation We. We will begin. by considering the sources of bias in valuation and then move on to evaluate. We will close with a discussion. Sources of Bias The. These. choices are almost never random, and how we make them can start laying the. It may be that we have read something in the press (good. We add to the. bias when we collect the information we need to value the firm. The. annual report and other financial statements include not only the accounting. With many larger companies, it is easy to access. Finally, we have the market’s. Valuations that stray too far from this number make analysts. For instance, it is an acknowledged fact that equity. This. can be traced partly to the difficulties analysts face in obtaining access and. An analyst whose. This should explain why acquisition. The analysis of the deal, which is. One is to find that the deal is seriously over priced and recommend. The other is to find that. Manifestations of Bias There. The first is in the inputs that we use in the. When we value companies, we constantly come to forks in the road. These assumptions can be. For a company with high operating margins now, we. Thus, an analyst who values a. This is a common device. In fact, the use of premiums and discounts, where we augment or. The use. of premiums – control and synergy are good examples – is. The use of discounts –. What to do about bias Bias. Analysts are human and. However, there are ways in which we can. Equity research analysts in the 1. In other words, if we want. An acquiring firm that comes up with a price prior to the valuation. In. far too many cases, the decision on whether a firm is under or over valued. An analyst. who is aware of the biases he or she brings to the valuation process can either. Thus, an environmentalist will have to reveal that he or she. The person reviewing the study can then. Valuations would be much. While we cannot eliminate bias in valuations. It is only an estimate: Imprecision and. Uncertainty in Valuation Starting. In other words, the precision of the answer is used as a measure of. While this may be. Barring a very small subset of assets, there will always be. In this section, we examine the sources of. Sources of Uncertainty Uncertainty. That information can be specific to the firm being. When valuing. an asset at any point in time, we make forecasts for the future. Since none. of us possess crystal balls, we have to make our best estimates, given the. Our estimates of value. Estimation Uncertainty. Even if our information sources are impeccable, we have to convert raw. Any mistakes or. mis- assessments that we make at either stage of this process will cause. Firm- specific Uncertainty. The path that we envision for a firm can prove to be hopelessly wrong. The firm. may do much better or much worse than we expected it to perform, and the. Macroeconomic Uncertainty. Even if a firm evolves exactly the way we expected it to, the macro economic. Interest rates can go up or down and. These macro economic. The contribution of each type of. When valuing a mature cyclical or commodity company, it may. Valuing a young technology company can expose. Note that the. only source of uncertainty that can be clearly laid at the feet of the analyst. With the benefit of. Responses of Uncertainty Analysts. Among the healthy responses. It should be noted, though, that even the. Some use. simulations and others derive expected, best- case and worst- case estimates of. Thus, an analyst who estimates a value. Here again, the probabilities that accompany. In general, healthy responses to. These users can then decide how much. For instance, analysts will often. If the valuation turns out to be right, they can claim. A few decide that valuation itself is pointless. In closing, it is natural to feel uncomfortable. We are after all trying to make our best. The discomfort will increase as we move. What to do about uncertainty The. Building better models and accessing superior. Even the best- constructed. How fast will earnings grow during that period? What type of. excess returns will the firm earn?– and steer away from bringing in their. To see why, assume that you believe that. If you build in the expected rise in interest rates into your. A person using these valuations will be faced. As new information comes in, they should update their. There is no place for false pride in. Valuations can change dramatically over time and they should if. The Payoff to Valuation Even. It. is unrealistic to expect or demand absolute certainty in valuation, since the. This also means that analysts have to give. The corollary to. Some. companies can be valued more precisely than others simply because there is less. We can value a mature company with relatively few. Valuing a technology. The irony is that the payoff to valuation will actually be highest when. After all, it is not how precise a. Since most analysts tend to give up in the face. We do not want to. Simulations, decision trees and sensitivity analyses are tools. Are bigger models better? Valuation Complexity Valuation. On the one side, computers and calculators. With. technology as our ally, tasks that would have taken us days in the pre- computer. On the other side, information is both. We can download detailed. The. complexity, though, has come at a cost. In this section, we will consider the. More detail or less detail A. There are some who believe that more. The trade off on adding detail is a simple one. On. the one hand, more detail gives analysts a chance to use specific information. On the other hand, more. Thus, breaking working capital down. The Cost of Complexity A. There are clear costs. In. fact, analysts can become overwhelmed when faced with vast amounts of. Models. that require dozens of inputs to value a single company often get short shrift. A model’s output is only as good as the inputs that go into it; it. They feed inputs into the model’s black. In effect, the refrain from analysts becomes. The model valued the company at $ 3. We valued the. company at $ 3. This is often the. In other words, the assumption that pre- tax. The Principle of Parsimony In. We would be well served adopting a similar principle in. When valuing an asset, we want to use the simplest model we can get. In other words, if we can value an asset with three inputs, we. If we can value a company with 3 years of cashflow. The problem with. In the process, we can mangle the values of assets that. Consider, for instance, the cash and marketable. The simplest way to value. Analysts who try to build discounted. Approaches to Valuation Analysts use. These. models often make very different assumptions about the fundamentals that. There are several advantages to such a. In general. terms, there are three approaches to valuation. The first, discounted cashflow. The second, relative valuation, estimates the. The third. contingent claim valuation, uses option pricing models to measure the value of. While they can yield different. Discounted Cashflow Valuation In. This approach gets the most play in. In this section, we. Basis for Approach We buy most. In. discounted cash flow valuation, we begin with a simple proposition. The value. of an asset is not what someone perceives it to be worth but it is a function. Put simply, assets with high and. In discounted cash flow valuation, we estimate the value. The discount. rate will be a function of the riskiness of the estimated cashflows, with. We believe that. every asset has an intrinsic value and we try to estimate that intrinsic value. What is intrinsic value? Consider it the. value that would be attached to an asset by an all- knowing analyst with access. No such. analyst exists, of course, but we all aspire to be as close as we can to this. The problem lies in the fact that none of us ever gets to see. Classifying Discounted Cash Flow Models There. In the second, we draw a distinction between. In the third. we lay out three different and equivalent ways of doing discounted cash flow. Going Concern versus Asset Valuation The. Extending this proposition to valuing a. While this may be. A business or a company is an on- going entity with. This. can be best seen when we look at the financial balance sheet (as opposed to an. Note that investments that have. In a going concern valuation, we have to make our best judgments not. While this may seem to be foolhardy, a large proportion of the. In an. asset- based valuation, we focus primarily on the assets in place and estimate. Adding the asset values together yields the. For companies with lucrative growth opportunities. In theory. this should be equal to the value obtained from discounted cash flow valuations. How large the discount will be will. Equity Valuation versus Firm Valuation There are two.
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