EQUITY RESEARCH & PORTFOLIO

MANAGEMENT
 UNIT II :
Valuation of Securities : Equity -
Preference shares - Debt instruments -
Hybrid securities - derivatives - Asset
pricing theories - CAPM - APT -
Portfolio theory - Option pricing theory.
 Valuation Concepts

Basic Valuation:

From The Time Value of Money we

realize that the value of anything is based
on the present value of the cash flows the
asset is expected to produce in the future.
 Basic Valuation

The Value of the Asset

= the sum of the discounted cash flows the
asset is expected to generate over time

Required return = the rate you use to discount

the cash flows back.
= the rate of return investors consider
appropriate for holding such an asset
= based on riskiness and economic
conditions
4
 Concept of Valuation

Intrinsic value of an asset is equal to PV of

benefits (future cash streams like
dividends/interest payments) associated with it
Concept of Value:

Book Value: accounting concept

-For an asset: historical cost less depreciation
-For debt: the outstanding amount
-For equity: assets less liabilities OR paid up
equity capital plus reserves and surplus: also
called shareholders funds or net worth
 Concept of Valuation (contd.)

Replacement Value: amount required to be

spent by the company to replace existing assets
in current condition
Liquidation Value: amount a company can
realize is it sells its assets on termination of
business
Going concern Value: amount a company can
realize if it sells its business as an operating
one; normally this value is higher than
liquidation value
Market Value: current price at which the
security is being bought/ sold in the market
 Valuation of Securities

Valuation of Bond (Debt Instruments)

Valuation of Shares
Equity Shares
Preference Shares
Valuation of Bond
 Bond Features
What is a bond -
debt issued by a corporation or a governmental body.
A bond represents a loan made by investors to the issuer.
In return for his/her money, the investor receives a legal claim on
future cash flows of the borrower.

The issuer promises to:

make regular coupon payments every period until the bond matures,
and
pay the face (par) value of the bond when it matures.

Default
an issuer who fails to pay is subject to legal action on behalf of the
lenders (bondholders). 9
 Bond Basics

Bonds are simply long-term IOUs

that represent claims against a
firms assets.
Bonds are a form of debt
Bonds are often referred to as
fixed-income investments.
 Key Features of a Bond

Debt instrument issued by a corp.

or government.
 Key Features of a Bond

Par value = face amount of the bond,

which is paid at maturity (assume
Rs.100).

=
 Key Features of a Bond

Coupon rate stated interest rate

(generally fixed) paid by the
issuer. Multiply by par to get
dollar payment of interest.
 Key Features of a Bond

Maturity date when the bond must

be repaid.
Yield to maturity - rate of return
earned on a bond held until maturity.
 What is interest rate risk?

Interest rate risk is the concern that

interest rates will change, and
therefore, a reduction in the
value/price of a security.
 Valuation of Bond
1. Maturity Period
i1 i2 in Mv
Vd=----- + ----- +.+------ +------
(1+kd)1 (1+kd)2 (1+kd)n (1+kd)n

1. Yield to Maturity
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