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					Valuation of bonds and shares
Bonds



Generally a fixed income security which
promise to give a certain fixed cash flow to
the holder at certain pre-determined time
points – coupon and the face value
Coupon



Is   the    periodical  payment.
Periodicity       pre-determined.
Quantum is also pre-determined
by the coupon rate
Face value



Is the lump sum payment at the end of the
fixed period
Date of maturity



Is the last coupon payment date
and it also coincides with the
lump sum payment of the face
value
Price of bond


Is the price at which bond can be sold
or bought and it depends on market
factors
Yield

Is the actual return (as different from the
coupon rate) worked out on the actual out
flow, which is the price of the bond
Yield to maturity

Is the rate at which we can
discount the coupon payments
until maturity and the face value
at maturity to get the present
value to be equal to the price of
bond
Equity
Face value is the simplest approach to
equity valuation. But this does not
reflect the real value
Book value is the distribution of
net worth (assets less outside
liabilities) among outstanding
shares
This book value approach depends on
accounting standards, procedures and
conventions and therefore does not reflect
the true value of the shares
Another approach to determine real
value is to value shares using dividend
discount models
Under the DDM, it is assumed constant
dividends are paid perpetually on a
share and its value derived as the
present value of perpetuity. It is
possible dividends may grow at
constant rate or at different rates.
Caution - DDM

While finding the value of share using
dividend models, one has to use a
discounting rate to obtain present
value of a stream of cash flow. The
problem is to find the appropriate
discounting rate. We do not have yield
curves for shares.
Caution - DDM

Another difficulty is the assumption
about dividend payments
Caution – DDM

This valuation approach looks at the return
from shares and the main components of
returns may not be dividend alone. It may be
difference between prices at two different
points of time
Hence the main problem is to find the
future    return. Using   probability
concepts, one can find expected
return, which can be a good estimate
of future return
The expected return can be calculated
from either past prices or from
forecasted values of prices. In either
case, there is an uncertainty in the
realization of predicted return. This is
the inherent risk
Hence risk-return analysis becomes an
important aspect in share valuation
The question to be addressed in RRA is
the capacity to estimate future
returns, which requires good amount
of information.
Efficient market hypothesis proposes future
prices do not depend on past prices. Current
prices reflect all relevant information from
the past and therefore it is not possible to
forecast future prices and hence the returns.
This means if a market is efficient it is not
possible to predict the returns
Valuation ratios
Yield

Is sum total of dividend yield and
capital  gains     yield    and  is
mathematically represented by

Yield = Dividend + Price change /
Initial price
Dividend Yield

Is the ratio of dividend received to the
initial price paid and is represented by

Dividend Yield = Dividend / Initial
price
Capital Gains Yield

Is the ratio of Price change to the
initial   price    paid   and     is
represented by

Capital Gains Yield       =   Price
change / Initial price
Market value to book value ratio



Market value per share / Book value
per share
Price earning ratio

Market price per share / Earning
per share
Thank you

				
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posted:9/6/2011
language:English
pages:29