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Valuation of individual investments ((SHAM FADS) (Smoothed market value,…
Valuation of individual investments
(SHAM FADS)
Smoothed market value
Historic book value
adjusted book value
market value
fair value
arbitrage value
discounted cashflow
stochastic modelling
Market value
advantages
easily obtainable in most cases
objective
realisable value of an asset, so suitable for discontinuance valuations
well understood
may be required by regulation
disadvantages
more than one market value is likely to exist (e.g. bid, offer, mid)
only known for certain at time of sale
may not exist or to be up-to-date for certain assets, such as direct property or unquoted investments
volatile
difficult to value liabilities in a consistent, market-related way
Discounted cashflow
advantages
method is consistent with discounted cashflow approach to valuing liabilities
stable, if assumptions are not changed too frequently
employs actuarial judgement, so can adjust out influence of market sentiment
disadvantages
subjective choice of assumptions, e.g. discount rate
time consuming
not well understood by clients
not suitable for short-term valuations, e.g. a discontinuance valuation
Stochastic model for valuing assets
uses the discounted cashflow method
future cashflows, or the interest rate, or both would be treated as random variables with a specified probability distribution
model is run many times
output is a distribution of results from which the expected asset value and the volatility can be calculated
arbitrage value
means of obtaining a proxy market value.
calculated by replicating the investment with a combination of other investments and applying the condition that in an efficient market (i.e. arbitrage free), the values must be equal.
often used in the valuation of derivatives
fair value
the amount for which an asset could be exchanged or a liability settled between knowledgeable, willing parties in an arm's length transaction.
bond valuation methods
government bond
discount the coupon/ redemption cashflows using market spot yields
ideally, term specific yields would be used for cashflows of different terms
corporate bond
adjust the yields upwards for a security, marketability and liquidity premium
bonds with embedded options can be valued using option pricing techniques
equity valuation methods
market value
discounted dividend model
net asset value, e.g. for property or investment trust companies
measurable key factor approach
determine a relevant and measurable key factor for the company's business. The relationship between this factor and the market price of other quoted companies is used as a basis of valuation.
Economic Value Added (EVA)
operating profits over one year less the cost of capital supporting those results
Simplified discounted dividend model for valuing equities
V= D/ (i-g)
V= value of the share
D= dividend in exactly one year's time
i= investor's required rate of return
g= dividend growth rate
Assumptions
Dividends paid annually with the payment in one year's time
dividends grow at a constant rate g per annum
the required rate of return is independent of the time at which the payments are received, and dividends can be reinvested at this rate
i and g are either both real or both nominal with i>g
share held in perpetuity
Discount rate for property valuation
use a government bond yield of a suitable term and add a margin to reflect the risks associated with property, e.g.
lack of marketability
risk of voids
default of risk
volatility of market value
illiquidity
indivisibility
depreciation and obsolescence
costs (if not allowed for explicitly in the cashflows)
swap valuation methods
discounted cashflow of income- outgo
as the sum of a series of forward arrangements