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Introduction to Valuation & Financial Math (Value vs Price (Factors…
Introduction to Valuation & Financial Math
Value vs Price
Price
What it trades in a market as a function of its supply and demand
Factors that affect supply and demand
The value of an asset
Financial regulation
Weather
Supplementary
Cost of production
Value
Asset worth
Affected by
Amount and timing of the assets expected cash flows
riskiness of these cash flows
Investors RRR for undertaking the investment
Finding the value of an asset
Assess the assets characteristics
E.g timing and riskiness
Determine the investors RRR and perception of the riskiness
Discount required for the expected cash flows to the present
Time
Money received today=greater in value
Money paid today=Greater cost
Utility of money
Comparison
Value<Price=overpriced
Value>Price=Underpriced
Cash Flow
Cash Flow Patterns
Single/lump cash flow for PV and FV
Mixed stream/ Multiple cash flow for PV and FV
Annuities
Perpetuities
Capital Budgeting
Compound interest
Interest paid is added to the principal
Rules
Calculating a FV given periodic growth on an investment is called compounding
FV=PV(1+i)^n
Calculating a PV by diminishing money earned in the future to reflect the time value of money is called discounting
PV=FV/(1+i)^n
Simple interest
Earn interest on your initial investment
Yield, return and discount rates
Various types of return
Nominal Return
Annual Percentage return (APR)
Effective Annual Return (EAR)
The Return that includes compounding
Real Return
Accounts for the erosion of purchasing power due to inflation
RRoR
Expected Rate of Return(ERR)
The anticipated return that will be earned on the asset
For relative perfomrance
It expresses the money earned by the asset
The money earned can be income, capital gains or both
The percentage a period of time
Yield=Return
Yield vs. Discount Rate
Yield is commonly a relative performance measure
Discount rate is used to calculate present value
Time value of money
Inflation
Risk