week 5 valuation of bonds and shares

• Price


  The amount of money needed to acquire an asset
• Value


  The worth of an asset to an individual
• Price and value can be quite different amounts
• Securities


  Tradable instruments that represent an ownership interest or the right to receive payment on a debt
• Securities


  • They are easily interchangeable
• Bid


  The price a trader is willing to pay for a security
• Offer


  The price a trader is willing to accept to sell a security
• Number of bids for a security (at a certain price)


  Indicates the demand for that security at that price
• Number of offers for a security (at a certain price)


  Indicates the supply of that security at that price
• Market price


  Represents the most widely held view of the value of the security at that point in time
• Book value


  The accounting measure of an asset's worth
• Book value does not provide us with a good representation of future cash flows
• Cash flows of a security

  Can come from dividends, coupon payments, redemption by the issuer or from the sale of the security on the secondary market
• Coupon payments


  The regular interest payments received by the holder of a bond
• Intrinsic value of a security

  The PV of expected future cash flows discounted at the investor's required rate of return
• Higher (lower) discount rate

  Will lead to a lower (higher) intrinsic value calculation
• The amount of uncertainty about cash flows varies between securities
• It is much simpler to forecast the cash flows associated with debt instruments than it is to forecast the cash flows associated with ordinary shares
• Determining a security's value

  • Investor's required return
  • Amount and timing of the security's cash flows
  • Level of risk associated with these cash flows
• Coupon


  The stated rate of interest paid on the bond
• Zero coupon bonds


  Bonds that pay no coupons but rather pay a lump sum (face value) at maturity
• Deep discount


  A purchase price for a security that is well below its face value
• Preference shares


  Hybrid securities that have features of both debt and equity
• Dividend discount and constant growth valuation models can not be applied to all companies
• These models are applicable to the valuation of blue chip companies as opposed valuing companies which exhibit unpredictable variability in dividends</b>
• Blue chip companies


  Well established and have a good track record for financial stability and a fairly predictable pattern of dividend payments
• Market capitalisation


  The total dollar value of all issued shares
• Earnings per share


  The total forecast earnings of the firm divided by the number of ordinary shares on issue
• Price-earnings ratio


  Compares the price per share to the forecast EPS
• Analysts pay a lot of attention to earnings results and devote considerable resources to developing earnings forecasts
• Earnings indicate profitability, but before we can compare the profitability of two firms we need to take the size of each of the operations into consideration
• Calculating the EPS standardises the total earnings for companies and puts them on a more comparable per share footing
• A change in the historical PE of a company can be due solely to a change in the general level of prices in the share market rather than with changes in the value of a company
• Analysts use a PE multiple based on the PEs of comparable firms and make adjustments for differences attributable to risk and gearing and any other factors they consider relevant
• Intrinsic value


  The present value of expected future cash flows
• Intrinsic value is the appropriate value for finance because it applies the principles of the time value of money
• Dividends are paid semi-annually on a preference share


  There is no difference in the intrinsic value compared to a share with the same total dividend paid annually and an annual required return
• Valuing ordinary shares


  • The most difficult aspect is making reliable forecasts for dividends over the infinite life of the security
• PE multiples in the financial press are calculated as the most recent price divided by the last period reported earnings per share for the company
• The PE ratios in the newspaper are not able to help us ascertain the intrinsic value of the share