FINANCIAL

MANAGEMENT
TOPIC 4:
VALUATION OF SECURITIES

Lecturer: MBA. Nguyen Mai Anh

DEFINITIONS OF VALUES
1. Book value: represents the accounting value of an asset – the asset’s cost minus
its accumulated depreciation – stated in the balance sheet.
2. Market value: represents the market price at which an asset trades.
3. Liquidation value: represents the amount of money that could be realized if an
asset is sold seperately from its operating organization.
4. Instrinsic value: represents the price a security “ought to have” based on all
factors bearing on valuation.
5. Going – concern value: represents the amount a firm could be sold for as a
continuing operating business.
DEBT FINANCING:
Debt:
Corporate firm • Contractual obligation between lender
and borrower
• Has fixed life (maturity)
Debt
Debt financing options:
1. Bank debt
Ø can be used for borrowing small
Assets
amounts of money
Ø can be used if company is not well
Equity known
Ø can be source of both short and long
term borrowing
Ø can offer to meet unanticipated or
seasonal financing needs
2. Bonds
DEBT FINANCING
Bond - is a security that is issued in connection
Corporate firm with borrowing agreement between company
(bond issuer) and investor (bond holder).
Debt Ø Usually carry more favorable financing terms
than an equivalent bank loan
Ø Might provide chance for the issuer to add on
special features that could not be added on to
Assets a bank loan
Whenever company issues bonds it creates a
contract - Bond Indenture.
Equity
1. Bond indenture is the contract between the
bond issuer and an investor
2. Bond indenture protects the bondholders
(investors). It provides legal recourse if
interest or principal payments are missed
1. BONDS
1. BONDS - Characteristics

YTM, yield to maturity

t=0 t=1 t=2 t=3

t, time

Bond price, P Coupon Coupon Coupon payment, C

payment, C payment, C +
Principal (Face value), FV

FV: Principal (face value) is the cash flow bond holders are promised to receive at maturity
t: Maturity is the date when the issuer pays back the face value of the bonds
r: Coupon rate is a proportion of a principal
P: Bond price = PV coupon PMTs (ordinary annuity) + PV principal (lump sum)
YTM (Yield to Maturity): market interest rate used to discount coupon and principal
payments to give current bond price
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P= × 1− +
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1. BONDS - Characteristics
Example 1:
Coca Cola would like to borrow $2,000,000 from the general public to finance its new project.
To meet its objective Coca Cola issues bonds with a $1,000 of face value. Bonds pay 5%
annual coupon rate and mature in 3 years. Current market interest rate (YTM) is 5% p.a.
(i) How many bonds does Coca Cola have to issue to meet its objective?
(ii) Determine annual coupon payment (C) to be received by bondholders.
(iii) Determine current bond price (P).
1. BONDS – Coupon payment
Coupon payments are typically made:
1. Annually
2. Semi-annually
3. Quarterly
Caution:
Ensure coupon rates and YTM quoted annually are adjusted to match the frequencies of coupon payments
before calculating bond price.

Year 1 Year 2 Year 3

t, time Annually
t=0 t=1 t=2 t=3

C C C+FV
Year 1 Year 2 Year 3
t, time Semi -annually
t=0 t=1 t=2 t=3

C C C C C C+FV
1. BONDS - Coupon payment
Example 2:
A General Electric bond carries a coupon rate of 8% p.a., has 9 years to maturity and sells at a
yield to maturity of 7% p.a. The bond has a face value of $1000 and pays coupon to
bondholders every 6 months (semi-annually).
i. What coupon payments do bondholders receive every 6 months?
ii. At what price does the bond sell?
1. BONDS – Bond price & Interest rate (YTM)

1. At issuance, bond is usually priced at par value ($1000). This reflects the original
amount corporations borrow
2. Coupon cash flows are predetermined and remain the same until maturity:
• Coupon rate is fixed
• Face/par value at maturity is fixed
3. As time goes on, price changes in response to the following:
• Time rolls forward, the life of the bond reduces as the maturity date approaches – calendar
turn
• Interest rate (ΔYTM) changes with news information in the market – market shifts
1. BONDS - Bond price & Interest rate (YTM)

Coupon rate of a bond is fixed; but YTM (interest rate) fluctuates throughout the lifetime of a
bond.

Bonds sold at par (i.e. face value); these bonds

YTM = coupon rate P = FV
are called Par-value Bonds

Bonds sold at a discount; these bonds are

YTM > coupon rate P < FV
called Discount Bonds

Bonds trade at premium; these bonds are

YTM < coupon rate P >FV
called Premium Bonds
1. BONDS – Bond price & Interest rate (YTM)
Recall that present value and market interest rates have inverse relationship
(YTM Ç => PV È )

Bond When YTM, the present value of

Price (P) the bond’s CFs declines and the
Interest bond is worth less
rate
(YTM)

Bond When YTM declines, the present

Price (P) value of the bond’s CFs rises and
Interest the bond is worth more
rate
(YTM)

Bond price movements inversely related to interest rate movements.

1. BONDS - Bond price & Interest rate (YTM)
Example 4:

A bond issued by Air New Zealand has a coupon rate of 10% per annum, pays annual coupons
and matures in 3 years. How much would you pay for $1,000 face value of this bond if:
i. the yield to maturity (YTM) is 10% per annum?
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i. the yield to maturity (YTM) is 5% per annum?

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ii. the yield to maturity (YTM) is 20% per annum?

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BONDS - Bond price & Interest rate (YTM)
Bond price and interest rate relationship for a 10% coupon
rate bond
$1,300.00 PREMIUM to
PAR
$1,200.00
P= $1136
$1,100.00
P=$1,000 (PAR)
$1,000.00
Bond A
DISCOUNT
$900.00
from PAR

$800.00 P=$789

$700.00
0% 5% 10% 15% 20% 25%
1. BONDS – Types of Bonds
1. Mortgage Bonds: are secured bonds backed by tangible assets (buildings, land).
Secured value is higher than value of bonds issued. If the company is unable to repay
loan on the maturity date, secured assets will be sold to repay loans to investors.
2. Denbentures: are unsecured bonds with assets è Higer risk than Mortgage Bonds è
higher rate of return
3. Convertible Bonds: can be converted to ordinary shares.
4. Zero Coupon Bonds: do not pay interest è Bonds are issued at discount (P < Par
Value)
5. High Yeild Bonds: pay interest only if the company has surplus earnings
6. Euro Bonds: are issued in a country but using currency different from its own
7. Foreign Currency Bonds: are issued in a country but using country’s currency by
debtors or issuing companies.
1. BONDS – Bonds Risks
You face three risks while holding the bonds:
• Market Interest Rate: an increase in interest rate causes a decrease in a bond’s
price

• Default/ Credit Risk: issuer is unable to repay the loan to investors.

The amount of default risk depends on financial stability of the issuers and it is ranked
by credit ratings by Standards & Poors, Moody & Fitch.

• Inflation: Higher inflation rate lowers the real value of interest you earns
2. SHARES
Corporate firm Debt Equity

Debt • No ownership interest • Ownership interest in the

(Bonds) • Fixed claim company’s profit in proportion
• High priority on to the number of shares owned.
company’s cash flows Profits may or may not be
• Fixed maturity distributed as dividends
Assets • No management control • Residual claim
• Lowest priority claim on
Equity company’s cash flows
(Shares) • Infinite life
• Management control
(Shareholders have voting
rights on appointment of board
members and on important
matters concerning the running
of the business)
VALUATIONS OF ORDINARY SHARES
2.1 - VALUATIONS OF ORDINARY SHARES
2.1 -VALUATIONS OF ORDINARY SHARES
1. One holding period:
2.1 - VALUATIONS OF ORDINARY SHARES
2. Multiple holding periods:
a. Zero Growth:

D1 = D2 = …. = Dn

+%
Value of share: Vs =
,
2.1 - VALUATIONS OF ORDINARY SHARES
2. Multiple holding periods:
a. Zero Growth:
2.1 - VALUATIONS OF ORDINARY SHARES
2. Multiple holding periods:
b. Constant Growth Rate:
Owners expect to experience growth with fixed dividends or constant dividends.
Dt = D0 (1+g))

+%
Value of share: Vs = (r >g)
,-.
2.1 - VALUATIONS OF ORDINARY SHARES
2. Multiple holding periods:
b. Constant Growth Rate:
.
2.1 - VALUATIONS OF ORDINARY SHARES
2. Multiple holding periods:
b. Inconstant Growth Rate:
The share is divided into 2 stages:
• Stage 1: Inconstant growth
• Stage 2: Constant growth
2.1 - VALUATIONS OF ORDINARY SHARES
2. Multiple holding periods:
b. Inconstant Growth Rate:
Example 4.10:
Cacluate the present value of ordinary shares with following information:
2.1 - VALUATIONS OF ORDINARY SHARES
2. Multiple holding periods:
b. Inconstant Growth Rate:
Example 4.10:
2.2 - VALUATIONS OF PREFERENCE SHARES
The owners receive fixed dividends from investment at each period. It does not have
maturity period => It is perpetuity

#
Vs = $