VALUATION OF SECURITIES

Security is a legal representation of the right to receive prospective I = The annual coupon payment for bond i
future benefits under stated conditions. Securities are forms of Kd = The prevailing yield to maturity for the bond
investments in financial assets. Investments commits funds for a period Bn = The par value of the bond
of time to derive a rate of return that would compensate the investors. n = The number of years to maturity
There are three important securities in the capital market which will be t = specific point in time
considered for analysis.
The formula is summarized as follows:
Bonds/ Debentures (Fixed Interest Securities)
Preference Shares (Fixed Dividend Securities)
Equity Shares - Constant Dividend
- Constant Growth
- Supernormal Growth

Bond/ Debenture valuation

Bonds and debentures are fixed-Income securities. They are debt
instruments created for the purpose of raising capital. They are basically
loan agreements between the bond issuer and an investor, in which the
bond issuer is obligated to pay a specified amount of money at
specified future dates.
In order to value bonds and debentures, the basic information required
include; face value, coupon rate, maturity value, redemption value and
perhaps the market value.
Bonds with maturity Period
This is a bond that is held by the investor for a specified period of time.
When the specified time lapses, the bond is said to have reached
maturity. Upon the maturity of the bond is redeemed at a specified
value. A holder of such bond is entitled to two types of cashflows.
Periodic interest income
Surrender or redemption or maturity value

The value of such bond is calculated as follows:

Where
Pm = The current market price of the bond/debenture

Perpetual Bonds
Bonds, which will never mature, are known as perpetual bonds. Since
perpetual bonds does not have maturity period, the investors continue
to draw interest annually indefinitely. There is no element of surrender
value since the bonds are held in perpetuity just like ordinary shares.
The formular for the value of perpetual bonds is as follows
Preference Shares valuation
Preference shares are shares in a company that are owned by people
who have the right to receive a fixed dividend. The preference dividends
ranks higher than the ordinary dividend in the pecking order.
Calculation of value of preference shares is more or less the same as
the bonds since they have a fixed income. For the preference shares
held in perpetuity, the value is calculated as follows:
Equity Shares valuation Constant Growth Model
Ordinary shares are shares that represent a normal equity ownership This model assumes that dividends will grow at a constant rate every
in a company. One of the most widely used equity valuation model is year. If we use “g” for the constant growth rate, we can show the
the Dividend Discounting model (DDM).The DDM defines the intrinsic dividend one year from now as (D1).
value of a share as the present value of future dividend. There are D1 = D0 (1 + g)
several valuation of the DDM because of different assumptions about
the growth rate of dividend and its relationship to the discount rate
used to calculate present value.
Zero growth model (Constant Dividends)
Constant growth model / Normal growth model
Super normal growth model

Zero Growth Model

This Model assumes that dividend will be constant over time, so that
growth is Zero, and that the investors required rate of return is constant.
This implies:
D1=D2 = D3 = Dn i.e. D is constant

The DDM model is based on the following assumptions.

The required rate of return (K) must be greater than the growth
rate Ke> g
The initial dividend must be greater than zero Do > O
The relationship between K and g is assumed to be constant and
perpetual.

Super Normal Growth Model

This is a situation where there is a supernormal growth for a period of
time after which it stabilizes back to normal. During that time the
dividend growth is expected to be higher than normal rate. In this case,
the equity share valuation will be calculated in stages, in relation to the
number of super normal growth periods.