VALUATION OF BONDS

AND STOCKS

By Prof Sameer Lakhani

 OUTLINE
• Distinction among valuation concepts
• Bond Valuation
• Bond Yields
• Bond Market
• Preferred Stock Valuation
• Equity Valuation : Dividend Discount Model
• Equity Valuation : PE Ratio Approach
• Earnings-Price Ratio, Expected Return, and Growth
• Stock Market
 CONCEPTS OF VALUE

• Liquidation Value

• Going Concern Value (Valuation are based on Going Concern Basis)

• Book Value (BV of Equity = BV of Assets – BV of Liabilities)

• Market Value

• Intrinsic Value (Present Value of Cash flow stream expected from the security
discounted at a rate of return appropriate for the risk associated with the security )
 TERMINOLOGY

• Par Value : Value stated on the face of the bond

• Coupon Rate : Par Value * Coupon Rate

• Maturity Period : Par Value is payable.

Value of a Bond = PV of the cash flow expected from it.

An estimate of expected cash flows

An estimate of the required return

 VALUE OF A BOND
n
C M
P=Σ (1+r)t
+
(1+r)n
t=1

P = C x PVIFAr,n + M x PVIFr,n
Assumptions:
Coupon Interest rate is fixed for the term of the bond

Annual coupon payments & next coupon payment is exactly a year now.

Bond will be redeemed at par on Maturity.

 ILLUSTRATION
To illustrate how to compute the price of a bond, consider a
10-year, 12 percent coupon bond with a par value of 1,000. Let
us assume that the required yield on this bond is 13 percent. The
cash flows for this bond are as follows:
• 10 annual coupon payments of Rs. 120
• Rs. 1000 principal repayment 10 years from now
The value of the bond is:
P = 120 x PVIFA13%, 10 yrs + 1,000 x PVIF 13%, 10 yrs
= 120 x 5.426 + 1,000 x 0.295
= 651.1 + 295 = Rs. 946.1
VALUE OF A BOND WITH SEMI-ANNUAL INTEREST
Bonds pay Interest Semi Annually means once in every six months. Bond
valuation equation needs to be modified along the following lines:

The annual Interest payment , C must be divided by two to obtain semi annual
interest payment.
Number of years to maturity must be multiplied by two to get the number of half
yearly periods.
Discount rate has to be divided by two to get the discount rate applicable to half
yearly periods.
2n
C/2 M
P = Σ (1+r/2)t
+
(1+r/2)2n
t=1

P = C/ 2 x (PVIFAr/2,2n) + M (PVIFr2,2n)
 ILLUSTRATION
As an illustration, consider an 8 year, 12 percent coupon bond
with a par value of Rs. 100 on which interest is payable semi-
annually. The required return on this bond is 14 percent.
Value of the bond is:

16
6 100
P=Σ (1.07) t
+
(1.07)16
t=1

= 6(PVIFA7%,16) + 100 (PVIF7%,16)

= Rs. 6(9.447) + Rs.100 (0.339) = Rs. 90.6
 PRICE-YIELD RELATIONSHIP
A basic property of bond is that its price varies inversely with
yield.
 As the required yield decreases the PV of the cash flow
Increases hence the price Increases.
 When the required yield Increases the PV of cash flow decreases
hence the price decreases.

Problem: Coupon rate of 14 percent issued 3 years ago for Rs 1000

(Par Value).The original Maturity of the bond was 10 years, so its
residual maturity now is 7 years. The Interest rate has fallen in last
3 years & Investor now expect a return of 10 percent from this
bond. What is the price of this bond now? Answer : 1194.5

Problem: There is a rise in Interest rate, investors expect a return of

18 percent. bond. What is the price of this bond now?
Answer : 848.5
PRICE-YIELD RELATIONSHIP
 Coupon Rate, Required Yield, & Price

To sum up, the relationship between the coupon

rate, the required yield, and the price is as follows:
Coupon rate > Required yield Price > Par (Premium bond)

Coupon rate > Required yield Price = Par

Coupon rate < Required yield Price < Par (Discount bond)
 PRICE - YIELD RELATIONSHIP
Price of a bond must be equal to to its par value at maturity assuming that there is no risk of
default, bond prices changes with time. For E.g. A bond that is redeemable for Rs 1000 after 5
years when it matures will have a price of Rs 1000 at maturity no matter what the current price
is .If its price is say Rs 1100 it is said to be a premium bond. If the required yield does change
between now and the maturity date the premium will decline over time as shown by curve A
.On the other hand if the bond has a current price of say Rs 900 it is said to be a discount bond.
The discount too will disappear over time as shown by Curve B.Only when the Current price =
Par Value there is no change in price as time passes assuming that the required yield does not
change between now and the maturity date.
PRICE CHANGES WITH TIME
VALUE OF
BOND PREMIUM BOND: rd = 11%

A
PAR VALUE BOND: rd = 13%

B
DISCOUNT BOND: rd = 15%

8 7 6 5 4 3 2 1 0
 BOND PRICE THEOREMS
1. BOND PRICES & YIELDS MOVE IN OPPOSITE
DIRECTIONS
2. BOND PRICES ARE MORE SENSITIVE TO YIELD
CHANGES THE LONGER THEIR MATURITIES
3. THE PRICE SENSITIVITY OF BONDS TO YIELD
CHANGES INCREASES AT A DECREASING RATE
WITH MATURITY
4. HIGH COUPON BOND PRICES ARE LESS SENSITIVE
TO YIELD CHANGES THAN LOW COUPON BOND
PRICES
5. WITH A CHANGE IN YIELD OF A GIVEN NUMBER OF
BASIS POINTS, THE ASSOCIATED PERCENT GAIN IS
LARGER THAN THE PERCENT LOSS.
 BOND YIELDS
•
CURRENT YIELD : It relates annual coupon payment to the market price.

ANNUAL INTEREST
PRICE

Problem: The current yield of a 10 year, 12 percent coupon bond with a par value of Rs
1000 and selling for Rs 950 is ??? (12.63%)

Interpretation: Current yield calculation reflects only the coupon interest rate. It does not
considers the capital gain or loss that an investor will realize if the bond is purchased at a
discount or premium and held till maturity. It also ignores the time value of money. Hence
it is an incomplete and simplistic measure of yield

•
 BOND YIELDS
• YIELD TO MATURITY : YTM of a bond is the Interest rate that makes the present
value of the cash flow receivable from owning the bond equal to the price of the bond.
Problem: Consider Rs 1000 par value bond carrying a coupon rate of 9 percent maturing after 8
years. Thee bond is currently selling for Rs 800.What is the YTM of the bond?
C C C M
P = + + …. +
(1+r) (1+r)2 (1+r)n (1+r)n
8 90 1,000
800 =  +
t=1 (1+r)t (1+r)8
AT r = 13% … RHS = 808
AT r = 14% … RHS = 768.1
808 - 800
YTM = 13% + (14% - 13%) * = 13.2% Linear Interpolation
808 - 768.1

C + (M - P) / n
YTM ≃ Approximation
0.4M + 0.6 P
YTM calculation considers the current coupon income as well as the capital gain or the loss the
Investor will realize by holding the bond to maturity. It takes into account timing of cash flow
 BOND YIELDS

• YIELD TO CALL : Bonds carrying a call feature entitles the issuer to call (buy back) the
bond prior to the stated maturity days in accordance with a call schedule ( which specifies a
call price for each call date).

n* C M*
P =  +
t=1 (1+r) t
(1+r)n

where M* = Call price

n
* = number of years until the assumed call date
 BOND YIELDS
• Problem: Consider a 20 year, 10% semiannual pay bond with a full price of 112 that can
be called in 5 years at 102 and called at par in 7 years. Calculate the YTM, YTC & yield to
first par call?

Answer: C = 5 N = 40 Price 112 Maturity 100

YTM = 5 (PVIFA r%,40) + 112 (PVIF r%,40)
Approximate YTM = 4.384 * 2 = 8.768%
Exact YTM = 4.3608 * 2 = 8.7216%

C = 5 N = 10 Price 112 Maturity 102

Yield to First Call = 5 (PVIFA r%,10) + 102 (PVIF r%,10)
Approximate Yield to First Call = 3.7 * 2 = 7.41%
Exact Yield to First Call = 3.710 * 2 = 7.421%
 BOND YIELDS

Problem: Consider a 20 year, 10% semiannual pay bond with a full price of 112 that can
be called in 5 years at 102 and called at par in 7 years. Calculate the YTM, YTC & yield to
first par call?

Answer: C = 5 N = 14 Price 112 Maturity 100

Yield to First par Call = 5 (PVIFA r%,14) + 102 (PVIF r%,14)
Approximate Yield to First par Call = 3.8646 * 2 = 7.7293%
Exact Yield to First par Call = 3.873 * 2 = 7.7469%
 BOND YIELDS

Realized Yield to Maturity: The YTM calculation assumes that the cash flow received
through the life of a bond are reinvested at a rate equal to the YTM.This assumption may
not be valid as reinvestment rate applicable to future cash flow may be different. It may be
necessary to define the future reinvestment rates & figure out the Realized YTM.

Problem: Consider a 1000 par value of bond carrying an Interest rate of 15 percent
(payable annually) and maturing after 5 years. The present market price of this bond is
850.The reinvestment rate applicable to the future cash flow of this bond is 16 percent.
 REALISED YIELD TO MATURITY
FUTURE VALUE OF BENEFITS
0 1 2 3 4 5

• INVESTMENT 850
• ANNUAL INTEREST 150 150 150 150 150
• RE-INVESTMENT
PERIOD (IN YEARS) 4 3 2 1 0
• COMPOUND FACTOR
(AT 16 PERCENT) 1.81 1.56 1.35 1.16 1.00
• FUTURE VALUE OF
INTERMEDIATE CASH FLOWS 271.5 234.0 202.5 174.0 150.0
• MATURITY VALUE 1000
• TOTAL FUTURE VALUE = 271.5 + 234.0 + 202.5 + 174.0 + 150.0 + 1000
= 2032
(1+r*)5 = 2032 / 850 = 2.391
r* = 0.19 OR 19 PERCENT
 PROBLEM

The Market price of a Rs 1000 par value bond carrying a

coupon rate of 14 percent and maturing after 5 years is Rs
1050.What is the YTM on this bond? What is the
approximate YTM ? What will be the realized YTM if the
reinvestment rate is 12 percent?

Answer: YTM: 12.60%

Approximate YTM : 12.62%
Realized YTM : 12.89%
 VALUATION OF PREFERENCE STOCK
n
D M
P=Σ (1+rp)t
+
(1+rp)n
t=1

Since the stream of dividends is an ordinary annuity, we can apply the

formula for the present value of an ordinary annuity. Hence the value of
the preference stock is:
Po = D x PVIFArp,n + M x PVIFr p,n
 VALUATION OF PREFERENCE STOCK
To illustrate how to compute the value of a preference stock,
consider an 8 year, 10 percent preference stock with a par
value of Rs. 1000. The required return on this preference
stock is 9 percent.

P = 100 x PVIFA 9%, 8yrs + 1000 x PVIF 9%, 8 yrs

= 100 x 5.535 x 1000 x 0.502

= Rs. 1110.5
EQUITY VALUATION: DIVIDEND DISCOUNT MODEL

According to DDM the value of an equity share is equal to the

present value of dividends expected from it plus the present value of
the sale price expected when the equity shares is sold.

Assumptions:

 Dividends are paid annually

 First dividend is received one year after the share is bought.

 DIVIDEND DISCOUNT MODEL
SINGLE PERIOD VALUATION MODEL
D1 P1
P0 = +
(1+r) (1+r)
Where P0 = Current price of equity share
D1 = Dividend expected a year hence
P1 = Price of the share expected a year hence
r = Rate of return required on equity share.

Problem: RIL is expected to provide a dividend of Rs 2 & fetch a price of

Rs 18 a year hence. What price would it sell for now if investors required
rate of return is 12 percent? (Answer 17.86)
 DIVIDEND DISCOUNT MODEL
MULTI - PERIOD VALUATION MODEL: Equity shares have no maturity
period they may be expected to bring a dividend stream of infinite duration.
•
 Dt
P0 = 
t=1 (1+r)t
•P0 = Price of the equity share today
•D1 = Dividend expected a year hence.
•D  = Dividend expected at the infinity.
• r = Expected return
 DIVIDEND DISCOUNT MODEL

ZERO GROWTH MODEL: Assumes dividend per share remains

constant year after year.
D
P0 =
r
DIVIDEND DISCOUNT MODEL
DIVIDEND DISCOUNT MODEL
 DIVIDEND DISCOUNT MODEL

CONSTANT GROWTH MODEL: Assumes that dividend per share

grows at a constant rate.
D1
P0 =
r–g (g = growth rate in dividend is constant)

Problem: ABC ltd is expected to grow at the rate of 6 percent per

annum.Dividend expected on ABC equity share a year hence is Rs 2 . What price
will you put on it if your required rate of return for this share is 14 percent?
(Answer Rs 25)

Constant growth model includes four variables so if we know any three of them
we can solve for the fourth.
 EXPECTED RATE OF RETURN

What rate of return can the investor expect, given the current market price and
the forecast value of dividend & share price?

D1
r = + g
P0

Problem: Expected dividend per share of ABC ltd is Rs 5. The dividend is

expected to grow at the rate of 6 percent per year. If the price per share now is Rs
50 what is the expected rate of return? (Answer 16%)
 EXPECTED GROWTH

g = r- D1
P0

Problem: Equity stock of ABC is currently selling for Rs 30 per share. The
dividend expected next year is Rs 2.The investors required rate of return is 15
percent. If the constant growth rate model applies to ABC what is the expected
growth rate? (Answer 8.3%)
 STRENGTHS & LIMITATIONS OF
CONSTANT GROWTH MODEL
 DIVIDEND DISCOUNT MODEL
• SINGLE PERIOD VALUATION MODEL
D1 P1
P0 = +
(1+r) (1+r)
• MULTI - PERIOD VALUATION MODEL
 Dt
P0 = 
t=1 (1+r)t
• ZERO GROWTH MODEL
D
P0 =
r
• CONSTANT GROWTH MODEL
D1
P0 =
r-g
 WHAT DRIVES GROWTH
• Most stock valuation models are based on the assumption that dividends grow over time.
What drives this growth?
•Two Major drivers of the growth are:
1.Retention Ratio (Ploughback Ratio)
2.Return on Equity (ROE)
Problem: Omega ltd has an Equity (net worth) base of 100 beginning of year 1. It earns a
ROE of 20%. It pays out 40% of its equity earnings and plough back 60% of its equity
earnings. The financial of Omega Limited for 3 year is given.
  Year 1 Year 2 Year 3
Beginning Equity 100 112 125.44
Return on Equity 0.2 0.2 0.20
Equity Earnings 20 22.4 25.09
Dividend payout ratio 0.4 0.4 0.40
Dividends 8 8.96 10.04
Plougback ratio 0.6 0.6 0.60
Retained Earnings 12 13.44 15.05
Dividends grow @ 12% per annum from 8 to 8.96 & from 8.96 to 10.04.
g = ROE * RR i.e. 0.2 * 0.6 = 0.12

•
TWO - STAGE GROWTH MODEL
TWO - STAGE GROWTH MODEL
 TWO - STAGE GROWTH MODEL

1 - 1+g1 n
1+r Pn
P0 = D1 +
r - g1 (1+r)n
WHERE
Pn D1 (1+g1)n-1 (1+g2) 1
=
(1+r)n r - g2 (1+r)n
 TWO - STAGE GROWTH MODEL : EXAMPLE
EXAMPLE THE CURRENT DIVIDEND ON AN EQUITY SHARE OF
VERTIGO LIMITED IS RS.2.00. VERTIGO IS EXPECTED TO ENJOY AN
ABOVE-NORMAL GROWTH RATE OF 20 PERCENT FOR A PERIOD OF 6
YEARS. THEREAFTER THE GROWTH RATE WILL FALL AND STABILISE
AT 10 PERCENT. EQUITY INVESTORS REQUIRE A RETURN OF 15
PERCENT. WHAT IS THE INTRINSIC VALUE OF THE EQUITY SHARE OF
VERTIGO ?
THE INPUTS REQUIRED FOR APPLYING THE TWO-STAGE MODEL ARE :
g1 = 20 PERCENT
g2 = 10 PERCENT
n = 6 YEARS
r = 15 YEARS
D1 = D0 (1+g1) = RS.2(1.20) = 2.40

PLUGGING THESE INPUTS IN THE TWO-STAGE MODEL, WE GET THE

INTRINSIC VALUE ESTIMATE AS FOLLOWS :

1.20 6
1 -
1.15 2.40 (1.20)5 (1.10) 1
P0 = 2.40 +
.15 - .20 .15 - .10 (1.15)6

1 - 1.291 2.40 (2.488)(1.10)

= 2.40 + [0.497]
-0.05 .05

= 13.968 + 65.289
= RS.79.597
 TWO - STAGE GROWTH MODEL

Problem: The current dividend on an equity share of pioneer

Technology is Rs 3.00.Pioneer is expected to enjoy an above normal
growth rate of 40% for 5 years. Thereafter the growth rate will fall
& stabilize at 12%.Equity Investors require a return of 15 percent
from pioneer stock. What is the intrinsic value of the equity share of
pioneer?
(Answer = 28.12 + 299.37 = 327.49)
TWO - STAGE GROWTH MODEL H - MODEL
 H MODEL

ga
gn

H 2H

D0
PO = [(1+gn) + H (ga - gn)] INCORRECT
FORMULA
Po = Intrinsic Value of r - gn
share
Do = Current dividend per D0 (1+gn) D0 H (ga - gn) CORRECT
share
r = Required rate of return
= + FORMULA
gn = Normal long run growth r - gn r - gn
rate
ga = High growth rate
H = One half of the period
VALUE BASED PREMIUM DUE TO
during which ga will level ON NORMAL ABNORMAL GROWH
 ILLUSTRATION :H MODEL
Problem: The current dividend on equity share of International computers ltd is Rs 3.The
present growth rate is 50%.However this will decline linearly over a period of 10 years and
then stabilize at 12%.What is the Intrinsic value per share of International computers ltd if
the Investors require a return of 16%?

Po = 3 ( 1.12) + 3 * (10 / 2) * (0.50 – 0.12)

0.16 – 0.12 0.16 – 0.12

= 84 + 142.5

= 226.5

Problem: The current dividend on equity share of ABC ltd is Rs 5.The present growth rate
is 50%.However this will decline linearly over a period of 8 years and then stabilize at
10%.What is the Intrinsic value per share of ABC ltd if the Investors require a return of
18% from this stock? (Answer: 168.75)
THREE STAGE DDM MODEL
 THREE STAGE DDM MODEL

Problem: Vardhman Ltd earnings & dividends have been growing at a rate of 18% p.a.
This growth rate is expected to continue for 4 years. After that the growth rate will fall to
12% for the next 4 years. Thereafter the growth rate is expected to be 6% forever. If the
last dividend per share was Rs 2 and the Investors required rate of return is 15%. What is
the Intrinsic value per share? (Answer Rs 16.83 + Rs 23.49 = Rs 40.32)
TERMINAL VALUE
TERMINAL VALUE
 IMPACT OF GROWTH ON PRICE, RETURNS,
AND P/E RATIO
The expected growth rates of companies differ widely. Some companies are
expected to remain virtually stagnant or grow slowly, other companies are
expected to show normal growth, still others are expected to achieve supernormal
growth rate. Assuming a constant total required return, differing expected growth
rate means differing stock prices, dividends yields, capital gain yields & Price
Earning ratio.
Illustration: Consider three cases:
Growth Rate (%)
Low growth firm 5
Normal growth firm 10
Supernormal growth firm 15
The expected Earnings per share & dividend per share of each of the three firms
are Rs 3 & Rs 2 respectively. Investors required total return from equity
investments is 20%.
 IMPACT OF GROWTH ON PRICE, RETURNS,
AND P/E RATIO

PRICE DIVIDEND CAPITAL PRICE

D1 YIELD GAINS EARNINGS
PO = YIELD RATIO
r-g (D1 / PO) (P1 - PO) / PO (P / E)

RS. 2.00
LOW GROWTH FIRM PO = = RS.13.33 15.0% 5.0% 4.44
0.20 - 0.05

RS. 2.00
NORMALGROWTH PO = = RS.20.00 10.0% 10.0% 6.67
FIRM 0.20 - 0.10

RS. 2.00
SUPERNORMAL PO = = RS.40.00 5.0% 15.0% 13.33
GROWTH FIRM 0.20 - 0.15
 IMPACT OF GROWTH ON PRICE, RETURNS,
AND P/E RATIO

Results in the above mentioned table suggest the following points:

I.As the expected growth in dividend increases, others things being equal, the
expected return depends more on the capital gains yield and less on the dividend
yield.
II.As the expected growth in dividend increases, others things being equal, the
Price – Earnings ratio Increases.
III.High dividend yield and low price earning ratio imply limited growth
prospects.

IV.Low dividend yield and high price earning ratio imply considerable growth
prospects.
EARNINGS MULTIPLIER APPROACH – P/E Ratio.

P0 = m E1

DETERMINANTS OF m (P / E)
D1
P0 =
r-g
E1 (1 - b)
P0 =
r - ROE x b
Equation Indicates that the factors that
(1 - b) determine the P/E ratio are:
 The dividend payout ratio, (1-b)
P0 / E1 =  The required rate of return, r
 The expected growth rate , ROE * b
r - ROE x b
EARNINGS MULTIPLIER APPROACH – P/E Ratio.
P/E ratio & Retention ratio: What is the effect of a change in b on the P/E ratio?
It depends on how ROE compares with r.
If ROE > r an increase in b leads to an increase in P/E.
If ROE = r an increase in b has no effect on P/E.
If ROE < r an increase in b leads to an decrease in P/E.

P/E ratio & Interest rate : The required rate of return on equity stocks reflects interest rate & risk.
When Interest rate increase, required rates of return on all securities including stocks increase
pushing security prices downwards. When Interest rate falls security price rise. Hence there is an
inverse relationship between P/E ratio & interest rate.

P/E ratio & Risk: Other things being equal riskier stocks have lower P/E multiples. Riskier stocks
have higher required rates of return (r) and hence lower P/E multiples. This is true in all case, not
just the constant growth model. For nay expected earnings & dividends stream, the present value
will be lower when the stream is considered to be riskier. Hence the P/E multiple will be lower.

P/E ratio & Liquidity: Others things being Equal stocks which are highly liquid command higher
P/E multiples &stocks which are highly Illiquid command lower P/E multiple. Investors value
liquidity just the way they value safety & hence are willing to give higher P/E multiple to liquid
stock .
 E / P, EXPECTED RETURN, AND GROWTH
1 2
……...
E1 = D1 E2 = D2
= 15 = 15
15
r = 15% P0 = = 100
0.15
INVESTMENT .. RS. 15 PER SHARE IN YEAR 1 … EARNS 15%
2.25
NPV PER SHARE = - 15 + = 0
0.15

RATE OF INCREMENTAL PROJECT'S IMPACT ON SHARE PRICE E1/P0 r

RETURN CASH FLOW NPV IN SHARE PRICE IN YEAR 0,
YEAR 1 IN YEAR 0 P0

0.05 0.75 -10 -8.70 91.30 0.164 0.15

0.10 1.50 -5 -4.35 95.65 0.157 0.15
0.15 2.25 0 0 0 0.15 0.15
0.20 3.00 5 4.35 104.35 0.144 0.15
0.25 3.75 10 8.70 108.70 0.138 0.15
IN GENERAL, WE CAN THINK OF THE STOCK PRICE AS THE
CAPITALISED VALUE OF THE EARNINGS UNDER THE ASSUMPTION OF
NO GROWTH PLUS THE PRESENT VALUE OF GROWTH OPPORTUNITIES
(PVGO).

E1
P0 = + PVGO
r

MANIPULATING THIS A BIT, WE GET

E1 PVGO
= r 1 -
P0 P0

FROM THIS EQUATION, IT IS CLEAR THAT :

 EARNINGS-PRICE RATIO IS EQUAL TO R WHEN PVGO IS ZERO.
 EARNINGS-PRICE RATIO IS LESS THAN R WHEN PVGO IS
POSITIVE.
 EARNINGS-PRICE RATIO IS MORE THAN R WHEN PVGO IS
NEGATIVE.
NET PRESENT VALUE
 NET PRESENT VALUE

Firm paying no dividends: It sometimes happens that a company although earns profit but
does not declare dividends. How would dividend capitalization model explain the share value
under such circumstances?.In fact
 STOCK MARKET

 Principal Exchanges

• The National Stock Exchange

• The Bombay Stock Exchange

 Veritable Transformation

• Screen-based Trading

• Electronic Delivery

• Rolling Settlement
 STOCK MARKET INDICES

• Bombay Stock Exchange Sensitive Index (Sensex)

• Base year 1978-79  100
• 30 shares
• Value-weighted index of the free float

• S & P CNX Nifty

• Base period ; November 3, 1995  1,000
• 50 shares
• Value-weighted index
 SUMMING UP

• The term value is used in different senses. Liquidation

value, going concern value, book value, market value, and
intrinsic value are the most commonly used concepts of
value.
• The intrinsic value of any asset, real or financial, is equal
to the present value of the cash flows expected from it.
Hence, determining the value of an asset requires an
estimate of expected cash flows and an estimate of the
required return.
• The value of a bond is:
n
C M
P = Σ (1+r)t
+
(1+r)n
t=1
 SUMMING UP
• A basic property of a bond is that its price varies inversely
with yield.
• The relationship between coupon rate, required yield, and
bond price is as follows:
Coupon rate < Required yield Price < Par (Discount bond)
Coupon rate = Required yield Price = Par
Coupon rate > Required yield Price > Par (Premium bond)

• The current yield on a bond is defined as: Annual interest /

Price.
 SUMMING UP
• The yield to maturity (YTM) on a bond is the rate of return the
investor earns when he buys the bond and holds it till maturity.

It is the value of r in the bond valuation model. For estimating

YTM readily, the following approximation may be used:
C + (M-P)/n
YTM =
0.4M + 0.6P
• According to the dividend discount model, the value of an
equity share is equal to the present value of dividends expect-
ed from its ownership.
• If the dividend per share remains constant rate, the value of the
share is:
PO = D / r
 SUMMING UP
• If the dividend per share grows at a constant rate, the value of
the
share is:
PO = D1 / (r – g)
• The two key drivers of dividend growth are (a) ploughback ratio

and (b) return on equity.

• The value per Do (1+gaccording
share, n) Dthe
to OH(g
Ha-g n)
model is:
P = +
r – gn r - gn
• An approach to valuation, practised widely by investment analysts, is

the P/E ratio approach. The value of an equity share, under this
approach, is estimated as follows:
PO = E1 x PO / E1
 SUMMING UP
• The stock price may be considered as the capitalised value of

of the earnings under the assumption of no growth plus the

present value of growth opportunities.

• The stock market consists of a primary segment and a

secondary segment. The principal bourses are the National
Stock Exchange and the Bombay Stock Exchange,
accounting for the bulk of the trading on the Indian stock
market.
GENERAL THEORY ON VALUATION
GENERAL THEORY ON VALUATION
GENERAL THEORY ON VALUATION
GENERAL THEORY ON VALUATION
GENERAL THEORY ON VALUATION
GENERAL THEORY ON VALUATION
GENERAL THEORY ON VALUATION
 IMPORTANT POINTS

r = Required rate of return / Opportunity cost of capital / Discount rate

of return / Capitalization rate.