3. Valuation of Future Cash Flows

5. Introduction to Valuation: The Time Value of Money

1. For a given rate of return, the value at some point in the future of an investment made today can be determined by calculating the future value of that investment

   

   
   
   1.  Future value (FV): The amount an investment is worth after one or more period
      
      1. Compounding 
   2. Present Value PV = \cfrac{1\$}{(1+r)^t}
   3.  Discounted cash flow (DCF) valuation
      = Calculating the present value of a future cash flow to determine its value today
2. The current worth of a future cash flow or series of cash flows can be determined for a given rate of return by calculating the present value of the cash flow(s) involved
3. The reason for this is that most investments can be analyzed using the discounted cash flow (DCF) approach

 

 

6. Discounted Cash Flow Valuation

• two ways of calculating present and future values when there are multiple cash flows
  • Both approaches are straightforward extensions of our earlier analysis of single cash flows
• ordinary annuity: A series of constant cash flows that arrive or are paid at the end of each period ,
  • it is some useful shortcuts for determining the present and future values of annuities
  • APR(annual percentage rate): charged per period multiplied by the number of periods per year
    •  if a loan is charging 1.2% per month , then ARP is reported at $1.2% X 12 = 14.4%

• Interest rates can be quoted in a variety of ways
  •  EAR(effective annual rate): expressed as if it were compounded once per year
  • The relationship between a quoted rate, such as an annual percentage rate (APR), and an effective annual rate (EAR) is that. where m is the number of times during the year the money is compounded

    

 Quoted rate can be APR

 

 

 

• Many loans are annuities
  • pure discount loan (short-term)
  • interest-only loan
  • amortizing the loan: The process of providing for a loan to be paid off gradually

    

    • how amortization schedules are prepared and interpreted 
    • ex) borrowing 5000 for 5 years at 9% interest, Interest paid of each year is beginning balance multiplied by 9% 

7. Interest Rates and Bond Valuation

• Determining bond prices and yields is an application of basic discounted cash flow principles.

• Bond values move in the direction opposite that of interest rates, leading to potential gains or losses for bond investors

• Bonds have a variety of features spelled out in a document called the indenture
  • +) protective covenants: limiting certain actions that might be taken during the term of the loan, usually to protect the lender's interest

 

• Bonds are rated based on their default risk
  • Some bonds, such as Treasury bonds, have no risk of default, whereas so-called junk bonds have substantial default risk
• A wide variety of bonds exist, many of which contain exotic or unusual features
  • zero coupon bond (zero): no coupon payment, initially priced at a deep discount
  • floating-rate bonds (floater): adjustable coupon payment
  • Income bond: except coupon payment 
  • convertible bond
  • put bond: allows the holder to force the issure to buy the bond back at a stated price
• Almost all bond trading is OTC(장외거래), with little or no market transparency. As a result, bond price and volume information can be difficult to find
• Bond yields and interest rates reflect the effect of 6 different things
  • the real interest rate
  • five premiums
    • investors demand as compensation for inflation
    • interest rate risk
    • default risk
    • taxability
    • lack of liquidity

 

The Term Structure of Interest Rates

 

8. Stock Valuation

• The cash flows from owning a share of stock come in the form of future dividends
  • In certain special cases, it is possible to calculate the present value of all the future dividends
  • thus come up with a value for the stock

• As the owner of shares of common stock in a corporation, you have various rights, including the right to vote to elect corporate directors
  • Voting in corporate elections can be either cumulative or straight
    • cumulative voting: shareholder may cast all votes for one member of the board of directors
    • straight voting: shareholder may cast all votes for each member of the board of directors
    • Effects of staggering
      • staggering : board that is made up of different classes of directors with different service terms(period)
      •  1: difficult for minority to elect a director on cumulative voting because of fewer directors to elect
        - 2: takeover attempts less successful because of difficulty to vote in majority of new directors
        - 3: continuity on the board of directors -> long-range plans
  • Proxy voting:
    •  proxy: the grant of authority by a shareholder allowing another individual to vote his/her shares (usually voting in large public corporation)
    • Most voting is actually done by proxy
    • proxy battle: attempt to replace management by electing enough directors
• In addition to common stock, some corporations have issued preferred stock
  • The name stems from the fact that preferred stockholders must be paid first, before common stockholders can receive anything
  • Preferred stock has a fixed dividend
• The two biggest stock markets in the United States are the NYSE and the Nasdaq.
  • the organization and operation of these two markets
    • NYSE
      • commision brokers:  execute customer orders
      • specialist(market maker) -> specialist's post on floor activity: dealer
      • floor broker: execute order for commission brokers
      • SuperDOT system
      • floor trader:  trade for their own accounts, trying to anticipate temporary price fluctuations