Warrants

Warrants

 A warrant is a detachable instrument issued along with bonds or preference shares. They give a 'right to buy' stated number of shares. they entitle the holder to buy a fixed number of shares at a predetermined price during some specified period of time.

Characteristics

• Detached warrants can be traded as independent securities, but they have a predetermined life and expires at a certain date. They may also be perpetual warrants, which never expire.
• Warrants are distributed to shareholders in lieu of cash or stock dividend or can be sold directly as a new security issue.
• A warrant holder has no right unlike a shareholder. he never receives any dividend and has no voting right. Usually 1:1 is the rate of share to warrants
• The exercise price of warrant is what the holder must pay to purchase the stated number of shares. The existence of positive premium on a warrant means that it will be more beneficial for the warrant holder to sell his warrant when he exercise it. The premium associated with a warrant shrink as the expiry date approaches.

Valuation of Warrants

S = Spot price of the share or current market price

X = Exercise price

N = Number of shares in a warrant

then

V= (S-X)N

Valuation of Preference Shares and Equity shares

Valuation of preference shares

         Preference shares, like debentures are subject to a fixed rate of return or dividend, In case of no stated maturity, their valuation is similar to perpetual bonds
          The valuation of redeemable preference shares have their redemption value part also.

 Valuation of Equity Shares

• Single Period Valuation Model: If the investor holds the security for one year, the value of such equity share will be:-

• Multi-Period Valuation model :-Since, there is no maturity period for equity share, the value of an equity share of infinite period is equal to the discounted value of the stream of dividends of infinite duration, We will calculate the value of equity shares with three conditions of dividends

(a) Zero Growth model / Constant dividends :- It is an approach to equity valuation that assumes a constant, non growing, dividend stream for infinite period.

Suppose, equity earns a dividend D every year

(b) Constant growth model / Gordon model:- It is assumed that dividends tend to increase over time because business firms usually grow over time. Therefore, if the growth of dividend is at a constant compound rate,then

Bonds (Debentures)

                 Bond are also termed as debentures. They are negotiable promissory notes that can be used by corporate, institutes or government agencies to raise funds from investors. it has the following features:-

• It is acknowledgement of debt
• It is convertible into equity at a later stage
• Redeemable at the time of maturity
• Secured instrument for raising debt against collateral
• Issuer can be the corporate or /and the government agencies.

Terms to remember

• Face value:- (Par value) It is the value on the face of the bond. It represents the amount of money, the person borrows and promises to repay at the time of maturity. A bond may be issued at par, at premium or at discount.
• Coupon rate:- It is the specific interest rate, payable to the bondholder on the par value irrespective of the price of issue.
• Maturity period:- It is the number of years after which the par value is payable to the bond holders. thus bond holder will receive redemption value at the time of maturity.
• Market Value:- A bond may be traded in a stock exchange. Market value is the price at which the bond is usually sold or purchased in the market.

Methods of Valuation of Bonds

Basic bond valuation model:- 

            The value of a bond is the present value of the payments its issuer will make to the bond issue from time to time till its maturity. The discounting rate to arrive at the present value depends on the risk and prevailing interest rate. It is also the required rate of  rerun on the bond. 

Payments to bond holder are

• Interest earned every year in form of annuity
• Par value at time of maturity i.e., redemption value

Bond value with semi-annual Interest

Some of the bonds carry interest payment semi-annually. Annual interest payment is halved,number of years to maturity will be doubled to get the number of half-yearly periods. Discount rate has to be divided by two to get the discount rate for half-yearly period.

Zero Coupon Bonds

Bonds which do not make periodic interest payments are zero coupon bonds. their coupon rate is zero. The return to the investor consists of the difference between the redemption value of the bond on the maturity  date and the 'below face value' at which he purchases it. Its valuation can be done as

Valuation of Long-term securities

                                The price, an investor is willing to pay to purchase a specific asset or security would be the value of that asset or security. The valuation process links risk and return expected by the investor from its assets to determine the worth at a given point of time.

The key factors in valuation process are
(1) Expected returns in terms of cash flows together with their timing.
(2) Risk in terms of required returns. Risk denotes the chance that an expected return/cash flow would not be realized. the greater the risk,lower the value and vice versa.

Valuation of tangible assets
The assets of permanent nature,which are held for the purpose of running a business, are termed as tangible assets. for example: plant, machinery, land, building, furniture and fixtures, vehicles like car,truck,etc, raw material and finished goods.
Tangible assets are to be valued at he cost price less depreciation in their value by constant use.

Concepts of values

• Book value :- The value of an asset as shown in the books of account of business concern.
• Market value:- The  price which can be realized by selling the assets in open market.
• Intrinsic Value:- The actual value of a company or an asset based on an underlying perception of its true value including all aspects of business, in terms of both tangible and in tangible factors. This value may or may not be the same as the current market value. For this value investors use a variety of analytical techniques in order to estimate the intrinsic value of securities in hopes of finding investments where the true value of the investment exceeds its current market value. its is also known as economic value.
• Liquidation value:- it is also called as realization value. the value represents the price at which each individual assets can be sold if the business operations are discontinued.
• Replacement value:- The which is required to purchase a similar new assets from  the market  with old assets .
• Salvage value:- The value at which the asset might be sold as scrap,once it is discarded.
• Value of goodwill:- (i) Value of goodwill= Average profits*years' of purchase

                                           (ii)Value of goodwill= Super profits* Years, of purchase

{Normal profit =Capital invested*Normal rate of return/100

Super profit= Actual profits-Normal profits}

Also

[Goodwill=Capitalized value of average profits- capital employed

Capital employed= Assets-Liabilities profits

Capitalized value of average profits= Average profits-Capital employed]

• Fair value:- the average of book value, intrinsic value and market value is called the fair value.
• Cost price:- the price at which the asset was acquired,might have been purchased or constructed, it also includes the cost of installation.

Valuation concept continued...

Present value of series of cash flows

In capital budgeting decisions when the cash flows comes in, in different time periods.Then in that case we determine the present value of each future payments and then aggregate them to find the total present value of the stream of the cash flows.

                                                                            or

Terms to remember:-

• Annuity:- An annuity is a fixed cash flow paid to someone each year. Bond,equity or any other investment that offers an investor a regular cash inflow each year can be valued with the help of present value of annuity.

•                           Perpetuity:- An annuity that goes on forever.

• Future value of Annuity:- Banks,SIP,RDs offer recurring investment schemes. If an investor opts for such a scheme, he would be required to calculate what would be the value of his investment over a period of times.
  

Valuation Concepts

Terms to remember:-

Time value of money:- 

     The sum of money to be received in future is less valuable than it is today. the reason for the time preference is the benefits from reinvestment that could be leveraged early. For example if somebody gives you Rs 100  now or he would offer you to give it after 5 years ,its always better to take it now.The money in hand could be invested  and with a good annual rate of return it could yield much higher value after 5 years instead of just Rs 100.

Discount rate:-

    The rate of return by which the time value of money is expressed is known as discount rate.

Techniques of Valuation

   The two techniques of valuation are :-

• Compounding Technique:-Here the interest is compounded on the initial principle amount at the end of compounding period.Compounding period could be Annual, Semi-annual, Quarterly compounding, Monthly compounding or Compounding 'n' times in a year.                                   
  

{Here for example if the interest is calculated quarterly then in place of n we will take 4 and it its for say 3 years then we will write 3 in place of t and the calculation will follow. The greater the number of times compounding is done in a year,higher will be the future value or the yield.}

• Discounting technique:-It is reverse of the compounding technique.it calculates the presnet value from the given future cash  flows.

Financial Management

Financial management:- It is concerned with the planning and controlling financial resources. It aims at minimizing expenses and maximizing profits.

Prime Objectives:-

1. Maximization of wealth of organization and owner.
2. Valuation of all the financial instruments so as to correctly assess the vale of the organizaton
3. Enables wise and profitable decision making
4. It considers careful selection of sources of capital for meeting long term financial requirements of the organization.

Approaches 

Traditional Approach:- Procurement and allotment of funds in an organization

Modern Approach:-

• Sourcing of finance:- Long-term and short-term financing.
• Deployment of finance:-Investment decisions for long-term and short-term.
• Strategic Decision:-Dividend decisions,mergers and acquisition.

Terms to Remember:-

• Working Capital Management:- The convertible short term assets which could be converted into cash within one year of period is called working capital. For example cash,inventory,accounts receivable etc. It measures company's liquidity. Managing this aspect of company comes under working capital management.

                          Working capital = Current asset-Current liabilities

                         (WCR) Working capital ratio = Current assest/Current liabilities

                          The higher the ratio the better is the company's liquidity.

• Capital Budgeting:- It refers to the long term projects or investments which yields the returns after long term,mostly after one year. It deals with setting up a plant, accepting projects being offered,installing big machines,expenditure in R&D etc.     

        Capital budgeting decisions:-

• How much money to be raised ?and sources
• The degree of risk is to be assessed
• Time and amount of return