FM PPT 1
FM PPT 1
Functions of FM
Compounding
Discounting
Compounding techniques
Compound value of a
lumpsum
Mr. Ram deposits Rs. 10000 for 3
years at 10%. What is the compound
value of his deposits?
Formula method:
FV = P(1+i)n
Multiple compounding
periods
Manohar deposits Rs. 20000 for 2
years at 10%. Calculate the maturity
value of the deposits if interest is
compounded half yearly.
Formula method:
FV = P(1+i/m)m*n
Doubling period
It refers to the time taken for
doubling the investment
Rule 72:
Doubling period = 72 /rate of interest
Rule 69:
Doubling period = 0.35 +69/interest rate
Compound value of an
annuity
Annuity refers to a series of equal
annual payments made at the end of
each year for a particular period
Rajiv deposits Rs. 1000 at the end of
every year for five years. The rate of
interest is 12%. What is the maturity
value of the deposits?
FV = A( 1+i)n-1+ A(1+i)n-2+..
+A
Discounting techniques
Present
Present
Present
Present
value
value
value
value
of
of
of
of
a lumpsum
a series of payments
an annuity
an annuity due
Present value of a
lumpsum
Arun expects to receive Rs. 100000
after 5 years. Find the present value
of the future receipt, if his time
preference rate is 10%
PV = FV/(1+i)n
Present value of an
annuity
Mr. Krishnan expects to receive an
annuity of Rs.5000 for three years.
His time preference rate is 10%.
Calculate the present value of
annuity.
PV = A/(1+i)1 + A/(1+i)2 ++
A/(1+i)n
Unique Risk
Unique risk which arises due to factors
specific to a company or security
Strike by workers of the company
Entry of a powerful competitors
Severe set back to the R&D efforts of the
company
Loss of big contract
Adverse verdict in a court case involving high
stakes
Dispute among the members of the promoters
family
Market Risk
Market risk which arises duo to
general economic wide factors
Political uncertainty
War and other calamities
Massive cut in government spending
Change in interest rate
Industrial recession
Relationship between
diversification and risk
Types of risk
Major two types of risk :
Systematic risk
Unsystematic risk
Other types:
Credit or default risk
Foreign exchange risk
country risk
Interest rate risk
Political risk
Liquidity risk
D1+(P1-P0)/P0
D1 = Dividend for the year
P0 = Price at the beginning of the
year
P1 = Price at the end of the year
P1-P0 = Capital gains
Variability of rate of
return
Expected Return
The concept of chances of
occurrence are estimated
Possible outcome should be mutually
exclusive and collectively exhaustive
The sum of probability assigned to
various rates is one
Expected return = (R x P)
Calculation of expected
return
Mr. Jitendra gives you an estimate of
possible return from a security and
their probability. Calculate the
expected return.
Economic condition
Probability
Decline
-5
Stagnation
1
Expansion
12
Growth
20
rate of return(%)
0.25
0.25
0.25
0.25
Choice of investment
Arun Ltd Varun Ltd
Expected return
22%
16%
Standard deviation 1.61% 16.25%
Advice Mr.Ganesh regarding the choice of
investment
Portfolio investment
The return of portfolio is the weighted
average of the return of the individual
securities
Probability x y
16
-5
7
Valuation of securities
Bond value
Liquidation value
Market value
Replacement value
Valuation of bonds or
debentures
Salient features:
Long term debt instruments
Coupon rate
Cash inflow consists of annual interest
and principal amount
No risk free
Bonds redeemable in
installments
Vd = CF1/(1+kd)1 + CF2/(1+kd)2 +.+
CFn/(1+kd)n
Air India has issued 5 years 8%% bonds of
Rs. 1000 each. The bond amount will be
amortized equally over its life. Ram, an
investor, requires a return of 7%. At what
price should he buy the bond?
Perpetual bonds
Vd = I/kd
Mr. Kannan has a perpetual bond of
Rs. 1000. He receives an interest of
Rs. 90 annually. What is the value of
the bond, if the required rate of
return is 10%?
Yield to maturity
YTM = Annual Return
Average Value
Valuation of preference
shares
Vp = P.D1 +
P.D2 ++ P.Dn
MVn
(1+kp)1
(1+kp)2
(1+kp)n
(1+kp)n
Valuation of equity
shares
Methods of valuation:
Dividend capitalization approach
Earnings capitalization approach
Dividend capitalization
approach
Single period valuation model:
P0 =
D1 + P1
1 + ke
Dividend valuation
model
P0 = D1/(1+ke)1 + D2/(1+ke)n +.
+ Dn/(1+ke)n
When the dividend is constant
When dividend is growing
No growth concept
P0 = D/ke
Mahindra Ltd is currently paying a
dividend of Rs. 6 per share. It is not
expected to change the dividend in future.
Calculate the value of the share if the
required rate of return is 12%
Growth in dividends
Normal growth:
P0 = D1
ke-g
= D0(1+g)
ke-g
When,
D0 = current dividend
D1 = expected dividend
ke = required rate of return
g = expected growth rate