Interest Rate and Security Valuation

BY: MIKKA OFELIA B.
LAVILLA
 is the amount a lender charges for the use of
assets expressed as a percentage of the
principal
 Interest rates apply to most lending or
borrowing transactions.
 A loan that is considered low risk by the
lender will have a lower interest rate. A loan
that is considered high risk will have a higher
interest rate
 is a quick and easy method of calculating the
interest charge on a loan. Simple interest is
determined by multiplying the daily interest
rate by the principal by the number of days
that elapse between payments.
 Some lenders prefer this method, which
means that the borrower pays even more in
interest.
 Compound interest also called interest on
interest, is applied to the principal but also
on the accumulated interest of previous
periods.
is the concept that money available at the
present time is worth more than the identical
sum in the future due to its potential earning
capacity.
Future Value
The FV calculation allows investors to predict,
with varying degrees of accuracy, the amount
of profit that can be generated by different
investments.
FV = PV x [ 1 + (i / n) ] (n x t)
 FV = Future value of money
 PV = Present value of money
 i = interest rate
 n = number of compounding periods per year
 t = number of years
 Assume a sum of $10,000 is invested for one year at 10%

interest. The future value of that money is:
 FV = $10,000 x (1 + (10% / 1) ^ (1 x 1) = $11,000
Compounding
 Quarterly Compounding: FV = $10,000 x (1 + (10% / 4) ^ (4 x 1) =
$11,038
 Monthly Compounding: FV = $10,000 x (1 + (10% / 12) ^ (12 x 1) =
$11,047
 Daily Compounding: FV = $10,000 x (1 + (10% / 365) ^ (365 x 1) =
$11,052
is the current value of a future sum of money or stream of
cash flows given a specified rate of return.
 The interest rate charged by banks is
determined by a number of factors such as
the state of the economy.
 A country’s central bank sets the interest
rate. When the central bank sets interest rates
at a high level the cost of debt rises.
 When the cost of debt is high, thus
discouraging people from borrowing and
slows consumer demand.
 Also, interest rates tend to rise with inflation.
 The process of determining how much a secu
rity is worth.
 Security valuation is important to decide on
the portfolio of an investor. All investment
decisions are to be made on a scientific
analysis of the right price of a share.
 is a process in which regulators assess the
safety and risk associated with the securities
that an insurance company has on its books.
 Book value- book value of an equity share is
equal to the net worth of the firm divided by the
number of equity shares, where the net worth is
equal to equity capital plus free reserves.
 The calculation of book value includes the

following factors:
+ Original purchase price
+ Subsequent additional expenditures charged to the item
- Accumulated depreciation
- Impairment charges
= Book value
 For example, a company spends $100,000 to
buy a machine and subsequently spends an
additional $20,000 for additions that expand
the production capacity of the machine. A
total of $50,000 of accumulated depreciation
has since been charged against the machine,
as well as a $25,000 impairment charge. The
book value of the machine therefore $45,000.
 Liquidating Value - If the assets are valued at
their breakdown value in the market and take
net fixed assets plus current assets minus
current liabilities as if the company is liquida-
ted, then divide this by the number of shares,
the resultant value is the liquidating value per
share
 As an example, assume liabilities for
company A are $550,000. Also, assume the
book value of assets found on the balance
sheet is $1 million, the salvage value is
$50,000, and the estimated value of selling
all assets at auction is $750,000. The
liquidation value is calculated by subtracting
the liabilities from the auction value, which is
$750,000 minus $550,000, which results to
$200,000.
 Intrinsic Value - Intrinsic price is the true
value of the share, which depends on its
earning capacity and its true worth.
According to the fundamentalist approach to
security valuation, the value of the security
must be equal to the discounted value of the
future income stream.
 Dividend Discount Model
Dividend per share is the dollar amount of
dividend paid for each share of common stock.
 Assume the dividend is $4 per share. The discount

rate is the investor’s required rate of return.
 Assume a 12% discount rate.
 Assume a 4% percentage rate of dividend growth
each year.
The DDM formula is ($4 / (12% - 4%) = $50).

If the current market price of the stock is less than
$50 per share, the formula indicates that the
stock price is undervalued. In other words, the
intrinsic value of the stock is higher than the
stock’s current price.
 Replacement Value - When the company is
liquidated and its assets are to be replaced by
new ones, their prices being higher, the
replacement value of a share will be different
from the Breakdown value.

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BY: MIKKA OFELIA B.

 Assume a sum of $10,000 is invested for one year at 10%

 FV = $10,000 x (1 + (10% / 1) ^ (1 x 1) = $11,000

 The calculation of book value includes the

 Assume the dividend is $4 per share. The discount

The DDM formula is ($4 / (12% - 4%) = $50).

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