Investment valuation technique WEEK # 9

Investment valuation
technique
WEEK # 9
Week 5 7 8 9 10 11 = Final assignment
2000 words
50 % Weighting
Learning objectives
 To understand the meaning of investment valuation
 To identify margin account and margin return
 To discuss investment decision from the margin return
Source:
https://www.isurv.com/info/390/features/8805/traditional_method_of_investment_valuation_for_beginners
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What is investment valuation?
This method involves reflecting risk, return and
expectations of growth through the use of a yield.
Example:
This yield is fed into the years purchase (YP) formula and the present value of
£1 (PV £1) formula to produce the figures that the rent is multiplied by.
Source:
https://www.isurv.com/info/390/features/8805/traditional_method_of_investment_valuation_for
_beginners
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Return
beginning – of – period wealth
end – of – period wealth beginning – of – period wealth
Return
—

V0
V1
0
1 0
V
V V
r


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Initial value of investment
Final value of investment
Return is
Or as a percentage 100
0
1 0



V
V V
r
Return
• Example 1
• An initial investment of $10,000 is made. One year
later, the value of the investment has risen to $12,500.
The return on the investment is 25%
• Example 2
• An investment initially costs $5,000. Three months
later, the investment is sold for $6,000. The return on
the investment per three months is 20%
100 25 %
10000
12500 10000
 

r 
100 20 %
5000
6000 5000
 

r 
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Return and Risk
• The greater the risk of a security, the higher is expected return
• Return is the compensation that has to be paid to induce investors to accept risk
• Success in investing is about balancing risk and return to achieve an optimal
combination
• The risk always remains because of unpredictable variability in the returns on
assets
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Buying Common Stocks
• Open an account with a brokerage and specify
1. Name of firm
2. Buy or sell
3. Size of order
4. How long until order is cancelled
5. Type of order
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Margin Account
• A margin account is marked to market at the end of each trading day
• A daily calculation of actual margin
• A margin account is subject to a maintenance margin requirement
• The minimum acceptable value of the actual margin
• If actual margin < maintenance margin then a margin call is issued
• The investor is obliged to add cash or securities to the margin account
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Margin Account
• Margin Purchase
• Borrow money from broker to invest
• The cost of borrowing is interest plus a service charge
• Initial margin requirement
• The minimum % of investment from investor’s own funds
• Actual margin
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market val ue of assets
market val ue of assets – loan
Actual Margin 
Actual margin = (V1-V0) x Unit shares – Loans x interest
Total cost x Initial margin
Market value of assets = (V1-V0) x 100 (unit shares)
Loans = Loans x % of interest
Market value of asset = Total cost x Initial margin
Margin and Return
Buying on the margin raises return
Example
• Let purchase price of a security be £50 = 100 units x £50 = £5,000 (initial investment)
• Let price of security now be £65 = 100 units x £65 = £ 6,500 (final investment)
• Assume 100 units of shares were purchased and no dividends were paid
• Return on cash purchase
Cash Return r = 6500 – 5000 = 0.30 x 100 = 30%
5000
0
1 0
V
V V
r

Cash Return 
Cash Return r = £ 65 – £ 50 = 0.30 x 100 = 30%
£ 50
• Return on margin purchase
• Total cost = £50 x 100 units of shares = £5000
• Interest rate = 11%
• Initial margin = 60% of total cost
= £5,000 x 0.60 = £3,000
• Loans = Total cost – Initial margin
= £5,000 – £3,000 = £2,000
2.
Actual margin return = (V1-V0) x Units of shares – (Loans x interest )
Total cost x Initial margin
Actual margin Return = (£ 65- £ 50) X 100 units – (2,000 x 0.11)
£ 5,000 x 0.6
= (15X100) – 220
£3,000

Margin and Return
Therefore, from the Cash Return 30%
comparing with 42.67%, the return on
cash purchase is increased.
1. Cash Return r = £65 – £50 = 0.30 x 100 = 30%
£50
Cash Return r = 6500 – 5000 = 0.30 x 100 = 30%
5000
• But if price falls to £40
• Assume price now is £40 rather than £65

2. Margin Return = (40 – 50) X 100 units – (2,000 x 0.11)
5,000 x 0.6
= (-10X100) – 220
3,000

• Hence buying on the margin also magnifies losses
• Conclusion: use margin when belief is that prices will rise
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Margin and Return
Return on margin purchase
Total cost = £50 x 100 = £5000
Interest rate = 11%
Initial margin = 60% = (5,000 x 0.60) = £3,000.
Loans = Total cost – Initial margin
= 5,000 – 3,000 = £ 2,000
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which is same with Renaissance Service.
b)

Actual margin return = (V1-V0) x Units of shares – (Loans x interest )
Total cost x Initial margin
Initial value = V0 = 80 OMR
Final value = V1 = 85 OMR
Cash return = V1-V0 x 100
V0
= XX…%
c)

Actual margin return = (V1-V0) x Units of shares – (Loans x interest )
Total cost x Initial margin
Initial value = V0 = 80 OMR
Final value = V1 = 90 OMR
Cash return = V1-V0 x 100
V0
= XX…%
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