CFP- Level-1-IP and Asset Management (Global) Chapter 1-6

Solution • D= Rs. 3 per share • D1= 3(1+g)= 3(1.05)= 3.15 • D2= DI (1+g) = 3.15(1.05)=3.3075 • D3= D2(1+g)= 3.3075(1.05)= 3.4728 • P3= 80 • Apply the formula • {3.15/(1.12)+3.3075/(1.12)^2+3.4728/(1.12)^3+80/(1.12)^3} • 2.8125+2.6367+2.4719+56.9435 • =64.8646 Friday, 15 July 2022 Investment Planning & Asset Management

Single period Valuation Model • When investor wishes to buy and hold the share for 1 year and then will sell • Prestige’s equity share is expected to provide a dividend of Rs.2.00 and fetch a price of Rs.18 a year hence. • What price would it sell for now if investors’ required rate of return is 12% • P0= {2.00/(1.12)+ 18/(1.12)} • Rs. 17.86 Friday, 15 July 2022 Investment Planning & Asset Management

Some more examples • R Ltd.’s equity share is expected to provide a dividend of Rs.4.00 and fetch a price of Rs.58 a year hence. • What price you should pay for it if required return is 15% p.a. • P0= {4.00/(1.15)+ 58/(1.15)} • 3.4782+50.4347 • =53.9129 Friday, 15 July 2022 Investment Planning & Asset Management

Constant Growth Model of Equity Valuation • Stocks are valued in many ways, using several metrics. Dividends can play an important part in the valuation of a stock, and perhaps the simplest valuation method using dividends is to calculate the Dividend Discount Model (DDM). • If we assume dividends grow at the same estimated rate as earnings, we can determine the intrinsic value of the stock by: • P0/V = ������0(1+������) ������������ ������ = ������1 ������−������ ������−������ • V=P0 or Intrinsic Value • Calculate the intrinsic value of a dividend-paying stock using the dividend discount model Friday, 15 July 2022 Investment Planning & Asset Management

Example of Constant Growth Model • Using the dividend discount model, what is the intrinsic value of a dividend paying stock where the current dividend is Rs.1.75, it is assumed to grow at 4% annually, and the required return is 10%? • ������ = ������0(1+������) ������������ ������ = ������1 ������−������ ������−������ • ������ = ������0(1+������) ������������ ������ = ������1 ������−������ ������−������ V = 1.75 (1.04)/.10 - .04 = 1.82/.06 = Rs.30.33 • The intrinsic value is Rs.30.33 Friday, 15 July 2022 Investment Planning & Asset Management

Zero Growth Model • When dividend per share remains constant year after year • Price of share (P0)= D/r • Dividend per share of X Ltd this year is Rs.3 per share • The dividend amount remains same per year • Expected rate of return is 12% • Compute Price/Intrinsic value per share P0= 3/.12 = Rs.25 per share Friday, 15 July 2022 Investment Planning & Asset Management

Additional Valuation Ratios • A financial advisor has several ratios to evaluate a stock’s value 1. Price to sales (P/S), 2. price to book (P/B), 3. price to earnings (P/E) and 4. price to earnings growth (PEG). Friday, 15 July 2022 Investment Planning & Asset Management

Additional Valuation Ratios • ABC corporation shares are valued at Rs.100 per share. • Being a relatively new company, ABC does not yet pay dividends. Revenue last year was Rs.5 crores and the company has ten lakh shares outstanding (sales per share = Rs.50). • ABC had earnings per share last year of Rs.10. The company currently has a book value per share of Rs.75. • What valuation ratios would you use to determine the value of ABC stock, and what is the value based on your choices and does the current price represent a good value? Friday, 15 July 2022 Investment Planning & Asset Management

Additional Valuation Ratios Solution: Price to sales (P/S) = Rs.100/Rs.50 = 2 Xs Price to book (P/B) = Rs.100/Rs.75 = 1.33 Xs Price to earnings (P/E) = Rs.100/Rs.10 = 10 Xs Without knowing comparable industry values, you cannot determine whether ABC represents good value. If comparable values are lower, it means ABC likely is overpriced. If ABC’s values were previously lower, the stock is probably overvalued Friday, 15 July 2022 Investment Planning & Asset Management

Additional Valuation Ratios (Price to earnings growth) • Price to earnings growth= EPS/EPS growth rate • B Ltd. has a price of Rs.58.00, 2018 EPS Rs.2.15, and 2019 EPS of Rs.3.23. • B Ltd. therefore, has a P/E of 27.0, which divided by its growth rate of 50 (3.23-2.15/2.15), results in a PEG ratio of 0.54. Friday, 15 July 2022 Investment Planning & Asset Management

Bonds • Bonds allow the issuer to borrow money. They represent loans made to the issuer with a promise of repayment along with interest. Once the bond is issued, the issuer has a legal obligation to repay the principal, along with interest, when due. • A bond’s par value (also called its face value or maturity value) is the amount of principal paid at maturity. Most bonds are issued with a minimum par value of Rs1000. • The amount of interest paid annually is based on the bond’s coupon rate (sometimes called simply the “coupon” ). The coupon rate is the annual interest rate paid by the bond issuer. So, a 6% coupon would pay Rs.60 each year, normally paid semiannually, on a Rs.1,000 par value bond. Friday, 15 July 2022 Investment Planning & Asset Management

Types of Bonds and Issuers • Notes or bills: Bonds issued for periods ranging from less than a year to 30 years or more. • Treasury or sovereign: Bonds issued by a national government (e.g., U.S. Treasuries, U.K. Gilts, German Bunds, French OATs, Japanese JGBs). As with all bonds, credit quality varies with the issuer, and interest paid varies by territory, monetary policy and economic environment. • Agency: Bonds issued by agencies created by, and related to, the government. These are not technically sovereign bonds, and do not carry the same credit rating and guarantees as sovereign debt. • Municipal: Bonds issued by country(territory), state, province, or city (municipal) governments. Friday, 15 July 2022 Investment Planning & Asset Management

Types of Bonds and Issuers • Corporate: Bonds issued by corporations. As with government bonds, corporate bonds vary in credit quality, with lower quality bonds typically paying higher interest rates. Very low quality bonds are often called junk or high-yield bonds. • Bonds with provisions such as Convertible, Callable and Puttable • Mortgage: Mortgage-backed securities are pools of mortgage loans, bundled, securitized (loans are sold and removed from the lending agency’s books) and sold to investors. Interest is often paid monthly (rather than on a more typical semiannual basis), along with a partial repayment of principal. Friday, 15 July 2022 Investment Planning & Asset Management

Types of Bonds and Issuers • Asset-backed securities: Bonds or notes backed, or secured, by financial assets. The asset is typically a nonmortgage loan (e.g., credit card, auto, home equity). The lending institution bundles the loans into a marketable security (i.e., securitization). • Zero-coupon: This type of bond does not have a coupon (i.e., regular interest payment). Instead, it is issued at a deep discount that reflects a rate of return. ������������0 = ������������������ (1 + i)������ Friday, 15 July 2022 Investment Planning & Asset Management

Types of Bonds and Issuers • Floating-rate: The coupon rate of a floating-rate bond can change over time hence the name “Floating-rate”. The Floating-rate equals a Reference rate plus a Spread. The size of the Spread will depend on the borrower’s credit rating. • Inflation-linked: An Inflation-lined bond is a special type of Floating- rate bond and it is important to understand the key differences between a Floating-rate bond and an Inflation-protected bond. • With an Inflation-linked bond, it is the par value that changes, so a constant coupon rate multiplied by a changing par value is what drives the changes in the coupon payment amounts. If inflation is going up, the bond-holder is protected from inflation, because on maturity, the par value of the bond has increased which has protected the investors purchasing power from inflation. Friday, 15 July 2022 Investment Planning & Asset Management

Various types of Risks in investing in Bonds are • Inflation risk • Interest rate risk • Credit Risk (Ratings of securities) • Liquidity risk • Reinvestment risk • Exchange rate risk • Regulatory risk Friday, 15 July 2022 Investment Planning & Asset Management

Bond Price/Valuation Calculations • The term “current bond price” is part of the yield calculation. It also is a part of determining duration. The bond’s current price is the discounted present value of its cash flow stream. You can use a financial calculator to compute a bond’s current price (its present value). To do so, you need to know four inputs for the upcoming calculations: • 1. Semiannual payment • 2. Par value (future value) • 3. Number of periods until maturity (Term to maturity) • 4. Current market interest rate for comparable bonds Friday, 15 July 2022 Investment Planning & Asset Management

Bond Price/Valuation Calculations • A three-year fixed-rate bond has a par value of €1,000 and a coupon rate of 5%, with coupon payments made semiannually. The bond will make six coupon payments of €25 (one coupon payment every six months over the life of the bond) and the final principal payment of €1,000 on the maturity date. • The value of the bond is calculated by discounting the bond’s promised payments using a discount rate that is appropriate to the riskiness of the bond’s cash flows. 1) When the discount rate equals the coupon rate, then the bond price will equal the par value. ������0 = €25 + €25 + €25 + €25 + €25 + €25 + (€11.0,02050)6= €1,000 (1.025)1 (1.025)2 (1.025)3 (1.025)4 (1.025)5 (1.025)6  P/Y = 2  Mode = End 1. N = 3 x 2 = 6 2. PMT = 25 3. FV = 1,000 4. CPT PV = -1,000 5. Yield= 2.5% (5%/2) Friday, 15 July 2022 Investment Planning & Asset Management

Bond Price/Valuation Calculations • The interest rate on a 20-year Government bond with a face value of ₹1000 is 8%. The expected yield to maturity is 9%. If interest is received on a half yearly basis, the current market price of the bond will be calculated in this way: • Calculation on FC200 V Calculator: Using CMPD Function Using BOND Function Set: End Set: Annu/Term N = 40 (20 years*2 (semi annually) N=40 I = 9% (Market yield) RDV=1000 (Redemption Value) PV= ? (-907.99) CPN=40 (8% of Rs.1000/2) PMT=40 (8% of Rs.1000/2) PRC=? (-907.99) FV=1000 (Redemption value) YTD=4.5% (9%/2) Semi annual cmpd P/Y= 2 (Payment twice in a year) C/Y =2 (Compounding twice in a year) Answer is Rs.907.99 Answer is Rs.907.99 Friday, 15 July 2022 Investment Planning & Asset Management

Bond Price/Valuation Calculations • When the discount rate is higher than the coupon rate, then the bond price will be below the par value. The algebra shows that we are increasing the numerator. Increasing the numerator decreases the present value or price. ������������0 = ������������������ (1 + i)������ • If interest rates have increased or if the company risk has increased and similarly risky investments are now paying 6% then why would someone buy a bond that is only paying 5%? If the price is reduced, or the bond is “discounted” then the bond’s yield to maturity will equal the market rate. ������0 = €25 + €25 + €25 + €25 + €25 + €25 + €(11.,0030)06= €972.91 (1.03)1 (1.03)2 (1.03)3 (1.03)4 (1.03)5 (1.03)6 • P/Y = 2 • Mode = End 1. N = 3 x 2 = 6 2. I/Y = 6 3. PMT = 25 4. FV = 1,000 5. CPT PV = -972.91 Friday, 15 July 2022 Investment Planning & Asset Management

Nominal Yield and Current Yield Friday, 15 July 2022 Investment Planning & Asset Management

Example of Nominal Yield and Current yield • K bought 1bond of face value Rs.1000 when the bonds were issued by the company, coupon rate 7% • M bought 1bond from secondary market and paid Rs.1100 per bond. Coupon rate 7% • Nominal Yield= 70/1000*100= 7% • Current Yield= 70/1100*100= 6.363% Friday, 15 July 2022

Yield-to-maturity (YTM) • This yield is the total return earned on a bond if it is held to maturity. It factors in both interest income and any price change from the purchase date to the bond’s maturity date. The price change is “spread out” over the number of years to maturity. The formula is: • YTM can also be calculated using CMPD or BOND function in CASIO FC 200 V • Example: Consider a Rs.1000 par value bond, carrying a coupon rate of 9% and maturing after 8 years. The bond is currently selling for Rs.800. Calculate the YTM on this bond? Friday, 15 July 2022 Investment Planning & Asset Management

Yield-to-maturity (YTM) Using CMPD Function Using BOND Function Set: End Set: Annu/Term N =8 N=8 I =? (13.1%) RDV=1000 (Redemption Value) PV= -800 CPN=90 PMT=90 PRC= -800 FV=1000 (Redemption value) YTM=? (13.1%) P/Y=1 (Payment once in a year) C/Y =1 (Compounding once in a year) Friday, 15 July 2022 Investment Planning & Asset Management

Yield-to-call (YTC) • Bonds come with imbedded call and put options. Call option is available to the issuer and bonds can be called back before maturity. Put option is available to the investor. • Yield to call is the total return earned on a bond if it is held to the time it is called back by the issuer. It factors in both interest income and any price change from the purchase date to the call price at a particular date. • Usually this is to the earliest date the bond can be called (the “first call date”), which is called the “yield to first,” meaning the yield to the first call date. • Note the similarity between yield to maturity and yield to call. Basically, the two calculations have two differences. • YTM uses the bond’s par value, and YTC uses the bond’s call price. • N in case of YTM is number of period remaining to maturity and in YTC is number of periods up to maturity. Friday, 15 July 2022 Investment Planning & Asset Management

Taxable-Equivalent Yield (TEY) • When comparing a bond with taxable interest and one where interest is tax-free, calculate the price equivalency between the two to determine which one offers the best value. • The equation to determine the taxable-equivalent yield (TEY) is: • Assume an investor is in a 30% marginal tax bracket and is considering a tax-free bond with a 3% yield. Friday, 15 July 2022 Investment Planning & Asset Management

Average maturity and Duration • Average Maturity= Term to maturity of Bond • Average Maturity of bond portfolio= Weighted average maturity by applying the following formula: • = Wa*AM a+Wb*AMb+--------------Wn*Amn • = .25(weight of bond a)*1.5*0.50(weight of b)*3+ 0.25(weight of c)*2 • Duration has two parts: Macaulay Duration Modified Duration • Macaulay duration is the weighted average, expressed in years, of the time period until the investor receives a bond’s interest and principal payments . • Modified duration measures interest rate sensitivity of the bond • Modified Duration= Macaulay Duration/(1+YTM) • Modified duration is less than Macaulay Duration Friday, 15 July 2022

Modified Duration /Duration • Duration is a measure of the sensitivity of the price of a bond or other debt instrument to a change in interest rates. • It measures the bond’s interest rate risk. • Duration is the weighted average, expressed in years, of the time period until the investor receives a bond’s interest and principal payments . • We all know that a bond’s price changes inversely to its interest rate. Interest rate drops, price of existing bond rises. Interest rate rises, price of existing bond drops. • The two factors are inversely related to each other and move correspondingly. For example, if interest rates rises by 1%, a bond with a duration of six years would decrease in value by about 6%. Duration is a valuable tool to evaluate bonds. Friday, 15 July 2022 Investment Planning & Asset Management

Duration • Duration helps the advisor determine the anticipated change in a bond’s price as interest rates change. • Duration is irrelevant to investors who hold the bond to maturity, at which time they would receive the full par value. • Before we look at calculating duration, we need to note a basic assumption that is not always true in real life. • Duration is based on the premise that for every change in interest rates, the bond price has an equal, and opposite, change (e.g., 1% interest increase means a 1% price drop). • For some bonds, this does not always happen, but it’s still appropriate to use duration as a reliable measure of risk. Friday, 15 July 2022 Investment Planning & Asset Management

Duration • Duration= [PV(C1)*1+PV(C2)*2+…………PV(CN)*N]/P0 • Bond A • Face Value Rs.100 • Coupon (interest rate) 15% payable annually • Years to maturity 6 • Redemption Value Rs.100 • Current market price Rs.89.50 • Yield to maturity 18% • Compute Duration Friday, 15 July 2022 Investment Planning & Asset Management

Duration Year(1) Cash inflow(2) PV of (3)*(1) inflow at PV(1)*1+PV(2)*2…… 18%(3) 1 15 12.71 12.71 2 15 10.77 21.54 3 15 9.13 27.39 4 15 7.74 30.96 5 15 6.56 32.8 6 115 42.60 255.6 Total 381 Duration= [PV(C1)*1+PV(C2)*2+…………PV(CN)*N]/P0 Duration= 381/89.50 = 4.257 years Friday, 15 July 2022 Investment Planning & Asset Management

Duration • 4.257 is Macaulay Duration • Modified Duration= Macaulay Duration/(1+ytm) • = 4.257/1.18 • =3.607 Years • If there is increase of 1% in interest rate, price of existing bond will decrease by 3.607% • Average maturity of one bond= Term to maturity of that bond • Average maturity of portfolio= Wa*Term to maturity of a+ Wb* Term to maturity of b-----------Wn* Term to maturity of n Friday, 15 July 2022 Investment Planning & Asset Management

Valuation of money market securities • Money market securities are discounted securities or zero coupon bonds • PV= FV/(1+I)^N • Since money market securities are for less than a year, the formula will be as follows • PV= FV/1+(i*n/365) • PV= Price of the Bond • FV= Face Value or Par Value • N= number of days to maturity • i= yield p.a. • I= (FV/PV-1)*365/N Friday, 15 July 2022

Example • A Rs.1,00,000 T-Bill is selling at Rs.98000 today. It will mature in 60 days. What is the annual yield • = (100000/98000-1)/365/60 • 0.020408*365/60 • .1241*100 • =12.41% Friday, 15 July 2022

What Is Immunization in Bonds • To immunize a bond portfolio, you need to know the duration of the bonds in the portfolio and adjust the portfolio so that the portfolio's duration equals the investment time horizon. For example, suppose you need to have Rs.5,00,000 in five years for your child's education. You might decide to invest in bonds. You can immunize your bond portfolio by selecting bonds that will equal exactly Rs.5,00,000 in five years regardless of interest rate changes. • You can buy one zero-coupon bond that will mature in five years to equal Rs.5,00,000, or several coupon bonds each with a five year duration, or several bonds that \"average\" a five-year duration. • Immunization, also known as multi-period immunization, is a risk-mitigation strategy that matches the duration of assets and liabilities in order to minimize the impact of interest rates on net worth over time. • Immunization is a risk-mitigation strategy that matches asset and liability duration so portfolio values are protected against interest rate changes. • Immunization can be accomplished by cash flow matching, duration matching, convexity matching, and trading forwards, futures, and options on bonds. • The downside to immunization of a portfolio is foregoing the opportunity cost if the assets were to increase in value while the liabilities did not also rise in the same manner. Friday, 15 July 2022

Immunization in Bonds • Immunization helps large firms and institutions protect their portfolios from exposure to interest rate fluctuations. Using a perfect immunization strategy, firms can nearly guarantee that movements in interest rates will have virtually no impact on the value of their portfolios. • For example, large banks must protect their current net worth , whereas pension funds have the obligation of payments after a number of years. These institutions are both concerned about protecting the future value of their portfolios and must deal with uncertain future interest rates. • Immunization is considered a \"quasi-active\" risk mitigation strategy because it has the characteristics of both active and passive strategies. By definition, pure immunization implies that a portfolio is invested for a defined return for a specific period of time regardless of any outside influences, such as changes in interest rates. Friday, 15 July 2022

Immunization in Bonds • As in the buy-and-hold strategy, by design, the instruments best suited for this strategy are high-grade bonds with remote possibilities of default. • In fact, the purest form of immunization would be to invest in a zero- coupon bond and match the maturity of the bond to the date on which the cash flow is expected to be needed. • This eliminates any variability of return, positive or negative, associated with the reinvestment of cash flows. • Duration , is commonly used in immunization. It is a much more accurate predictive measure of a bond's volatility than a bond's Term to maturity This strategy is commonly used in the institutional investment environment by insurance companies, pension funds, and banks to match the time horizon of their future liabilities with structured cash flows. Friday, 15 July 2022

Convexity • Convexity is a measure of the curvature, or the degree of the curve, in the relationship between bond prices and bond yields. • Convexity is a risk-management tool, used to measure and manage a portfolio's exposure to market risk. • Convexity is a measure of the curvature in the relationship between bond prices and bond yields. • Convexity demonstrates how the duration of a bond changes as the interest rate changes. • If a bond's duration increases as yields increase, the bond is said to have negative convexity. • If a bond's duration rises and yields fall, the bond is said to have positive convexity. Friday, 15 July 2022

Preferred Stock Preferred stock is a class of stock that pays dividends at a specified rate. Typically, preferred stock dividends are paid quarterly. To many people, this makes preferred stock seem more like a bond. It is senior to common stock, meaning that it has a higher priority when it comes to paying dividends and liquidating corporate assets. Companies may issue multiple classes of preferred stock with various stated rates of return. Preferred stock is unlike common stock in that it usually does not come with voting rights, and people generally are not investing for growth. Friday, 15 July 2022

Preferred Stock Preferred stock is a class of stock that pays dividends at a specified rate. Typically, preferred stock dividends are paid quarterly. To many people, this makes preferred stock seem more like a bond. It is senior to common stock, meaning that it has a higher priority when it comes to paying dividends and liquidating corporate assets. Companies may issue multiple classes of preferred stock with various stated rates of return. Preferred stock is unlike common stock in that it usually does not come with voting rights, and people generally are not investing for growth. Friday, 15 July 2022 Investment Planning & Asset Management

Preferred Stock • Holders of preference shares get priority over those who own ordinary shares if the company is wound up. • Preference shares can be convertible (into ordinary shares) as well as non-convertible. SEBI has recently allowed listing of non-convertible redeemable preference shares, that is, those that are not convertible into equity shares and are redeemed at maturity and privately-placed redeemable preference shares • Listing will give investors the option of exiting early rather than waiting for the instrument to mature. \"Preference shares are not popular due to lack of liquidity. Once they start trading, there will be more buyers,“ • Sebi has mandated a rating of AA- and above and three-year tenure for listing. Due to the risk involved, the minimum investment for preference shares is Rs 10 lakh. Friday, 15 July 2022

Preferred Stock • The zero-growth model. The formula for this is: ������ ������ = ������ Where: V = the preferred stock value D = the annual dividend r = the required rate of return Friday, 15 July 2022 Investment Planning & Asset Management

Preferred Stock Maria wants to know the value of her preferred stock. It has an annual dividend of 5 per share and her required rate of return is 5%. Using the zero-growth model, what is the current value of her stock? Solution: ������ ������ = ������ Where: V = the preferred stock value D = the annual dividend The current value is 100 (V = 5/.05) Friday, 15 July 2022 Investment Planning & Asset Management

Real Estate : Advantages and Disadvantages Advantages: Real estate has a low correlation to equity and bond markets, and provides diversification when added to an investment portfolio. Real estate can also serve as a hedge against inflation. As prices and the cost of living increase with inflation, typically so do real estate values (capital appreciation), as well as the amount of rent that is charged in investment properties (income). Rental properties can provide a consistent cash flow. Friday, 15 July 2022 Investment Planning & Asset Management

Real Estate : Advantages and Disadvantages Advantages Depending on the country in which real estate is owned, there may be tax advantages and deductions associated with owning real estate. Individuals who purchase real estate may do so with a mortgage loan rather than paying for a property in full. While borrowing can also be used to finance the purchase of other kinds of assets, greater levels of borrowing are typically available against real estate assets. This provides leverage to investors, as they only have to put up a fraction of the purchase price, but still enjoy ownership and appreciation of the whole property. Investors have some control over the measures taken to improve properties and, thus, increase values. Friday, 15 July 2022 Investment Planning & Asset Management

Real Estate : Advantages and Disadvantages Disadvantages: Where directly owned, real estate is much less liquid than financial assets like stocks or bonds. Investment properties must be managed and maintained. The initial investment in real estate is significantly higher than most financial assets. The acquisition and sale costs of real estate are also significantly higher than financial assets. Once a piece of real estate is developed for a certain purpose, it is rare that it can be used for another purpose Friday, 15 July 2022 Investment Planning & Asset Management

Real Estate Investment Trusts (REITs) • REITs is an investment trust that owns and manages a pool of commercial properties and mortgages and other real estate assets; • REITs typically offer investors high yields, as well as a highly liquid method of investing in real estate. • REITs are essentially a pooling vehicle which allows investors to participate in small amounts into a securitized real estate-linked investment. • On the one hand, these securities help to make investing in real estate more accessible, long term and income-oriented. • On the other hand, they also help to build an efficient secondary market for developers to exit projects. • REITs usually will invest in commercial properties and use rental income to distribute as dividend to unit holders. Friday, 15 July 2022 Investment Planning & Asset Management

Real Estate Investment Trusts (REITs) Thus, REITs are an investment vehicle for retail investors to invest in real estate and diversify their investment portfolio. Further, REITs provide an exit option to developers and investors in commercial/retail assets and also addresses the liquidity concerns for an illiquid asset. With listing of REITs, disclosures and transparency improve in addition to providing a professional management structure. Further, with 90% of profits to be distributed annually as dividend, regular dividend income with annual appreciation acts as a hedge against rising inflation. Friday, 15 July 2022 Investment Planning & Asset Management

Valuation of Real Estate NOI (Net Operating Income) Capitalization approach Example: Assume an apartment complex is projected to generate Rs.500,000 in total rents and an additional Rs.25,000 in other income from its onsite laundry facility and charges for detached parking garages. Based on experience, the complex estimates that vacancy and collection losses will be approximately 4% of its potential gross income. Operating expenses are estimated to be Rs.55,000. Based on recent sales of other similar properties, the cap rate is estimated to be 8%. What is the estimated intrinsic value of this apartment complex? 500,000 total rents + 25,000 other income = 525,000 potential gross income (PGI) - 21,000 estimated losses from vacancy expense = 504,000 effective gross income (EGI) - 55,000 operating expenses = 449,000 net operating income 449,000 NOI/.08 (cap rate) = 5,612,500 intrinsic value Important: The capitalization rate is the required rate of return for the potential investor. Friday, 15 July 2022 Investment Planning & Asset Management

Valuation of Real Estate (Gross Income Multiplier (GIM) • Another approach to valuing income properties is to calculate the ratio between the annual income estimates (total gross income, PGI or EGI) of nearby, similar properties to their recent sales price. • An average of these ratios is then calculated and multiplied by the estimated annual income of the property being valued. • This approach is similar to the price/sales ratio used to compute the value of a stock when the company has no dividends or earnings. • Before applying the multiplier, the analyst should be certain which of the three revenue numbers from comparable properties is used to determine the multiplier. Friday, 15 July 2022 Investment Planning & Asset Management