Chapter 5: Security Valuation

"The definition of an Investment is - Investment involves commitment of funds with an objective to obtain a return that would pay off the investor for the time during which the funds are invested or locked, for the expected rate of inflation over the investment horizon, and for the risk involved. Most investments are expected to have future cash flows and a stated market price (e.g., price of a common stock), and one must estimate a value for the investment to determine if its current market price is consistent with his estimated intrinsic value. Investment returns can take many forms, including earnings, cash flows, dividends, interest payments, interest on interest payments or capital gains (increases in value) during an investment horizon." "Knowing what an asset is worth and what determines its value is a pre-requisite for making intelligent investment decisions while choosing investments for a portfolio or in deciding an appropriate price to pay or receive in a business takeover and in making investment, financing and dividend choices when running a business. We can make reasonable estimates of value for most assets, and that the fundamental principles determining the values of all types of assets whether real or financial, are the same. Some assets may be easier to be valued than others and for different assets the details of valuation and the uncertainty associated with their value estimates may vary. However, the core" principles of valuation always remain the same.

A sound investment decision depends on the correct use and evaluation of the rate of return. Some of the different concepts of return are given as below:
2.1 Required Rate of Return
Required rate of return is the minimum rate of return that the investor is expected to receive while making an investment in an asset over a specified period of time. This is also called Opportunity Cost or Cost of Capital because it is the highest level of expected return forgone which is available elsewhere from investment of similar risks. Many times required rate of return and expected return
are used interchangeably.
2.2 Discount Rate
"Discount Rate is the rate used to calculate present value of future cash flows Discount rate depends on the risk-free rate and risk premium of an investment. Actually, each cash flow stream coming"
"from different assets can be discounted at a different discount rate. This is because of variation in risk premium which may be due to expected inflation rate, different maturity levels and probability of defaults. This can be explained with the help of term structure of interest rates. For instance, in upward sloping term structure of interest rates, interest rates increase with the maturity as longer maturity may mean more inflation risk, more liquidity risk or more default risk."
"Though future cash flows can be discounted at different discount rate, one may use the same discount rate to get the same present value of a stream of cash flows. When a single discount rate is applied instead of many discount rates, many individual discount rates can be replaced with an equivalent single discount rate which eventually gives the same present value."
Example: Cash flows and discount rates for each year of cash flows at different maturities have been given as below:-
1st year 2nd year 3rd year 4th year 5th year
"Cash flows
Discount rates" "₹100
2.0%" "₹200
3.2%" "₹300
3.6%" "₹400
4.8%" "₹500
5.0%"
"The present value of this stream of cash flows, by discounting each cash flow with the respective discount rate, is ₹ 1,278.99."
The single discount rate that approximately equates the present value of the stream of cash flows to ₹1278.99 is 4.4861% (any difference is due to rounding).
2.3 Internal Rate of Return
Internal Rate of Return is defined as that discount rate which equates the present value of future cash flows of a security to its market price. The IRR is viewed as the average annual rate of return that investors earn over their investment time period assuming that the cash flows are reinvested at the IRR. This can be explained with the help of an example as follows:
Example
"Suppose you are recommended to invest ₹ 20,000 now in an asset that offers a cash flow ₹ 3,000 one year from now and ₹ 23,000 two years from now. You want to estimate the IRR of the investment. For this purpose you must find the discount rate that equates the present value of cash inflows to ₹ 20,000, the value of the initial investment."
Time 0 1st year 2nd year
Cash flows "(₹ 20,000)" "₹ 3,000" "₹ 23,000"
We solve the following equation for r which denotes IRR and get 15%. 20000 = 3000/(1+r) + 23000/(1+r)2
=> r = 15%
"Thus, our IRR is 15%, which implies that we earn on an average 15% on the investment per annum. Now let's assume that when we receive ₹ 3,000, we reinvest it at 10% for one year and after one year we receive total ₹ 26,300, ₹ 3,300 of which is attributable to reinvestment of ₹ 3,000. Since we receive total cash ₹ 26300 we can estimate the IRR of the investment."
(26300/20000)1/2 - 1 = 0.1467 or 14.67%
"Annual return is now at 14.67% if reinvested at 10%, which is actually less than what was expected to be earned before investment. The reason is that the cash flow was reinvested at a rate (10%) which is less than our expected IRR (15%)."
"If we had a chance to reinvest ₹ 3,000 at 15%, we would receive ₹ 26,450 at the end of 2nd year, and the IRR of the investment would be equal to exactly 15% as calculated below:"
"(26450/20,000)1/2 - 1 = 0.15 or 15%"

"Equity risk premium is the excess return that an investment in equity shares provides over a risk free rate, such as return from tax free government bonds. This excess return compensates investors for taking on the higher risk of investing in equity shares of a company. The size of the premium will change depending upon the level of risk in a particular portfolio and will also change over time as market risk fluctuates. Generally, high-risk investments are compensated with a higher premium."
"The equity risk premium is based on the idea of the risk-reward trade-off. However, equity risk premium is a theoretical concept because it is difficult to predict that how a particular stock or the stock market as a whole will perform in the future. It can only be estimated by observing stock market and government bond market over a specified period of time, for instance from 1990 to the present period. Further, estimates may vary depending on the time frame and method of calculation."
3.1 Explanation of Equity Risk Premium
"Investment in equity shares of a company is a high risk investment. If an investor is investing in equity shares of a company, he wants some risk premium over the risk-free investment avenues such as government bonds. For example, if an investor could earn a 7% return on a Government Bond (which is generally considered as risk free investment), a company's share should earn 7% return plus an additional return (the equity risk premium) in order to attract the investor."
"Equity investors try to achieve a balance between risk and return. If a company wants to pursue investors to put their money into its stock, it must provide a stimulus in the form of a premium to attract the equity investors. If the stock gives a 15% return, in the example mentioned in the previous paragraph, the equity risk premium would be 8% (15% - 7% risk free rate). However, practically, the price of a stock, including the equity risk premium, moves with the market. Therefore, the investors"
"use the equity risk premium to look at historical values, risks, and returns on investments."
3.2 Calculating the Equity Risk Premium
"To calculate the equity risk premium, we can use the Capital Asset Pricing Model (CAPM), which is usually written:"
Rx = Rf + βx (Rm - Rf) Where:
"Rx = expected return on equity investment in ""x""(company x)"
Rf = risk-free rate of return
"βx = beta of ""x"""
Rm = expected return of market
"Now, if we assume that x is identical to the Market Index, m, then Rx = Rm. Beta is a measure of a stock's systematic risk ; and if x = m, then βx = βm = 1. Whereas Rm - Rf is known as the Market Risk Premium; Rx - Rf is the risk premium of a particular stock. If x is an equity investment, then Rx - Rf is the equity risk premium; if x = m, then the market premium and the equity risk premium are the same."
"Therefore, the equity risk premium can be calculated as follows:"
Equity Risk Premium = Rx - Rf = βx (Rm - Rf)

"If equity risk premium is calculated as indicated above, required rate of return can be easily calculated with the help of Capital Asset Pricing Model (CAPM). The main insight of the model is that the investors evaluate the risk of an asset in terms of the asset's contribution to the systematic risk (cannot be reduced by portfolio diversification) of their total portfolio. CAPM model provides a relatively objective procedure for required return estimation; it has been widely used in valuation." "So, the required return on the share of particular company can be computed as below:" Return on share 'A' = Risk free return + β x Market Risk Premium Example: "Risk free rate 5%," β 1.5 "and, Market risk premium 4.5% Calculate Required return on equity." Solution Required return on share A = Risk free return + β x Market Risk Premium = 0.05 + 1.5 (0.045) = 0.1175 or 11.75%

"Cash flows are discounted at a suitable rate to arrive at the present value of future cash flows. Cash flows are required by any organization to settle their debt claims and taxes. Whatever amount remains are the cash flows available to equity shareholders. When cashflows to be available to equity shareholders are discounted, the required rate of return on equity is an appropriate discount rate. Further, when cash flows are available to meet the claims of all of company's stakeholders, then the cost of capital is the appropriate discount rate."
5.1 Concept of Nominal Cash Flow and Real Cash Flow
"Nominal cash flow is the amount of future revenues the company expects to receive and expenses it expects to pay out, without any adjustments for inflation. For instance, a company which wants to invest in a utility plant wants to forecast its future revenues and expenses it has to incur while earning its income (i.e. wages to labour, electricity, water, gas pipeline etc.)."
"On the other hand, Real cash flow shows a company's cash flow with adjustments for inflation. Since inflation reduces the spending power of money over time, the real cash flow shows the effects of inflation on a company's cash flow."
"In the short term and under conditions of low inflation, the nominal and real cash flows are almost same. However, in conditions of high inflation rates, the nominal cash flows will be higher than the real cash flows."
5.2 Discount rate selection in Equity Valuation
"From the above discussion, it can be concluded that cash flows can be nominal or real. When cash flows are stated in real terms, then they are adjusted for inflation. However, in case of nominal cash flow, inflation is not adjusted."
"For nominal cash flow, nominal rate of discount is used and for real cash flow, real rate of discount is used. While valuing equity shares, only nominal cash flows are considered. Therefore, only nominal discount rate is considered. The reason is that the tax applying to corporate earnings is generally stated in nominal terms. Therefore, using nominal cash flow in equity valuation is the right approach because it reflects taxes accurately."
"Moreover, when the cash flows are available to equity shareholders only, nominal discount rate applicable in case of equity is used. And, the nominal after tax weighted average cost of capital is used when the cash flows are available to all the company's capital providers."

"In order to undertake equity valuations, an analyst can use different approaches, some of which are classified as follows:"
(1) Dividend Based Models
(2) Earning Based Models
(3) Cash Flows Based Model
6.1 Dividend Based Models
"As we know that dividend is the reward for the provider of equity capital, the same can be used to value equity shares. Valuation of equity shares based on dividend are based on the following assumptions:"
a. Dividend to be paid annually.
b. Payment of first dividend shall occur at the end of first year.
c. Sale of equity shares occur at the end of a year and that to at ex-dividend price.
"The value of any asset depends on the discounted value of cash streams expected from the same asset. Accordingly, the value of equity shares can be determined on the basis of stream of dividend expected at Required Rate of Return or Opportunity Cost i.e. Ke (Cost of Equity)."
Value of equity share can be determined based on holding period as follows:
(1) Valuation Based holding period of One Year : If an investor holds the share for one year
then the value of equity share is computed as follows:
P0 =
D1 +
(1 + K )1
P1
(1 + K )1
= D1+ P1 (1 + K )1
e e e
Example: Share of X Ltd. is expected to be sold at ₹ 36 with a dividend of ₹ 6 after one year. If required rate of return is 20% then what will be the share price?
Answer
The expected share price shall be computed as follows:
P0 =
6 +
(1+0.20)1
36
(1+0.20)1
= ₹ 35
(2) Valuation Based on Multi Holding Period: In this type of holding following three types of dividend pattern can be analyzed.
"(i) Zero Growth: Also, called as No Growth Model, as dividend amount remains same over the years infinitely. The value of equity can be found as follows:"
P0=
D
(Ke )
"(ii) Constant Growth: Constant Dividend assumption is quite an unrealistic assumption. Accordingly, one very common model used is based on Constant Growth in dividend for infinitely"
"long period. In such situation, the value of equity shares can be found by using following formula:"
P0=
D1 or D0(1+g)
Ke - g (Ke - g)
It is important to observe that the above formula is based on Gordon Growth Model of Calculation of Cost of Equity.
"(iii) Variable Growth in Dividend: Just like no growth in dividend assumption, the constant growth assumption also appears to be unrealistic. Accordingly, valuation of equity shares can be done on the basis of variable growth in dividends. It should however be noted that though we can assume multiple growth rates but one growth rate should be assumed for infinity, only then we can find value"
of equity shares.
"Although stages of Company's growth fall into following categories such as Growth, Transition and Maturity Phase but for Valuation the multiple dividend growth can be divided into following two categories."
"(a) Two Stage Dividend Discount Model: While simple two stage model assumes extraordinary growth (or supernormal growth) shall continue for finite number of years, the normal growth shall prevail for infinite period. Accordingly, the formula for computation of Share Price or equity value"
shall be as follows:
D0(1+g1) D0(1+g1)2 D0(1+g1)n  Pn
P0 =  (1+K )1 +
(1+K )2
...........+
(1+K )n
 + (1+K )n
 e e e  e
D (1+g1)n (1+g2)
Pn = 0
(Ke - g2)
"Where, D0 = Dividend Just Paid"
g1 = Finite or Super Growth Rate g2 = Normal Growth Rate
Ke = Required Rate of Return on Equity
Pn = Price of share at the end of Super Growth i.e. beginning of Normal Growth Period
"(b) Three Stage Dividend Discount Model: As per one version there are three phases for valuations: extraordinary growth period, transition period and stable growth period."
"In the initial phase, a firm grows at an extraordinarily high rate, after which its advantage gets depleted due to competition leading to a gradual decline in its growth rate. This phase is the transition phase, which is followed by the phase of a stable growth rate."
"Accordingly, the value of equity share shall be computed, as in case of two stage growth model by adding discounted value of Dividends for two growth periods and finally discounted value of share price at the beginning of sustainable or stable growth period."
"There is another version of three stage growth model called H Model. In the first stage dividend grows at high growth rate for a constant period, then in second stage it declines for some constant period and finally grow at sustainable growth rate."
H Model is based on the assumption that before extraordinary growth rate reach to normal growth it declines lineally for period 2H.
Though the situation is complex but the formula for calculation of equity share shall be as follows
which is sum of value on the normal growth rate and premium due to abnormal growth rate:
P0 =
D0(1 + gn) + D0H1(gc - gn)
r - gn r - gn
Where gn= Normal Growth Rate Long Run
gc= Current Growth Rate i.e. initial short term growth rate H1= Half of duration of the transition growth period
These variants of models can also be applied to Free Cash Flow to Equity Model discussed later.
6.2 Earning Based Models
"Above mentioned models are based on Dividends. However, nowadays an investor might be willing to forego cash dividend in lieu of higher earnings on retained earning ultimately leading to higher growth in dividend."
"Hence, these investors may be interested in determination of value of equity share based on Earning rather than Dividend. The different models based on earnings are as follows:"
(a) Gordon's Model: This model is based on following broad assumptions:
(i) Return on Retained earnings remains the same.
(ii) Retention Ratio remains the same. Valuation as per this model shall be
EPS1(1 - b)
Ke - br
"Where, r = Return on Equity b = Retention Ratio"
(b) Walter's Approach: This approach is based on Walter Model discussed at Intermediated Level
"in the Financial Management Paper. As per this model, the value of equity share shall be:"
D + (E - D) r
Ke
Ke
"(c) Price Earning Ratio or Multiplier Approach: This is one of the common valuation approaches followed. Since, Price Earning (PE) Ration is based on the ratio of Share Price and EPS, with a given PE Ratio and EPS, the share price or value can simply be determined as follows:"
Value = EPS X PE Ratio
"Now, the question arises how to estimate the PE Ratio. This ratio can be estimated for a similar type of company or of industry after making suitable adjustment in light of specific features pertaining to the company under consideration. It should further be noted that EPS should be of equity shares. Accordingly, it should be computed after payment of preference dividend as follows:"
EPS = Profit after tax - Preference Dividend
Number of Equity Shares
6.3 Cash Flow Based Models
In the case of Dividend Discounting Valuation model (DDM) the cash flows are dividend which are to be distributed among equity shareholders. This cash flow does not take into consideration the cash flows which can be utilised by the business to meet its long-term capital expenditure requirements and short-term working capital requirement. Hence dividend discount model does not reflect the true free cash flow available to a firm or the equity shareholders after adjusting for its capex and working capital requirement.
"Free cash flow valuation models discount the cash flows available to a firm and equity shareholders after meeting its long term and short-term capital requirements. Based on the perspective from which valuations are done, the free cash flow valuation models are classified as:"
 Free Cash Flow to Firm Model (FCFF)
 Free Cash Flow to Equity Model (FCFE)
"In the case of FCFF model, the discounting factor is the cost of capital (Ko) whereas in the case of FCFE model the cost of equity (Ke) is used as the discounting factor."
FCFE along with DDM is used for valuation of the equity whereas FCFF model is used to find out the overall value of the firm.
6.3.1 Calculation of Free Cash Flow to Firm (FCFF): FCFF can be calculated as follows:
(a) Based on its Net Income:
FCFF= Net Income + Interest expense *(1-tax) + Depreciation -/+ Capital Expenditure -/+ Change in Non-Cash Net Working Capital
(b) Based on Operating Income or Earnings Before Interest and Tax (EBIT):
FCFF= EBIT *(1 - tax rate) + Depreciation -/+ Capital Expenditure -/+ Change in Non-Cash Net Working Capital
"(c) Based on Earnings before Interest, Tax , Depreciation and Amortisation (EBITDA):"
FCFF = EBITDA* (1-Tax) +Depreciation* (Tax Rate) -/+ Capital Expenditure - /+Change in Non-Cash Net Working Capital
(d) Based on Free Cash Flow to Equity (FCFE):
FCFF = FCFE + Interest* (1-t) + Principal Prepaid - New Debt Issued + Preferred Dividend
(e) Based on Cash Flows:
FCFF = Cash Flow from Operations (CFO)* + Interest (1-t) -/+ Capital Expenditure
"* As per US GAAP. However, if interest is already been adjusted in CFO, then interest will not be added again."
"Capital Expenditure or Capex for a single year is calculated as Purchase of Fixed Asset current year - Sale of Fixed Asset current year taken from Cash Flow from Investing Activities.
Change in Non- Cash Working Capital is calculated as:
Step 1: Calculate Working Capital for the current year: Working Capital =Current Asset-Current Liability
Step 2: Calculate Non-Cash Net Working Capital for the current year: Current Assets - Cash and Bank Balance - Current Liabilities
Step 3: In a similar way calculate Working Capital for the previous year
Step 4: Calculate change in Non-Cash Working Capital as: Non-Cash Working Capital for the current year- Non-Cash Working Capital for the previous year
Step 5: If change in Non-Cash Working Capital is positive, it means an increase in the working capital requirement of a firm and hence is reduced to derive at free cash flow to a firm."
Based on the type of model discussed above the value of Firm can be calculated as follows:
(a) For one stage Model: Intrinsic Value = Present Value of Stable Period Free Cash Flows to Firm
"(b) For two stage Model: Intrinsic Value = Present value of Explicit Period Free Cash Flows to Firm + Present Value of Stable Period Free Cash Flows to a Firm, or"
Intrinsic Value = Present Value of Transition Period Free Cash Flows to Firm + Present Value of Stable Period Free Cash Flows to a Firm
(c) For three stage Model: Intrinsic Value=Present value of Explicit Period Free Cash Flows to Firm + Present Value of Transition Period Free Cash Flows to Firm + Present Value of Stable Period Free Cash Flows to Firm
"6.3.2 Calculation of Free Cash Flow to Equity (FCFE): Free Cash flow to equity is used for measuring the intrinsic value of the stock for equity shareholders. The cash that is available for equity shareholders after meeting all operating expenses, interest, net debt obligations and re- investment requirements such as working capital and capital expenditure. It is computed as follows:"
Free Cash Flow to Equity (FCFE) = Net Income -/+ Capital Expenditures + Depreciation -/+ Change in Non-cash Net Working Capital + New Debt Issued - Debt Repayments + Net issue of Preference Shares - Preference Share Dividends
or
FCFE = Net Profit + depreciation - ∆NWC - CAPEX + New Debt - Debt Repayment + Net issue of Preference Shares - Preference Share Dividends
∆NWC = changes in Net Working Capital.
CAPEX = Addition in fixed assets to sustain the basis.
FCFE can also be used to value share as per Multistage Growth Model approach.
6.4 Dividend Discount Model versus Free Cash Flow to Equity Model
In the dividend discount model the analyst considers the stream of expected dividends to value the company's stock. It is assumed that the company follows a consistent dividend payout ratio which can be less than the actual cash available with the firm.
Dividend discount model values a stock based on the cash paid to shareholders as dividend.
A stock's intrinsic value based on the dividend discount model may not represent the fair value for the shareholders because dividends are distributed in the form of cash from profits. In case the company is maintaining healthy cash in its balance sheet then it means that dividend pay-outs is low
which could result in undervaluation of the stock.
"In the case of free cash flow to equity model a stock is valued on the cash flow available for distribution after all the reinvestment needs of capex and incremental working capital are met. Thus, using the free cash flow to equity model provides a better measure for valuations in comparison to"
the dividend discount model.
6.5 Enterprise Value
Enterprise Value is the true economic value of a company. It is calculated by adding market
"capitalization, Long term Debt, Minority Interest minus cash and cash equivalents. (Also Minus like Equity investments like affiliates, investment in any company and also Long term investments.)"
"Enterprise Value is of three types: Total, Operating and Core EV. Total Enterprise Value is the value of all the business activities; it is the summation of market capitalization, Debt (Interest Bearing), Minority Interest "minus "cash. The operating Enterprise value is the value of all operating activities, and to get this we have to deduct "market value of non- operating assets" which includes Investments and shares (in associates) from the total enterprise value."
Core enterprise value is the value which does not include the value of operations which are not the part of core activities. To get this we deduct the value of non-core assets from the operating enterprise value.
Enterprise value measures the business as a whole and gives its true economic value. It is more comprehensive than equity multiples. Enterprise value considers both equity and debt in its valuation of the firm and is least affected by its capital structure. Enterprise multiples are more reliable than
equity multiples because Equity multiples focus only on equity claim.
There are different Enterprise Value multiples which can be calculated as per the requirement (which requirement). If we take the EV as numerator then the denominator must represent the claims of all the claimholders on enterprise cash flow.
6.5.1 Enterprise Value to Sales: This multiple is suitable for the corporates who maintain negative cash flows or negative earnings as cyclical firms. Corporate like technological firms generally use this multiple. Sales are the least manipulative top line for any business and least affected by accounting policies.
"6.5.2 Enterprise Value to EBITDA: EBITDA, which is commonly known as the proxy of cash flow, is the amount available to debt and equity holders of a company. This multiple is used for valuing capital intensive companies, which generally have substantial depreciation and amortization expenses. This multiple is used for acquisitions as it incorporates debts as well equity of the business. An analyst prefers this multiple because it is not affected by depreciation policy and changes in capital structure. The inverse of this multiple explains cash return on total investment."
6.6 Valuation of Rights
As we know that company offers right shares to the existing shareholders. Immediately after the
"right issue, the price of share is called Ex Right Price or Theoretical Ex-Right Price (TERP) which is computed as follows:"
nP0 + S
n + n1
n = No. of existing equity shares
P0 = Price of Share Pre-Right Issue
S = Subscription amount raised from Right Issue n1 = No. of new shares offered
"However, theoretical value of a right can be calculated as follows:"
Ex- Right Price - Subscription Price Value of Per Shareholding = Ex-Right Price - Subscription Price
Exiting Number of Shares

"Preference shares, like debentures, are usually subject to fixed rate of dividend. In case of non- redeemable preference shares, their valuation is similar to perpetual bonds."
Valuation of Redeemable preference share
"The value of redeemable preference share is the present value of all the future expected dividend payments and the maturity value, discounted at the required return on preference shares. Therefore, Value of Redeemable Preference Share shall be:"
= Dividend1 + Dividend2 + + Dividendn + Maturity value
1+ r 1
1+ r 2
1+ r n
and Value of Non-Redeemable Preference Share shall be:
Irredeemable Preference share value =
Example
Dividend
Required return on Preference share
"The face value of the preference share is ₹ 10,000 and the stated dividend rate is 10%. The shares are redeemable after 3 years period. Calculate the value of preference shares if the required rate of return is 12%."
Annual dividend = ₹10000 x 10% = ₹1000
Redeemable Preference share value
"= 1,000 + 1,000 + 1,000 + 10,000"
(1+ 0.12) (1+ 0.12)2 (1+ 0.12)3
"= 1,000 + 1,000 + 11,000"
(1.12) (1.12)2 (1.12)3
= 892.86 + 797.19 + 7829.58
= 9519.63
"Solving the above equation, we get the value of the preference shares as ₹ 9519.63"

8.1 Some Basics of a Bond
(a) Par Value: Value stated on the face of the bond of maturity.
"(b) Coupon Rate and Frequency of Payment: A bond carries a specific interest rate known as the Coupon Rate. The coupon can be paid monthly, quarterly, half-yearly or annually."
(c) Maturity Period: Total time till maturity.
(d) Redemption: Bullet i.e. one shot repayment of principal at par or premium.
8.2 Bond Valuation Model
The value of a bond is:
V   F
t1 (1 k )
d
(1 k )
d
V  I ( PVIFAk n )  F ( PVIFk n )
"Where,"
"d , d ,"
V = value of the bond
I = annual interest payable on the bond
F = principal amount (par value) of the bond repayable at the time of maturity n = maturity period of the bond
kd = Yield to Maturity (YTM) or Required Rate of Return on same type of Bonds.
8.3 Bond Value Theorems
"Some basic rules, which should be remembered with regard to bonds, are:"
CAUSE EFFECT
Required rate of return or YTM = coupon rate Bond sells at par value
Required rate of return or YTM > coupon rate Bond sells at a discount
Required rate of return or YTM < coupon rate Bond sells at a premium
Longer the maturity of a bond Greater the bond price change with a given change in the required rate of return.
8.4 Yield to Maturity (YTM)
The YTM is defined as that discount rate ("kd") at which the present value of future cash flows from a Bond equals its Market Price.
8.5 Bond Value with Semi-Annual Interest
The basic bond valuation equation thus becomes:
I
V = 2n 2 + F
t=1 
k t 
k 2n
1+ d  1+ d 
 2   2 
"= I/2(PVIFAkd/2,2n) + F(PVIFkd/2,2n)"
"Where,"
V = Value of the bond
I/2 = Semi-annual interest payment
Kd/2 = Discount rate applicable to a half-year period F = Par value of the bond repayable at maturity
2n = Maturity period expressed in terms of half-yearly periods.
8.6 Price Yield Relationship
"A basic property of a bond is that its price varies inversely with yield. The reason is - as the required yield increases, the present value of the cash flow decreases; hence the price decreases and vice"
versa.
8.7 Relationship between Bond Price and Time
"The price of a bond must equal its par value at maturity (assuming that there is no risk of default), because bond prices change with passage of time and they approach to the par value. It means that if a bond is trading at premium, its price will decrease over time and if a bond is trading at a discount,"
its price will increase over time.
8.8 Duration of Bond
"Duration is the weighted average time within which an investor gets back the promised principal and the promised YTM. Investment coupon bearing bond always has a duration which is lesser than its maturity. Higher the coupon rate, lesser would be the duration and higher the yield-to-maturity, lower will be the duration of a bond."
"It measures how quickly a bond will repay its true cost. The longer the time it takes the greater exposure the bond has to changes in the interest rate environment and hence, higher interest rate risk. Duration is also a measure of interest rate risk - higher duration implies higher interest rate risk and lower duration means lower interest rate risk. Following are some of factors that affect bond's duration:"
(i) Time to maturity: The shorter-maturity bond would have a lower duration and less interest rate risk and vice versa.
"(ii) Coupon rate: Coupon payment is a key factor in calculation of duration of bonds. The higher the coupon rate, the lower is the duration and vice versa."
"(iii) Yield-to-Maturity (YTM): Higher yield-to-maturity means lower duration and hence, lower interest rate risk and vice versa."
"Although there are many formulae to calculate the duration. However, following are commonly used methods:"
"(a) Macaulay Duration: This formula measures the number of years required to recover the true cost of a bond, considering the present value of all coupon and principal payments received in the future. The formula for Macaulay duration is as follows:"
 t*c + n*M
Macaulay Duration =
"Where,"
t=1 (1+i)t (1+i)n
P
n = Time to maturity
C = Cash flows (Coupon Amount) i = Required yield
M = Maturity (par) value
P = Bond price
(b) Modified Duration: This is a modified version of Macaulay duration which takes into account the interest rate changes because the changes in interest rates affect duration as the yield gets affected each time the interest rate varies.
The formula for modified duration is as follows:
 
Macaulay Duration in years 
Modified Duration =
 1 +
YTM  
  n  
Where
   
n = Number of compounding periods per year
YTM = Yield to Maturity
8.9 Immunization
"We know that when interest rate goes up though the reinvestment income improves but the value of bond falls and vice versa. Thus, the interest rate risk of a bond is subject to following two risks:"
(a) Price Risk
(b) Reinvestment Risk
"Further, with change in interest rates these two risks move in opposite direction. Through the process of immunization, selection of bonds shall be in such a manner that the effect of above two risks shall offset each other. It means that immunization takes place when the changes in the YTM in market has no effect on the promised rate of return on a bond i.e., a portfolio of bond is said to be immunized if the value of the portfolio at the end of a holding period is insensitive to interest rate changes. If the duration of a bond is equal to its holding period, then we ensure immunization of the same and"
"hence, the bond is not having interest rate risk."
8.10 Yield Curve
"Before we discuss the term ""yield curve,"" it is important to first understand the concept of the ""spot rate."" The spot rate can be defined as the relationship between spot rates and their corresponding maturities for a zero-coupon bond, which involves no coupon payments. It reflects the time value of money for a single future payment. This rate is used to value fixed-income securities. Let us now"
consider the following spot rates for different years.
Year Spot Rate
1 12.40%
2 13.18%
3 13.40%
4 13.70%
5 14.10%
"From the above spot curve, we can determine the selling price of a zero coupon bond with a par"
value of ₹ 10000 as follows:
Year Face Value (₹) Current Price (₹)
1 "10,000" "8,897"
2 "10,000" "7,807"
3 "10,000" "6,857"
4 "10,000" "5,984"
5 "10,000" "5,170"
"Now let us discuss the concept of Yield Curve. Also known as term structure of interest rates, it shows how yield to maturity is related to term of maturity of bonds."
Consider the following data for Government securities:
Face Value Coupon Rate (%) Maturity (years) Current Price Yield to Maturity (%)
"10,000" 12.40 1 "10,000" 12.400
"10,000" 12.75 2 "9,937" 13.128
"10,000" 13.50 3 "10,035" 13.351
"10,000" 13.50 4 "9,971" 13.599
"10,000" 13.75 5 "9,948" 13.901
The yield curve for the above bonds is shown in the diagram. It slopes upwards indicating that long-
term rates are greater than short-term rates.
14.50
14.00
13.50
13.00
12.50
12.00
11.50
1 2 3 4 5
Yield
"Yield curves, however, do not have to necessarily slope upwards. They may follow different pattern. Four patterns are depicted in the given diagram:"
Types of Yield Curve
"Another perspective on the term structure of interest rates is provided by the forward interest rates,"
"viz., the interest rates applicable to bonds in the future."
"To get forward interest rates, begin with the one-year Zero Coupon Bond:"
"8,897 = 10,000 / (1 + r1)"
"Where,"
r1 is the one-year spot rate i.e. the discount rate applicable to a cash flow receivable a year hence.
"Solving for r1, we get r1 = 0.124."
"Next, consider the two-year government security and split its benefits into two parts, the interest of"
"₹ 1,275 receivable at the end of year 1 and ₹ 11,275 (representing the interest and principal repayment) receivable at the end of year 2. The present value of the first part is:"
"1,275 = 1,275"
(1+r1) 1.124
"To get the present value of the second year's cash flow of ₹ 11,275, discount it twice at r1 (the"
discount rate for year 1) and f2 (the discount rate for year 2) (please use f notation for the forward rate so as to make a distinction between the spot rate and forward rate)
"11,275  11,275"
(1+r1 )(1+f2 ) 1.124(1+f2 )
"f2 is called the 'forward rate' for after one for next one year i.e., the current expected estimate of the"
"next year's one-year spot interest rate. Since r1, the market price of the bond, and the cash flow associated with the bond are known the following equation can be set up:"
"9,937= 1,275 +"
"11,275"
1.124 1.124(1+f2 )
"9,937(1.124)(1 + f2) = 1,275 (1 + f2) + 11,275"
"11,169 + 11,169 f2 = 1,275 + 1,275 f2 + 11,275"
"11,169 f2 - 1,275 f2 = 11,275 - 11,169 + 1,275"
"9,894 f2 = 1,381"
"f  1,381  0.1396"
"2 9,894"
"Thus, solving this equation, we get f2 = 0.1396 say 14%"
"Alternatively, using Spot Rate Curve this rate can also be derived as follows:"
(1.1318)2
(1.124)
 1 = 0.1397 say 14%
"To get the forward rate for year 3(f3), set up the equation for the value of the three year bond as"
follows:
"10,035  1,350 "
"1,350 "
"11,350"
(1 r1) (1 r1)(1 f2 ) (1 r1)(1 f2 )(1 f3 )
"10,035  1,350 "
"1,350 "
"11,350"
(1.124) (1.124)(1.140) (1.124)(1.140)(1 f3 )
"10,035  1,350 "
"1,350 "
"11,350"
(1.124) (1.28136) (1.28136)(1 f3 )
"10,035 1,2011,054 "
"11,350 (1.28136)(1 f3 )"
"7,780 "
"11,350"
1.28136(1 f3 )
1 + f3 = 1.13853
f3 = 0.13853
Solving this equation we get f3 = 0.13853. This is the forward rate for year three.
"Alternatively, using Spot Rate Curve this rate can also be derived as follows:"
(1.1340)3
(1.1318)2
 1 = 0.1384 say 13.84%
"Continuing in a similar fashion, set up the equation for the value of the four-year bond as follows:"
"9,971 = 1,350 +"
"1,350 +"
"1,350 +"
"11,350"
(1+ r1 ) (1+ r1 )(1+ f2 ) (1+ r1 )(1+ f2 )(1+ f3 ) (1+ r1 )(1+ f2 )(1+ f3 )(1+ f4 )
"Solving this equation we get f4 = 0.1461 (approx.). This is the forward rate for year four. Alternatively, using Spot Rate Curve this rate can also be derived as follows:"
(1.1370)4
(1.1340)3
 1 = 0.1460 say 14.60%
"Thus, from the given above Spot Rate Curve following Forward Rate Curve can be derived:"
Year Forward Rates
1 12.40
2 13.97
3 13.84
4 14.60
5 15.71
"It can be noted that while the current spot rate and forward rates are known, the future spot rates are not known - they will be revealed as the future unfolds."
The following diagram plots the forward rates for different years:
18.00
16.00
14.00
12.00
10.00
8.00
6.00
4.00
2.00
0.00
1 2 3 4 5
Forward Rate
"Thus, on the basis of above it can be said that though YTM and Forward Rates are two distinct measures but used equivalent way of evaluating a riskless cash flows."
Discount at the yield to maturity : (R ) PV [CF(t)] = CFt
1Rt t
Discount by the product of a spot rate plus the forward rates
PV [CF(t)] = CFt
1r11r2 1rt 
8.11 Term Structure Theories
The term structure theories explain the relationship between interest rates or bond yields and different terms or maturities. The different term structures theories are as follows:
(a) Expectation Theory: As per this theory the long-term interest rates can be used to forecast short-term interest rates in the future as long-term interest rates are assumed to unbiased estimator of the short term interest rate in future.
"(b) Liquidity Preference Theory: As per this theory investors are risk averse and they want a premium for taking risk. Long-term bonds have higher interest rate risk because of higher maturity, hence, long-term interest rates should have a premium for such a risk. Further, people prefer liquidity and if they are forced to sacrifice the same for a longer period, they need a higher compensation for the same. Hence, as per this theory, the normal shape of a yield curve is Positive sloped one."
"(c) Preferred Habitat Theory (Market Segmentation Theory): This theory states that though different investors may be having different preference for shorter and longer maturity periods and therefore, they have their own preferred habitat. Hence, the interest rate structure depends on the demand and supply of fund for different maturity periods for different market segments. In case there is a mismatch between these forces, the players of a particular segment should be compensated at a higher rate to pull them out from their preferred habitat; hence, that will determine the shape of the yield curve. Accordingly, shape of yield curve will be determined which can be sloping upward, falling"
or flat.
8.12 Convexity Adjustment
"As mentioned above duration is a good approximation of the percentage change in price due to percentage change for a small change in interest rate. However, the change cannot be estimated so accurately due to convexity effect as duration base estimation assumes a linear relationship."
This estimation can be improved by adjustment to the duration formula on account of 'convexity' as follows:
C* x (∆y)2 x100
C* =
V+ + V- - 2V0 2V (Δy)2
∆y = Change in Yield
V0 = Initial Price of bond
V+ = price of Bond if yield increases by ∆y
V- = price of Bond if yield decreases by ∆y
The convexity effect has been shown in the following diagram:
8.13 Convertible Debentures
Convertible Debentures are those debentures which are converted in equity shares after certain period of time. The number of equity shares for each convertible debenture is called Conversion Ratio and price paid for the equity share is called 'Conversion Price'.
"Further, conversion value of debenture is equal to Price per Equity Share x Converted No. of Shares per Debenture."
8.14 Valuation of Warrants
A warrant is a right that entitles a holder to subscribe equity shares during a specific period at a stated price. These are generally issued to sweeten the debenture issue.
Although both convertible Debentures and Warrants appeared to one and same thing but following are major differences.
"(i) In warrant, option of conversion is detachable while in convertible it is not so. Due to this reason, warrants can be separately traded."
(ii) Warrants are exercisable for cash payment while convertible debenture does not involve any such cash payment.
Theoretical value of warrant can be found as follows: (MP - E) x n
MP = Current Market Price of Share E = Exercise Price of Warrant
n = No. of equity shares convertible with one warrant
8.15 Zero Coupon Bond
"As name indicates these bonds do not pay any coupon during the life of the bonds. Instead, Zero Coupon Bonds (ZCBs) are issued at discounted price to their face value, which is the amount a bond will be worth when it matures or comes due. When a ZCB matures, the investor will receive one lump sum (face value) equal to the initial investment plus interest that has been accrued on the investment made. The maturity dates on ZCBs are usually long term. These maturity dates allow an investor for a long-range planning. ZCBs issued by banks, government and private sector companies. However, bonds issued by corporate sector carry a potentially higher degree of risk, depending on the financial strength of the issuer and longer maturity period, but they also provide"
an opportunity to achieve a higher return.
8.16 Refunding of Bonds
"Generally, Bonds issuer may refund bonds prior to its maturity date especially when interest rates are falling. Under this scheme by issuing fresh bonds at lower coupon rates company can refund the existing bonds issued earlier at higher interest or coupon rate. Therefore, company prefers to issue bonds with call features as it gives them the right or choice to redeem bonds before their due date of maturity especially when market conditions are favourable to them, and new bonds can be issued at lower interest rate. However, this call feature is not free of cost because companies are supposed"
to repay higher amount than the face value of bonds which is called 'Call Premium'.
"It is a type of strategic financial decision, and the Capital Budgeting method is used to evaluate the decision to refund the exiting bonds and issuing new bonds of an equivalent amount. Generally, the Net Present Value (NPV) method is used to evaluate such types of Bond Refunding decisions. If the Present Value of Cash Inflows (in form of net cash saving) exceeds the Present Value of cash outflow (call premium, interest during transition period etc.) then exiting bonds can be refunded and new bonds carrying lower coupon interest rate can be issued resulting in overall saving of cash outflows."
"In this context, it is important to note that, to ensure the smooth functioning of the organization, new bonds are generally issued before refunding old bonds. This often results in interest payments on"
both categories of bonds during the overlapping period.
8.17 Money Market Instruments
"Similar to Bonds, the money market instruments are important source of finance to industry, trade, commerce and the government sector for meeting their short-term requirement for both national and international trade. These financial instruments also provide an investment opportunity to the banks and others to deploy their surplus funds so as to reduce their cost of liquidity and earn some income."
The instruments of money market are characterised by:
(a) Short duration.
(b) Large volume.
(c) De-regulated interest rates.
(d) The instruments are highly liquid.
(e) They are safe investments owing to issuers inherent financial strength.
"The traditional short-term money market instruments consist of mainly call money and notice money with limited players, treasury bills and commercial bills. The new money market instruments were introduced giving a wider choice to short term holders of money to reap yield on funds even for a day to earn a little more by parking funds through instruments for a few days more or until such time till they need it for lending at a higher rate. The various types of instruments of money market are discussed in the following paragraphs:"
"8.17.1 Call/Notice money: Call money market, or inter-bank call money market, is a segment of the money market where scheduled commercial banks lend or borrow on call (i.e., overnight) or at short notice (i.e., for periods upto 14 days) to manage the day-to-day surpluses and deficits in their cash-"
flows.
"When money is borrowed on overnight basis or for 1 day it is termed as 'Call Money'. However, under notice money market, funds are transacted for a period between two days and fourteen days. These day-to-day surpluses and deficits arise due to the varying nature of their operations and the peculiar nature of the portfolios of their assets and liabilities."
8.17.2 Treasury Bills (TBs): Among money market instruments TBs provide a temporary outlet for short-term surplus as also provide financial instruments of varying short-term maturities to facilitate a dynamic asset-liabilities management. The interest received on them is the discount which is the difference between the price at which they are issued and their redemption value. They have assured yield and negligible risk of default. The TBs are short-term promissory notes issued by Government of India at a discount.
"More relevant to the money market is the introduction of 14 days, 28 days, 91 days and 364 days TBs on auction basis."
"However, at present, the RBI issues Treasury Bills of three maturities i.e. 91 days, 182 days and 364 days."
TBs are issued at discount and their yields can be calculated with the help of the following formula:
Y  F P× 365 ×100
 P  M
"where Y = Yield,"
"F = Face Value,"
"P = Issue Price/Purchase Price, M = Actual days to Maturity."
"8.17.3 Commercial Bills: A commercial bill is one which arises out of a genuine trade transaction,"
"i.e. credit transaction. As soon as goods are sold on credit, the seller draws a bill on the buyer for the amount due. The buyer accepts it immediately agreeing to pay amount mentioned therein after a certain specified date. Thus, a bill of exchange contains a written order from the creditor to the debtor, to pay a certain sum, to a certain person, after a creation period. A bill of exchange is a 'self- liquidating' paper and negotiable; it is drawn always for a short period ranging between 3 months and 6 months."
Bill financing is the core component of meeting working capital needs of corporates in developed countries. Such a mode of financing facilitates an efficient payment system. The commercial bill is instrument drawn by a seller of goods on a buyer of goods. RBI has pioneered its efforts in
"developing bill culture in India, keeping in mind the distinct advantages of commercial bills, like, self-"
"liquidating in nature, recourse to two parties, knowing exact date transactions, transparency of transactions etc."
Example
If a bank re-discounted a commercial bill with a face value of ₹ 100/- @ 15% for 2 months will fetch
"₹ 97.50, on the basis of the following calculation."
Discount = 100 × 15 × 2  ₹ 2.50
100 12
"However, as the discount amount is paid at front-end."
Example
The yield to the investor or cost to the borrower will be higher than the discount rate in view of the fact that the discounter can deploy the amount of discount received for earning further income. This
can be calculated with the following formula:
D = FV - SV × Days or months in a year ×100
where
SV M
D = Effective Discounting Rate FV = Face Value
SV = Sale Value
M = Period of Discount
"Accordingly, the Yield as per the data given in the example will be:"
100 - 97.50 × 12 ×100 = 15.385%
97.50 2
8.17.4 Certificate of Deposit: The Certificate of Deposits (CDs) are negotiable term-deposits accepted by commercial bank from bulk depositors at market related rates. CDs are usually issued
in Demat form or as a Usance Promissory Note.
"Just like Commercial Bills, Certificate of Deposit (CD) is a front-ended negotiable instrument, issued at a discount and the face value is payable at maturity by the issuing bank."
Example
Amount of Issue - ₹ 100 Period - 6 months
Rate of discount - 20%
Discount = 100 × 20 × 6  ₹ 10.00
100 12
"Hence CD will be issued for ₹ 100 - 10 = ₹ 90.00. The effective rate to the bank will, however, be calculated on the basis of the following formula:"
E = FV - SV × Days or months in a year ×100
where
SV M
E = Effective Yield FV = Face Value SV = Sale Value
M = Period of Discount
"Accordingly, the Yield as per the data given in the example will be:"
100 - 90 × 12 ×100 = 22.22%
90 6
"8.17.5 Commercial Paper: Commercial Paper (CP) has its origin in the financial markets of America and Europe. The concept of CPs was originated in USA in early 19th century when commercial banks monopolised and charged high rate of interest on loans and advances. In India, the CP was introduced in January 1990 on the recommendation of Vaghul Committee subject to various conditions. When the process of financial dis-intermediation started in India in 1990, RBI allowed issue of two instruments, viz., the Commercial Paper (CP) and the Certificate of Deposit (CD) as a part of reform in the financial sector. A notable feature of RBI Credit Policy announced on 16.10.1993 was the liberalisation of terms of issue of CP. At present it provides cheap source of funds for corporate sector and has caught the fancy of corporate sector and banks. Its market has picked up considerably in India due to interest rate differentials in the inter-bank and commercial lending rates."
CPs are unsecured and negotiable promissory notes issued by high rated corporate entities to raise short-term funds for meeting working capital requirements directly from the market instead of borrowing from banks. Its period ranges from 7 days to 1 year. CP is issued at discount to face value The issue of CP seeks to by-pass the intermediary role of the banking system through the process of securitisation.
"It partly replaces the working capital limits enjoyed by companies with the commercial banks and there will be no net increase in their borrowing by issue of CP. Generally, CP has to be issued at a discount to face value. Yield on CP is freely determined by the market."
The yield on CP can be calculated as follows:
Y = FV - SV × Days or months in a year ×100
where
SV M
Y = Yield
FV = Face Value SV = Sale Value
M = Period of Discount
"8.17.6 Repurchase Options (Repo.) and Reverse Repurchase Agreement (Reverse Repo): The term Repurchase Agreement (Repo) and Reverse Repurchase Agreement (Reverse Repo) refer to a type of transaction in which money market participant raises funds by selling securities and simultaneously agreeing to repurchase the same after a specified time generally at a specified price, which typically includes interest at an agreed upon rate. Sometimes it is also called Ready Forward Contract as it involves funding by selling securities (held on Spot i.e. Ready Basis) and repurchasing them on a forward basis."
Following are major differences between Repo and Reverse Repo:
"(a) Repo rate is the rate at which Reserve Bank of India (RBI) lends to Commercial Banks for a short period of time against Government Securities. On the other hand, Reverse Repo is the rate at which Commercial Banks lend to RBI."
"(b) A transaction is called a Repo when viewed from the perspective of the seller of securities (the party acquiring funds) and Reverse Repo when described from the point of view of the supplier of funds. Thus, whether a given agreement is termed a Repo or a Reverse Repo depends largely on which party initiated the transaction."
(c) The purpose of Repo is to fulfill the deficiency of funds. While the purpose of Reverse repo is to reduce excess liquidity in the economy.
(d) The Repo rate is comparatively high in comparison to Reverse Repo rate.
(e) The Repo rate strives to contain inflation in the economy. The Reverse repo aims to control money supply in the economy.

9.1 Role of Valuers
The role of Valuers has increased a lot due to increased statutory and information requirements. The valuations made by a Valuers are required statutorily for the following purposes: -
"(a) Mergers/Acquisitions/ De-Mergers/Takeovers: Valuation is mandated in cases of Mergers/ Acquisitions/ De-Mergers/ Takeovers by the Income Tax Act, 1961 for the purpose of determining the tax (if any) payable in such cases."
"(b) Slump Sale/ Asset Sale/ IPR Sale: Valuation is required by Insolvency and Bankruptcy Code, 2016 in case of liquidation of company and sale of assets of corporate debtor for the purpose of ascertaining fair value or liquidation value."
"(c) Conversion of Debt/ Security: Valuation is a necessitated by RBI for Inbound Foreign Investment, Outbound Foreign Investment and other business transactions."
(d) Capital Reduction: SEBI regulations such as ICDR/ LODR/ Preferential Allotment etc. also require valuations to be made for listed securities for various purposes on a period basis.
"(e) Strategic Financial Restructuring: Various statutes such as Companies Act, 2013, SARFAESI Act, 2002, Arbitration and Conciliation Act 1996 etc., warrant valuations to be made for meeting various statutory requirements. Valuation is also made for fulfilling IND AS purposes and"
may also be made on Court Orders.
9.2 Responsibilities of Valuers
"Under Rule 12(e) of the Companies (Registered Valuers and Valuation) Rules, 2017 the Model Code of Conduct for Registered Valuers is as follows:"
Integrity and Fairness
1. A valuer should in the conduct of his/its business follow high standards of integrity and fairness in all his/its dealings with his/its clients and other valuers.
"2. A valuer should maintain integrity by being honest, straightforward, and forthright in all professional relationships."
3. A valuer should endeavour to ensure that he/it provides true and adequate information and shall not misrepresent any facts or situations.
4. A valuer should refrain from being involved in any action that would bring disrepute to the profession.
Professional Competence and Due Care
"5. A valuer should render at all times high standards of service, exercise, due diligence, ensure proper care and exercise independent professional judgment."
6. A valuer should carry out professional services in accordance with the relevant technical and professional standards that may be specified from time to time
"7. A valuer should continuously maintain professional knowledge and skill to provide competent professional service based on up-to-date developments in practice, prevailing regulations/guidelines and techniques."
"8. In the preparation of a valuation report, the valuer should not disclaim liability for his/its expertise or deny his/its duty of care, except to the extent that the assumptions are statements of fact provided by the company and not generated by the valuer."
"9. A valuer should have a duty to carry out with care and skill, the instructions of the client insofar as they are compatible with the requirements of integrity, objectivity and independence."
Independence and Disclosure of Interest
"10. A valuer should act with objectivity in his/its professional dealings by ensuring that his/its decisions are made without the presence of any bias, conflict of interest, coercion, or undue influence of any party, whether directly connected to the valuation assignment or not."
11. A valuer should not take up an assignment under the Act/Rules if he/it or any of his/its relatives or associates is not independent in relation to the company and assets being valued.
12. A valuer should maintain complete independence in his/its professional relationships and shall conduct the valuation independent of external influences.
"13. A valuer should wherever necessary disclose to the clients, possible sources of conflicts of duties and interests, while providing unbiased services."
"14. A valuer should not deal in securities of any subject company after any time when he/it first becomes aware of the possibility of his/its association with the valuation, and in accordance with the SEBI (Prohibition of Insider Trading) Regulations, 2015."
15. A valuer should not indulge in "mandate snatching" or "convenience valuations" in order to cater to the company's needs or client needs. A valuer should communicate in writing with a prior
valuer if there is knowledge of any prior valuer having been appointed before accepting the assignment.
"16. As an independent valuer, the valuer should not charge success fee."
"17. In any fairness opinion or independent expert opinion submitted by a valuer, if there has been a prior engagement in an unconnected transaction, the valuer should declare the past association with the company."
Confidentiality
"18. A valuer should not use or divulge to other clients or any other party any confidential information about the subject company, which has come to his/its knowledge without proper and specific authority or unless there is a legal or professional right or duty to disclose."
Information Management
"19. A valuer should ensure that he/ it maintains written contemporaneous records for any decision taken, the reasons for taking the decision, and the information and evidence in support of such decision. This should be maintained so as to sufficiently enable a reasonable person to take a view on the appropriateness of his/its decisions and actions."
"20. A valuer should appear, co-operate and be available for inspections and investigations carried out by the Registration Authority, any person authorised by the Registration Authority, the Valuation Professional Organisation with which he/it is registered or any other statutory regulatory body."
"21. A valuer should provide all information and records as may be required by the Registration Authority, the Tribunal, Appellate Tribunal, the Valuation Professional Organisation with which he/it is registered, or any other statutory regulatory body."
"22. A valuer while respecting the confidentiality of information acquired during the course of performing professional services, should maintain proper working papers for a period of three years, for production before a regulatory authority or for a peer review. In the event of a pending case before the Tribunal or Appellate Tribunal, the record should be maintained till the disposal of the case."
Gifts and hospitality
"23. A valuer, or his/its relative should not accept gifts or hospitality which undermines or affects his independence as a valuer."
"24. A valuer should not offer gifts or hospitality or a financial or any other advantage to a public servant or any other person, intending to obtain or retain work for himself/ itself, or to obtain or retain an advantage in the conduct of profession for himself/ itself."
Remuneration and Costs
"25. A valuer should provide services for remuneration which is charged in a transparent manner, is a reasonable reflection of the work necessarily and properly undertaken and is not inconsistent with the applicable rules."
26. A valuer should not accept any fees or charges other than those which are disclosed to and approved by the persons fixing his/ its remuneration.
"Occupation, employability and restrictions"
"27. A valuer should refrain from accepting too many assignments, if he/it is unlikely to be able to devote adequate time to each of his/ its assignments."
"28. A valuer should not engage in any employment, except when he has temporarily surrendered his certificate of membership with the Valuation professional Organisation with which he is registered."
29. A valuer should not conduct business which in the opinion of the Registration Authority is inconsistent with the reputation of the profession.

It should be evidently clear to the valuation professional as well as to the end consumer that a good valuation is much more than just numbers. While it is critical to get the maths and application right- however it is equally important to have a comprehensive understanding of the narrative behind the valuation. Attention should be given to the following points while making a valuation:
1. A good valuation does not provide a precise estimate of value. A valuation by necessity involves many assumptions and is a professional estimate of value. The quality and veracity of a good valuation model does not depend just on number crunching. The quality of a valuation will be directly proportional to the time spent in collecting the data and in understanding the firm being valued.
2. Valuing a company is much more than evaluating the financial statements of a company and
estimating an intrinsic value based on numbers. This concept is getting more and more critical in today's day and age where most emerging business are valued not on their historical performances
"captured in the financial statement but rather on a narrative driven factors like scalability, ease of replication, growth potential, cross sell opportunities etc."
"3. More often than not, investors/users tend to focus on either numbers or the story without attempting to reach a middle ground. In both these cases, investors will fail to capture opportunities that could have been unlocked had they been willing to reach some middle ground between the two concepts."
"4. While it is true that a robust intrinsic value calculation using financial statements data and an error-free model makes investing a more technical subject, in reality, emotions play a massive role in moving stocks higher or lower. Not accounting for this fact, therefore, could become an obstacle"
in consistently getting the valuation right.