Treasury Securities and Stocks - Essay Example

 Essay 1 The rate on U.S. Treasury Securities functions as a risk-free rate. The risk-free rate is the rate that applies to assets which entails minimal credit risk, also known as default risk. This means that the individuals who have invested in the U.S Treasury are guaranteed that they will receive the interest and the principal amount in due time, as set out in the agreement. This rate is of great importance since it is used to determine the interest rates of other assets with default risk. As such, this rate influences the financial conditions across U.S’s economy as well as the forecasting of economic developments in markets with the default risk (Damodaran, 2008, p. 1). For various reasons, the U.S Treasury securities use a rate, which is considered risk-free. The U.S. Treasury Securities are accredited the U.S. government, and thus they are considered risk-free. The U.S. Treasury market is liquid and large with an agreement of an active repurchase in place. In addition, the faith placed on a security market depends on the credit rating of a nation, which is based on the borrowing and repayment history of the government. The repayment ability is based on the economic strength of the country. On the same vein, the U.S. has been rated under the highest credit ratings, AAA, by Standard and Poor’s, a credit rating institution. This positive rating is attributed to the fact that the U.S. is the most powerful economy across the globe. Given this, the Treasury securities of the U.S. are deemed to be risk-free and policy analysts, macroeconomic builders, investment bankers and financial analysts trust the U.S. Treasury Security rates when developing their forecast models (Damodaran, 2008, p. 1). The rates on the U.S. Treasury Securities have an impact on the financial conditions throughout the world. However, the repayment of the U.S. government’s debt can be hindered by a massive economic downturn. Despite its occurrence in rare circumstances, an economic downturn hit the U.S. in the form of a world-wide financial crisis in 2008. It was thought that this would make the benchmark rates of the U.S. Treasury to cease being risk-free. Nevertheless, the U.S. government upheld its faithfulness with its investors by purchasing some of the securities that it had issued. Besides, the government printed additional money and increased taxes so as to finance its debts (Damodaran, 2012, p. 12). Practically, U.S. treasury securities are still regarded as risk-free after overcoming the adversities of the monumental economic downturn. Several alternative investments can be used as risk-free benchmarks in the U.S. An alternative investment to be classified under this category ought to cut across all possible investments. The average real gross domestic product (GDP) growth is an ideal alternative for risk-free bedrock rate since it conveys growth in the entire economy as well as the assets thereof. The deleterious effects of inflation are eliminated by modifying nominal GDP in real terms. For this investment to be effective, it should be adjusted for population growth, bringing us to the other alternative investment: Population-Adjusted real Gross Domestic Product. Lastly, the productivity growth investment can be used as an alternative. If the aim of investing is to capture innovation and human productivity, the benchmark rate ought to be based on innovation and productivity, as well. In addition, the risk-free quality of the innate nature of humanity enhances the feasibility of this alternative (Piros and Pinto, 2013, p. 32). However, the Treasury securities emerge to be ideal as compared to the alternatives. Essay 2 It is overly important for an investor to realize the value of a stock before investing is a basic element of investing. Garnering knowledge on the worthiness of a stock is of much significance, and it aids the investor in making intelligent investments, rather than mere speculation. The stock of Premium Foods emerges is to be condidered, as it is traded in the London Stock Excahange.The analysis of the value of each share of Premium Foods will be conducted using various share valuation techniques. There are many techniques of determining the value of stocks. One of the methods is the net assets method. In this method, to get the each share’s value, the net assets of the firm are divided by the outstanding number of shares. The total value of the assets and liabilities has to be considered first to determine the value of net assets. The difference between the total assets and total liabilities gives the net assets of the firm (Damodaran, 2012, p. 15). In the context of Prime Foods, the value of each share traded on the London stock Exchange is determined using the Annual financial report released in December 31, 2013 (Premium Foods, 2013, p. 88 and 138). Value per Share= (Net Assets-Preference Share Capital) /Number of Equity Shares Net assets = £2,059,900,000 - £1,509,600,000 = £550,300,000 No. of shares = 239,828,166 equity shares Value per share = {(£550,300,000– 0) / 239,828,166 } = £ 2.3 / share Alternatively, the shares of prime foods can be valued using the market value method. In this method, the expected rate of return of an individual’s investment is considered. The expected return is sometimes denoted by the term yield and the expected rate of return can be calculated either on the basis of the expected dividend or the expected earnings (Damodaran, 2012, p.15). In the context of Prime Foods, there are no dividends that have been paid to the common stock shareholders and thus our valuation of the shares will be based on the expected earnings and will be determined as shown below (Premium Foods, 2013, p. 86-88). Value per Share = (Expected rate of earning/Normal rate of return) Expected rate of earning = (Profit after tax/paid up value of equity share) X 100 = (£46,700,000/£ 24,000,000 X 100) = 195 % Normal rate of return = (profit after Tax/ Total Assets) X 100 = (£46,700,000/£2,059,900,000) X 100 = 2.27% Value per share = (1.95/0.0227) X 24,000,000 Another alternative way of determining the value of each share of Prime Foods, which are traded on the London stock exchange, is the earning capacity method. This method is grounded on the disposable profit of the firm, which is determined through the deduction of tax and reserves from the net profit (Damodaran, 2012, p. 15). The disposable profit is then divided by the number of shares of the listed company to get the value of each share, and it is calculated as shown below (Premium Foods, 2013, p. 88). Value per share = Capitalized Value/Number of Shares Capitalized Value = (Profit available for equity dividend/Normal rate of return) X 100 Value per share = [{(£245,900,000)/0.027}X 100] /239,828,166 shares = £ - 38 /share The stocks of prime Foods are not worthwhile in terms of investment. An investor will not be assured that he or she will get value for his investment because the value of each share is positive. The major aim of investing in shares is to forgo current spending into the future periods and this sacrifice is compensated for through the surplus of selling the same shares in the future period. In the same vein, the shares of Prime Foods ought to offer an opportunity for prospective investors. Despite the volatility of the price of the shares in the London Stock exchange market, that is the fall and rise of the price, the historical performance of the stock shows that the prices fall than they rise and from the negative value given by the earning capacity method, it is evident that these stock is not worth an individuals investment. Reference List DAMODARAN, A., 2008, What is the Risk Free Rate? A Search for the Basic Building Block. A Journal of Riskfree rate. New York City, New York University Press. DAMODARAN, A., 2012, Investment valuation: tools and techniques for determining the value of any asset. Hoboken, N.J., Wiley. PIROS, C. D., & PINTO, J. E., 2013, Economics for investment decision makers: Micro, macro, and international economics. Hoboken, N. J: Wiley. PREMIUM FOODS, 2013, Annual Report and accounts 31 December 2013. High Wycombe, UK, Premium Foods PLC. accessed from: http://annualreport2013.premierfoods.co.uk/site-essentials/downloads/annual-report-2013> Read More