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Valuation Period

The time at the close of the business day, during which variable investment options are assigned a specific market value

What is the Valuation Period?

The valuation period refers to the time at the close of the business day, during which variable investment options are assigned a specific market value. Valuation is the comparison of equity offers or the calculation of an investment’s value and is conducted at the end of each business day by appraisers.

 

Valuation Period

 

Summary

  • The valuation period is a time between the close of the first business day and the close of the second business day, during which unit value is estimated for each investment option.
  • Valuation periods are classified as high, neutral, or low, depending on the acquisition made by companies.
  • Finding the present and future values is based on the time value concept, which states that a sum of money presently owned is worth more than the same money received later.

 

Valuation Period Explained

The valuation period is mostly applicable to investment options and retirement plans. An annuity is an example of a retirement plan and is defined as a contract between an insurance firm and a client with periodic payments that guarantees an income stream to the investors during retirement.

Annuities provide a range of investment options – typically mutual funds whose value depends on the performance of an investment option. They include unlimited investment products, and investors holding them can allocate either a portion or the entire amount of the funds towards long-term investment vehicles.

Except for the transfer charges by insurance companies, the transfer is possible without necessarily paying tax on investment gains and incomes. Despite the annuity payments and larger payouts being associated with variable annuities contracts, they involve higher risks and volatility than other forms of annuities, given the day-to-day valuation.

 

Classifications of Market Valuation Periods

Different valuation periods exist to help in determining the realized acquisition. The periods are classified as high, neutral, or low, depending on the detrended market price-to-earnings ratio of the associated value-weighted market index. Detrending the market price ratio involves removing the best straight-line feet from the price market ratio.

Similarly, managers are classified as either overconfident or non-confident based on their decisions regarding the executive stock options. Most insurance companies receive non-tradable stock options and substantial grants of stock as part of their compensation plans.

In this regard, risk-averse companies with sufficient back-up securities exercise their stock options before the valuation period expires. The reason behind such a phenomenon is that the companies are highly exposed to company-specific risks that are hard to diversify away.

Upon exercising stock options, the companies usually receive shares of their stock, which are traded almost immediately. Thus, managers who maintain their stock options until the maturity date are referred to as overconfident.

The managers believe that their companies will continuously maintain superb performance, exposing them to a high level of risks. Conversely, managers who are not overconfident sell their stock options after the expiration of the valuation period, a strategy that reduces company-specific risks.

 

Finding the Present and Future Values

It is important to understand the process of valuation because the present and future formulas are involved when finding the values. The present value of an annuity is the lump sum amount that equals the current value of a set of equal rates of return or discount rates to be paid in the future.

The future cash flows of annuities are determined by the discount rate. The discount rate is inversely related to the annuity’s present value – i.e., as the discount rate increases, the current value of annuity decreases.

This approach is founded on the time value of money (TVM) concept, which states that a sum of money presently owned carries a higher value than a similar amount of money earned in the future.

The concept implies that an investor currently owning the sum of money to invest and obtain future gains, such as the interest on profits, is worth more than receiving the same amount of money and investing in the future because the sum can be invested at a given rate of return.

For example, getting a lump sum amount of $ 50,000 is worth more than receiving $5,000 annually for five years. The money will be worth more at the end of five years if invested today compared to a series of investments of $5,000 yearly. The technique is applied to facilitate comparison and calculation of the annuity’s present value.

An annuity’s future value is a measure of how many regular investments will gain at a certain time in the future based on a specified interest rate. Knowledge of the future value of an ordinary annuity is essential when investors are certain about how much they want to invest in every period over time.

Additionally, the future value is useful for borrowers who make regular payments to determine the entire cost of their loan. The calculated future value of each cash flow over a period provides the future value of an annuity.

It requires taking the future value of each cash flow and paying attention to the original interest rate and investment. The accumulated future value of an annuity is then calculated by getting the sum of the future value of each cash flow and that of an annuity.

 

More Resources

CFI is the official provider of the Certified Banking & Credit Analyst (CBCA)™ certification program, designed to transform anyone into a world-class financial analyst.

To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:

  • Valuation Infographic
  • Stock Option
  • Annuitization
  • Time Value of Money

Valuation Techniques

Learn the most important valuation techniques in CFI’s Business Valuation course!

Step by step instruction on how the professionals on Wall Street value a company.

 

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