Securities and Financial Analysis
Equity side
Equity valuation rests on discounted cash flow models (Gordon growth, multistage dividend discount, free cash flow to firm and to equity) and on relative valuation through P/E, P/B, P/S and EV/EBITDA. For Gordon growth, P0 = D1/(r − g) with D1 = D0(1 + g); the model requires r > g and a growth rate that is sustainable (roughly no faster than long-run nominal GDP). Multiples demand like-for-like comparables and consistent definitions - trailing versus leading P/E, and enterprise value that includes debt and deducts cash.
Fixed income side
Price and yield move inversely. A bond trades at a premium when the coupon exceeds the yield, at a discount when it is below, and at par when they are equal. Yield to maturity assumes the bond is held to maturity with coupons reinvested at the YTM. Duration is the weighted average time to cash flows and, in modified form, gives the percentage price change for a 1% change in yield; convexity corrects duration for larger moves. Know clean versus dirty price (accrued interest), spot versus forward rates, and credit spread as compensation for default risk.
Traps: discounting D0 instead of D1; forgetting to annualise a semi-annual yield correctly (double the semi-annual yield, or compound it - read which is asked); assuming duration equals maturity for coupon-paying bonds.
Worked example
A share has just paid a dividend of KES 2.00. Dividends grow at 5% a year and the required return is 12%. Then D1 = 2.00 × 1.05 = 2.10 and P0 = 2.10/(0.12 − 0.05) = KES 30.00. Substituting the just-paid dividend gives 28.57, a classic distractor.