Chapter 4 Introduction to Practical Valuation

In this chapter we will take a first look on how different instruments can be priced using a relatively small set of tools. We present the most commonly used approaches and solutions, but do not enter into the pros and cons of each method. If you wish to follow market standards you can safely apply the presented toolbox. However, if you wish to overcome known shortcomings and “beat the market,” you are advised to study the related academic literature. Use Cochrane (2005) as a starting to that literature.

We start with pricing using discounted cash flows, which is arguably the most fundamental tool. We then move on to market interest rates and in particular how to use yield curves to obtain appropriate ...

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