cnc4_understanding equity returns concepts (noted)
TRANSCRIPT
-
!
!
"
# "$
% # #&%##' ! "
-
( )
#
$ %
&
$
' (
) ( " "
' (
*
+ ,
- . " ! / ,
& ,
$ " $ ( (
-
"$ *
!
" " !
0 $ "
1 2 "" " ( + '
-
%
3 ,4,
)"
0,4564 ,
1,762""",
Amos Lim
Amos LimReinvestment risk: Risk that future coupons from a bond will not be reinvested at the prevailing interest rate when the bond was initially purchased.
-
+,% -./
$./,42"
/-!4""/-!4"/-!4"/-4$#.!//7"
Amos LimTIPS: Treasury Inflation Protected Security. It is a treasury security that is indexed to inflation to protect investors from the negative effects of inflation.
Amos LimB, because (1) 10y T-bond is more liquid, more reflective of stocks; and (2) Expected holding period of a stock for investment is on average 8-10y (matching discount rate to expected holding period).
Amos Lim
Amos LimDone
-
0,% "
Amos LimFocus on 10y rate, as more appropriate for computing risk-free rate.For the same reason, we use Germany, as it has the lowest risk.
Amos LimDone
-
1,% 2
4$08!"
"9,:;
-
..,(
)"2",4""2"",
)
-
..,"07++
-
8 (
$
-
%"#"$ *33
& -
'
F2%-
Amos LimThese methods are historical approaches.
-
+3#9%
!"
#$%!!%&%'
()
*&$%+%
*),&)-)#)-.)/-(
Amos LimUS T-Bond i/r: 4.29%Brazil USD Sovereign Bond i/r: 10.30%Therefore default spread = 6.01%
Amos Lim
Amos Lim
-
03 "$
4",2,
0,)- 01#! /.("
!&%2
3 *4)-#)-5/)-(4)-
!4)-. )-4)/-
#3&% &)-&167&/)-(
Amos LimHowever, what should be the time frame under consideration for the risk premium?Daily Return: Too volatileAnnual Return: May not have enough observationsIn practice, we use weekly return
Amos Lim
Amos Lim
Amos Lim
Amos Lim
-
13 9:.;%
-""",5-188D6
"
18 #9:%(4)-18*.4)-8 .4)-
#$%&'()*$+#',#$)*'-.$/0'
Amos LimThis variable factors in the effect of country risk premium
Amos LimBond market must be liquid, as otherwise the data gathered will not reflect the true standard deviation. This is especially a problem for Asian Bond Markets.
Amos Lim
Amos Lim
Amos Lim
Amos Lim
-
!"# $
%&!
'% '! ()"*% +,"- *% *%& . -& + +/0 /"&"1& +/!& & "20 +$ $!% +$0& 3& +
&"4&%
& &5& 6 +5 '!& ' '"7 % " 6% 1& ,% &8 + / / +/& 9 3&&5& +
+& 5&) & "%",&5&6 ' '5&!"7& + +1&
, -50! 26 2! +%6 &&
/% 7 7 + 60 + 6&":; +90&
! +*& +.% - 2& +
-
? G " ! . / . /
G & ! " " ,
. 9G
. -" $
" " ,
2 - @ "$ * "0
Amos LimBecause of (1) compounding, and (2) arithmetic mean weighs gains in each period equally.
Amos LimFirms that go bankrupt are delisted, and contribute nothing to estimates of return. This creates an upward bias in indexes.
In practice, analysts usually make adjustments for the bankruptcies by:- treating small cap bankruptcies as -30% return- treating large cap bankruptcies as -50% return
Amos LimE.g. subprime mortgage crisis
Amos Lim
- ?>
- ?>
- ", " ?>
-
8&&% *#" $& % A&%$*/ A&%
8&&% *#" +
7&"& ! 2"%62" ! +
8&&% & >6%&% &%7&6&& & ++
&"%&"&B 0 &C
7/ ?*(2@? 17/ @?1/@*'
?+@?+@?@+
", " ?>
-
! -#' F! 6 ! ?-
C " ?-
! C
$ B C
$ $
$ $
19
&9)* *'
1"$
0 -#' . -# '/
0"'
-"#4
Amos LimCAPM has only one factor: the market
Multi factor models, on the other hand
Arbitrage Pricing
Amos LimBuild-up approach
-
# % * %*'
6 @ - "
"
"
#
"G + + ' #
G ' #
0
? 9 "$ .'/
! "6"& ' D E F"& ' A ?G
G ! =8! 4!" !
" ,
G " ? ! "
G ! " .,," " /
L .'/F%.'/
Amos LimIn practice, 10y T-bond
Amos LimMarket model
-
G $
G $ " 1!
G
B B # % * %*'
2M# :88 7I2 2
# 2
)
" 1 " !! "
0F=.0,8/
%C 9
$ "
"
" " MN
* ?
#%* 9
0
Amos LimS&P500: Top 500 MCap companies - bias toward large cap companies
NYSE Composite: Excludes a lot of large MCap stock that is in NASDAQ (e.g. Apple, Google.. )
Amos LimNeed to always have enough observations
Amos LimAdjusted beta is based on the assumption that historically superior/inferior growth rates cannot be sustained to infinity. If not adjusted, we are assuming that the company will perpetually grow at the same historical rate. 2/3 reflects the weight assigned to the present growth
Amos LimMany 0 observations due to no trade
-
?
$ "$
;*
.!*
*
>?
G -#' .!/
G -#'
G 4 "
G 8 "
G ?
( > ? (
-
> &+:1' A ? ? &??'0") . /) !
? ?
G 4 ! "6
? ? ? =8 4!"
? .9 . "/ ?
? @< . / ? "!! "!!
G 2 " " 5 ,
.9 & 'G ? , 25 .!5/ ,$ ,
G ", O ,
G *, ",
@< & 'G ? , " "!!,
G ", O ,
G *, . "!!/ ,
0 5&
6& D 77(D D ,2E
Amos Lim
Amos Lim
Amos LimReturns vary depending on whether growth (low BV:MCap) or value stock (high BV:MCap)
Amos Lim(In the long run)
Amos LimSuperior explanatory power than CAPM for explaining market performance. Accounts for (1) market factors, (2) Small cap stock outperform large cap stock, and (3) Value stock outperform growth stock.
Amos Lim
Amos Lim
Amos Lim
Amos Lim
Amos Lim
Amos LimFun fact: SMB & HML hypotheses were tested by comparing portfolios using a zero-investment portfolio
Amos Lim
Amos Lim
-
> &0:1' A *A. 0") . /) !
?>? *A.
G ) 6G ? ? =8 4!"
G .9 L 4
G P5 L 4
G @< L 4
G P L 4
G
-
", ?A?
0 5& 6& D 77(D D ,2
+?@ +?++@ F?@
*! .> " 5,
7 "
22;3$!! ' ;,$&!,&!
" B J
0"
! =,8;
:,8;
0,18
25 1,1;
25 " 8,01
% =,9;
% " 8,=D
* ; "
- "
Amos LimDone
-
%K8@" ",?A?
-
6>?%#8 8".>!.#>>(>!1 !!
: ;" " " " ? : ;" " @"" " : ;
"""""""""""""" " : ;" " : ;
Amos Lim4th factor: Contrarian portfolios tend to outperform momentum portfolios
Amos LimMomentum: Stocks that performed well in the previous year will perform well next yearContrarian: Stocks that performed well in the previous year will not perform well next year
Amos Lim
- "L%*
-
"&M'
-
> &1:1' A &%*'0") . /) !
455(4-
?! &")))""' !
2
#@)# !$)
Amos LimMacro model
Amos Lim
-
%*&%*'
)6$$% !&.QR/,
46
&"&"&8!&"""!&"&"1/""!&"&"#""!&"
Amos LimText
-
%*&%*'
26 4.) ?7 4)
1 4)
+
-
%*&%*'
3
$"=;"9;6
'" L2L? 4-A -4-
+
+
Amos Lim
-
%*&%*'
$$% "D;"0;6
'$% L2$% L? L0;? D;L? =;
+
@?+
-
%*&%*'
$!&.QR/"08;""6
'& L2L? L8;? 08;L? 08;
@?+
@?@?+
-
%*&%*'
)9;6
@?@?+
@?@?+
-
9 ) * * &9)* *' 4 " 6
9)* * $ D ) > E :
" ,
1
G 2 ! " 5" N
G $ " " . =!D ; 2/ " .I4'/ ! ",
? I4' " BB
? 4 5 N "
Amos LimNote that this risk premium is for the difference in returns between equity and bonds
Amos Lim
Amos Lim
Amos Lim
-
9 ) * * &9)* *'
"A 9) *
"LA;4"LD,88;,
"I#/C
Amos LimCommon stock - Bond
Amos LimDone
-
#
; B>&>
; &9:%
; !>&
;
-
% # # $
*-
&"
&"'%
&" 4
'%
3>
3' ?$8 7&@ E3>3' 3>3'
-
"#
4""$",
4"6 C, %%,$
,
)3 !%&,,$:&%
C, ,, $ ,)B !$"$!,)D,
F
Amos LimIf >1 bond, need to use weighted average of YTM of bonds outstanding. Note that for bonds that are illiquid (and so PV, or mkt value, is unreliable or unavailable), you may have to infer the market value from comparable bonds or use the alternate method
Amos LimMore accurate if bonds issued all have the same rating
Amos Lim
Amos Lim
Amos Lim
Amos Lim
-
" +, % # # &)%
'
:? @ ; +?@
3 >
3 'G' ' ? $8 7 & @ 3 > 3 ' 3 > 3 '
F ? @? @ ? @
! =,8; :,8;
0,18
I4' ! " @0;H! "F4
D8;
4 =8;
Amos Lim6.1
Amos LimDone
-
"0,#%##%C9&)%
'
4N"D=":B,4""18Q0888,4"01"Q01B=,9:@D,4!@,=:00,=:,4"0,=:9:,4(=:,
Amos LimAdjusted Beta= 1.3585 (2/3) + 1 (1/3) = 1.239Bond YTM = .09019428.. 0.902 (Using FC)Ks 0.12545WACC =
Amos LimAns: 9.67%
Amos LimSemi-annual
Amos LimDone
-
"0,#%##%C9&. %
'
; 3! %E,! !!
/ !,.$" !!!"/ ! !)
; 3! %' /),93))
; 3! %E!$4)); 3 "+ A ": !)
3. !); 3! %
, !
%F)) 3 !F); 3! %E' !)
Amos LimAns: 9.55%
Amos Lim
-
".
4",$"
,
-
2# B .,0771H0776
,
-
#
4 --!,
188D0,88;" "
L> LD,1A;>0,88;L:,1A;
Amos LimNeed to use latest period, as deriving current market value
Amos Lim6.00% + 1.00% = 7.00%
Amos LimKs = (1.2 * 2/3 + 1/3) * 0.05 + 0.06 = 0.116666 0.117Preferred: 2 / 25 = 0.08Debt YTM:
-
-.> N07+1
+
5 )- )- )- )-5H )- )- )- )-5 )/- )- )- )-5. )- )- )- )/-5H )- )- )- )-5 )- )- )/- )-5. )- )- )- )-5H )- )- )- )//-5 )- )- )- )-
5. )/- )/- )- )-5H )- )- )- )-5 )- )- )/- )/-5. )- )- )- )-5H )- )- )- )-5 )/- )/- )/- )-5. )/- )- )- )-5H )- )- )- )-
-
""
$!&"'(
-
""
I.0/,".,,#%*CB??#6>B1>%*9) *
/.1/,$",
F 6642578&0,#1,%%/
Amos LimAdjusted Beta = 1.4 (2/3) + 1/3 = 1.266666 1.27CAPM Ks = 0.0275 + 1.27 * 0.0708 = 11.72%Macro: 0.0275 + 1.8 [0.01 - (-0.01)] + 0.7 (-0.02 - 0.025) + 1 (0.02 - 0.035) = 0.017FF4 Ks = 12 * {0.0275 / 12 + (1.068)(0.0059) + (-0.374)(0.0023) + (-0.814)(0.0041) + (-0.226)(0.0077)} = 12 * 0.0026 = 0.0319Bond YTM = 0.07% (Using FC)BYRP Ks = 0.07 + 0.04 = 0.11
Highest - Lowest = 0.1172 - 0.017 = .1002
Amos LimFor exams, use the simple average of all Ks that you can calculate.
Amos LimNote: FF4 Ks ignores compounding (/12 rather than 12. Just /12 in exams.