This document defines key financial terms related to interest rates, bonds, and capital budgeting. It provides formulas for calculating simple and compound interest, present value, future value, real and nominal interest rates, yield to maturity, net present value, and internal rate of return. Examples are given for coupon bonds, zero-coupon bonds, treasury bonds, and consol bonds. Factors that can shift the supply and demand of bonds and money are also outlined.
The document provides an overview of the foreign exchange market, including its key participants and characteristics. It describes the functions and size of the FX market, with an average daily turnover of over $2 trillion. The key participants are banks and dealers that act as market makers by buying and selling currencies. Spot transactions settle in 2 days while forwards lock in an exchange rate for future delivery. The document outlines different currency quotes and rates, including bid-ask spreads, direct vs indirect quotes, and how forward rates are expressed.
risk which the exporters importers have to go through.
A credit risk is the risk of default on a debt that may arise from a borrower failing to make required payments. In the first resort, the risk is that of the lender and includes lost principal and interest, disruption to cash flows, and increased collection costs.
Credit risk refers to the risk that a borrower may not repay a loan and that the lender may lose the principal of the loan or the interest associated with it.
This document discusses tools for conducting an economic analysis of small hydro-power projects. It outlines various economic analysis methods like payback period, return on investment, net present value, benefit-cost ratio, and internal rate of return. It provides examples of how to calculate these metrics and compares the advantages and disadvantages of each. The document also includes an example economic analysis of a typical small hydro-power project, outlining parameters like installed capacity, estimated annual output, project costs, revenue assumptions, and results of the net present value and benefit-cost ratio calculations.
This document discusses various methods for evaluating investment projects, including net present value (NPV), internal rate of return (IRR), and modified internal rate of return (MIRR). It defines each measure and explains their appropriate uses and limitations. NPV measures the present value of incremental cash flows, while IRR is the discount rate that makes NPV equal to zero. MIRR accounts for reinvestment at the cost of capital rather than the project rate. The document recommends using NPV to choose between mutually exclusive projects of different sizes, as IRR can provide erroneous results in some cases.
The document discusses exchange rate mechanisms and types of exchange rates. It provides details about:
1) The Exchange Rate Mechanism (ERM) which is used by central banks to manage currency exchange rates relative to other currencies through fixed or floating exchange rates.
2) The notable European ERM introduced in 1979 to reduce exchange rate variability between European countries before adopting a single currency. It faced issues in 1992 when Britain withdrew.
3) Types of exchange rates including fixed rates which maintain stable rates, floating rates set by market forces, and managed floats where governments influence rate changes.
International Monetary Fund (IMF) finalMayur Panchal
The International Monetary Fund (IMF) was established in 1944 to promote international monetary cooperation and stability. It is governed by its 188 member countries and seeks to facilitate international trade, promote sustainable economic growth, and reduce poverty. The IMF provides loans to countries experiencing economic difficulties, engages in economic surveillance of its members, and offers technical assistance and training. It is governed by the Board of Governors and managed by an Executive Board and staff led by a Managing Director.
Payback period (PP) is the number of years it takes for a company to recover its original investment in a project, when net cash flow equals zero. In the calculation of the payback period, the cash flows of the project must first be estimated. The payback period is then a simple calculation.
This document defines key financial terms related to interest rates, bonds, and capital budgeting. It provides formulas for calculating simple and compound interest, present value, future value, real and nominal interest rates, yield to maturity, net present value, and internal rate of return. Examples are given for coupon bonds, zero-coupon bonds, treasury bonds, and consol bonds. Factors that can shift the supply and demand of bonds and money are also outlined.
The document provides an overview of the foreign exchange market, including its key participants and characteristics. It describes the functions and size of the FX market, with an average daily turnover of over $2 trillion. The key participants are banks and dealers that act as market makers by buying and selling currencies. Spot transactions settle in 2 days while forwards lock in an exchange rate for future delivery. The document outlines different currency quotes and rates, including bid-ask spreads, direct vs indirect quotes, and how forward rates are expressed.
risk which the exporters importers have to go through.
A credit risk is the risk of default on a debt that may arise from a borrower failing to make required payments. In the first resort, the risk is that of the lender and includes lost principal and interest, disruption to cash flows, and increased collection costs.
Credit risk refers to the risk that a borrower may not repay a loan and that the lender may lose the principal of the loan or the interest associated with it.
This document discusses tools for conducting an economic analysis of small hydro-power projects. It outlines various economic analysis methods like payback period, return on investment, net present value, benefit-cost ratio, and internal rate of return. It provides examples of how to calculate these metrics and compares the advantages and disadvantages of each. The document also includes an example economic analysis of a typical small hydro-power project, outlining parameters like installed capacity, estimated annual output, project costs, revenue assumptions, and results of the net present value and benefit-cost ratio calculations.
This document discusses various methods for evaluating investment projects, including net present value (NPV), internal rate of return (IRR), and modified internal rate of return (MIRR). It defines each measure and explains their appropriate uses and limitations. NPV measures the present value of incremental cash flows, while IRR is the discount rate that makes NPV equal to zero. MIRR accounts for reinvestment at the cost of capital rather than the project rate. The document recommends using NPV to choose between mutually exclusive projects of different sizes, as IRR can provide erroneous results in some cases.
The document discusses exchange rate mechanisms and types of exchange rates. It provides details about:
1) The Exchange Rate Mechanism (ERM) which is used by central banks to manage currency exchange rates relative to other currencies through fixed or floating exchange rates.
2) The notable European ERM introduced in 1979 to reduce exchange rate variability between European countries before adopting a single currency. It faced issues in 1992 when Britain withdrew.
3) Types of exchange rates including fixed rates which maintain stable rates, floating rates set by market forces, and managed floats where governments influence rate changes.
International Monetary Fund (IMF) finalMayur Panchal
The International Monetary Fund (IMF) was established in 1944 to promote international monetary cooperation and stability. It is governed by its 188 member countries and seeks to facilitate international trade, promote sustainable economic growth, and reduce poverty. The IMF provides loans to countries experiencing economic difficulties, engages in economic surveillance of its members, and offers technical assistance and training. It is governed by the Board of Governors and managed by an Executive Board and staff led by a Managing Director.
Payback period (PP) is the number of years it takes for a company to recover its original investment in a project, when net cash flow equals zero. In the calculation of the payback period, the cash flows of the project must first be estimated. The payback period is then a simple calculation.
Project appraisal for financial marketskarangoyal972
This document discusses various financial techniques used for project appraisal, including net present value (NPV), internal rate of return (IRR), average rate of return (ARR), payback period, discounted payback period, and profitability index. It provides formulas for calculating each technique and discusses their advantages and disadvantages for assessing the viability and profitability of potential projects.
Describes in detail the steps involved in the calculation of Internal Rate of Return. Useful to students of Under graduate, post graduate and professional course students pursuing course in finance
Project finance deals with analyzing the financial feasibility of a particular project based on expected cash flows. It is a form of financing used for long-term infrastructure and industrial projects that often involve governments. Key features include risk sharing between multiple parties and better management. The different stages of project finance include feasibility, structuring, and implementation. Advantages are reducing lender recourse and maximizing leverage, while disadvantages include higher costs and disclosure requirements. Parties typically involved are the project company, sponsors, lenders, host government, offtaker, suppliers, and contractors. Sources of finance include loans, equity, retained profits, and sale/leaseback arrangements.
This document discusses how multinational corporations can manage economic and translation exposure through hedging strategies. It explains that economic exposure refers to how exchange rate fluctuations can impact future cash flows. MNCs can assess economic exposure and reduce it by restructuring operations to balance exchange rate sensitive cash flows. Translation exposure results from translating foreign subsidiary financials to the home currency, but does not directly impact cash flows. MNCs can hedge translation exposure using forward contracts to offset gains or losses from currency fluctuations. However, hedging translation exposure has limitations from inaccurate forecasts and accounting distortions.
The document discusses exchange rate determination and factors that influence exchange rates. It defines exchange rates as the price of one currency in terms of another, and explains that exchange rates are determined by the relative demand and supply of the currencies. Exchange rates can appreciate or depreciate based on relative inflation rates, interest rates, income levels, and expectations between countries, as well as government controls and speculative activities in foreign exchange markets. The document provides examples of how a bank can profit by borrowing one currency at a lower interest rate and lending it at a higher interest rate based on anticipated exchange rate movements.
This document discusses financial management. It defines financial management as dealing with planning and controlling a firm's financial resources to harmonize individual and enterprise goals. The three main functions of finance are investment decisions, financing decisions, and dividend decisions. Investment decisions involve selecting assets for funds investment. Financing decisions determine the optimal debt-equity ratio. Dividend decisions involve distributing profits. The objectives of financial management are profit maximization and wealth maximization. A financial manager's roles include business forecasting, capital structure design, investment decisions, and working capital management.
Determination of exchange rate chapter 6Nayan Vaghela
Determination of exchange rate, mint par theory, balance of payment theory, Purchasing power parity theory, Absolute version and relative version, Criticisms
The document provides an overview of the Black-Scholes-Merton model for pricing options. It describes the key assumptions of the model, including that stock prices follow a random walk and there are no arbitrage opportunities or transaction costs. It also outlines the Black-Scholes formulas for pricing European call and put options, and defines the Greek letters (delta, gamma, theta, vega, rho) which represent how the value of an option changes with factors like the price of the underlying stock and volatility. The document provides an example of how options traders can use delta hedging to hedge their risks and maintain a delta-neutral portfolio.
This presentation discusses bond valuation. It defines bonds and bond valuation, which includes calculating the present value of future interest payments and the bond's value at maturity. It then discusses various ways to calculate bond returns, including coupon rate, current yield, spot interest rate, and yield to maturity. It also covers bond price valuation, bond risks, bond duration, and five principles of bond pricing theorems.
PGBM01 - MBA Financial Management And Control (2015-16 Trm1 A)Lecture 9 lon...Aquamarine Emerald
This document provides an overview of long-term decision making processes and techniques. It discusses the characteristics of long-term investments, the typical decision making process including initial investigation, evaluation, authorization, implementation and monitoring. It then covers techniques for evaluating investments, including payback period, accounting rate of return, net present value and internal rate of return. An example calculation compares two potential investment projects using these techniques, and recommends selecting the project with the highest net present value or internal rate of return.
This report focuses on the Cost-Benefit Analysis which is effective tool and a rational technique for economic valuation where market information is either non-existent or deficient is.
This document provides an overview of fixed and flexible exchange rate systems. It discusses key concepts like the demand and supply of foreign exchange, historical exchange rate regimes like the gold standard and Bretton Woods system, and current regimes including pegged rates, crawling pegs, and target zones. The advantages of fixed exchange rates are outlined as promoting international trade and investment by providing certainty, removing speculative activities, and being suitable for currency areas and developing countries seeking economic stability.
This document discusses interest rate swaps. It defines an interest rate swap as an agreement to exchange interest rate payments, with one leg fixed and the other floating. Common types include paying fixed rate interest to receive floating, and vice versa. Interest rate swaps are used to hedge against rising or falling interest rates by transforming fixed deposits/borrowings to floating, or floating to fixed. Examples show how swaps can benefit entities by reducing income/funding costs if rates move in the desired direction.
This pdf is only to learn payback, timevalue of money and IIr
and there example are also given by me to easy to lean there example if any doute then contact me...
The document discusses the cost of capital, including its meaning, significance, and methods for determining it. The cost of capital is the minimum expected rate of return required by a firm's investors. It is used to evaluate investment projects and determine the optimal capital structure. There are different types of costs - historical vs future, specific vs composite, explicit vs implicit, and average vs marginal. Determining the accurate cost of capital can be challenging due to conceptual issues around capital structure and difficulties calculating costs like equity and retained earnings.
Interest rates are determined by the interaction of supply and demand in the market for loanable funds. The supply comes from domestic savings, foreign lending, and money creation by banks. The demand comes from consumers, businesses, and governments seeking credit, as well as foreign borrowers. Equilibrium is reached where the supply and demand for loanable funds are equal. Factors such as expected inflation, default risk, liquidity risk, and monetary policy influence the supply and demand curves and thus impact interest rate levels.
A currency swap involves the exchange of principal and interest payments in one currency for the same in another currency at fixed intervals over the contract period. In a currency swap, counterparties can choose to exchange principal at the start and end of the swap or just exchange interest payments. An interest rate swap is an agreement where one party pays a fixed interest rate on a loan while receiving a floating rate, or vice versa, from the other party in order to reduce exposure to interest rate fluctuations. Common types of interest rate swaps include fixed to floating, floating to fixed, and float to float (basis) swaps. Swaps allow parties to achieve their desired interest rate exposure and are customized over-the-counter agreements.
The document discusses Eurocurrency and the Eurodollar market. It defines Eurocurrency as currency deposited by governments or corporations in banks outside their home market, such as US dollars deposited in a London bank. The Eurodollar market refers specifically to US dollar deposits held in banks outside the US. The market originated in the late 1950s when European banks began accepting dollar deposits. It grew due to less regulation than in the US market, allowing for higher interest rates and more banking competition internationally. However, the unregulated nature of offshore banking also carries greater risks of bank failures and foreign exchange volatility for borrowers.
This document discusses myopic loss aversion as a potential solution to the equity premium puzzle. It poses key questions around why the equity premium is so large and why anyone holds bonds. The theory is that the combination of loss aversion, as described in prospect theory, and mental accounting, as proposed by Richard Thaler, results in myopic loss aversion which can explain the size of the equity premium if investors frequently evaluate their portfolios, such as every 12 months.
Project appraisal for financial marketskarangoyal972
This document discusses various financial techniques used for project appraisal, including net present value (NPV), internal rate of return (IRR), average rate of return (ARR), payback period, discounted payback period, and profitability index. It provides formulas for calculating each technique and discusses their advantages and disadvantages for assessing the viability and profitability of potential projects.
Describes in detail the steps involved in the calculation of Internal Rate of Return. Useful to students of Under graduate, post graduate and professional course students pursuing course in finance
Project finance deals with analyzing the financial feasibility of a particular project based on expected cash flows. It is a form of financing used for long-term infrastructure and industrial projects that often involve governments. Key features include risk sharing between multiple parties and better management. The different stages of project finance include feasibility, structuring, and implementation. Advantages are reducing lender recourse and maximizing leverage, while disadvantages include higher costs and disclosure requirements. Parties typically involved are the project company, sponsors, lenders, host government, offtaker, suppliers, and contractors. Sources of finance include loans, equity, retained profits, and sale/leaseback arrangements.
This document discusses how multinational corporations can manage economic and translation exposure through hedging strategies. It explains that economic exposure refers to how exchange rate fluctuations can impact future cash flows. MNCs can assess economic exposure and reduce it by restructuring operations to balance exchange rate sensitive cash flows. Translation exposure results from translating foreign subsidiary financials to the home currency, but does not directly impact cash flows. MNCs can hedge translation exposure using forward contracts to offset gains or losses from currency fluctuations. However, hedging translation exposure has limitations from inaccurate forecasts and accounting distortions.
The document discusses exchange rate determination and factors that influence exchange rates. It defines exchange rates as the price of one currency in terms of another, and explains that exchange rates are determined by the relative demand and supply of the currencies. Exchange rates can appreciate or depreciate based on relative inflation rates, interest rates, income levels, and expectations between countries, as well as government controls and speculative activities in foreign exchange markets. The document provides examples of how a bank can profit by borrowing one currency at a lower interest rate and lending it at a higher interest rate based on anticipated exchange rate movements.
This document discusses financial management. It defines financial management as dealing with planning and controlling a firm's financial resources to harmonize individual and enterprise goals. The three main functions of finance are investment decisions, financing decisions, and dividend decisions. Investment decisions involve selecting assets for funds investment. Financing decisions determine the optimal debt-equity ratio. Dividend decisions involve distributing profits. The objectives of financial management are profit maximization and wealth maximization. A financial manager's roles include business forecasting, capital structure design, investment decisions, and working capital management.
Determination of exchange rate chapter 6Nayan Vaghela
Determination of exchange rate, mint par theory, balance of payment theory, Purchasing power parity theory, Absolute version and relative version, Criticisms
The document provides an overview of the Black-Scholes-Merton model for pricing options. It describes the key assumptions of the model, including that stock prices follow a random walk and there are no arbitrage opportunities or transaction costs. It also outlines the Black-Scholes formulas for pricing European call and put options, and defines the Greek letters (delta, gamma, theta, vega, rho) which represent how the value of an option changes with factors like the price of the underlying stock and volatility. The document provides an example of how options traders can use delta hedging to hedge their risks and maintain a delta-neutral portfolio.
This presentation discusses bond valuation. It defines bonds and bond valuation, which includes calculating the present value of future interest payments and the bond's value at maturity. It then discusses various ways to calculate bond returns, including coupon rate, current yield, spot interest rate, and yield to maturity. It also covers bond price valuation, bond risks, bond duration, and five principles of bond pricing theorems.
PGBM01 - MBA Financial Management And Control (2015-16 Trm1 A)Lecture 9 lon...Aquamarine Emerald
This document provides an overview of long-term decision making processes and techniques. It discusses the characteristics of long-term investments, the typical decision making process including initial investigation, evaluation, authorization, implementation and monitoring. It then covers techniques for evaluating investments, including payback period, accounting rate of return, net present value and internal rate of return. An example calculation compares two potential investment projects using these techniques, and recommends selecting the project with the highest net present value or internal rate of return.
This report focuses on the Cost-Benefit Analysis which is effective tool and a rational technique for economic valuation where market information is either non-existent or deficient is.
This document provides an overview of fixed and flexible exchange rate systems. It discusses key concepts like the demand and supply of foreign exchange, historical exchange rate regimes like the gold standard and Bretton Woods system, and current regimes including pegged rates, crawling pegs, and target zones. The advantages of fixed exchange rates are outlined as promoting international trade and investment by providing certainty, removing speculative activities, and being suitable for currency areas and developing countries seeking economic stability.
This document discusses interest rate swaps. It defines an interest rate swap as an agreement to exchange interest rate payments, with one leg fixed and the other floating. Common types include paying fixed rate interest to receive floating, and vice versa. Interest rate swaps are used to hedge against rising or falling interest rates by transforming fixed deposits/borrowings to floating, or floating to fixed. Examples show how swaps can benefit entities by reducing income/funding costs if rates move in the desired direction.
This pdf is only to learn payback, timevalue of money and IIr
and there example are also given by me to easy to lean there example if any doute then contact me...
The document discusses the cost of capital, including its meaning, significance, and methods for determining it. The cost of capital is the minimum expected rate of return required by a firm's investors. It is used to evaluate investment projects and determine the optimal capital structure. There are different types of costs - historical vs future, specific vs composite, explicit vs implicit, and average vs marginal. Determining the accurate cost of capital can be challenging due to conceptual issues around capital structure and difficulties calculating costs like equity and retained earnings.
Interest rates are determined by the interaction of supply and demand in the market for loanable funds. The supply comes from domestic savings, foreign lending, and money creation by banks. The demand comes from consumers, businesses, and governments seeking credit, as well as foreign borrowers. Equilibrium is reached where the supply and demand for loanable funds are equal. Factors such as expected inflation, default risk, liquidity risk, and monetary policy influence the supply and demand curves and thus impact interest rate levels.
A currency swap involves the exchange of principal and interest payments in one currency for the same in another currency at fixed intervals over the contract period. In a currency swap, counterparties can choose to exchange principal at the start and end of the swap or just exchange interest payments. An interest rate swap is an agreement where one party pays a fixed interest rate on a loan while receiving a floating rate, or vice versa, from the other party in order to reduce exposure to interest rate fluctuations. Common types of interest rate swaps include fixed to floating, floating to fixed, and float to float (basis) swaps. Swaps allow parties to achieve their desired interest rate exposure and are customized over-the-counter agreements.
The document discusses Eurocurrency and the Eurodollar market. It defines Eurocurrency as currency deposited by governments or corporations in banks outside their home market, such as US dollars deposited in a London bank. The Eurodollar market refers specifically to US dollar deposits held in banks outside the US. The market originated in the late 1950s when European banks began accepting dollar deposits. It grew due to less regulation than in the US market, allowing for higher interest rates and more banking competition internationally. However, the unregulated nature of offshore banking also carries greater risks of bank failures and foreign exchange volatility for borrowers.
This document discusses myopic loss aversion as a potential solution to the equity premium puzzle. It poses key questions around why the equity premium is so large and why anyone holds bonds. The theory is that the combination of loss aversion, as described in prospect theory, and mental accounting, as proposed by Richard Thaler, results in myopic loss aversion which can explain the size of the equity premium if investors frequently evaluate their portfolios, such as every 12 months.
The document discusses challenges in estimating cost of capital in the current economic environment. It addresses issues with estimating the risk-free rate due to declines in Treasury bond yields, and issues with estimating the equity risk premium based on historical data, which may be too low. It also notes that betas calculated using recent historical data may be lower than expected future betas due to volatility in financial and highly leveraged stocks. The presentation recommends using a higher risk-free rate than current Treasury yields, a higher equity risk premium of 6% rather than estimates based on historical data, and adjusting betas based on the underlying risk of each company rather than purely historical estimates.
Determinants of the implied equity risk premium in BrazilFGV Brazil
This document summarizes a research paper that proposes and tests determinants of the implied equity risk premium (ERP) in Brazil. The paper calculates the ERP using current stock prices rather than historical returns. It finds several market fundamentals are significantly related to changes in the ERP, including changes in interest rates, debt risk spreads, US market liquidity, and the S&P 500 index level. The paper also compares using implied ERP versus historical averages and finds implied ERP varies with market events while historical averages do not.
The document discusses the relationship between the equity risk premium, duration, and dividend yield based on the author's views as an individual, not a representative of their company. It references Ockham's Razor principle that the simplest solution tends to be the right one, and provides a snapshot of the S&P Composite from 1870 to 1900.
Equity Risk Premium in an Emerging Market Economyiosrjce
The finance literature suggests that in almost any kind of investing, returns would at least have some
relationship with risk-free rate of return (Rf), with investors demanding higher returns for greater risk. Risk-free
asset is regarded as one where the investor knows the expected return with certainty. This leads to the notion of
Equity Risk Premium (ERP), the extra return that, as compensation for the additional borne risk, the investor
earns over the Rf
, typically taken as 91-day Treasury bills (TB) rate of return. While similar studies have been
performed in the past, the applicability of the ERP concept across financial markets and its economic
implications as a risk measure has remained a contentious issue in the field, particular in emerging markets.
The present study seeks to revisit the issue in the Nigerian context based on secondary data spanning 2000-
2011. The statistical analysis based on the capital asset pricing model shows that the country’s Rf proxied by
TBs, had over the years traded at significantly higher levels of return than obtainable from market portfolio,
thus creating a negative ERP phenomenon. The implications of this peculiarity for sustainable wealth creation,
business development and valuation practice, are highlighted. Recent changes in the country’s Administration
makes this study even more relevant, thus, the paper also renews the call for creating a more pro-industry fiscal
policy climate if the national aspiration for sustainable inclusive growth is to be attained.
Myopic loss aversion is a concept that explains the equity premium puzzle by combining high sensitivity to losses (loss aversion) and a tendency to frequently evaluate one's wealth. Loss aversion means that people are more sensitive to decreases in wealth than increases, and frequent evaluation of wealth against a reference point, known as mental accounting, makes losses more salient, leading investors to be reluctant to hold risky equities and contributing to a large premium for equities over bonds.
This document discusses different methods for estimating the cost of equity for Aero Pieces, an aircraft parts company, by incorporating industry risk. It compares using the Capital Asset Pricing Model with an industry risk premium, versus the traditional build-up method which factors industry risk into the company-specific risk premium. Applying each method using equity risk premium data from different sources, the estimated cost of equity for Aero Pieces ranges from 12.40% to 15.80%.
Baker Tilly provides expert valuation services for businesses and assets in various industries. Their valuations aid important strategic, financial, and legal decisions. Baker Tilly's experienced professionals have extensive knowledge of valuation methods and deliver high-quality, defensible opinions. They identify the right valuation approach for each client's needs. Baker Tilly's valuation team consists of professionals with various certifications and experience valuing businesses from small to large corporations.
Working capital refers to the capital required to finance short-term operating expenses such as raw materials, wages, and other day-to-day expenses. It is needed to purchase inventory, pay employees, and cover other daily costs. Determining the appropriate level of working capital requires considering factors like the nature of the business, size, production processes, cash needs, and seasonality. There are various methods for estimating working capital, and having the right amount provides benefits like maintaining goodwill and securing favorable loan terms, while too little or too much can lead to inefficiency.
1) Total risk of a security is composed of systematic risk, which stems from external market factors, and unsystematic risk, which is specific to a company.
2) Diversifying a portfolio by holding many securities with returns that are not perfectly positively correlated can reduce total risk through lowering unsystematic risk exposure.
3) The degree of risk reduction from diversification depends on the correlation between the returns of the securities in the portfolio. Perfectly negatively correlated securities eliminate risk, while perfectly positively correlated securities do not allow for risk reduction through diversification.
The document discusses various ways to estimate growth rates for earnings, revenues, and operating income. It explores using historical growth rates, analyst estimates, and fundamentals-based approaches. The fundamentals-based approaches estimate growth based on reinvestment rates and returns on capital/equity. They note growth rates depend upon changing returns over time and how negative earnings, changing margins, and size effects are incorporated into the estimates.
IRJET - Stock Recommendation System using Machine Learning ApproacheIRJET Journal
This document proposes a stock recommendation system using machine learning approaches. It uses five machine learning algorithms (linear regression, random forest, ridge regression, stepwise regression, and gradient boosted regression) to predict stock returns based on 20 financial factors. The system selects the top 200 stocks in each sector quarterly based on the model with the lowest mean squared error on past data. It then backtests portfolio strategies using the recommended stocks to demonstrate the system outperforms the S&P 500 index in terms of risk-adjusted returns. The key steps are data preprocessing, model training/selection, stock ranking/selection, and backtesting portfolio strategies.
This document discusses estimating the weighted average cost of capital (WACC) for a company. It covers the three main components needed to calculate WACC: 1) the cost of equity, 2) the after-tax cost of debt, and 3) the target capital structure weights. For the cost of equity, it describes the capital asset pricing model (CAPM) and how to estimate beta and market risk premium. Historical data and industry unlevered betas are used to improve estimates. The example shows how WACC is calculated for Home Depot using CAPM cost of equity and after-tax cost of debt weighted by targets.
This document provides an overview of fundamental analysis techniques used in security analysis and portfolio management. It outlines 5 course outcomes related to macro/industry analysis, equity valuation, financial statement analysis, bond/fixed income strategies, and options/futures. It then discusses various fundamental analysis approaches including economic analysis, industry analysis, and company analysis. Several analysis models and techniques are described such as DuPont analysis, P/E ratios, and portfolio construction approaches. Technical analysis indicators like support/resistance levels, point and figure charts, and gaps are also introduced.
The document provides an overview of various topics to be covered in a stock analyst program, including portfolio performance, equity analysis techniques, macroeconomic analysis, valuation methodologies, investment styles, and key financial ratios. It discusses approaches like discounted cash flow valuation, comparable companies analysis, and precedent transactions. It also covers different investment strategies such as value investing, growth investing, and contrarian investing.
GEO NECF 2015 - Best Practices and Trends in Financial ReportingAndrea Huck-Esposito
Financial reporting for equity compensation is not a new topic. However, developments in the complexity of the types of awards offered combined with vagueness in guidance has resulted in an evolution of best practices in financial reporting. Attend this session and hear how best in class companies are currently handling their financial reporting as a result. Get tips for how to handle your financial reporting dilemmas—whether in a system or in excel. What’s more, hear all about the latest trends in award design that are causing financial reporting issues and how best to address these. Financial reporting for equity compensation will never be easier!
The Arbitrage Pricing Theory (APT) provides an alternative to the Capital Asset Pricing Model (CAPM) for estimating expected returns. The APT assumes returns are generated by multiple systematic risk factors rather than a single market factor. It allows for assets to be mispriced and does not require assumptions of a market portfolio or homogeneous expectations. Under the APT, the expected return of an asset is equal to the risk-free rate plus the product of each risk factor's premium and the asset's sensitivity to that factor.
This document summarizes IPART's proposed methodology for estimating the weighted average cost of capital (WACC). It discusses estimating the cost of debt using both current market data and long-term averages. For the cost of equity, it proposes using the capital asset pricing model with the risk-free rate and market risk premium estimated based on both current and long-term data. Stakeholders provided feedback on the appropriate time periods and estimation methods to use. The document analyzes IPART's WACC model and determination process, and considers economic uncertainty in the final WACC value.
Persistence of Mutual Fund Performance in IndiaAman Kesarwani
The document discusses analyzing the persistence of mutual fund performance in India. It provides motivation for studying whether past performance can predict future returns. The objective is to analyze equity fund performance using risk-adjusted measures and regressing past performance on future returns over 1, 2, and 3 year periods. The methodology section outlines the various formulas and techniques used, including Sharpe ratio, Treynor ratio, Jensen's alpha, and others. Literature review finds mixed evidence from international and Indian studies on whether past performance persists. Sample fund data is analyzed over rolling periods and performance measures are regressed on future returns to examine predictability.
The Capital Asset Pricing Model (CAPM) measures the relationship between the expected return and the risk of investing in security.
This model is used to analyze securities and price them given the expected rate of return and cost of capital involved.
1) The study examines the economic importance of accounting information by analyzing how accounting data from financial statements can improve portfolio optimization for US equities.
2) Using a parametric portfolio policy method, the researchers modeled portfolio weights as a linear function of three accounting characteristics - accruals, change in earnings, and asset growth - and compared it to weights based on size, book-to-market, and momentum.
3) They found that the accounting-based portfolio generated an out-of-sample annual information ratio of 1.9 compared to 1.5 for the price-based portfolio, indicating accounting information provides valuable signals for optimizing equity investments.
Chapter 05(a) financial analysis-ratio and other analysisAl Sabbir
The document discusses various methods for analyzing the financial performance of a company through its financial statements, including ratio analysis, common size analysis, trend analysis, DuPont analysis, and other types of analyses. It provides examples of different types of ratios that can be used, such as liquidity ratios, activity ratios, leverage ratios, and profitability ratios. It also discusses how to interpret ratios and cautions that ratios must be compared to benchmarks and should account for differences in accounting methods.
Fundamental analysis is a method of evaluating securities that involves analyzing a company's financial statements and health, its management, and the overall prospects of the company's industry. It is used to determine a company's intrinsic value and assess whether its stock is underpriced (a good buy), overpriced (a sell), or fairly priced (a hold). The document discusses key concepts in fundamental analysis like discounted cash flow models, valuation methodologies like PE ratio and PBV ratio, and financial statement components like the balance sheet, income statement, and cash flow statement. It also covers the time value of money, weighted average cost of capital, equity risk premium, and the beta.
The dividend discount model (DDM) is commonly used to value stocks. It calculates a stock's intrinsic value based on expected future dividends, discounted back to the present. The DDM has advantages like simplicity and relying on theoretical foundations, but it also has disadvantages like not accounting for intangible assets and being dependent on assumptions about stable dividend growth rates. Whether the DDM or multiples approach is more accurate depends on the specific company and analysts must consider various valuation techniques and compare to industry averages to determine if a stock is undervalued, overvalued, or fairly valued.
The document outlines an overview of the Stock Analyst Program for winter 2010. It includes the schedule of upcoming meetings and topics to be covered, such as valuation, stock screening, risk management, and technical analysis. Evaluation criteria for research reports are also mentioned, focusing on choice of industry and identification of growth potential and catalysts. Various resources for company and industry analysis are listed, including screening tools, industry reports, and the Bloomberg terminal.
The document provides an overview of the Stock Analyst Program for 2010, including upcoming meeting dates and topics. It discusses components of a research report, evaluation criteria, sources for where to trade stocks, different stock screening strategies, and concepts related to risk management. Key topics covered include industry and company analysis, valuation methods, investment styles like value investing and growth investing, and sayings from famous investors about diversification and market trends.
8 9 forecasting of financial statementsJohn McSherry
1) Lectures 8 and 9 cover forecasting techniques and credit risk analysis. Readings are provided on analyst forecasts and credit risk assessment models.
2) There are two general approaches to forecasting - non-econometric qualitative methods typically used by analysts, and econometric quantitative methods. Top-down and bottom-up are common non-econometric techniques.
3) Financial ratios tend to revert to historical norms over time. An analysis of a company's ratios should consider the typical behavior of those ratios and anchor forecasts accordingly.
This document provides an overview of ratio analysis, outlining various types of ratios used to analyze a company's financial health and performance. It discusses short-term and long-term solvency ratios, profitability ratios, liquidity ratios, efficiency ratios, and valuation ratios. For each ratio type, several example ratios are defined and the factors that influence them are described. Comparative standards and benchmarks for analyzing ratios are also outlined.
This document summarizes critiques of the Capital Asset Pricing Model (CAPM) and presents alternative models. It discusses empirical studies from the 1980s and 1990s that found variables other than beta help explain stock returns, contradicting CAPM. Fama and French's 1992 study found firm size and book-to-market ratio better predict returns than beta. Their three-factor model and the Arbitrage Pricing Theory were proposed as alternatives to CAPM. Overall, the document outlines major empirical challenges to CAPM and influential models that improved on its ability to explain stock returns.
Similar to Estimating The Equity Risk Premium (20)
2. Introduction
• Broadly, there are three approaches to estimating the Equity Risk
Premium (ERP). These employ the use of (1) historical data, (2) surveys,
and (3) market data.
• Estimates of ERP may vary widely, depending upon which approach is
used and which inputs the analyst selects.
• This presentation will cover portions of (1) a recent article by Aswath
Damodaran, “Equity Risk Premium (ERP): Determinants, Estimation and
Implications – The 2010 Edition” and (2) recent articles by Pablo
Fernandez, “The Equity Risk Premium in 150 Textbooks”, “Market Risk
Premium Used in 2010 by Professors: a Survey with 1,500 answers”, and
“Market Risk Premium Used in 2010 by Analysts and Companies: a Survey
with 2,400 Answers.”
• Disclaimer: This presentation communicates the findings and opinions of
the above sources. It is not intended to be definitive. Each analyst should
exercise discretion in determining the appropriate ERP to apply to a given
valuation analysis. Further, this presentation does not address other
inputs critical to deriving present value discount rates (e.g., beta, size
premia, company-specific risk premia, etc.). Careful consideration must
be given to these factors as well.
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3. The ERP
• The ERP is the rate of return investors receive as
compensation for the risk of equities in excess of the rate
of return received on the risk-free security
ERP = E(Rm) – Rf
where:
E(Rm) = Expected return on the market
Rf = Risk-free rate of return
• ERP is a forward-looking concept. It is based on the
expected excess return on the stock market during the
term of the investment and should be reflective of what
the ERP will be in the future. However, the ERP is
unobservable and as a result the ERP must be estimated.
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4. Estimation Approaches
• Historical Realized ERP: The actual past returns earned on
stocks over a long time period is estimated, and compared
to the actual past returns earned on a risk-free investment
(usually a government security). The difference, on an
annual basis, between the two returns is computed and
represents the historical realized ERP.
• Historical Expected ERP: Fundamental information– such as
earnings, dividend, or overall economic productivity– are
used to estimate the expected ERP.
• Survey-based ERP: Individual investors,
institutional/professional investors, CFOs, and/or academics
are asked for their expectations of the ERP.
• Implied ERP: Market prices on assets as of the valuation
date are used to estimate a forward-looking ERP.
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5. Historical Realized ERP
• The historical realized ERP used in practice varies widely
across analysts, from 3% to 12% at the extremes.
• Reasons for divergence
– Time period: Analysts use historical data that ranges from as
long as 1792 to the present to as short as the most recent 10
years.
• Some analysts believe that using data over a shorter historical
time frame is preferable to a longer one because the risk aversion
of investors changes over time. However, using a shorter time
frame results in “noisier” data (i.e., a higher standard error).
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6. Historical Realized ERP
• Even using an 80 year time span results in a relatively high standard
error of 2.23%.
Estimation Period Standard Error of Risk Premium Estimate
5 years 20% / √5 = 8.94%
10 years 20% / √10 = 6.32%
25 years 20% / √25 = 4.00%
50 years 20% / √50 = 2.83%
80 years 20% / √80 = 2.23%
– Length of term on risk-free security: Analysts use a broad range of
maturity lengths. Since the yield curve has typically been upward
sloping, the ERP is larger when estimated relative to short-term
government securities and smaller when estimated relative to long-
term government securities.
• Using T-Bills makes sense only if a single period (say, one) year ERP is
being estimated. If the time horizon being estimated for is long-term, T-
Bonds should be used.
• Most analysts and Ibbotson Associates (in their SBBI Valuation Edition
yearbooks) use the 20-year Treasury Bond.
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7. Historical Realized ERP
– Averaging approach:
• Arithmetic vs. Geometric
– Arithmetic average: the simple mean of a series of annual returns.
– Geometric average: the compounded average return.
• Arithmetic average results in higher ERP than geometric average.
• The arithmetic average provides a better estimate of the ERP than
does the geometric average if there is no “serial correlation” (or
autocorrelation) between returns.
• SBBI recommends the arithmetic mean based on (1) empirical
evidence which they conclude indicates no serial correlation and
(2) the belief that a full range of outcomes is possible and the
most reasonable expectation is the weighted average of all
outcomes.
• Damodaran states that evidence of serial correlation is
“extensive.” He also states that using the arithmetic average to
obtain discount rates which are then compounded over time
“seems internally inconsistent” and that the argument for using
geometric average premiums as estimates is strong.
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8. Historical Realized ERP
ERP: Stocks minus T-Bills ERP: Stocks minus T-Bonds
Arithmetic Geometric Arithmetic Geometric
1928-2009 7.53% 6.03% 5.56% 4.29%
1967-2009 5.48% 3.78% 4.09% 2.74%
1997-2009 -1.59% -5.47% -3.68% -7.22%
Source: "Equity Risk Premiums (ERP): Determinants, Estimation and
Implications," Aswath Damodaran, 2/10.
• If, based on the aforementioned discussion, an analyst takes the position that a
long-term (1928-2009) geometric average premium over T-Bonds is the most
appropriate measure, 4.29% would be the appropriate ERP. SBBI reports that the
historical realized ERP on a geometric average basis for the period 1926 to 2009 was
4.7%.
• However, this conclusion comes with significant standard error (about 2.4%) and is
reflective of time periods (e.g., the 1920s and 1930s) when the U.S. equity market
(and investors in it) had very different characteristics than they do today.
• Further, the addition or subtraction of just one year will have a large impact on the
conclusion. Because stock market returns were so high in 2009, if instead of 1928-
2009, a period of 1928-2008 were used, the geometric average premium over T-
Bonds would be 3.88% (0.41% lower than the 1928-2009 period). The impact of
using data ended 2008 instead of 2009 would have a large impact on any of the
above approaches to calculating historical realized ERP.
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9. Historical Realized ERP
• Sources of the historical realized ERP include:
– The Ibbotson SBBI Valuation Yearbook 2010, which reports an
historical realized ERP for large company stocks of 6.7% over
the period 1926 to 2009.
– The Duff & Phelps, LLC, Risk Premium Report 2010, which
reports an historical realized ERP for large company stocks of
4.25% over the period 1963 to 2009.
– Dimson, Marsh, Staunton and Wilmont (2010) estimated
equity returns for 19 markets from 1900 to 2009. Their results
are summarized as follows:
2000-2009 1960-2009 1990-2009
U.S. -7.4% 2.3% 4.2%
World -6.6% 0.9% 3.7%
World ex-U.S. -5.2% 0.6% 3.8%
Europe -5.7% 1.3% 3.9%
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10. Historical Expected ERP
• Many studies have concluded that the historical realized ERP is higher than
investors have expected. Therefore, the expected ERP should be less than
the historical realized ERP.
• To measure the expected ERP, researchers have created supply-side
models which use fundamental information, such as earnings, dividend, or
overall economic productivity, to estimate the expected ERP.
• In recent years, the SBBI Valuation Edition Yearbook has presented the
the supply-side ERP model developed by Ibbotson and Peng. This earnings
model breaks historical realized equity returns into four pieces: (1)
inflation, (2) income return, (3) growth in real earnings per share, and (4)
growth in P/E ratio.
• The three returns historically supplied by companies (i.e., inflation, income
return, and growth in real earnings per share) are expected to continue in
the future. However, the growth in the P/E ratio, which is based on
investors’ predictions of future earnings growth, is not. As a result, the
historical growth in the P/E ratio is subtracted from the ERP forecast.
• In the Ibbotson SBBI Valuation Yearbook 2010, the supply-side ERP for
large company stocks is reported to be 5.2%.
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11. Survey-based ERP
• The rationale for using surveys to estimate ERP is that, if
the objective of estimating ERP is to conclude what return
investors require on risky assets, then the most logical way
to accomplish this is to ask investors.
• Survey groups
– Investors
• Individual investors: conducted by (1) Robert Shiller; (2)
UBS/Gallup; and (3) The Securities Industry Association (SIA).
– The Shiller and UBS/Gallup surveys are directional in nature and do not
report an ERP. The SIA survey reported an ERP of 8.3% in 2004
• Institutional investors: conducted by (1) Investors Intelligence and
(2) Merrill Lynch.
– Investors Intelligence is a directional survey, which does not report an
ERP. The Merrill Lynch monthly survey of 300 institutional investors
reported an average ERP of 3.8% in 2009.
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12. Survey-based ERP
– Managers and Analysts
• Graham and Harvey annual survey of CFOs:
– 2009 survey reported an average ERP of 4.7% and a median ERP of
4.3% (up from 3.8% and 4.2%, respectively, in 2008). It also reported
significant dispersion, with expected return on the market ranging from
1.3% to 12.4% at the 10th and 90th percentiles.
• Fernandez survey of analysts and companies
– Among analysts, the 2010 survey reported an average ERP of 5.1%
and a median ERP of 5.0%. Among companies, the 2010 survey
reported an average ERP of 5.3% and a median ERP of 5.0% (U.S. and
Canadian survey respondents).
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13. Survey-based ERP
– Academics
• While academics are obviously not big players in equity markets,
practitioners often use their work as support for the ERP estimates they
use.
• Surveys
– Welch (2000) surveyed 226 financial economists on the magnitude of the
ERP and reported interesting results. On average, economists forecast an
average ERP (arithmetic) of about 7% for a ten-year time horizon and 6-7%
for one to five-year time horizons. As with other the other survey estimates,
there is a wide range on the estimates, with premia ranging from 2% to
13%.
– Fernandez (2009) examined 150 widely used textbooks in corporate finance
and valuation and noted that the ERP varied widely across the books and
that the moving average premium has declined from 8.4% in 1990 to 5.7%
in 2008. The average of the ERP of the textbooks he surveyed was 6.5%.
– Fernandez (2010) surveyed finance and economics professors. He found
that the average ERP used by U.S. professors was 6.0%. He also found that
the dispersion of responses was high among U.S. professors (from 2% to
12% with a standard deviation of 1.7%).
• The ERP indicated by surveys of academics (1) are much higher than the
ERP in practice and (2) contradict other academic research that indicates
that even the lower ERP used by practitioners are too high.
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14. Implied ERP: DCF Model-based Premia
• The rationale for using an implied ERP is that it provides an
indication of the forward-looking ERP based on market prices as of
the valuation date.
• DCF Model-based ERP
– The implied ERP can be derived using the following formula:
Where:
E(FCFE) = expected free cash flow to equity
g = expected long-term growth rate
ke = cost of equity
The price of the selected market index (e.g., the S&P 500) as of the
valuation date is input for the “Value of Equity”, projected dividends
and share buybacks can be input for E(FCFE), and the yield on the risk-
free security can be used for the long-term growth rate “g”. Then “ke”
can is solved for. Subtracting the yield on the selected risk-free asset
results in the estimate of the implied ERP.
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16. Implied ERP: DCF Model-based Premia
• As of January 1, 2010, the implied ERP was 4.36%,
calculated as follows:
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17. Implied ERP: Default Spread-based
Premia
• It can be argued that assets across all classes of risky
assets (equities, corporate bonds, etc.) should be priced
consistently.
• If this is the case, ERP can be estimated in terms of the
default spread on corporate bonds.
– For instance, assume that (1) the default spread on Baa-rated
corporate bonds, relative to the ten-year treasury bond, is
2.2% and (2) that the ERP is routinely twice as high as the
default spread on Baa bonds. Then, the ERP would be 4.4%.
• The average and median ratio of the ERP to the Baa
default spread from 1960 to 2008 is 2.38 and 2.02,
respectively.
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19. Implied ERP: Default Spread-based
Premia
• As of January 1, 2010, the default spread on a Baa-rated bond
was 2.41%. Applying the median ratio of 2.02 (estimated from
1960-2009) to the Baa default spread of 2.41% on January 1,
2010 results in the following estimate of the imputed ERP:
Default Spread on Baa bonds (over treasury) on 9/30/09 = 2.41%
Imputed ERP = Default Spread * Median ratio or ERP/Spread
Imputed ERP = 2.41%* 2.02 = 4.87%
This is higher than the implied DCF model-based ERP of 4.36% in
January 2010, but there is significant variation in the ratio (of ERP
to default spreads) over time.
– The ratio dropped below 1.0 at the peak of the dot.com boom (when
ERP dropped to 2%) and rose to as high as 2.63 at the end of
2006. The standard error in the estimate is 0.20.
• However, whenever the ratio has deviated significantly from the
median there has been reversion back to the median over time.
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20. Summary of ERP Estimates
Approach Used ERP Additional Information
SBBI Long-Horizon ERP (Arithmetic Mean) 6.70% Ibbotson SBBI 2010 Valuation Yearbook (1926-2009)
Duff & Phelps historical ERP for large company stocks 4.25% Duff & Phelps, LLC Risk Premium Report 2010 (1963-2009)
Historical Realized ERP - U.S. (Geometric) 4.70% Geometric Average - Stocks over T-Bonds: 1926-2009
Historical Realized ERP - Multiple Equity Markets 3.70% Average Premium Across 17 Markets: Dimson, Marsh and
Staunton (2010)
SBBI Long-Horizon ERP (Supply Side) 5.20% Ibbotson SBBI 2010 Valuation Yearbook (1926-2009)
Survey: CFOs 4.30% Graham and Harvey survey of CFOs (2009)
Survey: Global Fund Managers 3.80% Merrill Lynch (September 2009) survey of global managers
Survey: Individual Investors 8.30% Securities Industry Association (SIA) survey (2004)
Survey: Analyst and Companies 5.00% Fernandez survey of analysts and companies (2010)
Survey: Academics 7.00% Welch (2000)
Survey: Academics 6.00% Fernandez (2010)
Survey: Textbooks 6.50% Fernandez (2009)
Current Implied DCF-based Premium 4.56% From S&P 500 - February 1, 2010
Average Implied Premium 3.92% Average of Implied ERP: 1960-2009
Default Spread Based Premium 4.87% Default Spread * (ERP / Default Spread average)
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21. ERP used by Damodaran
• Prior to September 2008, Damodaran used 4.0% as the mature
market ERP. This was based on his estimate of the average
implied ERP over time (1960-2007).
• However, the banking and financial crisis of 2008 was unlike other
market downturns and exposed weaknesses in developed capital
markets.
• After the crisis, in the first half of 2009, Damodaran used an ERP
of 5.0 to 6.0% in his valuations.
• Having observed the reversion to historical averages in 2009,
Damodaran will use an ERP of 4.5% to 5.0% in his 2010
valuations.
• “While some may view this shifting equity risk premium as a sign
of weakness, I would frame it differently. When valuing individual
companies, I want my valuations to reflect my assessments of the
company and not assessments of the overall equity market. Using
equity risk premiums that are very different from the implied
premium will introduce a market view into individual company
valuations.” – Aswath Damodaran
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