New Final

For Calculating ERP, when are the two types of means and when are they used?

Arithmetic: For single-period models

Geometric: For multi-period models

For calculating ERP, what is the best proxy for R_f?

Short-term bills for when discounting one-year cash flows

Long-term bonds for when discounting multiple periods

Damodaran model formula

ERP = Developed market ERP + (Lambda * Country Risk Premium), where

Country Risk Premium = Sovereign Yield Spread * (o_{equity-Country B} / o_{bond-Country B})

What’s another way to think of ERP?

It’s the Required Rate of Return - the R_f ,Therefore, if solving for ERP using the GGM, you would use as normal but then remember to minus off the risk free rate at the end

What is a commonly cited risk metric for hedge funds? what does it do?

Maximum Drawdown - Refers to the greatest peak-to-trough of an investment strategy

What is a commonly cited risk metric for banks? what does it do?

Liquidity Gap - Indicates mismatches between assets and liabilities

What two scenario risk measures are common for hedge funds and what are their purpose?

Single Factor Stress Test is used to isolate specific risk factors, such as the use of leverage

Reverse Stress Test is used to identify the most significant risks

What scenario risk measure is used to isolate specific risk factors?

Single Factor Stress Test

What scenario risk measure is used to identify the most significant risks?

Reverse Stress Test

What scenario risk measure is common around traditional asset managers that do not use leverage?

Multifactor scenario test

Historical simulation method of VaR uses only what?

Current Portfolio Constituents

What are the limitations of VaR?

Subjective nature, oversimplification, correlations, and liquidity

VaR methods that assume a normal distribution often underestimate what?

Probability of extreme adverse events, also known as left-tail events

What’s an advantage of VaR

Can be validated through backtesting

Another name for ex-ante tracking error?

Relative VaR

Another name for relative VaR?

ex-ante tracking error

What are the two second order effects?

Convexity and Gamma

Single-stage RI model formula

B₀ + [(ROE - r) / (r - g)]B₀

Formula for multistage RI model with persistence factor

PV(Terminal Value) = RI / [(1 + r - w)(1 + r)^t-1

Justified price-to-book ratio:

(ROE - g) / (r - g)

Key difference between Justified Price-to-Book ratio, and the single-factor RI income factor formulas?

The P/B ratio uses growth (g) in the numerator, in place of the required rate of return (r) (excluding the BVPS parts)

RI Formula (Equity Charge)

RI = NI - Equity Charge

Equity Charge Formula

Equity Charge = Equity Capital (BV) x Cost of Equity

How does a single-stage RI valuation work?

Values a company by assuming a constant, perpetual ROE and constant earnings growth rate

For Residual Income, report Net Income may need an adjustment for what?

Clearn surplus violations and nonrecurring items

For Residual Income, report Book Value of Equity may need an adjustment for what?

Off-balance sheet items, fair value discrepencies, and amortization of intangibles

NAV calculation method reminders:

Apply growth rate before capitalising

Don’t include goodwill

(Come back to this question)

How does the direct capitalisation method work?

Values the property as a perpetuity, using the first year’s NOI as a proxy and the going-in cap rate as the perpetual cashflow, i.e.:

NOI₁ / Cap-Rate Going In

Is Terminal or Going-In Cap Rate used for the Direct Capitalization Method?

Going-In

Direct Capitalisation Method Formula

NOI₁ / Going-in Cap Rate

Which Cap Rate is used for DCF valuation method?

Terminal

NOI is expected to peak during periods of:

oversupply in the retail space

Market Price of risky bond

MP = {[(MV x (1 - POD)] + (MV x RR x POD)} / (1 + r_f)

LGD Formula

LGD = EE(1 - RR)

CFA Formula

CVA = Sum of All(EL) x DF, where DF is the Discount Factor

EL Formula

EL = LGD x POD

What actually is Expected Exposure?

It’s literally just the cashflows, and then discounted if provided, thus:

Coupon rate = 3, t = 3:

EE = 3 + 3 + 103, and then they would also get discounted at their discount factors if provided

Credit Rating % Price Change Formula

- Modified Duration x Yield Spread Change

The factors driving livestock exports in the US include:

Improved freezing technologies, and increased demand from developing nation nations

The factors driving increased US livestock investment include:

Low-cost sources of animal feed, large grazing acreage, and stong domestic demand

What is the Insurance Theory

Futures Curve always in Backwardation because producers constantly sell forward to lock in price

What is the Hedging Pressure Hypothesis?

Producers and consumers seek protection from volatility by hedging, therefore, if producers are more interested in hedging, they push future price lower causing backwardation, and vice versa for consumers causing contango

What is the Theory of Storage?

Difference in spot price and futures price is caused by storage cost and convenience yield