Chapter 24: Valuation of asset classes Flashcards

1
Q

Required return for:

conventional government bond

A

risk-free real return
+ expected inflation
+ inflation risk premium

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2
Q

Required return for:

corporate bond

A

risk-free real return
+ expected inflation
+ corporate bond risk premium

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3
Q

Required return for:

Equity

A

risk-free real return
+ expected inflation
+ equity risk premium

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4
Q

Required return for:

Property

A

risk-free real return
+ expected inflation
+ property risk premium

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5
Q

Risk-free real return

A

The return on an index-linked government bond of an appropriate duration

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6
Q

Corporate bond risk premium

A

A margin to compensate for

  • the risk of default,
  • low marketability and liquidity and
  • the uncertainty over future inflation.
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7
Q

Equity risk premium

A

A margin to compensate for:

  • the risk of default,
  • low marketability and liquidity and
  • high volatility of share prices and dividends
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8
Q

Property risk premium

A

A margin to compensate for:

  • the risk of default, void
  • low marketability and liquidity
  • indivisibility
  • depreciation
  • obsolescence
  • volatility of property prices
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9
Q

Expected return for a conventional government bond

A

Gross redemption yield

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10
Q

Expected return for a corporate bond

A

Gross redemption yield

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11
Q

Expected return for an equity

A

Dividend yield + expected dividend growth

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12
Q

Expected return for a property

A

rental yield + expected rental growth

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13
Q

When does an asset ‘seem cheap’?

A

If required return < expected return

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14
Q

Simplifying assumptions when equating expected and required return to derive a fair value

A
  • all investors want a real rate of return
  • all investors have the same time horizon
  • tax can be ignored
  • reinvestment of income occurs at the expected return
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15
Q

Reverse yield gap equation

A
= gross redemption yield on conventional government bonds
- equity dividend yield
= Inflation risk premium
- equity risk premium
\+ expected dividend growth
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16
Q

What can you deduce from the reverse yield gap increasing?

A

If the assumption about fair pricing is true,
then either:
- the inflation risk premium has increased
- the equity risk premium has decreased
- prospects for equity dividend growth have increased

17
Q

When would an overseas market seem cheap?

A

If the expected return in the overseas currency
+ expected depreciation of the domestic currency
> expected return in the domestic currency

18
Q

Other methods for assessing whether an asset seems cheap or dear

A
  • yield norms
  • index levels
  • price charts (technical analysis)
  • yield ratios
19
Q

If assets are valued using market values, how would you get a consistent value for the liabilities?

A

most liabilities are not bought and sold, so a market value does not readily exist.

You could derive a market-related discount rate based on the returns on a set of assets that most closely match the liabilities.