Core Activity C - Recommend finance strategies Flashcards
What beta should be used in CAPM ?
Market implied beta ?
What are the 3 bases for valuation ?
Assets
Earnings
Cash flows
What considerations need to be taken when valuing a business ?
Intention after purchase
If selling, why?
What’s a weekness of CAPM
It’s relies on historical covariance which is not always representative of future events
How does holt approach beta?
HOLT doesn’t like beta as it doesn’t make sense to use a historical beta to predict a stocks foreward risk
Instead inputs an expected return by measuring the average return anticipated by all stocks. Form specific adjustments are then made for exposure to size and leverage factors that define the estimate
What’s another weekness of CAPM ?
It’s reliance on historical average of the ERP
What does a beta of 1 mean?
A beta of 1 means the stock moves in line with market movements
A beta of greater than 1 means the stock moves more aggressively than the market leading to more upside potential and downside in bearish periods
A beta of less than 1 means the stock is more defensive than the market
Beta of - are assets that are not correlated to the market and move in opposite directions… eg gold
What is the formula for CAPM?
E (R) = RF + B * (RM-RF)
E (r) = expected return
RM = market return
Ow can CAPM be used to deter min discount rates?
Review graph and review beta to determine the expected return using the security market line (S&P 500)
Below line = overvalued
Above line = undervalued
What are the three classifications for foreign exchange risk?
Economic, transaction & translation
How can we determine if currency hedging is required ?
Perform time series regression analysis to understand historic currency volatility
What does IRP state ?
Interest rate parity between two countries can indicate Fx volatility
How can IRP be used to forecast exchange rates ?
Use the government bond yields and the IRP formula to forecast future rates in line with the bond yields
How else can foreign currency risks be calculated relative to purchasing power ?
PPP - replacing interest rate figure with inflation rate
How is TVM expanded into Fx
Fished effect
What could be reason for slight differences between IRP and PPP?
Transaction costs
Specific items
Government intervention
What else is IRP useful for ?
An unbiased predictor of future rates … all the foreword contractors in place for hedging May impact future rates ‘self fulfilling prophecy’
How can we measure Fx risk?
Use standard deviation for currency pair and estimate downside risk based VaR ( Value at risk)
Vat calculates maximum possible risk due to normal market movements in a given period for a given level of probability
How else can VaR be a useful tool for rotomyne ?
It can also be used to ad confidence to commodity price volatility as well as Fx
Why are Fx and commodities useful for IRP PPP and VaR?
Accessible historical data
What’s the bid price ?
Highest the buyer is willing to pay
What’s the ask price ?
Lowest the seller is willing to accept
What’s the bid ask spread ?
Profit made by the bank or broker
What does wider spread suggest ?
Lower liquidity an more risk
What are the 3 steps involved in setting up a futures hedge ?
Which contracts are appropriate?
This means date / ending on or as soon as possible after
How many contracts?
Quantity / closest match
Buy or sell?
If receiving funds in future the futures hedge is sell
What’s an example of hedging translation exposure?
Matching the currency of assets and liabilities
Where is further practical example required ?
Money market hedge for Fx
What are 2 base rate benchmarks that now replace LIBOR ?
SOFR (secured overnight finance rate, US)
SONIA (sterling overnight index average)
What tools can be used to hedge interest rate risk?
Interest rate futures
Interest rate options
Interest rate swaps
What’s the difference between futures and forward contracts ?
Futures are off the shelf products and cheaper but not always perfect in terms of size
Forward contracts are customisable and more expensive but don’t leave any exposure as it’s built to cover the entire bet to the penny.
What’s the difference between an option and a futures contract ?
Options gives the right, but not the obligation
Future is an obligation
What’s a call option ?
Right to buy futures contracts (and receive interest)
Used by lenders
What’s a put option ?
Right to sell futures contracts (and pay interest)
used by borrowers
What’s the minimum equity value required to be listed on NYSE and LSE?
60m
700,000?
