Session 10 - Equity Valuation Concepts

Question 1

Fama - French Model

Answer 1

Required Return =
Rf + βmkt(Rmkt - rf)
+ βSMB(Rsmall - Rbig)
+βHML(Rsbm - Rlbm)

*Multifactor model that attempts to account for the higher returns generally associated w/ small cap stocks.

Question 2

Pastor - Stambaugh Model

Answer 2

• Adds a liquidity factor to the Fama - French model.
• The baseline value for the liquidity factor beta is zero. Less liquid assets should have a positive beta, more liquid = negative beta.

Question 3

Macroeconomic Multifactor Models (Burmeister, Roll, and Ross Model)

Answer 3

1. Confidence risk
2. Time horizon risk
3. Inflation risk
4. Business cycle risk
5. Market timing risk

Question 4

Build-up Model

Answer 4

Similar to risk premium approach, it is usually applied to closely-held companies where betas are not readily obtainable.
= Rf + equity risk premium
+ size premium
+ specific-company premium

Question 5

Adjusted Beta

Answer 5

Used to compensate for beta drift.

= (2/3)(regression beta) + (1/3)(1.0)

Question 6

Unlevered Beta

Answer 6

Unlevering isolates systematic risk

= (Beta of X) x [1/(1+debt/equity ratio)]

Question 7

Estimate of Beta for Company Y

Answer 7

= (unlevered Beta company X) (1+ debt/equity ratio)

Question 8

Holding Period Return

Answer 8

= (Price1 - Price0 + CF1) / Price0

Question 9

Gordon Growth Model Risk Premium

Answer 9

= (1-yr forecasted div yield market index)
+ (consensus long-term earnings growth rate)
+ (long-term government bond yield)

Question 10

Confidence Risk (multifactor models)

Answer 10

Unexpected change in the difference between the return of risky corporate bonds and government bonds.

Question 11

Time horizon risk (multifactor models)

Answer 11

Unexpected change in the difference between the return of long-term government bonds and Treasury bills

Question 12

Business cycle risk (multifactor models)

Answer 12

Unexpected change in the level of real business activity

Question 13

Market timing risk (multifactor models)

Answer 13

The equity market return that is not explained by the other multifactors.