Security Analysis

Transcription

Security Analysis

SecurityAnalysis
Part1
Sigit Wibowo
Email: [email protected]
DepartmentofManagement
FacultyofEconomics&Business
February15, 2015
.
CourseGrade
SecurityAnalysis
AnIntroductionto
Investment
1.
2.
3.
4.
5.
Participation
Paper&presentation1
Mid-termexam
Paper&presentation2
Finalexam
Total
Introductionto
AssetPricing
Models
10%
15%
30%
15%
30%
100%
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
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TopicOutlines
SecurityAnalysis
Session
1
Description
References
InvestinginIndonesia
Basicportfoliotheory(Markowitz)
[1], Ch. 1&3
[1], Ch. 7
2
CapitalAssetPricingModel
[1], Ch. 8
3
Fundamentalanalysis
Firmanalysisusingfinancialstatement
[1], Ch. 10
[1], Ch. 4
[1], Ch. 11
Macroeconomicanalysis
Industryanalysis
[1], Ch. 11
[1], Ch. 12
[1], Ch. 13
5
Technicalanalysis
[1], Ch. 16
6
Indexasmarketrepresentation
(Paperssubmission)
[1], Ch. 4&5
7
Grouppresentation
4
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
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Investment
WhyDoIndividualsInvest?
SecurityAnalysis
AnIntroductionto
Investment
4
.
TheInvestmentSetting
InvestmentsinaGlobal
Market
▶
AnIntroductiontoPortfolio
Management
Bysavingmoney(insteadofspendingit),
individualstradeoffpresentconsumptionfora
largerfutureconsumption.
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
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Investment
HowDoWeMeasureTheRateOfReturnOnAnInvestment?
SecurityAnalysis
▶
The purerateofinterest istheexchangerate
betweenfutureconsumption(futuredollars)and
presentconsumption(currentdollars). Market
forcesdeterminethisrate.
AnIntroductionto
Investment
5
.
Market
Management
Appendix
Introductionto
AssetPricing
Models
$1.00 + 4% = $1.04
Fundamental
Analysis
▶
Macroeconomic
andIndustry
Analysis
People’swillingnesstopaythedifferencefor
borrowingtodayandtheirdesiretoreceivea
surplusontheirsavingsgiverisetoaninterest
ratereferredtoasthe puretimevalueofmoney.
TechnicalAnalysis
IndexasMarket
Representation
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Investment
HowDoWeMeasureTheRateOfReturnOnAnInvestment?
SecurityAnalysis
▶
▶
Ifthefuturepaymentwillbediminishedinvalue
becauseof inflation, thentheinvestorwill
demandaninterestratehigherthanthepuretime
valueofmoneytoalso covertheexpected
inflationexpense.
Ifthefuturepaymentfromthe investmentisnot
certain, theinvestorwilldemandaninterestrate
thatexceedsthepuretimevalueofmoneyplus
theinflationrateto provideariskpremium to
covertheinvestmentrisk.
AnIntroductionto
Investment
6
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Market
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
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DefininganInvestment
SecurityAnalysis
AnIntroductionto
Investment
7
▶
Market
A currentcommitmentof$foraperiodoftimein
ordertoderivefuturepaymentsthatwill
compensatefor:
▶
▶
▶
.
Management
Appendix
Introductionto
AssetPricing
Models
thetimethefundsarecommitted
theexpectedrateofinflation
uncertaintyoffutureflowoffunds.
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
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MeasuresofHistoricalRatesofReturn
HoldingPeriodReturnandHoldingPeriodYield
SecurityAnalysis
▶
HoldingPeriodReturn(HPR)
Endingvalueofinvestment
HPR =
Beginningvalueofinvestment
$220
=
= 1.10
$200
AnIntroductionto
Investment
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.
Market
(1)
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
▶
HoldingPeriodYield(HPY)
HPY = HPR − 1
= 1.10 − 1 = 0.10 = 10%
Macroeconomic
andIndustry
Analysis
(2)
TechnicalAnalysis
IndexasMarket
Representation
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SecurityAnalysis
AnIntroductionto
Investment
▶
AnnualHoldingPeriodReturn
𝑛
AnnualHPR = √HPR
▶
9
Market
Management
(3)
Appendix
Introductionto
AssetPricing
Models
where 𝑛 = numberofyearsinvestmentisheld
AnnualHoldingPeriodYield
AnnualHPY = AnnualHPR − 1
.
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
(4)
TechnicalAnalysis
IndexasMarket
Representation
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ArithmeticMeanandGeometricMean
SecurityAnalysis
▶
ArithmeticMean(AM)
AnIntroductionto
Investment
𝐴𝑀 = 􏾜
HPY
𝑛
10
(5)
.
Market
Management
Appendix
▶
where ∑ HPY = thesumofannualholding
periodyields
GeometricMean(GM)
𝑛
𝐺𝑀 = √𝜋HPR − 1
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
(6)
TechnicalAnalysis
where 𝜋 = theproductoftheannualholding
periodreturnsasfollows: HPR􏷠 × HPR􏷡 ...HPR𝑛
IndexasMarket
Representation
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A PortfolioofInvestments
SecurityAnalysis
AnIntroductionto
Investment
11
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Market
▶
Themeanhistoricalrateofreturnforaportfolio
ofinvestmentsismeasuredastheweighted
averageoftheHPYsfortheindividual
investmentsintheportfolio, ortheoverallchange
inthevalueoftheoriginalportfolio
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
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A PortfolioofInvestments
(cont’d)
SecurityAnalysis
Table 1: ComputationofHoldingPeriodYieldforaportfolio
AnIntroductionto
Investment
12
#
Begin
Stock Shares Price
A
B
C
Total
Beginning
Mkt. Val.
100,000 $10 $ 1,000,000
200,000 $20 $ 4,000,000
500,000 $30 $15,000,000
$20,000,000
End.
Price
$12
$21
$33
End.
Mkt. Val. HPR HPY
Mkt
Wt.
Wtd.
HPY
$ 1,200,000 1.20 20% 0.05
$ 4,200,000 1.05 5% 0.20
$16,500,000 1.10 10% 0.75
0.010
0.010
0.075
$21,900,000
0.095
.
Market
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
$21, 900, 000
= 1.095
$20,000,000
HPY = 1.095 − 1 = 0.095 = 9.5%
HPR =
TechnicalAnalysis
IndexasMarket
Representation
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ExpectedRatesofReturn
SecurityAnalysis
▶
▶
▶
Riskisuncertaintythataninvestmentwillearnits
expectedrateofreturn
Probabilityisthelikelihoodofanoutcome
Expectedratesofreturn 𝐸 = (𝑅𝑖 )
AnIntroductionto
Investment
13
Market
Management
Appendix
Introductionto
AssetPricing
Models
𝐸(𝑅𝑖 ) = (Probabilityofreturn) × (Possiblereturn)
Fundamental
Analysis
𝑛
= 􏾜 𝑃􏷠 𝑅􏷠 + 𝑃􏷡 𝑅􏷡 + ... + (𝑃𝑛 𝑅𝑛 )
.
(7)
Macroeconomic
andIndustry
Analysis
𝑛
TechnicalAnalysis
= 􏾜 𝑃𝑖 𝑅𝑖
IndexasMarket
Representation
𝑖=􏷠
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RiskAversion
SecurityAnalysis
AnIntroductionto
Investment
14
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Market
▶
Management
Theassumptionthatmostinvestorswillchoose
theleastriskyalternative, allelsebeingequaland
thattheywillnotacceptadditionalriskunless
theyarecompensatedintheformofhigherreturn
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
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ProbabilityDistributions
SecurityAnalysis
1.0
AnIntroductionto
Investment
15
0.8
Market
Management
0.6
Appendix
0.4
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AssetPricing
Models
Fundamental
Analysis
0.2
0.0
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Macroeconomic
andIndustry
Analysis
-5%
0%
5%
RateofReturn
10%
15%
TechnicalAnalysis
IndexasMarket
Representation
Figure 1: Risk-freeInvestment
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SecurityAnalysis
1.0
AnIntroductionto
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0.8
Market
Management
0.6
Appendix
0.4
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Models
Fundamental
Analysis
0.2
0.0
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.
Macroeconomic
andIndustry
Analysis
-30
-20%
-10%
0%
10%
RateofReturn
20%
30%
TechnicalAnalysis
IndexasMarket
Representation
Figure 2: RiskyInvestmentwith3PossibleReturns
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SecurityAnalysis
1.0
AnIntroductionto
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0.8
Market
Management
0.6
Appendix
0.4
Introductionto
AssetPricing
Models
Fundamental
Analysis
0.2
0.0
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.
Macroeconomic
andIndustry
Analysis
-40% -30% -20% -10% 0 10% 20% 30% 40% 50%
RateofReturn
TechnicalAnalysis
IndexasMarket
Representation
Figure 3: Riskyinvestmentwithtenpossibleratesofreturn
417
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MeasuringtheRiskofExpectedRates
ofReturn
SecurityAnalysis
▶
Variance(𝜎􏷡 )
AnIntroductionto
Investment
𝜎 = (Probabilityofreturn)
× (Possiblereturn − Expectedreturn)
18
Management
Appendix
𝑛
= 􏾜 𝑃𝑖 [𝑅𝑖 − 𝐸(𝑅𝑖 )]
.
Market
􏷡
􏷡
(8)
Introductionto
AssetPricing
Models
𝑖=􏷠
Fundamental
Analysis
▶
StandardDeviationisthesquarerootofthe
variance
􏽭 𝑛
⃓
𝜎 = ⃓􏾜 𝑃𝑖 [𝑅𝑖 − 𝐸(𝑅𝑖 )]􏷡
⎷ 𝑖=􏷠
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
(9)
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MeasuringtheRiskofExpectedRates
ofReturn
SecurityAnalysis
▶
AnIntroductionto
Investment
Coefficientofvariation(CV)
▶
19
Market
ameasureofrelativevariabilitythatindicatesrisk
perunitofreturn
StandardDeviationofReturns
ExpectedRateofReturns
𝜎𝑖
=
𝐸(𝑅)
.
Management
Appendix
Introductionto
AssetPricing
Models
𝐶𝑉 =
Fundamental
Analysis
(10)
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
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MeasuringtheRiskofHistoricalRates
ofReturn
SecurityAnalysis
AnIntroductionto
Investment
20
𝑛
𝜎 = 􏾜 [HPY𝑖 − 𝐸(HPY)]
􏷡
􏷡/𝑛
Market
(11)
Management
𝑖=􏷠
▶
▶
▶
▶
.
Appendix
Introductionto
AssetPricing
Models
𝜎􏷡 = varianceoftheseries
HPY𝑖 = holdingperiodyieldduringperiod 𝑖
𝐸(HPY) =expectedvalueoftheHPY thatisequal
tothearithmeticmeanoftheseries
𝑛 = thenumberofobservations
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
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DeterminantsofRequiredRatesofReturn
SecurityAnalysis
AnIntroductionto
Investment
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.
Market
▶
▶
▶
Management
Timevalueofmoneyduringtheperiodof
investment
Expectedrateofinflationduringtheperiod
Riskinvolved
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
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TheRealRiskFreeRate(RRFR)
SecurityAnalysis
▶
▶
▶
▶
Assumesnoinflation.
Assumesnouncertaintyaboutfuturecashflows.
Influencedbytimepreferenceforconsumptionof
incomeandinvestmentopportunitiesinthe
economy
Adjustingforinflation
1 + NominalRFR
RealRFR = 􏿰
􏿳−1
1 + RateofInflation
AnIntroductionto
Investment
22
.
Market
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
(12)
TechnicalAnalysis
IndexasMarket
Representation
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NominalRisk-FreeRate
SecurityAnalysis
AnIntroductionto
Investment
▶
Dependentupon
▶
▶
▶
23
.
Market
ConditionsintheCapitalMarkets
ExpectedRateofInflation
Management
Appendix
Introductionto
AssetPricing
Models
Adjustingforinflation
NominalRFR = (1 + RealRFR)
× (1 + ExpectedRateofInflation) − 1
(13)
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
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FacetsofFundamentalRisk
SecurityAnalysis
AnIntroductionto
Investment
24
▶
▶
▶
▶
▶
.
Market
Businessrisk
Financialrisk
Liquidityrisk
Exchangeraterisk
Countryrisk
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
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.
BusinessRisk
SecurityAnalysis
AnIntroductionto
Investment
25
.
Market
▶
▶
Management
Uncertaintyofincomeflowscausedbythe
natureofafirm’sbusiness
Salesvolatilityandoperatingleveragedetermine
thelevelofbusinessrisk.
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
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FinancialRisk
SecurityAnalysis
AnIntroductionto
Investment
26
▶
▶
▶
.
Market
Uncertaintycausedbytheuseofdebtfinancing.
Borrowingrequiresfixedpaymentswhichmust
bepaidaheadofpaymentstostockholders.
Theuseofdebtincreasesuncertaintyof
stockholderincomeandcausesanincreaseinthe
stock’sriskpremium.
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
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LiquidityRisk
SecurityAnalysis
AnIntroductionto
Investment
27
▶
Market
Uncertaintyisintroducedbythesecondary
marketforaninvestment.
▶
▶
.
Management
Appendix
Introductionto
AssetPricing
Models
Howlongwillittaketoconvertaninvestment
intocash?
Howcertainisthepricethatwillbereceived?
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
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ExchangeRateRisk
SecurityAnalysis
AnIntroductionto
Investment
28
▶
▶
.
Market
Uncertaintyofreturnisintroducedbyacquiring
securitiesdenominatedinacurrencydifferent
fromthatoftheinvestor.
Changesinexchangeratesaffecttheinvestors
returnwhenconvertinganinvestmentbackinto
the“home”currency.
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
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.
CountryRisk
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Politicalriskistheuncertaintyofreturnscaused
bythepossibilityofamajorchangeinthe
politicaloreconomicenvironmentinacountry.
Individualswhoinvestincountriesthathave
unstablepolitical-economicsystemsmust
includeacountryrisk-premiumwhen
determiningtheirrequiredrateofreturn
29
.
Market
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
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RiskPremium
SecurityAnalysis
AnIntroductionto
Investment
30
.
Market
▶
▶
Management
𝑓(BusinessRisk, FinancialRisk, LiquidityRisk,
ExchangeRateRisk, CountryRisk)
or
𝑓(SystematicMarketRisk)
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
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.
RiskPremiumandPortfolioTheory
SecurityAnalysis
AnIntroductionto
Investment
31
▶
▶
▶
.
Market
Therelevantriskmeasureforanindividualasset
isitsco-movementwiththemarketportfolio
Systematicriskrelatesthevarianceofthe
investmenttothevarianceofthemarket
Beta(𝛽)measuresthissystematicriskofanasset
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
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FundamentalRiskvs. SystematicRisk
SecurityAnalysis
AnIntroductionto
Investment
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▶
▶
.
Market
Fundamentalriskcomprisesbusinessrisk,
financialrisk, liquidityrisk, exchangeraterisk,
andcountryrisk
Systematicriskreferstotheportionofan
individualasset’stotalvarianceattributabletothe
variabilityofthetotalmarketportfolio
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
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RelationshipBetweenRiskandReturn
SecurityAnalysis
𝐸(return)
AnIntroductionto
Investment
33
Lowrisk Averagerisk
Highrisk
.
Market
Security
Market
Line
Management
Appendix
Introductionto
AssetPricing
Models
The slope indicates the required return per unit of risk
Fundamental
Analysis
RFR
.
Macroeconomic
andIndustry
Analysis
Risk
TechnicalAnalysis
(Businessrisk, etc., orsystematicriskbeta)
IndexasMarket
Representation
Figure 4: SecurityMarketLine
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SecurityAnalysis
𝐸(return)
AnIntroductionto
Investment
34
•
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
RFR
.
.
Market
Security
Market
Line
• Movement along the curve
that reflect changes in the
risk of the asset
Macroeconomic
andIndustry
Analysis
Risk
TechnicalAnalysis
IndexasMarket
Representation
Figure 5: Changesintherequiredrateofreturnduetomovements
alongtheSML
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ChangesintheSlopeoftheSML
SecurityAnalysis
AnIntroductionto
Investment
35
.
Market
𝑅𝑃𝑖 = 𝐸(𝑅𝑖 ) − 𝑁𝑅𝐹𝑅
▶
▶
▶
(14)
Management
Appendix
Introductionto
AssetPricing
Models
𝑅𝑃𝑖 = riskpremiumforasseti
𝐸(𝑅𝑖 ) = theexpectedreturnforasseti
𝑁𝑅𝐹𝑅 = thenominalreturnonarisk-freeasset
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
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MarketPortfolioRisk
SecurityAnalysis
▶
Themarketriskpremiumforthemarketportfolio
(containsalltheriskyassetsinthemarket)canbe
computed:
𝑅𝑃𝑚 = 𝐸(𝑅𝑚 ) − 𝑁𝑅𝐹𝑅
AnIntroductionto
Investment
36
Market
Management
Appendix
Introductionto
AssetPricing
Models
(15)
Fundamental
Analysis
where
▶
▶
▶
.
Macroeconomic
andIndustry
Analysis
𝑅𝑃𝑚 = riskpremiumonthemarketportfolio
𝐸(𝑅𝑚 ) = expectedreturnonthemarketportfolio
𝑁𝑅𝐹𝑅 = expectedreturnonarisk-freeasset
TechnicalAnalysis
IndexasMarket
Representation
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SecurityAnalysis
𝐸(return)
AnIntroductionto
Investment
37
•
𝑅𝑚′
New
SML
Market
Original
SML
Management
Appendix
Introductionto
AssetPricing
Models
•
𝑅𝑚
.
Fundamental
Analysis
NRFR
.
Macroeconomic
andIndustry
Analysis
Risk
TechnicalAnalysis
IndexasMarket
Representation
Figure 6: Changeinmarketriskpremium
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TheSML andExpectedInflation
SecurityAnalysis
𝐸(return)
AnIntroductionto
Investment
38
New
SML
.
Market
Original
SML
Management
Appendix
Introductionto
AssetPricing
Models
NRFR’
Fundamental
Analysis
NRFR
.
Macroeconomic
andIndustry
Analysis
Risk
TechnicalAnalysis
IndexasMarket
Representation
Figure 7: Capitalmarketconditions, expectedinflation, andthe
SML
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Reasons for the expansion of investmentopportunities
SecurityAnalysis
AnIntroductionto
Investment
40
.InvestmentsinaGlobal
Market
Management
1. Growthanddevelopmentofforeignfinancial
markets
2. Advancesintelecommunicationstechnology
3. Mergersoffirmsandsecurityexchanges
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
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TheCaseforGlobalInvestments
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Ratesofreturnavailableonnon-U.S.securities
oftenexceedU.S.Securitiesduetohighergrowth
ratesinforeigncountries, especiallytheemerging
markets
Diversificationwithforeignsecuritiescanhelp
reduceportfolioriskbecauseforeignmarkets
havelowcorrelationwithU.S.capitalmarkets
41
Market
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
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GlobalBondPortfolioRisk
SecurityAnalysis
AnIntroductionto
Investment
1. Macroeconomicdifferencescausethecorrelation
ofbondreturnsbetweentheUnitedStatesand
foreigncountriestodiffer
2. Thecorrelationofreturnsbetweenasinglepairof
countrieschangesovertimebecausethefactors
influencingthecorrelationchangeovertime
42
Market
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
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Risk of Combined Country Investments
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
Diversifiedportfoliosreducevariabilityofreturns
overtime
Correlationcoefficientsmeasurediversification
contribution
ComparecorrelationofreturnamongU.S.bonds
andstockswithreturnsonforeignbondsand
stocks
43
Market
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
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GlobalBondPortfolioRisk
SecurityAnalysis
▶
▶
▶
▶
▶
▶
Lowpositivecorrelation
OpportunitiesforU.S.investorstoreducerisk
Correlationchangesovertime
Addingnon-correlatedforeignbondstoa
portfolioofU.S.bondsincreasestherateof
returnandreducestheriskoftheportfolio
Lowpositivecorrelation
Opportunitiestoreduceriskofstockportfolioby
includingforeignstocks
AnIntroductionto
Investment
44
Market
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
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.
SummaryonGlobalInvesting
SecurityAnalysis
AnIntroductionto
Investment
45
▶
Market
Management
Relativelyhighratesofreturncombinedwithlow
correlationcoefficientsindicatethatadding
foreignstocksandbondstoaU.S.portfoliowill
reduceriskandmayincreaseitsaveragereturn
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
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.
GlobalInvestmentChoices
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
▶
▶
▶
Fixed-incomeinvestments: bondsandpreferred
stocks
Equityinvestments
Specialequityinstruments: warrantsandoptions
Futurescontracts
Investmentcompanies
Realassets
46
Market
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Fixed-IncomeInvestments
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
Contractualpaymentschedule
Recoursevariesbyinstrument
Bonds
▶
▶
▶
47
Management
Appendix
Introductionto
AssetPricing
Models
investorsarelenders
expectinterestpaymentandreturnofprincipal
Fundamental
Analysis
Preferredstocks
▶
Market
Macroeconomic
andIndustry
Analysis
dividendsrequireboardofdirectorsapproval
TechnicalAnalysis
IndexasMarket
Representation
417
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.
SavingsAccounts
SecurityAnalysis
▶
▶
▶
▶
▶
▶
Fixedearnings
Convenient
Liquid
Lowrisk
Lowrates
CertificatesofDeposit(CDs)
▶
▶
AnIntroductionto
Investment
48
Market
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
instrumentsthatrequireminimumdepositsfor
specifiedterms, andpayhigherratesofinterest
thansavingsaccounts
Penaltyimposedforearlywithdrawal
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
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.
MoneyMarketCertificates
SecurityAnalysis
AnIntroductionto
Investment
49
▶
▶
▶
▶
▶
CompeteagainstTreasurybills(T-bills)
Minimum$10,000
Minimummaturityofsixmonths
Redeemableonlyatbankofissue
Penaltyifwithdrawnbeforematurity
Market
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
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.
CapitalMarketInstruments
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
▶
▶
Fixedincomeobligationsthattradeinsecondary
market
U.S.Treasurysecurities
U.S.Governmentagencysecurities
Municipalbonds
Corporatebonds
50
Market
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
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.
U.S.TreasurySecurities
SecurityAnalysis
AnIntroductionto
Investment
▶
Bills, notes, orbonds-dependingonmaturity
▶
▶
▶
▶
▶
51
Market
Management
Billsmatureinlessthan1year
Notesmaturein1-10years
Bondsmatureinover10years
Appendix
Introductionto
AssetPricing
Models
Highlyliquid
BackedbythefullfaithandcreditoftheU.S.
Government
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
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.
U.S.GovernmentAgencySecurities
SecurityAnalysis
▶
▶
▶
▶
▶
▶
AnIntroductionto
Investment
Soldbygovernmentagencies
FederalNationalMortgageAssociation(FNMA or
FannieMae)
FederalHomeLoanBank(FHLB)
GovernmentNationalMortgageAssociation
(GNMA orGinnieMae)
FederalHousingAdministration(FHA)
52
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
NotdirectobligationsoftheTreasury
▶
Market
Stillconsidereddefault-freeandfairlyliquid
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
MunicipalBonds
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
Issuedbystateandlocalgovernmentsusuallyto
financeinfrastructuralprojects.
Exemptfromtaxationbythefederalgovernment
andbythestatethatissuedthebond, provided
theinvestorisaresidentofthatstate
Twotypes:
▶
▶
53
Market
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
Generalobligationbonds(GOs)
Revenuebonds
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
CorporateBonds
SecurityAnalysis
▶
▶
▶
▶
▶
Issuedbyacorporation
Fixedincome
Creditqualitymeasuredbyratings
Maturity
Features
▶
▶
▶
AnIntroductionto
Investment
54
Market
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Indenture
Callprovision
Sinkingfund
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
CorporateBonds
SecurityAnalysis
▶
▶
▶
55
Appendix
Introductionto
AssetPricing
Models
securedbyliensonspecificassets
Fundamental
Analysis
securedbyfinancialassets
Macroeconomic
andIndustry
Analysis
Equipmenttrustcertificates
▶
Market
Management
Collateraltrustbonds
▶
▶
mostseniorbondsincapitalstructureandhave
thelowestriskofdefault
Mortgagebonds
▶
▶
AnIntroductionto
Investment
Seniorsecuredbonds
TechnicalAnalysis
securedbytransportationequipment
IndexasMarket
Representation
417
Sigit Wibowo
.
CorporateBonds
SecurityAnalysis
▶
Debentures
▶
▶
▶
Unsecuredpromisestopayinterestandprincipal
Incaseofdefault, debentureownercanforce
bankruptcyandclaimanyunpledgedassetsto
payoffthebonds
AnIntroductionto
Investment
56
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Subordinatedbonds
▶
Market
Unsecuredlikedebentures, butholdersofthese
bondsmayclaimassetsafterseniorsecuredand
debentureholdersclaimshavebeensatisfied
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
CorporateBonds
SecurityAnalysis
AnIntroductionto
Investment
▶
Incomebonds
▶
▶
57
Management
Interestpaymentcontingentuponearning
sufficientincome
Appendix
Introductionto
AssetPricing
Models
Convertiblebonds
▶
▶
Market
Offertheupsidepotentialofcommonstockand
thedownsideprotectionofabond
Usuallyhavelowerinterestrates
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
CorporateBonds
SecurityAnalysis
▶
▶
▶
▶
AnIntroductionto
Investment
Warrants
Allowsbondholdertopurchasethefirm’s
commonstockatafixedpriceforagiventime
period
Interestratesusuallyloweronbondswith
warrantsattached
58
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Zerocouponbond
▶
▶
Market
Macroeconomic
andIndustry
Analysis
Offeredatadeepdiscountfromthefacevalue
Nointerestduringthelifeofthebond, onlythe
principalpaymentatmaturity
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
PreferredStock
SecurityAnalysis
▶
▶
▶
▶
▶
▶
Hybridsecurity
Fixeddividends
Dividendobligationsarenotlegallybinding, but
mustbevotedonbytheboardofdirectorstobe
paid
Mostpreferredstockiscumulative
Creditimplicationsofmissingdividends
Corporationsmayexclude80%ofdividend
incomefromtaxableincome
AnIntroductionto
Investment
59
Market
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
InternationalBondInvesting
SecurityAnalysis
AnIntroductionto
Investment
60
▶
Market
Management
Investorsshouldbeawarethatthereisavery
substantialfixedincomemarketoutsidethe
UnitedStatesthatoffersadditionalopportunity
fordiversification
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
▶
Bondidentificationcharacteristics
▶
▶
▶
▶
▶
AnIntroductionto
Investment
61
Countryoforigin
Locationofprimarytradingmarket
Homecountryofthemajorbuyers
Currencyofthesecuritydenomination
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Eurobond
▶
Market
Macroeconomic
andIndustry
Analysis
Aninternationalbonddenominatedinacurrency
notnativetothecountrywhereitisissued
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
▶
Yankeebonds
▶
▶
▶
AnIntroductionto
Investment
62
SoldintheUnitedStatesanddenominatedis
U.S.dollars, butissuedbyforeigncorporations
orgovernments
EliminatesexchangerisktoU.S.investors
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Internationaldomesticbonds
▶
Market
Macroeconomic
andIndustry
Analysis
Soldbyissuerwithinitsowncountryinthat
country’scurrency
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
EquityInvestments
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Returnsarenotcontractualandmaybebetteror
worsethanonabond
CommonStock
▶
▶
63
Market
Management
Appendix
Introductionto
AssetPricing
Models
Representsownershipofafirm
Investor’sreturntiedtoperformanceofthe
companyandmayresultinlossorgain
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
ClassificationofCommonStockCategorisedByGeneralBusinessLine
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
▶
Industrial: manufacturersofautomobiles,
machinery, chemicals, beverages
Utilities: electricalpowercompanies, gas
suppliers, waterindustry
Transportation: airlines, trucklines, railroads
Financial: banks, savingsandloans, creditunions
64
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Management
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Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
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.
AcquiringForeignEquities
SecurityAnalysis
AnIntroductionto
Investment
1. PurchaseofAmericanDepositoryReceipts
(ADRs)
2. PurchaseofAmericanshares
3. DirectpurchaseofforeignshareslistedonaU.S.
orforeignstockexchange
4. Purchaseofinternationalmutualfunds
65
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Management
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Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
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.
AmericanDepositoryReceipts(ADRs)
SecurityAnalysis
▶
▶
▶
▶
▶
▶
▶
Easiestwaytodirectlyacquireforeignshares
CertificatesofownershipissuedbyaU.S.bank
thatrepresentsindirectownershipofacertain
numberofsharesofaspecificforeignfirmon
depositinaU.S.bankinthefirm’shomecountry
BuyandsellinU.S.dollars
DividendsinU.S.dollars
Mayrepresentmultipleshares
ListedonU.S.exchanges
Verypopular
AnIntroductionto
Investment
66
Market
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
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.
PurchaseorSaleofAmericanshares
SecurityAnalysis
AnIntroductionto
Investment
67
▶
▶
▶
Market
Management
IssuedintheUnitedStatesbytransferagenton
behalfofaforeignfirm
Higherexpenses
Limitedavailability
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
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.
Direct Purchase or Sale of Foreign
Shares
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Directinvestmentinforeignequitymarketsdifficultandcomplicatedduetoadministrative,
information, taxation, andmarketefficiency
problems
PurchaseforeignstockslistedonaU.S.exchange
–limitedchoice
68
Market
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Purchase or Sale of Global Mutual
FundsorETFs
SecurityAnalysis
▶
▶
▶
Globalfunds-investinbothU.S.andforeign
stocks
Internationalfunds-investmostlyoutsidethe
U.S.
Fundscanspecialize
▶
▶
▶
▶
▶
AnIntroductionto
Investment
69
Market
Management
Appendix
Introductionto
AssetPricing
Models
Diversificationacrossmanycountries
Concentrateinasegmentoftheworld
Concentrateinaspecificcountry
Concentrateintypesofmarkets
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
Exchange-tradedfundsorETFsarearecent
innovationintheworldofindexproducts
IndexasMarket
Representation
417
Sigit Wibowo
.
SpecialEquityInstruments
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
▶
▶
Equity-derivativesecuritieshaveaclaimon
commonstockofafirm
Optionsarerightstobuyorsellatastatedprice
foraperiodoftime
Warrantsareoptionstobuyfromthecompany
Putsareoptionstoselltoaninvestor
Callsareoptionstobuyfromastockholder
70
Market
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
FuturesContracts
SecurityAnalysis
▶
▶
▶
▶
Exchangeofaparticularassetataspecified
deliverydateforastatedpricepaidatthetimeof
delivery
Deposit(10%margin)ismadebybuyerat
contracttoprotecttheseller
Commoditiestradingislargelyinfutures
contracts
Currentpricedependsonexpectations
AnIntroductionto
Investment
71
Market
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
FinancialFutures
SecurityAnalysis
▶
▶
▶
▶
Recentdevelopmentofcontractsonfinancial
instrumentssuchasT-bills, Treasurybonds, and
Eurobonds
TradedmostlyonChicagoMercantileExchange
(CME) andChicagoBoardofTrade(CBOT)
Allowinvestorsandportfoliomanagerstoprotect
againstvolatileinterestrates
Currencyfuturesallowprotectionagainst
changesinexchangerates
AnIntroductionto
Investment
72
Market
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
InvestmentCompanies
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
Ratherthanbuyindividualsecuritiesdirectly
fromtheissuertheycanbeacquiredindirectly
throughsharesinaninvestmentcompany
Investmentcompaniessellsharesinitselfand
usesproceedstobuysecurities
Investorsownpartoftheportfolioofinvestments
73
Market
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
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InvestmentCompanies
Moneymarketfunds
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
▶
▶
▶
Acquirehigh-quality, short-terminvestments
YieldsarehigherthannormalbankCDs
Typicalminimuminvestmentis$1,000
Nosalescommissioncharges
Withdrawalisbycheckwithnopenalty
Investmentsusuallyarenotinsured
74
Market
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
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.
InvestmentCompanies
Bondfunds
SecurityAnalysis
AnIntroductionto
Investment
75
▶
▶
▶
Investinlong-termgovernment, corporate, or
municipalbonds
Bondfundsvaryinbondqualityselectedfor
investment
Expectedreturnsvarywithriskofbonds
Market
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
InvestmentCompanies
Commonstockfunds
SecurityAnalysis
▶
Manydifferentfundswithvaryingstated
investmentobjectives:
▶
▶
▶
▶
▶
AnIntroductionto
Investment
76
Aggressivegrowth, income, preciousmetals,
internationalstocks
Market
Management
Appendix
Introductionto
AssetPricing
Models
Offerdiversificationtosmallerinvestors
Sectorfundsconcentrateinanindustry
InternationalfundsinvestoutsidetheUnited
States
GlobalfundsinvestintheU.S.andother
countries
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
InvestmentCompanies
Balancedfunds
SecurityAnalysis
AnIntroductionto
Investment
77
Market
Management
▶
Appendix
Investinacombinationofstocksandbonds
dependingontheirstatedobjectives
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
InvestmentCompanies
Indexfunds
SecurityAnalysis
AnIntroductionto
Investment
78
Market
Management
▶
Appendix
Thesearemutualfundscreatedtoequalthe
performanceofamarketindexliketheS&P 500
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
InvestmentCompanies
Exchange-TradedFunds(ETFs)
SecurityAnalysis
▶
▶
▶
Thesearedepositoryreceiptsforaportfolioof
securitiesdepositedatafinancialinstitutionina
unittrustthatissuesacertificateofownershipfor
theportfolioofstocks
Thestocksinaportfolioarethoseinanindexlike
theS&P 500anddozensofcountryorindustry
indexes
ETFscanbeboughtandsoldcontinuouslyonan
exchangelikecommonstock
AnIntroductionto
Investment
79
Market
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
RealEstateInvestmentTrusts(REITs)
SecurityAnalysis
▶
▶
▶
▶
Investmentfundthatinvestsinavarietyofreal
estateproperties
Constructionanddevelopmenttrustsprovide
builderswithconstructionfinancing
Mortgagetrustsprovidelong-termfinancingfor
properties
Equitytrustsownvariousincome-producing
properties
AnIntroductionto
Investment
80
Market
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
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.
DirectRealEstateInvestment
Purchaseofahome
SecurityAnalysis
AnIntroductionto
Investment
81
▶
▶
▶
Averagecostofasingle-familyhouseexceeds
$100,000
Financingbymortgagerequiresdownpayment
Homeownerhopestosellthehouseforcostplus
again
Market
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Purchaseofrawland
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
Intentionofsellinginfutureforaprofit
Ownershipprovidesanegativecashflowdueto
mortgagepayments, taxes, andproperty
maintenance
Riskfromsellingforanuncertainpriceandlow
liquidity
82
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Macroeconomic
andIndustry
Analysis
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LandDevelopment
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
▶
▶
Buyrawland
Divideintoindividuallots
Buildhousesorashoppingmallonit
Requirescapital, time, andexpertise
Returnsfromsuccessfuldevelopmentcanbe
significant
83
Market
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
RentalProperty
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
Acquireapartmentbuildingsorhouseswithlow
downpayments
Deriveenoughincomefromtherentstopaythe
expensesofthestructure, includingthemortgage
payments, andgenerateagoodreturn
Rentalpropertyprovidesacashflowandan
opportunitytoprofitfromthesaleoftheproperty
84
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Management
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Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
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Low-LiquidityInvestments
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
▶
Someinvestmentsdon’ttradeonsecurities
markets
Lackofliquiditykeepsmanyinvestorsaway
Auctionsalescreatewidefluctuationsinprices
Withoutmarkets, dealersincurhightransaction
costs
85
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Management
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AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
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.
Antiques
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
Dealersbuyatestatesales, refurbish, andsellata
profit
Seriouscollectorsmayenjoygoodreturns
Individualsbuyingafewpiecestodecoratea
homemayhavedifficultyovercomingtransaction
coststoeverenjoyaprofit
86
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Management
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AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
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.
Art
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
▶
Investmentrequiressubstantialknowledgeofart
andtheartworld
Acquisitionofworkfromawell-knownartist
requireslargecapitalcommitmentsandpatience
Hightransactioncosts
Uncertaintyandilliquidity
87
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Management
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AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
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.
CoinsandStamps
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
▶
▶
Enjoyedbymanyashobbyandasaninvestment
Marketismorefragmentedthanstockmarket, but
moreliquidthanartandantiquesmarkets
Pricelistsarepublishedweeklyandmonthly
Gradingspecificationsaidsales
Widespreadbetweenbidandaskprices
88
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Management
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AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
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.
Diamonds
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
▶
▶
Canbeilliquid
Gradingdeterminesvalue, butissubjective
Investment-gradegemsrequiresubstantial
investments
Nopositivecashflowuntilsold
Costsofinsurance, storage, andappraisal
89
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Macroeconomic
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ArtandAntiques
SecurityAnalysis
▶
▶
▶
▶
Marketdataislimited
Resultsvarywidely, andchangeovertime,
makinggeneralizationimpossible, butshowinga
reasonablyconsistentrelationshipbetweenrisk
andreturn
Correlationcoefficientsvarywidely, allowingfor
greatdiversificationpotential
Liquidityisstillaconcern
AnIntroductionto
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Appendix
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Fundamental
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Macroeconomic
andIndustry
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TechnicalAnalysis
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Representation
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.
RealEstate
SecurityAnalysis
▶
▶
▶
▶
Returnsaredifficulttoderiveduetolackof
consistentdata
Residentialshowslowerriskandreturnthan
commercialrealestate
DuringsomeshorttimeperiodsREITshave
shownhigherreturnsthanstockwithlowerrisk
measures
Longtermreturnsforrealestatearelowerthan
stocks, andhavelowerrisk
AnIntroductionto
Investment
91
Market
Management
Appendix
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AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
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RealEstate
SecurityAnalysis
AnIntroductionto
Investment
92
▶
▶
▶
Negativecorrelationbetweenresidentialand
farmrealestateandstocks
Lowpositivecorrelationbetweencommercial
realestateandstocks
Potentialfordiversification
Market
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
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.
BackgroundAssumptions
SecurityAnalysis
▶
▶
▶
▶
Asaninvestoryouwanttomaximisethereturns
foragivenlevelofrisk.
Yourportfolioincludesallofyourassetsand
liabilities
Therelationshipbetweenthereturnsforassetsin
theportfolioisimportant.
A goodportfolioisnotsimplyacollectionof
individuallygoodinvestments.
AnIntroductionto
Investment
Market
94
.AnIntroductiontoPortfolio
Management
Appendix
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AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
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.
RiskAversion
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Givenachoicebetweentwoassetswithequal
ratesofreturn, mostinvestorswillselecttheasset
withthelowerlevelofrisk.
Evidencethatinvestorsareriskaverse:
▶
▶
Market
95
Management
Appendix
Introductionto
AssetPricing
Models
Manyinvestorspurchaseinsurancefor: Life,
Automobile, Health, andDisabilityIncome.
Yieldonbondsincreaseswithriskclassifications
fromAAA toAA toA.
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
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.
NotallInvestorsareRiskAverse
SecurityAnalysis
AnIntroductionto
Investment
Market
96
▶
Riskpreferencemayhavetodowithamountof
moneyinvolved—riskingsmallamounts, but
insuringlargelosses
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
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.
DefinitionofRisk
SecurityAnalysis
AnIntroductionto
Investment
Market
97
Management
Appendix
1. Uncertaintyoffutureoutcomes, or
2. Probabilityofanadverseoutcome
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
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.
MarkowitzPortfolioTheory
SecurityAnalysis
▶
▶
▶
▶
Quantifiesrisk
Derivestheexpectedrateofreturnforaportfolio
ofassetsandanexpectedriskmeasure
Showsthatthevarianceoftherateofreturnisa
meaningfulmeasureofportfoliorisk
Derivestheformulaforcomputingthevariance
ofaportfolio, showinghowtoeffectively
diversifyaportfolio
AnIntroductionto
Investment
Market
98
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
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.
Assumptions
SecurityAnalysis
1. Investorsconsidereachinvestmentalternativeas
beingpresentedbyaprobabilitydistributionof
expectedreturnsoversomeholdingperiod.
2. Investorsmaximiseone-periodexpectedutility,
andtheirutilitycurvesdemonstratediminishing
marginalutilityofwealth.
3. Investorsestimatetheriskoftheportfolioonthe
basisofthevariabilityofexpectedreturns.
AnIntroductionto
Investment
Market
99
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Appendix
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AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
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IndexasMarket
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.
Assumptions(cont’d)
SecurityAnalysis
AnIntroductionto
Investment
4. Investorsbasedecisionssolelyonexpected
returnandrisk, sotheirutilitycurvesarea
functionofexpectedreturnandtheexpected
variance(orstandarddeviation)ofreturnsonly.
5. Foragivenrisklevel, investorspreferhigher
returnstolowerreturns. Similarly, foragiven
levelofexpectedreturns, investorspreferlessrisk
tomorerisk.
Market
100
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Appendix
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AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
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SecurityAnalysis
AnIntroductionto
Investment
▶
Usingthesefiveassumptions, asingleassetor
portfolioofassetsisconsideredtobeefficientif
nootherassetorportfolioofassetsoffershigher
expectedreturnwiththesame(orlower)risk, or
lowerriskwiththesame(orhigher)expected
return.
Market
101
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Macroeconomic
andIndustry
Analysis
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AlternativeMeasuresofRisk
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
Varianceorstandarddeviationofexpectedreturn
Rangeofreturns
Returnsbelowexpectations
▶
▶
Market
102
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Appendix
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Models
Semivariance—ameasurethatonlyconsiders
deviationsbelowthemean
Thesemeasuresofriskimplicitlyassumethat
investorswanttominimisethedamagefrom
returnslessthansometargetrate
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
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.
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Foranindividualasset—sumofthepotential
returnsmultipliedwiththecorresponding
probabilityofthereturns
Foraportfolioofinvestments—weighted
averageoftheexpectedratesofreturnforthe
individualinvestmentsintheportfolio
Market
103
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.
(cont’d)
SecurityAnalysis
AnIntroductionto
Investment
Table 2: ComputationofExpectedReturnforanIndividualRisky
Investment
Probability
PossibleRateof
Return(Percent)
ExpectedReturn
(Percent)
0.35
0.30
0.20
0.15
0.08
0.10
0.12
0.14
0.0280
0.0300
0.0240
0.0210
𝐸(𝑅) =
Market
104
Management
Appendix
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AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
0.1030
TechnicalAnalysis
IndexasMarket
Representation
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.
(cont’d)
SecurityAnalysis
AnIntroductionto
Investment
Table 3: ComputationoftheExpectedReturnforaPortfolioof
RiskyAssets
Weight
(PercentofPortfolio)
(𝑊𝑖 )
Expected
SecurityReturn
(𝑅𝑖 )
Expected
PortfolioReturn
(𝑊𝑖 × 𝑅𝑖 )
0.20
0.30
0.30
0.20
0.10
0.11
0.12
0.13
0.0200
0.0330
0.0360
0.0260
𝐸(𝑅𝑝𝑜𝑟𝑡 ) =
0.1150
Market
105
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Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
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.
(cont’d)
SecurityAnalysis
AnIntroductionto
Investment
Market
106
𝑛
𝐸(𝑅𝑝𝑜𝑟𝑡 ) = 􏾜 𝑊𝑖 𝑅𝑖
(16)
Appendix
Introductionto
AssetPricing
Models
𝑖=􏷠
▶
▶
Management
Fundamental
Analysis
𝑊𝑖 = thepercentoftheportfolioinasset 𝑖
𝐸(𝑅𝑖 ) = theexpectedrateofreturnforasset 𝑖
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
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VarianceofReturnsforanIndividual
Investment
SecurityAnalysis
AnIntroductionto
Investment
▶
Varianceisameasureofthevariationofpossible
ratesofreturn 𝑅𝑖 , fromtheexpectedrateofreturn
[𝐸(𝑅𝑖 )]:
Market
107
Appendix
Introductionto
AssetPricing
Models
𝑛
􏷡
𝜎 = 􏾜 [𝑅𝑖 − 𝐸(𝑅𝑖 )]􏷡 𝑃𝑖
Management
(17)
Fundamental
Analysis
𝑖=􏷠
where 𝑃𝑖 istheprobabilityofthepossiblerateof
return, 𝑅𝑖
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
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.
StandardDeviationofReturnsforan
IndividualInvestment
SecurityAnalysis
AnIntroductionto
Investment
▶
Market
Standarddeviationisthesquarerootofthe
variance
􏽭 𝑛
⃓
𝜎 = ⃓􏾜 [𝑅𝑖 − 𝐸(𝑅𝑖 )]􏷡 𝑃𝑖
⎷ 𝑖=􏷠
108
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Models
(18)
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
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.
Variance (Standard Deviation) of Returns
SecurityAnalysis
Table 4: Computationofvarianceandstandarddeviationofreturn
foranindividualinvestment
Possible
Rateof
Return
( 𝑅𝑖 )
􏷟.􏷟􏷧
􏷟.􏷠􏷟
􏷟.􏷠􏷡
􏷟.􏷠􏷣
AnIntroductionto
Investment
Market
Expected
Return
𝐸(𝑅𝑖 )
􏷟.􏷠􏷟􏷢
􏷟.􏷠􏷟􏷢
􏷟.􏷠􏷟􏷢
􏷟.􏷠􏷟􏷢
109
Management
Appendix
𝑅𝑖 − 𝐸(𝑅𝑖 )
−􏷟.􏷟􏷡􏷢
−􏷟.􏷟􏷟􏷢
􏷟.􏷟􏷠􏷦
􏷟.􏷟􏷢􏷦
[𝑅𝑖 − 𝐸(𝑅𝑖 )]􏷫
􏷟.􏷟􏷟􏷟􏷤
􏷟.􏷟􏷟􏷟􏷟
􏷟.􏷟􏷟􏷟􏷢
􏷟.􏷟􏷟􏷠􏷣
𝑃𝑖
􏷟.􏷢􏷤
􏷟.􏷢􏷟
􏷟.􏷡􏷟
􏷟.􏷠􏷤
[𝑅𝑖 − 𝐸(𝑅𝑖 )]􏷫 𝑃𝑖
Introductionto
AssetPricing
Models
􏷟.􏷟􏷟􏷟􏷠􏷧􏷤
􏷟.􏷟􏷟􏷟􏷟􏷟􏷢
􏷟.􏷟􏷟􏷟􏷟􏷤􏷧
􏷟.􏷟􏷟􏷟􏷡􏷟􏷤
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
􏷟.􏷟􏷟􏷟􏷣􏷤􏷠
TechnicalAnalysis
▶
▶
IndexasMarket
Representation
Variance (𝜎􏷡 ) = 0.000451
Standarddeviation (𝜎) = 0.021237
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CovarianceofReturns
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
A measureofthedegreetowhichtwovariables
“movetogether”relativetotheirindividualmean
valuesovertime
Fortwoassets, 𝑖 and 𝑗, thecovarianceofratesof
returnisdefinedas:
𝐶𝑜𝑣𝑖𝑗 = 𝐸 􏿺[𝑅𝑖 − 𝐸(𝑅𝑖 )][𝑅𝑗 − 𝐸(𝑅𝑗 )]􏿽
Market
110
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Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
(19)
TechnicalAnalysis
IndexasMarket
Representation
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.
CovarianceandCorrelation
SecurityAnalysis
▶
▶
Thecorrelationcoefficientisobtainedby
standardising(dividing)thecovariancebythe
productoftheindividualstandarddeviations
Correlationcoefficientvariesfrom–1to+1
𝜌𝑖𝑗 =
𝐶𝑜𝑣𝑖𝑗
𝜎𝑖 𝜎𝑗
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Investment
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111
Appendix
Introductionto
AssetPricing
Models
(20)
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
where
▶
▶
▶
Management
𝜌𝑖𝑗 = thecorrelationcoefficientofreturns
𝜎𝑖 = thestandarddeviationof 𝑅𝑖𝑡
𝜎𝑗 = thestandarddeviationof 𝑅𝑗𝑡
TechnicalAnalysis
IndexasMarket
Representation
417
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CorrelationCoefficient
SecurityAnalysis
▶
▶
Itcanvaryonlyintherange+1to–1.
A valueof+1wouldindicateperfectpositive
correlation.
▶
▶
AnIntroductionto
Investment
Market
112
Appendix
Thismeansthatreturnsforthetwoassetsmove
togetherinacompletelylinearmanner
Introductionto
AssetPricing
Models
Fundamental
Analysis
A valueof–1wouldindicateperfectcorrelation
▶
Management
Thismeansthatthereturnsfortwoassetshave
thesamepercentagemovement, butinopposite
directions
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
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PortfolioStandardDeviationFormula
SecurityAnalysis
𝜎𝑝𝑜𝑟𝑡
􏽭 𝑛
𝑛
𝑛
⃓
􏷡
􏷡
= ⃓􏾜 𝑤𝑖 𝜎𝑖 + 􏾜 􏾜 𝑤𝑖 𝑤𝑗 𝐶𝑜𝑣𝑖𝑗
⃓ 𝑖=􏷠
𝑖=􏷠 𝑗=􏷠
⎷
AnIntroductionto
Investment
(21)
Market
113
where
▶ 𝜎𝑝𝑜𝑟𝑡 = thestandarddeviationoftheportfolio
▶ 𝑤𝑖 = theweightsoftheindividualassetsinthe
portfolio, whereweightsaredeterminedbythe
proportionofvalueintheportfolio
▶ 𝜎􏷡 = thevarianceofratesofreturnforasset 𝑖
𝑖
▶ 𝐶𝑜𝑣𝑖𝑗 = thecovariancebetweentheratesofreturn
forassets 𝑖 and 𝑗, where 𝐶𝑜𝑣𝑖𝑗 = 𝑟𝑖𝑗 𝜎𝑖 𝜎𝑗
Management
Appendix
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AssetPricing
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Fundamental
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Macroeconomic
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PortfolioStandardDeviationCalculation
SecurityAnalysis
▶
Anyassetofaportfoliomaybedescribedbytwo
characteristics:
▶
▶
▶
▶
AnIntroductionto
Investment
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114
Theexpectedrateofreturn
Theexpectedstandarddeviationsofreturns
Management
Appendix
Introductionto
AssetPricing
Models
Thecorrelation, measuredbycovariance, affects
theportfoliostandarddeviation
Lowcorrelationreducesportfolioriskwhilenot
affectingtheexpectedreturn
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
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.
Combining Stocks with Different ReturnsandRisk
SecurityAnalysis
Table 5: Portfolioreturnandstandarddeviationcalculation
Asset
𝐸(𝑅𝑖 )
𝑤𝑖
𝜎􏷡𝑖
𝜎𝑖
1
2
.10
.20
.50
.50
.0049
.0100
.07
.10
Case
Correlation
Coefficient
a
b
c
d
e
+1.00
+0.50
0.00
−0.50
−1.00
AnIntroductionto
Investment
Market
115
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Appendix
Introductionto
AssetPricing
Models
Covariance
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
.0070
.0035
.0000
−.0035
−.0070
TechnicalAnalysis
IndexasMarket
Representation
417
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SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
Assetsmaydifferinexpectedratesofreturnand
individualstandarddeviations
Negativecorrelationreducesportfoliorisk
Combiningtwoassetswith −1.0correlation
reducestheportfoliostandarddeviationtozero
onlywhenindividualstandarddeviationsare
equal
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116
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.
SecurityAnalysis
Table 6: ConstantCorrelationwithChangingWeights
Asset 𝐸(𝑅𝑖 )
1
.10
𝜌𝑖𝑗 = 0.00
2
.20
AnIntroductionto
Investment
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117
Management
Appendix
Case
𝑤􏷠
𝑤􏷡
𝐸(𝑅𝑖 )
𝐸(𝐹𝑝𝑜𝑟𝑡 )
f
g
h
i
j
k
l
0.00
0.20
0.40
0.50
0.60
0.80
1.00
1.00
0.80
0.60
0.50
0.40
0.20
0.00
0.20
0.18
0.16
0.15
0.14
0.12
0.10
0.1000
0.0812
0.0662
0.0610
0.0580
0.0595
0.0700
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
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Portfolio Risk-Return Plots for DifferentWeights
SecurityAnalysis
𝐸(𝑅)
AnIntroductionto
Investment
•􏷡
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118
Appendix
𝜌𝑖𝑗 = +􏷠.􏷟
Introductionto
AssetPricing
Models
•􏷠
Fundamental
Analysis
With two perfectly correlated assets, it is only possible to create a two asset portfolio with risk-return
along a line between either single asset
.
Management
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
𝜎
IndexasMarket
Representation
Figure 8: A two-assetportfoliowith 𝜌 = +1.0
417
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𝐸(𝑅)
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Investment
•􏷡
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119
Appendix
𝜌𝑖𝑗 = +􏷠.􏷟
𝜌𝑖𝑗 = 􏷟
Introductionto
AssetPricing
Models
•􏷠
Fundamental
Analysis
With uncorrelated assets it is possible to create a
two asset portfolio with lower risk than either single
asset
.
Management
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
𝜎
IndexasMarket
Representation
Figure 9: A two-assetportfoliowith 𝜌 = 0.0
417
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𝐸(𝑅)
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Appendix
𝜌𝑖𝑗 = +􏷠.􏷟
Introductionto
AssetPricing
Models
𝜌𝑖𝑗 = 􏷟 𝜌𝑖𝑗 = +􏷟.􏷤 • 􏷠
Fundamental
Analysis
With correlated assets it is possible to create a two
asset portfolio between the first two curves
.
Management
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
𝜎
IndexasMarket
Representation
Figure 10: A two-assetportfoliowith 𝜌 = +0.5
417
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𝐸(𝑅)
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Appendix
𝜌𝑖𝑗 = +􏷠.􏷟
𝜌𝑖𝑗 = −􏷟.􏷤
Introductionto
AssetPricing
Models
𝜌𝑖𝑗 = 􏷟 𝜌𝑖𝑗 = +􏷟.􏷤 • 􏷠
Fundamental
Analysis
With negatively correlated assets it is possible to
create a two asset portfolio with much lower risk
than either single asset
.
Management
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
𝜎
IndexasMarket
Representation
Figure 11: A two-assetportfoliowith 𝜌 = −0.5
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𝐸(𝑅)
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𝜌𝑖𝑗 = −􏷠.􏷟
Appendix
𝜌𝑖𝑗 = +􏷠.􏷟
𝜌𝑖𝑗 = −􏷟.􏷤
Introductionto
AssetPricing
Models
𝜌𝑖𝑗 = 􏷟 𝜌𝑖𝑗 = +􏷟.􏷤 • 􏷠
Fundamental
Analysis
With perfectly negatively correlated assets it is possible to create a two asset portfolio with almost no
risk
.
Management
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
𝜎
IndexasMarket
Representation
Figure 12: A two-assetportfoliowith 𝜌 = −1.0
417
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EstimationIssues
SecurityAnalysis
▶
▶
Resultsofportfolioallocationdependon
accuratestatisticalinputs
Estimatesof
▶
▶
▶
Market
123
▶
Management
Appendix
Expectedreturns
Standarddeviation
Correlationcoefficient
▶
▶
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Fundamental
Analysis
Amongentiresetofassets
With100assets, 4,950correlationestimates
Macroeconomic
andIndustry
Analysis
Estimationriskreferstopotentialerrors
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
EstimationIssues
SecurityAnalysis
▶
▶
Withassumptionthatstockreturnscanbe
describedbyasinglemarketmodel, thenumber
ofcorrelationsrequiredreducestothenumberof
assets
Singleindexmarketmodel:
𝑅𝑖 = 𝑎𝑖 + 𝑏𝑖 𝑅𝑚 + 𝜀𝑖
AnIntroductionto
Investment
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124
Appendix
Introductionto
AssetPricing
Models
(22)
Fundamental
Analysis
where
▶
▶
Management
Macroeconomic
andIndustry
Analysis
𝑏𝑖 = theslopecoefficientthatrelatesthereturns
forsecurity 𝑖 tothereturnsfortheaggregatestock
market
𝑅𝑚 = thereturnsfortheaggregatestockmarket
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
EstimationIssues
SecurityAnalysis
▶
Ifallthesecuritiesaresimilarlyrelatedtothe
marketandabiderivedforeachone, itcanbe
shownthatthecorrelationcoefficientbetween
twosecurities 𝑖 and 𝑗 isgivenas:
𝜌 = 𝑏 𝑖 𝑏𝑗
𝜎􏷡𝑚
𝜎𝑖 𝜎𝑗
AnIntroductionto
Investment
Market
125
Management
Appendix
Introductionto
AssetPricing
Models
(23)
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
where 𝜎􏷡𝑚 = thevarianceofreturnsforthe
aggregatestockmarket
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
TheEfficientFrontier
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Theefficientfrontierrepresentsthatsetof
portfolioswiththemaximumrateofreturnfor
everygivenlevelofrisk, ortheminimumriskfor
everylevelofreturn
Frontierwillbeportfoliosofinvestmentsrather
thanindividualsecurities
▶
Market
126
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
Exceptionsbeingtheassetwiththehighestreturn
andtheassetwiththelowestrisk
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
AnIntroductionto
Investment
𝐸(𝑅)
Ef
i
fic
Global
minimum- • •
variance portfolio
.
en
t
n
f ro
tie
r
Market
•
•
•
•
• •
•
•
127
Management
Appendix
•
Introductionto
AssetPricing
Models
Fundamental
Analysis
Individualassets
Minimum-variancefrontier
Macroeconomic
andIndustry
Analysis
𝜎
TechnicalAnalysis
IndexasMarket
Representation
Figure 13: EfficientFrontierforAlternativePortfolios
417
Sigit Wibowo
.
TheEfficientFrontier&InvestorUtility
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
Anindividualinvestor’sutilitycurvespecifiesthe
trade-offsheiswillingtomakebetweenexpected
returnandrisk
Theslopeoftheefficientfrontiercurvedecreases
steadilyasyoumoveupward
Thesetwointeractionswilldeterminethe
particularportfolioselectedbyanindividual
investor
Market
128
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Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Theoptimalportfoliohasthehighestutilityfora
giveninvestor
Itliesatthepointoftangencybetweenthe
efficientfrontierandtheutilitycurvewiththe
highestpossibleutility
Market
129
Management
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
𝐸(𝑅)
𝑈􏷬 𝑈􏷫
𝑈􏷪
AnIntroductionto
Investment
𝑈􏷬′
𝑈􏷫′
𝑈􏷪′
Market
130
Management
Appendix
•
Y
Introductionto
AssetPricing
Models
•X
.
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
𝜎
IndexasMarket
Representation
Figure 14: SelectinganOptimalRiskyPortfolio
417
Sigit Wibowo
.
UsingR
Optional
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
Therearemanywaystoconstructefficientfrontier
Check R codeforconstructingefficientfrontier:
http://economistatlarge.com/portfolio-theory/
r-optimized-portfolio/
r-code-graph-efficient-frontier
Trytoemployyourowndatausingthecode.
Market
Management
132
.
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
UsingR
HypotheticalData
SecurityAnalysis
AnIntroductionto
Investment
Efficient Frontier
and Optimal Portfolio
Market
Management
133
0.00150
Return
0.00145
0.00140
Fundamental
Analysis
0.00135
0.00130
.
Appendix
Introductionto
AssetPricing
Models
●
Risk: 1.305
Return: 0.1325%
0.013
0.014
0.015
0.016
0.017
Sharpe: 10.15% Risk (standard deviation of portfolio)
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
0.018
IndexasMarket
Representation
417
Sigit Wibowo
.
GeometricReturn&LogReturn
SecurityAnalysis
▶
AnIntroductionto
Investment
Fromthetimevalueofmoneyconcept, weknow
𝑡
thatthefuturevalueof 𝑦𝑡 is 𝑦𝑡 = 𝑦􏷟 (1 + 𝑟) .
Market
Management
134
𝑡 = 1 → 𝑦􏷠 = 𝑦􏷟 (1 + 𝑟)
Fundamental
Analysis
.
▶
.
Appendix
Introductionto
AssetPricing
Models
Macroeconomic
andIndustry
Analysis
Ifthevalue 𝑟 canbecompoundedby 𝑚 times,
𝑚
then 𝑦􏷠 = 𝑦􏷟 􏿴1 + 𝑚𝑟 􏿷
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Geometric Return & Log Return
(cont’d)
SecurityAnalysis
▶
AnIntroductionto
Investment
Ifthevalueof 𝑚 isverylarge, wecandolimit
operationasfollows.
𝑟 𝑚
lim 𝑦􏷠 = 𝑦􏷟 􏿵1 + 􏿸
𝑚→∞
𝑚
Market
Management
135
.
Appendix
Introductionto
AssetPricing
Models
𝑟 𝑚
􏿸 􏿳
𝑚→∞
𝑚
⎛
⎡
𝑚 ⎞𝑟 ⎤
𝑟 ⎟ ⎥
⎜⎜
⎢⎢
⎟⎥
1
= 𝑦􏷟 ⎢⎢⎢ 𝑚lim ⎜⎜⎜􏿶1 + 𝑚 􏿹 ⎟⎟⎟ ⎥⎥⎥
⎠⎦
⎣ 𝑟 →∞ ⎝
𝑟
Fundamental
Analysis
= 𝑦􏷟 􏿰 lim 􏿵1 +
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
(cont’d)
SecurityAnalysis
▶
𝑥
Using lim 􏿴1 + 􏷠𝑥 􏿷 = 𝑒, thenwecanwrite
AnIntroductionto
Investment
𝑥→∞
𝑦􏷠 = 𝑦􏷟 (𝑒)
= 𝑦 􏷟 𝑒𝑟
▶
Market
𝑟
Management
136
Therefore, for 𝑡 = 1, 𝑦􏷠 = 𝑦􏷟 𝑒𝑟 .
⟺ 𝑒𝑟 =
.
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
𝑦􏷠
𝑦􏷟
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
𝑦􏷠
𝑟 = ln 􏿶 􏿹 .
𝑦􏷟
IndexasMarket
Representation
417
Sigit Wibowo
.
(cont’d)
SecurityAnalysis
▶
Wecanalsodotheiterationasfollows:
𝑦􏷡 = 𝑦􏷠 𝑒𝑟
𝑦􏷢 = 𝑦􏷡 𝑒𝑟
▶
AnIntroductionto
Investment
Market
Management
137
Thus, 𝑦𝑡 = 𝑦𝑡−􏷠 𝑒𝑟 . Therefore:
𝑒𝑟 =
Fundamental
Analysis
𝑦𝑡
𝑦𝑡−􏷠
𝑟 = ln 􏿶
.
Appendix
Introductionto
AssetPricing
Models
Macroeconomic
andIndustry
Analysis
𝑦𝑡
􏿹.
𝑦𝑡−􏷠
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
InvestorType
Classof2015
SecurityAnalysis
A
MA
C
MC
M
AnIntroductionto
Investment
Market
Management
138
.
Appendix
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
CapitalMarketTheory
AnOverview
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Capitalmarkettheoryextendsportfoliotheory
anddevelopsamodelforpricingallriskyassets
Capitalassetpricingmodel(CAPM) willallow
youtodeterminetherequiredrateofreturnfor
anyriskyasset
Introductionto
AssetPricing
Models
140
.
CapitalMarketTheory
RiskandReturn
Relationship
TheCapitalAssetPricing
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
AssumptionsofCapitalMarketTheory
SecurityAnalysis
AnIntroductionto
Investment
1. AllinvestorsareMarkowitzefficientinvestors
whowanttotargetpointsontheefficientfrontier.
Introductionto
AssetPricing
Models
141
.
CapitalMarketTheory
RiskandReturn
Relationship
▶
Model
Theexactlocationontheefficientfrontierand,
therefore, thespecificportfolioselected, will
dependontheindividualinvestor’srisk-return
utilityfunction.
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
AnIntroductionto
Investment
2. Investorscanborroworlendanyamountof
moneyattherisk-freerateofreturn(RFR).
▶
▶
Clearlyitisalwayspossibletolendmoneyatthe
nominalrisk-freeratebybuyingrisk-free
securitiessuchasgovernmentT-bills
Itisnotalwayspossibletoborrowatthisrisk-free
rate, butwewillseethatassumingahigher
borrowingratedoesnotchangethegeneral
results.
Introductionto
AssetPricing
Models
142
.
CapitalMarketTheory
RiskandReturn
Relationship
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
AnIntroductionto
Investment
3. Allinvestorshavehomogeneousexpectations;
thatis, theyestimateidenticalprobability
distributionsforfutureratesofreturn.
▶
▶
Introductionto
AssetPricing
Models
143
.
CapitalMarketTheory
RiskandReturn
Relationship
Model
Again, thisassumptioncanberelaxed
Aslongasthedifferencesinexpectationsarenot
vast, theireffectsareminor.
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
4. Allinvestorshavethesameone-periodtime
horizonsuchasone-month, sixmonths, orone
year.
▶
▶
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
144
.
CapitalMarketTheory
RiskandReturn
Relationship
Themodelwillbedevelopedforasingle
hypotheticalperiod, anditsresultscouldbe
affectedbyadifferentassumption
A differenceinthetimehorizonwouldrequire
investorstoderiveriskmeasuresandrisk-free
assetsthatareconsistentwiththeirtimehorizons.
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
AnIntroductionto
Investment
5. Allinvestmentsareinfinitelydivisible, which
meansthatitispossibletobuyorsellfractional
sharesofanyassetorportfolio.
▶
▶
Introductionto
AssetPricing
Models
145
.
CapitalMarketTheory
RiskandReturn
Relationship
Model
Thisassumptionallowsustodiscussinvestment
alternativesascontinuouscurves.
Changingitwouldhavelittleimpactonthe
theory.
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
AnIntroductionto
Investment
6. Therearenotaxesortransactioncostsinvolved
inbuyingorsellingassets.
▶
▶
▶
Thisisareasonableassumptioninmany
instances.
Neitherpensionfundsnorreligiousgroupshave
topaytaxes, andthetransactioncostsformost
financialinstitutionsarelessthan1percenton
mostfinancialinstruments.
Again, relaxingthisassumptionmodifiesthe
results, butdoesnotchangethebasicthrust.
Introductionto
AssetPricing
Models
146
.
CapitalMarketTheory
RiskandReturn
Relationship
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
AnIntroductionto
Investment
7. Thereisnoinflationoranychangeininterest
rates, orinflationisfullyanticipated.
▶
Introductionto
AssetPricing
Models
147
Thisisareasonableinitialassumption, anditcan
bemodified.
RiskandReturn
Relationship
Model
Fundamental
Analysis
8. Capitalmarketsareinequilibrium.
▶
.
CapitalMarketTheory
Macroeconomic
andIndustry
Analysis
Thismeansthatwebeginwithallinvestments
properlypricedinlinewiththeirrisklevels.
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
Someoftheseassumptionsareunrealistic
Relaxingmanyoftheseassumptionswouldhave
onlyminorinfluenceonthemodelandwould
notchangeitsmainimplicationsorconclusions.
A theoryshouldbejudgedonhowwellit
explainsandhelpspredictbehaviour, notonits
assumptions.
Introductionto
AssetPricing
Models
148
.
CapitalMarketTheory
RiskandReturn
Relationship
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Risk-FreeAsset
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
▶
Anassetwithzerostandarddeviation
Zerocorrelationwithallotherriskyassets
Providestherisk-freerateofreturn(RFR)
Willlieontheverticalaxisofaportfoliograph
Introductionto
AssetPricing
Models
149
.
CapitalMarketTheory
RiskandReturn
Relationship
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
CovariancewithaRisk-FreeAsset
SecurityAnalysis
▶
𝑛
𝐶𝑜𝑣𝑖𝑗 = 􏾜
𝑖=􏷠
▶
AnIntroductionto
Investment
Covariancebetweentwosetsofreturnsis
[𝑅𝑖 − 𝐸(𝑅𝑖 )][𝑅𝑗 − 𝐸(𝑅𝑗 )]
𝑛
(24)
Introductionto
AssetPricing
Models
CapitalMarketTheory
151
.RiskandReturn
Relationship
Model
Fundamental
Analysis
Becausethereturnsfortheriskfreeassetare
certain,
𝜎𝑅𝐹 = 0
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
Thus, 𝑅𝑖 = 𝐸(𝑅𝑖 ), and 𝑅𝑖 − 𝐸(𝑅𝑖 ) = 0.
417
Sigit Wibowo
.
CovariancewithaRisk-FreeAsset
(cont’d)
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Consequently, thecovarianceoftherisk-free
assetwithanyriskyassetorportfoliowillalways
equalzero
Similarlythecorrelationbetweenanyriskyasset
andtherisk-freeassetwouldbezero.
Introductionto
AssetPricing
Models
CapitalMarketTheory
152
.RiskandReturn
Relationship
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
ExpectedReturn
CombiningaRisk-FreeAssetwithaRiskyPortfolio
SecurityAnalysis
AnIntroductionto
Investment
▶
Expectedreturntheweightedaverageofthetwo
returns
𝐸(𝑅𝑝𝑜𝑟𝑡 ) = 𝑤𝑅𝐹 (𝑅𝐹𝑅) + (1 − 𝑤𝑅𝐹 )𝐸(𝑅𝑖 )
▶
Introductionto
AssetPricing
Models
CapitalMarketTheory
153
.RiskandReturn
Relationship
Model
(25)
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
Thisisa linear relationship
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
StandardDeviation
CombiningaRisk-FreeAssetwithaRiskyPortfolio
SecurityAnalysis
▶
Theexpectedvarianceforatwo-assetportfoliois
𝐸(𝜎􏷡𝑝𝑜𝑟𝑡 ) = 𝑤􏷡􏷠 𝜎􏷡􏷠 + 𝑤􏷡􏷡 𝜎􏷡􏷡 + 2𝑤􏷠 𝑤􏷡 𝜌􏷠,􏷡 𝜎􏷠 𝜎􏷡
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
(26)
CapitalMarketTheory
154
▶
Model
Substitutingtherisk-freeassetforSecurity1, and
theriskyassetforSecurity2, equation (26) would
become
𝐸(𝜎􏷡𝑝𝑜𝑟𝑡 ) = 𝑤􏷡𝑅𝐹 𝜎􏷡𝑅𝐹 + (1 − 𝑤𝑅𝐹 )􏷡 𝜎􏷡𝑖
+ 2𝑤𝑅𝐹 (1 − 𝑤𝑅𝐹 )𝜌𝑅𝐹,𝑖 𝜎𝑅𝐹 𝜎𝑖
.RiskandReturn
Relationship
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
(27)
IndexasMarket
Representation
417
Sigit Wibowo
.
StandardDeviation
CombiningaRisk-FreeAssetwithaRiskyPortfolio(cont’d)
SecurityAnalysis
AnIntroductionto
Investment
▶
Sinceweknowthatthevarianceoftherisk-free
assetiszeroandthecorrelationbetweenthe
risk-freeassetandanyriskyasset 𝑖 iszero, wecan
adjustequation (27) into
𝐸(𝜎􏷡𝑝𝑜𝑟𝑡 ) = (1 − 𝑤𝑅𝐹 )􏷡 𝜎􏷡𝑖
Introductionto
AssetPricing
Models
CapitalMarketTheory
155
.RiskandReturn
Relationship
Model
Fundamental
Analysis
(28)
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
StandardDeviation
CombiningaRisk-FreeAssetwithaRiskyPortfolio(cont’d)
SecurityAnalysis
▶
Giventhevarianceformulain (28), thestandard
deviationis
(1 − 𝑤𝑅𝐹 )􏷡 𝜎􏷡𝑖
􏽯
= (1 − 𝑤𝑅𝐹 )𝜎𝑖
𝐸(𝜎𝑝𝑜𝑟𝑡 ) =
▶
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
CapitalMarketTheory
(29)
156
.RiskandReturn
Relationship
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
Therefore, thestandarddeviationofaportfolio
thatcombinestherisk-freeassetwithriskyassets
isthelinearproportionofthestandarddeviation
oftheriskyassetportfolio.
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
EfficientFrontier
SecurityAnalysis
𝐸(𝑅𝑝𝑜𝑟𝑡 )
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
•
𝐷
CapitalMarketTheory
•
𝑀
𝐶
•
157
.RiskandReturn
Relationship
Model
•𝐵
•𝐴
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
𝑅𝐹𝑅
.
TechnicalAnalysis
𝐸(𝜎𝑝𝑜𝑟𝑡 )
IndexasMarket
Representation
Figure 15: PortfolioPossibilitiesCombiningtheRisk-FreeAsset
andRiskyPortfolios
417
Sigit Wibowo
.
Risk-Return Possibilities with Leverage
SecurityAnalysis
▶
▶
▶
Toattainahigherexpectedreturnthanis
availableatpoint 𝑀 (inexchangeforaccepting
higherrisk)
Eitherinvestalongtheefficientfrontierbeyond
point 𝑀, suchaspoint 𝐷
Or, addleveragetotheportfoliobyborrowing
moneyattherisk-freerateandinvestinginthe
riskyportfolioatpoint 𝑀
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
CapitalMarketTheory
158
.RiskandReturn
Relationship
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
Bo
Le
n
g
d in
•
•
•
𝑀•
•
• •
•
wi
r ro
ng
•
•
AnIntroductionto
Investment
𝐶𝑀𝐿
Introductionto
AssetPricing
Models
CapitalMarketTheory
159
•
.RiskandReturn
Relationship
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
RFR
.
TechnicalAnalysis
IndexasMarket
Representation
Figure 16: PortfolioPossibilitiesCombiningtheRisk-FreeAsset
andRiskyPortfoliosontheEfficientFrontier
417
Sigit Wibowo
.
TheMarketPortfolio
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
Becauseportfolio 𝑀 liesatthepointoftangency,
ithasthehighestportfoliopossibilityline
EverybodywillwanttoinvestinPortfolio 𝑀 and
borroworlendtobesomewhereonthe 𝐶𝑀𝐿
ThereforethisportfoliomustincludeALL RISKY
ASSETS
Introductionto
AssetPricing
Models
CapitalMarketTheory
160
.RiskandReturn
Relationship
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
TheMarketPortfolio
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Becausethemarketisinequilibrium, allassets
areincludedinthisportfolioinproportionto
theirmarketvalue
Becauseitcontainsallriskyassets, itisa
completelydiversifiedportfolio, whichmeans
thatalltheuniqueriskofindividualassets
(unsystematicrisk)isdiversifiedaway
Introductionto
AssetPricing
Models
CapitalMarketTheory
161
.RiskandReturn
Relationship
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SystematicRisk
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
Onlysystematicriskremainsinthemarket
portfolio
Systematicriskisthevariabilityinallriskyassets
causedbymacroeconomicvariables
Systematicriskcanbemeasuredbythestandard
deviationofreturnsofthemarketportfolioand
canchangeovertime
Introductionto
AssetPricing
Models
CapitalMarketTheory
162
.RiskandReturn
Relationship
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Examples of Macroeconomic Factors
AffectingSystematicRisk
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
Variabilityingrowthofmoneysupply
Interestratevolatility
Variabilityin
▶
▶
▶
Introductionto
AssetPricing
Models
CapitalMarketTheory
163
.RiskandReturn
Relationship
Model
industrialproduction
corporateearnings
cashflow
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
HowtoMeasureDiversification
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Allportfoliosonthe 𝐶𝑀𝐿 areperfectlypositively
correlatedwitheachotherandwiththe
completelydiversifiedmarketPortfolio 𝑀
A completelydiversifiedportfoliowouldhavea
correlationwiththemarketportfolioof +1.00
Introductionto
AssetPricing
Models
CapitalMarketTheory
164
.RiskandReturn
Relationship
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
DiversificationandtheEliminationof
UnsystematicRisk
SecurityAnalysis
▶
▶
▶
▶
▶
Thepurposeofdiversificationistoreducethe
standarddeviationofthetotalportfolio
Thisassumesthatimperfectcorrelationsexist
amongsecurities
Asyouaddsecurities, youexpecttheaverage
covariancefortheportfoliotodecline
Howmanysecuritiesmustyouaddtoobtaina
completelydiversifiedportfolio?
Observewhathappensasyouincreasethe
samplesizeoftheportfoliobyaddingsecurities
thathavesomepositivecorrelation
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
CapitalMarketTheory
165
.RiskandReturn
Relationship
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
DiversificationConcept
SecurityAnalysis
Standard deviation of return
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
CapitalMarketTheory
166
Unsystematic
(diversifiable)
risk
Systematicrisk
Model
Standard deviation of
the market portfolio
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
Total risk
.
.RiskandReturn
Relationship
TechnicalAnalysis
Numberofstocksinportfolio
IndexasMarket
Representation
Figure 17: Numberofstocksinaportfolioandthestandarddeviationofportfolioreturn
417
Sigit Wibowo
.
TheCML andtheSeparationTheorem
SecurityAnalysis
▶
▶
▶
▶
TheCML leadsallinvestorstoinvestintheM
portfolio
Individualinvestorsshoulddifferinpositionon
theCML dependingonriskpreferences
HowaninvestorgetstoapointontheCML is
basedonfinancingdecisions
Riskaverseinvestorswilllendpartofthe
portfolioattherisk-freerateandinvestthe
remainderinthemarketportfolio
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
CapitalMarketTheory
167
.RiskandReturn
Relationship
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
▶
Investorspreferringmoreriskmightborrowfunds
attheRFR andinvesteverythinginthemarket
portfolio
CapitalMarketTheory
168
.RiskandReturn
Relationship
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
AnIntroductionto
Investment
𝐶𝑀𝐿
Introductionto
AssetPricing
Models
•
𝐵
CapitalMarketTheory
•
𝑀
169
.RiskandReturn
Relationship
Model
•
𝐴
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
RFR
.
TechnicalAnalysis
IndexasMarket
Representation
Figure 18: Financingandinvestmentdecision
417
Sigit Wibowo
.
SecurityAnalysis
▶
▶
▶
Thedecisionofbothinvestorsistoinvestin
portfolioM alongtheCML
Thefinancingdecision
▶
▶
AnIntroductionto
Investment
Theinvestmentdecision
Introductionto
AssetPricing
Models
CapitalMarketTheory
170
.RiskandReturn
Relationship
Model
Thedecisiontoborroworlendtoobtainapoint
ontheCML isaseparatedecisionbasedonrisk
preferences
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
Tobinreferstothisseparationoftheinvestment
decisionfromthefinancingdecision, the
separationtheorem
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
A RiskMeasurefortheCML
SecurityAnalysis
▶
▶
▶
▶
CovariancewiththeM portfolioisthesystematic
riskofanasset
TheMarkowitzportfoliomodelconsidersthe
averagecovariancewithallotherassetsinthe
portfolio
TheonlyrelevantportfolioistheM portfolio
Together, thismeanstheonlyimportant
considerationistheasset’scovariancewiththe
marketportfolio
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
CapitalMarketTheory
171
.RiskandReturn
Relationship
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
A RiskMeasurefortheCML
SecurityAnalysis
▶
Becauseallindividualriskyassetsarepartofthe
𝑀 portfolio, anasset’srateofreturninrelationto
thereturnforthe 𝑀 portfoliomaybedescribed
usingthefollowinglinearmodel:
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
CapitalMarketTheory
172
𝑅𝑖𝑡 = 𝑎𝑖 + 𝑏𝑖 𝑅𝑀𝑖 + 𝜀
(30)
Model
Fundamental
Analysis
where
▶
▶
▶
▶
▶
.RiskandReturn
Relationship
Macroeconomic
andIndustry
Analysis
𝑅𝑖𝑡 =returnforasset 𝑖 duringperiod 𝑡
𝑎𝑖 =constanttermforasset 𝑖
𝑏𝑖 =slopecoefficientforasset 𝑖
𝑅𝑀𝑡 =returnfortheM portfolioduringperiod 𝑡
𝜀 = randomerrorterm
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
VarianceofReturnsforaRiskyAsset
SecurityAnalysis
▶
Thevarianceforthe 𝑀 portfolio
𝑉𝑎𝑟(𝑏𝑖 𝑅𝑀𝑖 ) = 𝑉𝑎𝑟(𝑎𝑖 + 𝑏𝑖 𝑅𝑀𝑖 + 𝜀)
= 𝑉𝑎𝑟(𝑎𝑖 ) + 𝑉𝑎𝑟(𝑏𝑖 𝑅𝑀𝑖 ) + 𝑉𝑎𝑟(𝜀) (31)
= 0 + 𝑉𝑎𝑟(𝑏𝑖 𝑅𝑀𝑖 ) + 𝑉𝑎𝑟(𝜀)
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
CapitalMarketTheory
173
Model
Fundamental
Analysis
where
▶
▶
.RiskandReturn
Relationship
Macroeconomic
andIndustry
Analysis
𝑉𝑎𝑟(𝑏𝑖 𝑅𝑀𝑖 ) isvariancerelatedtomarketreturnor
systematicrisk
𝑉𝑎𝑟(𝜀) istheresidualreturnnotrelatedtothe
marketportfolioorunsystematicrisk
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
TheCapitalAssetPricingModel
ExpectedReturnandRisk
SecurityAnalysis
▶
▶
▶
Theexistenceofarisk-freeassetresultedin
derivingacapitalmarketline(CML) thatbecame
therelevantfrontier
Anasset’scovariancewiththemarketportfoliois
therelevantriskmeasure
Thiscanbeusedtodetermineanappropriate
expectedrateofreturnonariskyasset-the
capitalassetpricingmodel(CAPM)
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
CapitalMarketTheory
RiskandReturn
Relationship
175
.TheCapitalAssetPricing
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
TheCapitalAssetPricingModel
ExpectedReturnandRisk(cont’d)
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
CAPM indicateswhatshouldbetheexpectedor
requiredratesofreturnonriskyassets
Thishelpstovalueanassetbyprovidingan
appropriatediscountratetouseindividend
valuationmodels
Youcancompareanestimatedrateofreturnto
therequiredrateofreturnimpliedbyCAPM over/undervalued?
Introductionto
AssetPricing
Models
CapitalMarketTheory
RiskandReturn
Relationship
176
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
TheSecurityMarketLine(SML)
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
Therelevantriskmeasureforanindividualrisky
assetisitscovariancewiththemarketportfolio
(𝐶𝑜𝑣𝑖 , 𝑚)
Thisisshownastheriskmeasure
Thereturnforthemarketportfolioshouldbe
consistentwithitsownrisk, whichisthe
covarianceofthemarketwithitself—orits
variance: 𝜎􏷡𝑚
Introductionto
AssetPricing
Models
CapitalMarketTheory
RiskandReturn
Relationship
177
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
𝐸(𝑅𝑖 )
AnIntroductionto
Investment
𝑆𝑀𝐿
Introductionto
AssetPricing
Models
CapitalMarketTheory
𝑅𝑚
RiskandReturn
Relationship
178
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
RFR
.
TechnicalAnalysis
𝜎􏷫𝑚
𝐶𝑜𝑣𝐼 ′ 𝑚
IndexasMarket
Representation
Figure 19: TheSecurityMarketLine(SML)
417
Sigit Wibowo
.
SecurityAnalysis
▶
𝑅𝑀 − 𝑅𝐹𝑅
𝐸(𝑅𝑖 ) = 𝑅𝐹𝑅 +
𝐶𝑜𝑣𝑖,𝑀
𝜎􏷡𝑀
= 𝑅𝐹𝑅 +
(𝑅𝑀 − 𝑅𝐹𝑅)
𝜎􏷡𝑀
▶
AnIntroductionto
Investment
Theequationfortherisk–returnline
Wethendefineas
𝜎􏷫𝑀
Introductionto
AssetPricing
Models
CapitalMarketTheory
(32)
RiskandReturn
Relationship
179
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
asbeta (𝛽𝑖 )
𝐸(𝑅𝑖 ) = 𝑅𝐹𝑅 + 𝛽𝑖 (𝑅𝑀 − 𝑅𝐹𝑅)
Model
TechnicalAnalysis
(33)
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
𝐸(𝑅𝑖 )
AnIntroductionto
Investment
𝑆𝑀𝐿
Introductionto
AssetPricing
Models
CapitalMarketTheory
𝑅𝑚
RiskandReturn
Relationship
180
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
RFR
Negative 𝛽
.
TechnicalAnalysis
􏷠
𝛽 = 𝐶𝑜𝑣𝑖,𝑀 /𝜎􏷫𝑀
IndexasMarket
Representation
Figure 20: TheSML withwithNormalisedSystematicRisk
417
Sigit Wibowo
.
DeterminingtheExpectedRateofReturnforaRiskyAsset
SecurityAnalysis
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
𝐸(𝑅𝑖 ) = 𝑅𝐹𝑅 + 𝛽𝑖 (𝑅𝑀 − 𝑅𝐹𝑅)
CapitalMarketTheory
▶
▶
Theexpectedrateofreturnofariskassetis
determinedbythe 𝑅𝐹𝑅 plusariskpremiumfor
theindividualasset
Theriskpremiumisdeterminedbythesystematic
riskoftheasset(beta)andtheprevailingmarket
riskpremium(𝑅𝑀 − 𝑅𝐹𝑅)
RiskandReturn
Relationship
181
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
▶
Assume:
▶
▶
▶
AnIntroductionto
Investment
𝑅𝐹𝑅 = 5%
𝑅𝑀 = 9%
Impliedmarketriskpremium = 4%
Introductionto
AssetPricing
Models
CapitalMarketTheory
RiskandReturn
Relationship
182
Stock
Beta 𝛽
A
B
C
D
E
0.70
1.00
1.15
1.40
−0.30
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
DeterminingtheExpectedRateofReturnforaRiskyAsset(cont’d)
SecurityAnalysis
AnIntroductionto
Investment
𝐸(𝑅𝐴 ) = 0.05 + 0.70(0.09 − 0.05)
𝐸(𝑅𝐵 ) = 0.05 + 1.00(0.09 − 0.05)
𝐸(𝑅𝐶 ) = 0.05 + 1.15(0.09 − 0.05)
𝐸(𝑅𝐷 ) = 0.05 + 1.40(0.09 − 0.05)
𝐸(𝑅𝐸 ) = 0.05 + −0.30(0.09 − 0.05)
= 0.078 = 7.8%
= 0.090 = 09.0%
= 0.096 = 09.6%
= 0.106 = 10.6%
= 0.038 = 03.8%
Introductionto
AssetPricing
Models
CapitalMarketTheory
RiskandReturn
Relationship
183
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
▶
AnIntroductionto
Investment
Inequilibrium, all assetsand all portfoliosof
assetsshouldplotontheSML
▶
▶
▶
Anysecuritywithanestimatedreturnthatplots
abovetheSML isunderpriced
Anysecuritywithanestimatedreturnthatplots
belowtheSML isoverpriced
A superiorinvestormustderivevalueestimates
forassetsthatareconsistentlysuperiortothe
consensusmarketevaluationtoearnbetter
risk-adjustedratesofreturnthantheaverage
investor
Introductionto
AssetPricing
Models
CapitalMarketTheory
RiskandReturn
Relationship
184
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
IdentifyingUndervaluedandOvervaluedAssets
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Comparetherequiredrateofreturntothe
expectedrateofreturnforaspecificriskyasset
usingtheSML overaspecificinvestmenthorizon
todetermineifitisanappropriateinvestment
Independentestimatesofreturnforthesecurities
providepriceanddividendoutlooks
Introductionto
AssetPricing
Models
CapitalMarketTheory
RiskandReturn
Relationship
185
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
CalculatingSystematicRisk
TheCharacteristicLine
SecurityAnalysis
▶
Thesystematicriskinputofanindividualassetis
derivedfromaregressionmodel, referredtoas
theasset’scharacteristiclinewiththemodel
portfolio:
𝑅𝑖 = 𝛼𝑖 + 𝛽𝑖 𝑅𝑀,𝑡 + 𝜀
(34)
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
CapitalMarketTheory
RiskandReturn
Relationship
186
where:
▶
▶
▶
▶
Model
Fundamental
Analysis
𝑅𝑖,𝑡 = therateofreturnforasset 𝑖 duringperiod 𝑡
𝑅𝑀,𝑡 = therateofreturnforthemarketportfolio
𝑀 during 𝑡
𝛼𝑖 = 𝑅 𝑖 − 𝛽 𝑖 𝑅 𝑚
𝐶𝑜𝑣
𝛽𝑖 = 􏷫𝑖,𝑀
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
𝜎𝑀
▶
𝜀 = therandomerrorterm
417
Sigit Wibowo
.
TheImpactoftheTimeInterval
SecurityAnalysis
▶
▶
▶
▶
▶
▶
Numberofobservationsandtimeintervalusedin
regressionvary
ValueLineInvestmentServices(VL) usesweekly
ratesofreturnoverfiveyears
MerrillLynch, Pierce, Fenner&Smith(ML) uses
monthlyreturnoverfiveyears
Thereisno“correct”intervalforanalysis
WeakrelationshipbetweenVL &ML betasdueto
differenceinintervalsused
Thereturntimeintervalmakesadifference, and
itsimpactincreasesasthefirm’ssizedeclines
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
CapitalMarketTheory
RiskandReturn
Relationship
187
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
TheEffectoftheMarketProxy
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Themarketportfolioofallriskyassetsmustbe
representedincomputinganasset’scharacteristic
line
Standard&Poor’s500CompositeIndexismost
oftenused
▶
▶
Introductionto
AssetPricing
Models
CapitalMarketTheory
RiskandReturn
Relationship
188
Model
Fundamental
Analysis
LargeproportionofthetotalmarketvalueofU.S.
stocks
Valueweightedseries
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
WeaknessesofUsingS&P 500asthe
MarketProxy
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
IncludesonlyU.S.stocks
Thetheoreticalmarketportfolioshouldinclude
U.S.andnon-U.S.stocksandbonds, realestate,
coins, stamps, art, antiques, andanyother
marketableriskyassetfromaroundtheworld
Introductionto
AssetPricing
Models
CapitalMarketTheory
RiskandReturn
Relationship
189
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
RelaxingtheAssumptions
SecurityAnalysis
▶
DifferentialBorrowingandLendingRates
▶
▶
Introductionto
AssetPricing
Models
HeterogeneousExpectationsandPlanning
Periods
ZeroBetaModel
▶
▶
AnIntroductionto
Investment
CapitalMarketTheory
RiskandReturn
Relationship
190
doesnotrequirearisk-freeasset
Fundamental
Analysis
TransactionCosts
▶
Model
Macroeconomic
andIndustry
Analysis
withtransactionscosts, theSML willbeabandof
securities, ratherthanastraightline
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
RelaxingtheAssumptions
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
Introductionto
AssetPricing
Models
HeterogeneousExpectationsandPlanning
Periods
willhaveanimpactontheCML andSML
CapitalMarketTheory
RiskandReturn
Relationship
191
Taxes
▶
Model
Fundamental
Analysis
couldcausemajordifferencesintheCML and
SML amonginvestors
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
EmpiricalTestsoftheCAPM
SecurityAnalysis
▶
StabilityofBeta
▶
▶
AnIntroductionto
Investment
betasforindividualstocksarenotstable, but
portfoliobetasarereasonablystable. Further, the
largertheportfolioofstocksandlongerthe
period, themorestablethebetaoftheportfolio
Introductionto
AssetPricing
Models
CapitalMarketTheory
RiskandReturn
Relationship
192
Fundamental
Analysis
ComparabilityofPublishedEstimatesofBeta
▶
▶
Model
Macroeconomic
andIndustry
Analysis
differencesexist
Hence, considerthereturnintervalusedandthe
firm’srelativesize
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
RelationshipBetweenSystematicRisk
andReturn
SecurityAnalysis
▶
EffectofSkewnessonRelationship
▶
▶
AnIntroductionto
Investment
investorspreferstockswithhighpositive
skewnessthatprovideanopportunityforvery
largereturns
Introductionto
AssetPricing
Models
CapitalMarketTheory
RiskandReturn
Relationship
193
EffectofSize, P/E,andLeverage
▶
▶
Model
Fundamental
Analysis
size, andP/E haveaninverseimpactonreturns
afterconsideringtheCAPM
FinancialLeveragealsohelpsexplain
cross-sectionofreturns
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
RelationshipBetweenSystematicRisk
andReturn
SecurityAnalysis
▶
EffectofBook-to-MarketValue
▶
▶
AnIntroductionto
Investment
FamaandFrenchquestionedtherelationship
betweenreturnsandbetaintheirseminal1992
study. TheyfoundtheBV/MV ratiotobeakey
determinantofreturns
Introductionto
AssetPricing
Models
CapitalMarketTheory
RiskandReturn
Relationship
194
Fundamental
Analysis
SummaryofCAPM Risk-ReturnEmpiricalResults
▶
Model
Macroeconomic
andIndustry
Analysis
therelationshipbetweenbetaandratesofreturn
isamootpoint
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
TheMarketPortfolio
TheoryversusPractice
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
Thereisacontroversyoverthemarketportfolio.
Hence, proxiesareused
Thereisnounanimityaboutwhichproxytouse
Anincorrectmarketproxywillaffectboththe
betariskmeasuresandthepositionandslopeof
theSML thatisusedtoevaluateportfolio
performance?
Introductionto
AssetPricing
Models
CapitalMarketTheory
RiskandReturn
Relationship
195
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Summary
SecurityAnalysis
▶
▶
Theassumptionofcapitalmarkettheoryexpand
onthoseoftheMarkowitzportfoliomodeland
includeconsiderationoftherisk-freerateof
return
Thedominantlineistangenttotheefficient
frontier
▶
▶
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
CapitalMarketTheory
RiskandReturn
Relationship
196
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
Referredtoasthecapitalmarketline(CML)
Allinvestorsshouldtargetpointsalongthisline
dependingontheirriskpreferences
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Summary
SecurityAnalysis
AnIntroductionto
Investment
▶
Allinvestorswanttoinvestintheriskyportfolio,
sothismarketportfoliomustcontainallrisky
assets
▶
▶
▶
Theinvestmentdecisionandfinancingdecision
canbeseparated
Everyonewantstoinvestinthemarketportfolio
Investorsfinancebasedonriskpreferences
Introductionto
AssetPricing
Models
CapitalMarketTheory
RiskandReturn
Relationship
197
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Summary
SecurityAnalysis
▶
Therelevantriskmeasureforanindividualrisky
assetisitssystematicriskorcovariancewiththe
marketportfolio
▶
▶
OnceyouhavedeterminedthisBetameasure
andasecuritymarketline, youcandetermine
therequiredreturnonasecuritybasedonits
systematicrisk
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
CapitalMarketTheory
RiskandReturn
Relationship
198
Model
Fundamental
Analysis
Assumingsecuritymarketsarenotalways
completelyefficient, youcanidentify
undervaluedandovervaluedsecuritiesby
comparingyourestimateoftherateofreturnon
aninvestmenttoitsrequiredrateofreturn
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Summary
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Whenwerelaxseveralofthemajorassumptions
oftheCAPM,therequiredmodificationsare
relativelyminoranddonotchangetheoverall
conceptofthemodel.
Betasofindividualstocksarenotstablewhile
portfoliobetasarestable
Introductionto
AssetPricing
Models
CapitalMarketTheory
RiskandReturn
Relationship
199
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Summary
SecurityAnalysis
▶
▶
Thereisacontroversyabouttherelationship
betweenbetaandrateofreturnonstocks
Changingtheproxyforthemarketportfolio
resultsinsignificantdifferencesinbetas, SMLs,
andexpectedreturns
Itisnotpossibletoempiricallyderiveatrue
marketportfolio, soitisnotpossibletotestthe
CAPM modelproperlyortousemodelto
evaluateportfolioperformance
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
CapitalMarketTheory
RiskandReturn
Relationship
200
Model
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Company Analysis and StockValuation
SecurityAnalysis
▶
▶
▶
▶
Afteranalysingtheeconomyandstockmarkets
forseveralcountries, youhavedecidedtoinvest
someportionofyourportfolioincommonstocks
Afteranalysingvariousindustries, youhave
identifiedthoseindustriesthatappeartooffer
above-averagerisk-adjustedperformanceover
yourinvestmenthorizon
Whicharethebestcompanies?
Aretheyoverpriced?
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Fundamental
Analysis
202
.CompanyAnalysisand
StockValuation
RiskAnalysisandGrowth
Potential
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Company Analysis and StockValuation
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
▶
Goodcompaniesarenotnecessarilygood
investments
Comparetheintrinsicvalueofastocktoits
marketvalue
Stockofagreatcompanymaybeoverpriced
Stockofagrowthcompanymaynotbegrowth
stock
Introductionto
AssetPricing
Models
Fundamental
Analysis
203
.CompanyAnalysisand
StockValuation
Potential
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
GrowthCompanies
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Growthcompanieshavehistoricallybeendefined
ascompaniesthatconsistentlyexperience
above-averageincreasesinsalesandearnings
Financialtheoristsdefineagrowthcompanyas
onewithmanagementandopportunitiesthat
yieldratesofreturngreaterthanthefirm’s
requiredrateofreturn
Introductionto
AssetPricing
Models
Fundamental
Analysis
204
.CompanyAnalysisand
StockValuation
Potential
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
GrowthStocks
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
Growthstocksarenotnecessarilysharesin
growthcompanies
A growthstockhasahigherrateofreturnthan
otherstockswithsimilarrisk
Superiorrisk-adjustedrateofreturnoccurs
becauseofmarketundervaluationcomparedto
otherstocks
Introductionto
AssetPricing
Models
Fundamental
Analysis
205
.CompanyAnalysisand
StockValuation
Potential
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
DefensiveCompaniesandStocks
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
▶
Defensivecompanies’futureearningsaremore
likelytowithstandaneconomicdownturn
Lowbusinessrisk
Notexcessivefinancialrisk
Stockswithlowornegativesystematicrisk
Introductionto
AssetPricing
Models
Fundamental
Analysis
206
.CompanyAnalysisand
StockValuation
Potential
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
CyclicalCompaniesandStocks
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Cyclicalcompaniesarethosewhosesalesand
earningswillbeheavilyinfluencedbyaggregate
businessactivity
Cyclicalstocksarethosethatwillexperience
changesintheirratesofreturngreaterthan
changesinoverallmarketratesofreturn
Introductionto
AssetPricing
Models
Fundamental
Analysis
207
.CompanyAnalysisand
StockValuation
Potential
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SpeculativeCompaniesandStocks
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Speculativecompaniesarethosewhoseassets
involvegreatriskbutthosethatalsohavea
possibilityofgreatgain
Speculativestockspossessahighprobabilityof
lowornegativeratesofreturnandalow
probabilityofnormalorhighratesofreturn
Introductionto
AssetPricing
Models
Fundamental
Analysis
208
.CompanyAnalysisand
StockValuation
Potential
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
ValueversusGrowthInvesting
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
Growthstockswillhavepositiveearnings
surprisesandabove-averageriskadjustedratesof
returnbecausethestocksareundervalued
Valuestocksappeartobeundervaluedfor
reasonsbesidesearningsgrowthpotential
ValuestocksusuallyhavelowP/E ratioorlow
ratiosofpricetobookvalue
Introductionto
AssetPricing
Models
Fundamental
Analysis
209
.CompanyAnalysisand
StockValuation
Potential
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Economic, Industry, and Structural
LinkstoCompanyAnalysis
SecurityAnalysis
▶
▶
▶
Companyanalysisisthefinalstepinthe
top-downapproachtoinvesting
Macroeconomicanalysisidentifiesindustries
expectedtoofferattractivereturnsinthe
expectedfutureenvironment
Analysisoffirmsinselectedindustries
concentratesonastock’sintrinsicvaluebasedon
growthandrisk
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Fundamental
Analysis
210
.CompanyAnalysisand
StockValuation
Potential
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
EconomicandIndustryInfluences
SecurityAnalysis
▶
▶
▶
Iftrendsarefavourableforanindustry, the
companyanalysisshouldfocusonfirmsinthat
industrythatarepositionedtobenefitfromthe
economictrends
Firmswithsalesorearningsparticularlysensitive
tomacroeconomicvariablesshouldalsobe
considered
Researchanalystsneedtobefamiliarwiththe
cashflowandriskofthefirms
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Fundamental
Analysis
211
.CompanyAnalysisand
StockValuation
Potential
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
CompanyAnalysis
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
▶
Industrycompetitiveenvironment
SWOT analysis
Presentvalueofcashflows
Relativevaluationratiotechniques
Introductionto
AssetPricing
Models
Fundamental
Analysis
212
.CompanyAnalysisand
StockValuation
Potential
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
RiskAnalysis
SecurityAnalysis
AnIntroductionto
Investment
▶
Introductionto
AssetPricing
Models
Riskanalysisexaminestheuncertaintyofincome
flowsforthetotalfirmaandfortheindividual
sourcesofcapital
▶
▶
▶
Debt
Preferredstock
Commonstock
Fundamental
Analysis
CompanyAnalysisand
StockValuation
214
.RiskAnalysisandGrowth
Potential
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
RiskAnalysis
SecurityAnalysis
▶
Totalriskofafirmhastwocomponents:
▶
Businessrisk
▶
▶
▶
AnIntroductionto
Investment
Theuncertaintyofincomecausedbythefirm’s
industry
Generallymeasuredbythevariabilityofthe
firm’soperatingincomeovertime
Financialrisk
▶
▶
Introductionto
AssetPricing
Models
Fundamental
Analysis
CompanyAnalysisand
StockValuation
215
Potential
CashFlowTechniques
Additionaluncertaintyofreturnstoequity
holdersduetoafirm’suseoffixedobligation
debtsecurities
Theacceptableleveloffinancialriskforafirm
dependsonitsbusinessrisk
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
ExternalMarketLiquidity
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
MarketLiquidityistheabilitytobuyorsellan
assetquicklywithlittlepricechangefromaprior
transactionassumingnonewinformation
Externalmarketliquidityisasourceofriskto
investors
Introductionto
AssetPricing
Models
Fundamental
Analysis
CompanyAnalysisand
StockValuation
216
Potential
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
DeterminantsofMarketLiquidity
SecurityAnalysis
AnIntroductionto
Investment
▶
Thedollarvalueofsharestraded
▶
▶
▶
▶
Thiscanbeestimatedfromthetotalmarketvalue
ofoutstandingsecurities
Itwillbeaffectedbythenumberofsecurity
owners
Numerousbuyersandsellersprovideliquidity
Introductionto
AssetPricing
Models
Fundamental
Analysis
CompanyAnalysisand
StockValuation
217
Potential
CashFlowTechniques
RelativeValuation
Techniques
Tradingturnover(percentageofoutstanding
sharestradedduringaperiodoftime)
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Introductionto
AssetPricing
Models
A measureofmarketliquidityisthebid-ask
spread
Certaincorporatevariables
▶
▶
Totalmarketvalueofoutstandingsecurities
(numberofcommonsharesoutstandingtimesthe
marketpricepershare)
Numberofsecurityowners
Fundamental
Analysis
CompanyAnalysisand
StockValuation
218
Potential
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
DeterminantsofGrowth
SecurityAnalysis
▶
▶
Resourcesretainedandreinvestedintheentity
Rateofreturnearnedontheresourcesretained
𝑔 = 𝑅𝑅 × 𝑅𝑂𝐸
▶
▶
Introductionto
AssetPricing
Models
(35)
where:
▶
AnIntroductionto
Investment
Fundamental
Analysis
CompanyAnalysisand
StockValuation
𝑔 = potentialgrowthrate
𝑅𝑅 = theretentionrateofearnings
𝑅𝑂𝐸 = thefirm’sreturnonequity, where 𝑅𝑂𝐸 is
afunctionof
▶
▶
▶
219
Potential
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
Netprofitmargin
Totalassetturnover
Financialleverage(totalassets/equity)
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
EstimatingIntrinsicValue
SecurityAnalysis
AnIntroductionto
Investment
A. Presentvalueofcashflows(PVCF)
Introductionto
AssetPricing
Models
1. Presentvalueofdividends(DDM)
2. Presentvalueoffreecashflowtoequity(FCFE)
3. Presentvalueoffreecashflow(FCFF)
Fundamental
Analysis
CompanyAnalysisand
StockValuation
B. Relativevaluationtechniques
1.
2.
3.
4.
Priceearningsratio(P/E)
Pricecashflowratios(P/CF)
Pricebookvalueratios(P/BV)
Pricesalesratio(P/S)
Potential
221
.
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
ApproachestotheValuationofCommonStock
SecurityAnalysis
▶
▶
▶
Bothoftheseapproachesandallofthese
valuationtechniqueshaveseveralcommon
factors:
Allofthemaresignificantlyaffectedbyinvestor’s
requiredrateofreturnonthestockbecausethis
ratebecomesthediscountrateorisamajor
componentofthediscountrate;
Allvaluationapproachesareaffectedbythe
estimatedgrowthrateofthevariableusedinthe
valuationtechnique
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
222
.
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
PresentValueofDividends
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Simplifyingassumptionshelpinestimating
presentvalueoffuturedividends
Assumptionofconstantgrowthrate
𝐷􏷠
IntrinsicValue =
𝑘−𝑔
𝐷􏷠 = 𝐷􏷟 (1 + 𝑔)
Introductionto
AssetPricing
Models
Fundamental
Analysis
CompanyAnalysisand
StockValuation
(36)
Potential
223
.
CashFlowTechniques
RelativeValuation
Techniques
(37)
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
GrowthRateEstimates
SecurityAnalysis
▶
AverageDividendGrowthRate
𝑔𝐷 =
𝑛
􏽱
▶
AnIntroductionto
Investment
𝐷𝑛
−1
𝐷􏷟
Introductionto
AssetPricing
Models
(38)
CompanyAnalysisand
StockValuation
Potential
224
SustainableGrowthRate
𝑔 = 𝑅𝑅 × 𝑅𝑂𝐸
Fundamental
Analysis
.
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
(39)
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
RequiredRateofReturnEstimate
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
Nominalrisk-freeinterestrate
Riskpremium
Market-basedriskestimatedfromthefirm’s
characteristiclineusingregression
Introductionto
AssetPricing
Models
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
225
.
CashFlowTechniques
RelativeValuation
Techniques
𝑅stock = 𝐸(𝑅𝐹𝑅) + 𝛽stock [𝐸(𝑅market ) − 𝐸(𝑅𝐹𝑅)] (40)
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
ThePV ofDividendsModel(DDM)
SecurityAnalysis
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
▶
▶
Fundamental
Analysis
Modelrequires 𝑘 > 𝑔
With 𝑔 > 𝑘, analystmustusemulti-stagemodel
CompanyAnalysisand
StockValuation
Potential
226
.
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
PV ofFreeCashFlowtoEquity
SecurityAnalysis
AnIntroductionto
Investment
FCFE =
+
−
−
−
+
Net income
Depreciation Expense
.
Capital Expenditures
Δ in Working Capital
Principal Debt Repayments
New Debt Issues
Introductionto
AssetPricing
Models
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
227
.
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
PV ofFreeCashFlowtoEquity
SecurityAnalysis
AnIntroductionto
Investment
Value =
▶
▶
▶
𝐹𝐶𝐹𝐸􏷠
𝑘 − 𝑔𝐹𝐶𝐹𝐸
Introductionto
AssetPricing
Models
(41)
𝐹𝐶𝐹𝐸 = theexpectedfreecashflowinperiod1
𝑘 = therequiredrateofreturnonequityforthe
firm
𝑔𝐹𝐶𝐹𝐸 = theexpectedconstantgrowthrateoffree
cashflowtoequityforthefirm
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
228
.
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
PV ofOperatingFreeCashFlow
SecurityAnalysis
▶
Discountthefirm’soperatingfreecashflowtothe
firm(FCFF) atthefirm’sweightedaveragecostof
capital(WACC) ratherthanitscostofequity
𝐹𝐶𝐹𝐹 = 𝐸𝐵𝐼𝑇(1 − TaxRate)
+ DepreciationExpense
− CapitalSpending
− Δ inWorkingCapital
− Δ inotherassets
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
229
.
CashFlowTechniques
RelativeValuation
Techniques
(42)
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
PV ofOperatingFreeCashFlow
SecurityAnalysis
Firmvalue =
𝐹𝐶𝐹𝐹􏷠
𝑂𝑝𝑒𝑟. 𝐹𝐶𝐹􏷠
=
WACC − 𝑔𝐹𝐶𝐹𝐹 WACC − 𝑔𝑂𝐶𝐹𝐹
AnIntroductionto
Investment
(43)
where:
▶ 𝐹𝐶𝐹𝐹􏷠 = thefreecashflowinperiod1
▶ 𝑂𝑝𝑒𝑟. 𝐹𝐶𝐹􏷠 = thefirm’soperatingfreecashflow
inperiod1
▶ WACC = thefirm’sweightedaveragecostof
capital
▶ 𝑔𝐹𝐶𝐹𝐹 = thefirm’sconstantinfinitegrowthrateof
freecashflow
▶ 𝑔𝑂𝐹𝐶𝐹 = theconstantinfinitegrowthrateof
operatingfreecashflow
Introductionto
AssetPricing
Models
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
230
.
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
AnAlternateMeasureofGrowth
SecurityAnalysis
AnIntroductionto
Investment
𝑔 = 𝑅𝑅 × 𝑅𝑂𝐼𝐶
where:
▶ 𝑅𝑅 = theaverageretentionrate
▶ 𝑅𝑂𝐼𝐶 = 𝐸𝐵𝐼𝑇(􏷠−TaxRate)
TotalCapital
Introductionto
AssetPricing
Models
(44)
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
231
.
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
CalculationofWACC
SecurityAnalysis
AnIntroductionto
Investment
WACC = 𝑊𝐸 𝑘 + 𝑊𝐷 𝑖
where:
▶ 𝑊𝐸 = theproportionofequityintotalcapital
▶ 𝑘 = theafter-taxcostofequity(fromtheSML)
▶ 𝑊𝐷 = theproportionofdebtintotalcapital
▶ 𝑖 = theafter-taxcostofdebt
Introductionto
AssetPricing
Models
(45)
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
232
.
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
WhyandWhentoUse
SecurityAnalysis
AnIntroductionto
Investment
▶
Themeasureofcashflowused
▶
▶
▶
Fundamental
Analysis
CompanyAnalysisand
StockValuation
WeightedAverageCostofCapital(WACC)
Freecashflowtoequity
▶
▶
Costofequityasthediscountrate
Operatingcashflow
▶
▶
Introductionto
AssetPricing
Models
Dividends
Potential
233
.
CashFlowTechniques
RelativeValuation
Techniques
Costofequity
Macroeconomic
andIndustry
Analysis
Dependentongrowthratesanddiscountrate
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
DiscountedCF ValuationTechniques
SecurityAnalysis
AnIntroductionto
Investment
𝑡=𝑛
𝐶𝐹𝑡
𝑉𝑗 = 􏾜
𝑡
𝑡=􏷠 (1 + 𝑘)
(46)
where:
▶ 𝑉𝑗 = valueofstockj
▶ 𝑛 = lifeoftheasset
▶ 𝐶𝐹𝑡 = cashflowinperiodt
▶ 𝑘 = thediscountratethatisequaltotheinvestor’s
requiredrateofreturnforassetj, whichis
determinedbytheuncertainty(risk)ofthestock’s
cashflows
Introductionto
AssetPricing
Models
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
234
.
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
TheDividendDiscountModel(DDM)
SecurityAnalysis
▶
Thevalueofashareofcommonstockisthe
presentvalueofallfuturedividends
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
𝐷􏷡
𝐷􏷢
𝐷∞
𝐷􏷠
+
+
+
...
+
𝑉𝑗 =
(1 + 𝑘) (1 + 𝑘)􏷡 (1 + 𝑘)􏷢
(1 + 𝑘)∞
Fundamental
Analysis
CompanyAnalysisand
StockValuation
𝑡=𝑛
𝐷𝑡
=􏾜
𝑡
𝑡=􏷠 (1 + 𝑘)
(47)
Potential
235
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
where
▶
▶
▶
.
CashFlowTechniques
𝑉𝑗 = valueofcommonstock 𝑗
𝐷𝑡 = dividendduringtimeperiod 𝑡
𝑘 = requiredrateofreturnonstock 𝑗
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
AnIntroductionto
Investment
▶
Introductionto
AssetPricing
Models
Ifthestockisnotheldforaninfiniteperiod, a
saleattheendofyear2wouldimply:
Fundamental
Analysis
CompanyAnalysisand
StockValuation
𝑉𝑗 =
𝑆𝑃𝑗,􏷡
𝐷􏷠
𝐷􏷡
+
+
(1 + 𝑘) (1 + 𝑘)􏷡 (1 + 𝑘)􏷡
Potential
236
.
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
▶
Sellingpriceattheendofyeartwoisthevalueof
allremainingdividendpayments, whichissimply
anextensionoftheoriginalequation
𝑆𝑃𝑗,􏷡 =
▶
Introductionto
AssetPricing
Models
𝐷􏷢
𝐷∞
+ ... +
􏷢
(1 + 𝑘)
(1 + 𝑘)∞
Thepresentvalueof 𝑆𝑃𝑗,􏷡
𝑃𝑉(𝑆𝑃𝑗,􏷡 ) =
AnIntroductionto
Investment
𝐷􏷬
(􏷠+𝑘)
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
237
.
CashFlowTechniques
RelativeValuation
Techniques
𝐷􏷭
𝐷∞
+ (􏷠+𝑘)
+ ... + (􏷠+𝑘)
∞
􏷫
Macroeconomic
andIndustry
Analysis
(1 + 𝑘)􏷡
𝐷􏷢
𝐷􏷣
𝐷∞
=
+
+
...
+
(1 + 𝑘)􏷢 (1 + 𝑘)􏷣
(1 + 𝑘)∞
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
▶
AnIntroductionto
Investment
Stockswithnodividendsareexpectedtostart
payingdividendsatsomepoint, sayyearthree...
Introductionto
AssetPricing
Models
Fundamental
Analysis
𝐷􏷠
𝐷􏷡
𝐷􏷢
𝐷∞
𝑉𝑗 =
+
+ ... +
+
􏷡
􏷢
(1 + 𝑘) (1 + 𝑘)
(1 + 𝑘)
(1 + 𝑘)∞
CompanyAnalysisand
StockValuation
Potential
238
where:
▶
▶
.
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
𝐷􏷠 = 0
𝐷􏷡 = 0
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
▶
Infiniteperiodmodelassumesaconstantgrowth
rateforestimatingfuturedividends
􏷡
𝑉𝑗 =
∞
𝐷􏷟 (1 + 𝑔)
𝐷􏷟 (1 + 𝑔) 𝐷􏷟 (1 + 𝑔)
+
+...+
(1 + 𝑘)
(1 + 𝑘)􏷡
(1 + 𝑘)∞
▶
▶
▶
▶
Introductionto
AssetPricing
Models
(48)
where:
▶
AnIntroductionto
Investment
𝑉𝑗 = valueofstock 𝑗
𝐷􏷟 = dividendpaymentinthecurrentperiod
𝑔 = theconstantgrowthrateofdividends
𝑘 = requiredrateofreturnonstock 𝑗
𝑛 = thenumberofperiods, whichweassumeto
beinfinite
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
239
.
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
▶
▶
AnIntroductionto
Investment
Infiniteperiodmodelassumesaconstantgrowth
rateforestimatingfuturedividends
(48) canbereducedto:
𝐷􏷠
𝑉𝑗 =
𝑘−𝑔
Introductionto
AssetPricing
Models
Fundamental
Analysis
CompanyAnalysisand
StockValuation
(49)
Potential
240
.
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
1. Estimatetherequiredrateofreturn(𝑘)
2. Estimatethedividendgrowthrate(𝑔)
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Infinite Period DDM and Growth
Companies
SecurityAnalysis
AnIntroductionto
Investment
▶
Introductionto
AssetPricing
Models
AssumptionsofDDM:
1. Dividendsgrowataconstantrate
2. Theconstantgrowthratewillcontinueforan
infiniteperiod
3. Therequiredrateofreturn(𝑘)isgreaterthanthe
infinitegrowthrate(𝑔)
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
241
.
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Companies
SecurityAnalysis
▶
▶
▶
Growthcompanieshaveopportunitiestoearn
returnoninvestmentsgreaterthantheirrequired
ratesofreturn
Toexploittheseopportunities, thesefirms
generallyretainahighpercentageofearningsfor
reinvestment, andtheirearningsgrowfasterthan
thoseofatypicalfirm
ThisisinconsistentwiththeinfiniteperiodDDM
assumptions
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
242
.
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Companies
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
TheinfiniteperiodDDM assumesconstant
growthforaninfiniteperiod, butabnormallyhigh
growthusuallycannotbemaintainedindefinitely
Riskandgrowtharenotnecessarilyrelated
Temporaryconditionsofhighgrowthcannotbe
valuedusingDDM
Introductionto
AssetPricing
Models
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
243
.
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Valuation with Temporary SupernormalGrowth
SecurityAnalysis
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
▶
Combinethemodelstoevaluatetheyearsof
supernormalgrowthandthenuseDDM to
computetheremainingyearsatasustainablerate
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
244
.
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Valuation with Temporary SupernormalGrowth
SecurityAnalysis
▶
▶
Combinethemodelstoevaluatetheyearsof
supernormalgrowthandthenuseDDM to
computetheremainingyearsatasustainablerate
Forexample:
▶
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Fundamental
Analysis
Witha14percentrequiredrateofreturnand
dividendgrowthof:
Year
1−3∶
4−6∶
7−9∶
10𝑜𝑛 ∶
Dividend
GrowthRate
CompanyAnalysisand
StockValuation
Potential
245
.
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
25%
20%
15%
9%
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
ComputationofStockValue
CompanywithTemporarySupernormalGrowth
SecurityAnalysis
Year
1
2
3
4
5
6
7
8
9
10
Dividend
Discount
Factor
Present
Value
Growth
Rate
􏷟.􏷧􏷦􏷦􏷡
􏷟.􏷦􏷥􏷨􏷤
􏷟.􏷥􏷦􏷤􏷟
􏷟.􏷤􏷨􏷡􏷠
􏷟.􏷤􏷠􏷨􏷣
􏷟.􏷣􏷤􏷤􏷥
􏷟.􏷢􏷨􏷨􏷥
􏷟.􏷢􏷤􏷟􏷥
􏷟.􏷢􏷟􏷦􏷤
$􏷡.􏷠􏷨􏷢
$􏷡.􏷣􏷟􏷧
$􏷡.􏷥􏷢􏷨
$􏷡.􏷦􏷦􏷦
$􏷡.􏷨􏷡􏷣
$􏷢.􏷟􏷧􏷟
$􏷢.􏷠􏷟􏷤
$􏷢.􏷠􏷢􏷣
$􏷢.􏷠􏷥􏷠
􏷡􏷤%
􏷡􏷤%
􏷡􏷤%
􏷡􏷟%
􏷡􏷟%
􏷡􏷟%
􏷠􏷤%
􏷠􏷤%
􏷠􏷤%
􏷨%
􏷟.􏷢􏷟􏷦􏷤𝑏
$􏷥􏷧.􏷨􏷣􏷢
$􏷡.􏷤􏷟
􏷢.􏷠􏷢
􏷢.􏷨􏷠
􏷣.􏷥􏷨
􏷤.􏷥􏷢
􏷥.􏷦􏷥
􏷦.􏷦􏷦
􏷧.􏷨􏷣
􏷠􏷟.􏷡􏷧
􏷠􏷠.􏷡􏷠
$􏷡􏷡􏷣.􏷡􏷟𝑎
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
246
.
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
$􏷨􏷣.􏷢􏷥􏷤
𝑎 Value of dividend stream for year 10 and all future dividends, that is
TechnicalAnalysis
𝑏 The discount factor is the ninth-year factor because the valuation of the
IndexasMarket
Representation
$11.21/(0.14-0.09)=$224.20
remainingstreamismadeattheendofYear9toreflectthedividendinYear
10andallfuturedividends.
417
Sigit Wibowo
.
PresentValueofOperatingFreeCash
Flows
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Derivethevalueofthetotalfirmbydiscounting
thetotaloperatingcashflowspriortothe
paymentofinteresttothedebt-holders
Thensubtractthevalueofdebttoarriveatan
estimateofthevalueoftheequity
Introductionto
AssetPricing
Models
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
247
.
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Flows
SecurityAnalysis
𝑡=𝑛
𝑉𝑗 = 􏾜
𝑡=􏷠
AnIntroductionto
Investment
𝑂𝐶𝐹𝑡
(1 + WACC𝑗 )𝑡
Introductionto
AssetPricing
Models
(50)
where:
▶ 𝑉𝑗 = valueoffirm 𝑗
▶ 𝑛 = numberofperiodsassumedtobeinfinite
▶ 𝑂𝐶𝐹𝑡 = thefirmsoperatingfreecashflowin
period 𝑡
▶ 𝑊𝐴𝐶𝐶 = firm 𝑗’sweightedaveragecostofcapital
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
248
.
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Flows
SecurityAnalysis
▶
▶
SimilartoDDM,thismodelcanbeusedto
estimateaninfiniteperiod
Wheregrowthhasmaturedtoastablerate, the
adaptationis
𝑂𝐶𝐹𝑡
𝑉𝑗 =
WACC𝑗 − 𝑔𝑂𝐶𝐹
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Fundamental
Analysis
CompanyAnalysisand
StockValuation
(51)
Potential
249
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
where:
▶
▶
.
CashFlowTechniques
𝑂𝐶𝐹􏷠 = operatingfreecashflowinperiod1
𝑔𝑂𝐶𝐹 = long-termconstantgrowthofoperating
freecashflow
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Flows
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Assumingseveraldifferentratesofgrowthfor
OCF,theseestimatescanbedividedintostages
aswiththesupernormaldividendgrowthmodel
Estimatetherateofgrowthandthedurationof
growthforeachperiod
Introductionto
AssetPricing
Models
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
250
.
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
PresentValue of Free Cash Flows to
Equity
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
“Free”cashflowstoequityarederivedafter
operatingcashflowshavebeenadjustedfordebt
payments(interestandprinciple)
Thediscountrateusedisthefirm’scostofequity
(𝑘)ratherthan WACC
Introductionto
AssetPricing
Models
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
251
.
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
PresentValue of Free Cash Flows to
Equity
SecurityAnalysis
AnIntroductionto
Investment
𝑉𝑗 =
𝑂𝐶𝐹𝑡
WACC𝑗 − 𝑔𝑂𝐶𝐹
where:
▶ 𝑉𝑗 = Valueofthestockoffirm 𝑗
▶ 𝑛 = numberofperiodsassumedtobeinfinite
▶ 𝐹𝐶𝐹𝐸𝑡 = thefirm’sfreecashflowinperiod 𝑡
▶ 𝑘𝑗 = thecostofequity
Introductionto
AssetPricing
Models
(52)
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
252
.
CashFlowTechniques
RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
RelativeValuationRatioTechniques
SecurityAnalysis
AnIntroductionto
Investment
▶
PriceEarningsRatio
𝑃/𝐸𝑡 =
Introductionto
AssetPricing
Models
𝐷􏷠 /𝐸􏷠
𝑘−𝑔
Fundamental
Analysis
(53)
CompanyAnalysisand
StockValuation
Potential
▶
Earningspershareisafunctionof
▶
▶
CashFlowTechniques
254
Salesforecast
Estimatedprofitmargin
.RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Why and When to Use the Relative
ValuationTechniques
SecurityAnalysis
▶
▶
▶
▶
▶
AnIntroductionto
Investment
Providesinformationabouthowthemarketis
currentlyvaluingstocks
aggregatemarket
alternativeindustries
individualstockswithinindustries
Noguidanceastowhethervaluationsare
appropriate
▶
▶
Introductionto
AssetPricing
Models
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
CashFlowTechniques
255
.RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
bestusedwhenhavecomparableentities
aggregatemarketandcompany’sindustryarenot
atavaluationextreme
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Estimating Company Earnings Multipliers
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Introductionto
AssetPricing
Models
MacroanalysisoftheEarningsMultiplier
MicroanalysisoftheEarningsMultiplier
▶
▶
▶
▶
ComparingDividend-PayoutRatios
EstimatingtheRequiredRateofReturn
EstimatingtheExpectedGrowthRate
ComputingtheEarningsMultiplier
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
CashFlowTechniques
256
.RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
AdditionalMeasuresofRelativeValue
SecurityAnalysis
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
▶
▶
▶
Price/BookValueRatio
Price/CashFlowRatio
Price-to-SalesRatio
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
CashFlowTechniques
257
.RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
AnalysisofGrowthCompanies
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
▶
Generatingratesofreturngreaterthanthefirm’s
costofcapitalisconsideredtobetemporary
Earningshighertherequiredrateofreturnare
pureprofits
Howlongcantheyearntheseexcessprofits?
Isthestockproperlyvalued?
Introductionto
AssetPricing
Models
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
CashFlowTechniques
258
.RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
▶
▶
▶
AnIntroductionto
Investment
GrowthcompaniesandtheDDM
Introductionto
AssetPricing
Models
constantgrowthmodelnotappropriate
Alternativegrowthmodels
▶
Fundamental
Analysis
nogrowthfirm
𝐸 = 𝑟 × Assets = Dividends
𝐸 (1 − 𝑏)𝐸
𝑉= =
𝑘
𝑘
𝐸
𝑘=
𝑣
CompanyAnalysisand
StockValuation
Potential
CashFlowTechniques
259
(54)
.RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
▶
Long-rungrowthmodels
▶
▶
AnIntroductionto
Investment
assumessomeearningsarereinvested
Introductionto
AssetPricing
Models
Simplegrowthmodel
▶
Grosspresentvalueofgrowthinvestments
𝑏𝐸𝑚𝑘 𝑏𝐸𝑚
=
𝑘􏷡
𝑘
Fundamental
Analysis
CompanyAnalysisand
StockValuation
(55)
Potential
CashFlowTechniques
260
▶
Macroeconomic
andIndustry
Analysis
Netpresentvalueofgrowthinvestments
𝑏𝐸𝑚 𝑏𝐸
=
𝑘
𝑘
.RelativeValuation
Techniques
TechnicalAnalysis
(56)
IndexasMarket
Representation
417
Sigit Wibowo
.
SimpleGrowthModel(cont.)
SecurityAnalysis
▶
Simplegrowthmodel
𝐸 𝑏𝐸𝑚 𝑏𝐸
+
−
𝑘
𝑘
𝑘
𝐸(1 − 𝑏) 𝑏𝐸𝑚
=
+
𝑘
𝑘
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
𝑣=
Fundamental
Analysis
(57)
CompanyAnalysisand
StockValuation
Potential
CashFlowTechniques
▶
261
Presentvalueofconstantdividendplusthe
presentvalueofgrowthinvestment
𝐷 𝑏𝐸𝑚
𝑣= +
𝑘
𝑘
.RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
(58)
IndexasMarket
Representation
417
Sigit Wibowo
.
SimpleGrowthModel(cont.)
SecurityAnalysis
AnIntroductionto
Investment
▶
Presentvalueofconstantearningsplusthe
presentvalueofexcessearningsfromgrowth
investment
𝐸 𝑏𝐸(𝑚 − 1)
𝑣= +
(59)
𝑘
𝑘
Introductionto
AssetPricing
Models
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
CashFlowTechniques
262
.RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
ExpansionModel
SecurityAnalysis
AnIntroductionto
Investment
▶
Introductionto
AssetPricing
Models
Firmretainsearningstoreinvest, butreceivesa
rateofreturnonitsinvestmentequaltoitscostof
capital 𝑚 = 1 so 𝑟 = 𝑘
𝐸 𝐸(1 − 𝑏) 𝑏𝐸 𝐸
𝑣= =
+
=
𝑘
𝑘
𝑘
𝑘
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
(60)
CashFlowTechniques
263
.RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
NegativeGrowthModel
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Firmretainsearnings, butreinvestmentreturns
arebelowthefirm’scostofcapital
Sincegrowthwillbepositive, butslowerthanit
shouldbe, thevaluewilldeclinewhenthe
investorsdiscountthereinvestmentstreamatthe
costofcapital
Introductionto
AssetPricing
Models
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
CashFlowTechniques
264
.RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
TheCapitalGainComponent
SecurityAnalysis
𝑏𝐸𝑚
𝑘
where:
▶ 𝑏 = Percentageofearningsretainedfor
reinvestment
▶ 𝑚 = relatesthefirm’srateofreturnon
investmentsandthefirm’srequiredrateofreturn
(costofcapital)
▶
▶
▶
AnIntroductionto
Investment
(61)
Introductionto
AssetPricing
Models
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
CashFlowTechniques
265
.RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
𝑚 = 1 costofcapital
𝑚 > 1 isatruegrowthcompany
TechnicalAnalysis
IndexasMarket
Representation
Timeperiodforsuperiorinvestments
417
Sigit Wibowo
.
DynamicTrueGrowthModel
SecurityAnalysis
AnIntroductionto
Investment
▶
Introductionto
AssetPricing
Models
Firminvestsaconstantpercentageofcurrent
earningsinprojectsthatgenerateratesofreturn
abovethefirm’srequiredrateofreturn
𝐷􏷠
𝑉=
𝑘−𝑔
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
(62)
CashFlowTechniques
266
.RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
MeasuresofValue-Added
SecurityAnalysis
▶
EconomicValue-Added(EVA)
▶
▶
AnIntroductionto
Investment
Comparenetoperatingprofitlessadjustedtaxes
(NOPLAT) tothefirm’stotalcostofcapitalin
dollarterms, includingthecostofequity
Introductionto
AssetPricing
Models
Fundamental
Analysis
EVA returnoncapital
CompanyAnalysisand
StockValuation
Potential
EVA
Capital
▶
CashFlowTechniques
267
Macroeconomic
andIndustry
Analysis
AlternativemeasureofEVA
▶
.RelativeValuation
Techniques
TechnicalAnalysis
Comparereturnoncapitaltocostofcapital
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
Measureofexternalperformance
Howthemarkethasevaluatedthefirm’s
performanceintermsofmarketvalueofdebtand
marketvalueofequitycomparedtothecapital
investedinthefirm
RelationshipsbetweenEVA andMVA
▶
Introductionto
AssetPricing
Models
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
CashFlowTechniques
268
.RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
mixedresults
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
TheFranchiseFactor
SecurityAnalysis
▶
BreaksP/E intotwocomponents
▶
▶
AnIntroductionto
Investment
P/E basedonongoingbusiness(baseP/E)
FranchiseP/E themarketassignstotheexpected
valueofnewandprofitablebusiness
opportunities
Introductionto
AssetPricing
Models
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
CashFlowTechniques
Franchise 𝑃/𝐸 = Observed 𝑃/𝐸 − Base 𝑃/𝐸
Macroeconomic
IncrementalFranchise 𝑃/𝐸 = FranchiseFactor × GrowthFactor
andIndustry
Analysis
𝑅−𝑘
TechnicalAnalysis
=
×𝐺
𝑟𝑘
IndexasMarket
269
.RelativeValuation
Techniques
Representation
417
Sigit Wibowo
.
GrowthDurationModel
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Introductionto
AssetPricing
Models
EvaluatethehighP/E ratiobyrelatingP/E ratioto
thefirm’srateanddurationofgrowth
P/E isfunctionof
▶
▶
▶
expectedrateofgrowthofearningspershare
stock’srequiredrateofreturn
firm’sdividend-payoutratio
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
CashFlowTechniques
270
.RelativeValuation
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andIndustry
Analysis
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417
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.
GrowthDuration
SecurityAnalysis
′
AnIntroductionto
Investment
𝑡
𝐸 (𝑡) = 𝐸(0)(1 + 𝐺)
𝑁(𝑡) = 𝑁(0)(1 + 𝐷)𝑡
𝐸′ (𝑡) = 𝐸′ (𝑡)𝑁(𝑡) = 𝐸(0)[(1 + 𝐺)𝑡 (1 + 𝐷)]𝑡
􏿶
𝑃𝑔 (0)
𝑃𝑑 (0)
𝑃𝑔 (0)/𝐸𝑔 (0)
􏿹≅􏿶
𝐸𝑔 (0)(1 + 𝐺𝑔 + 𝐷𝑔 )𝑇
)𝑇
𝐸𝑎 (0)(1 + 𝐺𝑎 + 𝐷𝑎
(1 + 𝐺𝑔 + 𝐷𝑔 )𝑇
≅
􏿶
􏿹
􏿹 􏿶
𝑃𝑑 (0)/𝐸𝑎 (0)
(1 + 𝐺𝑎 + 𝐷𝑎 )𝑇
𝑃𝑔 (0)/𝐸𝑔 (0)
(1 + 𝐺𝑔 + 𝐷𝑔 )
ln 􏿶
􏿹 ≅ 𝑇 ln 􏿶
􏿹
𝑃𝑑 (0)/𝐸𝑎 (0)
(1 + 𝐺𝑎 + 𝐷𝑎 )
Introductionto
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Fundamental
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􏿹
CashFlowTechniques
271
.RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
RelativeValuationTechniques
SecurityAnalysis
▶
▶
▶
▶
Valuecanbedeterminedbycomparingtosimilar
stocksbasedonrelativeratios
Relevantvariablesincludeearnings, cashflow,
bookvalue, andsales
Relativevaluationratiosincludeprice/earning;
price/cashflow; price/bookvalueandprice/sales
Themostpopularrelativevaluationtechniqueis
basedonpricetoearnings
AnIntroductionto
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Introductionto
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272
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Analysis
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Representation
417
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.
Intra-IndustryAnalysis
SecurityAnalysis
▶
▶
▶
AnIntroductionto
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Directlycomparetwofirmsinthesameindustry
Analternativeuseof 𝑇 todetermineareasonable
𝑃/𝐸 ratio
Factorstoconsider
▶
▶
▶
▶
A majordifferenceintheriskinvolved
Inaccurategrowthestimates
Stockwithalow 𝑃/𝐸 relativetoitsgrowthrateis
undervalued
Stockwithhigh 𝑃/𝐸 andalowgrowthrateis
overvalued
Introductionto
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273
.RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
EarningsMultiplierModel
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Thisvaluesthestockbasedonexpectedannual
earnings
Thepriceearnings(P/E) ratio, orearnings
multiplier
Currentmarketprice
𝑃/𝐸 =
Expected12-monthearnings
Introductionto
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(63)
.RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
▶
Theinfinite-perioddividenddiscountmodel
indicatesthevariablesthatshoulddeterminethe
valueoftheP/E ratio
𝐷􏷠
𝑃𝑖 =
𝑘−𝑔
▶
𝐷􏷠 /𝐸􏷠
𝑘−𝑔
Introductionto
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Fundamental
Analysis
(64)
CompanyAnalysisand
StockValuation
Potential
Dividingbothsidesbyexpectedearningsduring
thenext12months(E1)
𝑃𝑖 /𝐸􏷠 =
AnIntroductionto
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CashFlowTechniques
275
.RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
(65)
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
AnIntroductionto
Investment
▶
Introductionto
AssetPricing
Models
Thus, the 𝑃/𝐸 ratioisdeterminedby
▶
▶
▶
Expecteddividendpayoutratio
Requiredrateofreturnonthestock(𝑘)
Expectedgrowthrateofdividends(𝑔)
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
CashFlowTechniques
276
.RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
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.
SecurityAnalysis
▶
AnIntroductionto
Investment
Asanexample, assume:
▶
▶
▶
▶
Introductionto
AssetPricing
Models
Dividendpayout=50%
Requiredreturn=12%
Expectedgrowth=8%
D/E =.50; k=.12; g=.08
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
CashFlowTechniques
0.50
0.50
=
𝑃/𝐸 =
0.12 − 0.08 0.04
= 12.5
277
.RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
▶
▶
AnIntroductionto
Investment
A smallchangeineitherorboth 𝑘 or 𝑔 willhave
alargeimpactonthemultiplier
Using (65)
▶
▶
▶
▶
▶
▶
𝐷/𝐸 = .50; 𝑘 = .13; 𝑔 = .08
𝑃/𝐸 = .50/(.13 − /.08) = .50/.05 = 10
𝐷/𝐸 = .50; 𝑘 = .12; 𝑔 = .09
𝑃/𝐸 = .50/(.12 − /.09) = .50/.03 = 16.7
𝐷/𝐸 = .50; 𝑘 = .11; 𝑔 = .09
𝑃/𝐸 = .50/(.11 − /.09) = .50/.02 = 25
Introductionto
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Fundamental
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andIndustry
Analysis
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Representation
417
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.
SecurityAnalysis
▶
A smallchangeineitherorbothkorgwillhave
alargeimpactonthemultiplier
▶
▶
𝐷/𝐸 = .50; 𝑘 = .12; 𝑔 = .09
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
𝑃/𝐸 = 16.7
Fundamental
Analysis
Givencurrentearningsof$2.00andgrowthof
9%
▶
CompanyAnalysisand
StockValuation
Potential
Youwouldexpect 𝐸􏷠 tobe$2.18
CashFlowTechniques
279
𝑉 = 16.7 × $2.18 = $36.41
▶
.RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
Comparethisestimatedvaluetomarketpriceto
decideifyoushouldinvestinit
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
ThePrice-CashFlowRatio
SecurityAnalysis
▶
▶
▶
Companiescanmanipulateearnings
Cash-flowislesspronetomanipulation
Cash-flowisimportantforfundamentalvaluation
andincreditanalysis
𝑃𝑡
𝑃/𝐶𝐹𝑖 =
𝐶𝐹𝑡+􏷠
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
(66)
CashFlowTechniques
280
where:
▶
▶
▶
.RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
𝑃/𝐶𝐹𝑗 = theprice/cashflowratioforfirm 𝑗
𝑃𝑡 = thepriceofthestockinperiod 𝑡
𝐶𝐹𝑡+􏷠 = expectedcashlowpershareforfirm 𝑗
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
ThePrice-BookValueRatio
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Widelyusedtomeasurebankvalues(mostbank
assetsareliquid(bondsandcommercialloans)
FamaandFrenchstudyindicatedinverse
relationshipbetween 𝑃/𝐵𝑉 ratiosandexcess
returnforacrosssectionofstocks
Introductionto
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Fundamental
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CashFlowTechniques
281
.RelativeValuation
Techniques
Macroeconomic
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Analysis
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Representation
417
Sigit Wibowo
.
SecurityAnalysis
AnIntroductionto
Investment
𝑃/𝐵𝑉𝑗 =
𝑃𝑡
𝐵𝑉𝑡+􏷠
Introductionto
AssetPricing
Models
(67)
where:
▶ 𝑃/𝐵𝑉𝑗 = theprice/bookvalueforfirm 𝑗
▶ 𝑃𝑡 = theendofyearstockpriceforfirm 𝑗
▶ 𝐵𝑉𝑡+􏷠 = theestimatedendofyearbookvalueper
shareforfirm 𝑗
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
CashFlowTechniques
282
.RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Besuretomatchthepricewitheitherarecent
bookvaluenumber, orestimatethebookvalue
forthesubsequentyear
Canderiveanestimatebaseduponhistorical
growthratefortheseriesorusethegrowthrate
impliedbythe 𝑅𝑂𝐸 × RetentionRate analysis
Introductionto
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Fundamental
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CashFlowTechniques
283
.RelativeValuation
Techniques
Macroeconomic
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Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
ThePrice-SalesRatio
SecurityAnalysis
▶
▶
Strong, consistentgrowthrateisarequirementof
agrowthcompany
Salesissubjecttolessmanipulationthanother
financialdata
𝑃
𝑃𝑡
=
(68)
𝑆 𝑆𝑡+􏷠
where
▶
▶
▶
AnIntroductionto
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Introductionto
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Fundamental
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284
𝑃
𝑆
= pricetosalesratioforfirm 𝑗
𝑃𝑡 = endofyearstockpriceforfirm 𝑗
𝑆𝑡+􏷠 = annualsalespershareforfirm 𝑗 during
year 𝑡
.RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
ThePrice-SalesRatio
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
▶
Matchthestockpricewithfirm’sexpectedsales
pershare
Thisratiovariesdramaticallybyindustry
Profitmarginsalsovarybyindustry
Relativecomparisonsusing 𝑃/𝑆 ratioshouldbe
betweenfirmsinsimilarindustries
Introductionto
AssetPricing
Models
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CashFlowTechniques
285
.RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Implementing the Relative Valuation
Technique
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Firststep: Comparethevaluationratiofora
companytothecomparableratioforthemarket,
forstock’sindustryandtootherstocksinthe
industrytodeterminehowitcompares
Secondstep: Explaintherelationship
Introductionto
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417
Sigit Wibowo
.
EstimatingtheInputs
The Required Rate of Return andThe Expected Growth Rate of
ValuationVariables
SecurityAnalysis
AnIntroductionto
Investment
▶
Valuationprocedureisthesameforsecurities
aroundtheworld, buttherequiredrateofreturn
(𝑘)andexpectedgrowthrateofearningsand
othervaluationvariables(𝑔)suchasbookvalue,
cashflow, anddividendsdifferamongcountries
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Analysis
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Representation
417
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.
RequiredRateofReturn(𝑘)
SecurityAnalysis
▶
▶
▶
▶
Theinvestor’srequiredrateofreturnmustbe
estimatedregardlessoftheapproachselectedor
techniqueapplied
Thiswillbeusedasthediscountrateandalso
affectsrelative-valuation
Thisisnotusedforpresentvalueoffreecashflow
whichusestherequiredrateofreturnonequity
(𝑘)
Itisalsonotusedinpresentvalueofoperating
cashflowwhichuses WACC
AnIntroductionto
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andIndustry
Analysis
TechnicalAnalysis
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Representation
417
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.
RequiredRateofReturn(𝑘)
SecurityAnalysis
AnIntroductionto
Investment
▶
Introductionto
AssetPricing
Models
Threefactorsinfluenceaninvestor’srequiredrate
ofreturn:
▶
▶
▶
Theeconomy’srealrisk-freerate(𝑅𝑅𝐹𝑅)
Theexpectedrateofinflation(𝐼 )
A riskpremium(𝑅𝑃)
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
CashFlowTechniques
289
.RelativeValuation
Techniques
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andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
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.
TheEconomy’sRealRisk-FreeRate
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
▶
Introductionto
AssetPricing
Models
Minimumrateaninvestorshouldrequire
Dependsontherealgrowthrateoftheeconomy
Fundamental
Analysis
(Capitalinvestedshouldgrowasfastasthe
economy)
Rateisaffectedforshortperiodsbytightnessor
easeofcreditmarkets
CompanyAnalysisand
StockValuation
Potential
CashFlowTechniques
290
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Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
TheExpectedRateofInflation
SecurityAnalysis
▶
▶
Investorsareinterestedinrealratesofreturnthat
willallowthemtoincreasetheirrateof
consumption
Theinvestor’srequirednominalrisk-freerateof
return(NRFR) shouldbeincreasedtoreflectany
expectedinflation:
AnIntroductionto
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Introductionto
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𝑁𝑅𝐹𝑅 = [1 + 𝑅𝑅𝐹𝑅][1 + 𝐸(𝐼)] − 1
(69)
Macroeconomic
andIndustry
Analysis
where:
▶
.RelativeValuation
Techniques
TechnicalAnalysis
E(I) =expectedrateofinflation
IndexasMarket
Representation
417
Sigit Wibowo
.
TheRiskPremium
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
Causesdifferencesinrequiredratesofreturnon
alternativeinvestments
Explainsthedifferenceinexpectedreturns
amongsecurities
Changesovertime, bothinyieldspreadand
ratiosofyields
Introductionto
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Analysis
TechnicalAnalysis
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417
Sigit Wibowo
.
Estimating the Required Return for
ForeignSecurities
SecurityAnalysis
▶
ForeignRealRFR
▶
▶
▶
AnIntroductionto
Investment
Shouldbedeterminedbytherealgrowthrate
withintheparticulareconomy
Canvarysubstantiallyamongcountries
Introductionto
AssetPricing
Models
Fundamental
Analysis
InflationRate
▶
CompanyAnalysisand
StockValuation
Estimatetheexpectedrateofinflation, andadjust
theNRFR forthisexpectation
𝑁𝑅𝐹𝑅 =(1 + RealGrowth)
× (1 + ExpectedInflation) − 1
Potential
CashFlowTechniques
293
.RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
(70)
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
RiskPremium
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Mustbederivedforeachinvestmentineach
country
Thefiveriskcomponentsvarybetweencountries
▶
▶
▶
▶
▶
Businessrisk
Financialrisk
Liquidityrisk
Exchangeraterisk
Countryrisk
Introductionto
AssetPricing
Models
Fundamental
Analysis
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StockValuation
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CashFlowTechniques
294
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Techniques
Macroeconomic
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Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
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.
ExpectedGrowthRate
SecurityAnalysis
▶
▶
Estimatinggrowthfromfundamentals
Determinedby
▶
▶
▶
▶
AnIntroductionto
Investment
thegrowthofearnings
theproportionofearningspaidindividends
Introductionto
AssetPricing
Models
Intheshortrun, dividendscangrowatadifferent
ratethanearningsduetochangesinthepayout
ratio
Earningsgrowthisalsoaffectedbycompounding
ofearningsretention
𝑔 = RetentionRate × ReturnonEquity
= 𝑅𝑅 × 𝑅𝑂𝐸
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
CashFlowTechniques
295
.RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
(71)
IndexasMarket
Representation
417
Sigit Wibowo
.
BreakdownofROE
SecurityAnalysis
AnIntroductionto
Investment
NetIncome
Sales
TotalAssets
×
×
Sales
TotalAssets CommonEquity
Financial
Profit
Totalasset
=
×
×
leverage
margin
turnover
(72)
Introductionto
AssetPricing
Models
Fundamental
Analysis
𝑅𝑂𝐸 =
CompanyAnalysisand
StockValuation
Potential
CashFlowTechniques
296
.RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
BreakdownofROE
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
Thefirstoperatingratio, netprofitmargin,
indicatesthefirm’sprofitabilityonsales
Thesecondcomponent, totalassetturnoveristhe
indicatorofoperatingefficiencyandreflectthe
assetandcapitalrequirementsofbusiness.
Thefinalcomponentmeasurefinancialleverage
▶
Introductionto
AssetPricing
Models
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
CashFlowTechniques
297
Itindicateshowmanagementhasdecidedto
financethefirm
.RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
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.
EstimatingGrowthBasedonHistory
Historicalgrowthratesofsales, earnings, cashflow, anddividends
SecurityAnalysis
AnIntroductionto
Investment
▶
1. arithmeticorgeometricaverageofannual
percentagechanges
2. linearregressionmodels
3. log-linearregressionmodels
▶
Introductionto
AssetPricing
Models
Threetechniques
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
CashFlowTechniques
298
Allthreeusetime-seriesplotofdata
.RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Estimating Dividend Growth for ForeignStocks
SecurityAnalysis
AnIntroductionto
Investment
▶
Introductionto
AssetPricing
Models
Differencesinaccountingpracticesaffectthe
componentsofROE
▶
▶
▶
▶
RetentionRate
NetProfitMargin
TotalAssetTurnover
TotalAsset/EquityRatio
Fundamental
Analysis
CompanyAnalysisand
StockValuation
Potential
CashFlowTechniques
299
.RelativeValuation
Techniques
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
TheInvestmentDecisionProcess
SecurityAnalysis
▶
▶
AnIntroductionto
Investment
Determinetherequiredrateofreturn
Evaluatetheinvestmenttodetermineifitsmarket
priceisconsistentwithyourrequiredrateof
return
▶
▶
Estimatethevalueofthesecuritybasedonits
expectedcashflowsandyourrequiredrateof
return
Comparethisintrinsicvaluetothemarketprice
todecideifyouwanttobuyit
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
301
.
ValuationProcess
MacroeconomicAnalysis
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
ValuationProcess
SecurityAnalysis
AnIntroductionto
Investment
▶
Introductionto
AssetPricing
Models
Twoapproaches
1. Top-down, three-stepapproach
2. Bottom-up, stockvaluation, stockpicking
approach
▶
Thedifferencebetweenthetwoapproachesisthe
perceivedimportanceofeconomicandindustry
influenceonindividualfirmsandstocks
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
302
.
ValuationProcess
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
OverviewoftheValuationProcess
SecurityAnalysis
▶
▶
▶
▶
Valuationprocessislikethe
chicken-and-egg-dilemma;
Firstexaminetheinfluenceofthegeneral
economyonallfirmsandthesecuritymarkets
Thenanalysetheprospectsforvariousglobal
industrieswiththebestoutlooksinthiseconomic
environment
Finallyturntotheanalysisofindividualfirmsin
thepreferredindustriesandtothecommonstock
ofthesefirms.
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
303
.
ValuationProcess
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Whyisa3-StepValuationApproach?
SecurityAnalysis
1. Generaleconomicinfluences
▶
AnIntroductionto
Investment
Decidehowtoallocateinvestmentfundsamong
countries, andwithincountriestobonds, stocks,
andcash
Introductionto
AssetPricing
Models
Fundamental
Analysis
2. Industryinfluences
▶
Determinewhichindustrieswillprosperand
whichindustrieswillsufferonaglobalbasisand
withincountries
Macroeconomic
andIndustry
Analysis
304
IndustryAnalysis
3. Companyanalysis
▶
.
ValuationProcess
TechnicalAnalysis
IndexasMarket
Representation
Determinewhichcompaniesintheselected
industrieswillprosperandwhichstocksare
undervalued
417
Sigit Wibowo
.
Doesthe3-StepProcessWork?
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Studiesindicatethatmostchangesinan
individualfirm’searningscanbeattributedto
changesinaggregatecorporateearningsand
changesinthefirm’sindustry
Studieshavefoundarelationshipbetween
aggregatestockpricesandvariouseconomic
seriessuchasemployment, income, or
production
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
305
.
ValuationProcess
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Doesthe3-StepProcessWork?
SecurityAnalysis
AnIntroductionto
Investment
▶
Ananalysisoftherelationshipbetweenratesof
returnfortheaggregatestockmarket, alternative
industries, andindividualstocksshowedthat
mostofthechangesinratesofreturnfor
individualstockcouldbeexplainedbychanges
intheratesofreturnfortheaggregatestock
marketandthestock’sindustry
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
306
.
ValuationProcess
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
TheoryofValuation
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Thevalueofanassetisthepresentvalueofits
expectedreturnsYouexpectanassettoprovidea
streamofreturnswhileyouownit
Toconvertthisstreamofreturnstoavalueforthe
security, youmustdiscountthisstreamatyour
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
307
.
ValuationProcess
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
TheoryofValuation
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Introductionto
AssetPricing
Models
Toconvertthisstreamofreturnstoavalueforthe
security, youmustdiscountthisstreamatyour
Thisrequiresestimatesof:
▶
▶
Thestreamofexpectedreturns, and
Therequiredrateofreturnontheinvestment
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
308
.
ValuationProcess
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
StreamofExpectedReturns
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
▶
▶
▶
▶
Introductionto
AssetPricing
Models
Formofreturns
Earnings
Cashflows
Dividends
Interestpayments
Capitalgains(increasesinvalue)
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
309
.
ValuationProcess
IndustryAnalysis
Timepatternandgrowthrateofreturns
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
RequiredRateofReturn
SecurityAnalysis
▶
▶
AnIntroductionto
Investment
UncertaintyofReturn(cashflow)
Determinedby
1. Economy’srisk-freerateofreturn, plus
2. Expectedrateofinflationduringtheholding
period, plus
3. Riskpremiumdeterminedbytheuncertaintyof
returns
▶
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
310
.
ValuationProcess
IndustryAnalysis
Businessrisk; financialrisk; liquidityrisk;
exchangerrateriskandcountry
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
InvestmentDecisionProcess
A ComparisonofEstimatedValuesandMarketPrices
SecurityAnalysis
AnIntroductionto
Investment
▶
Introductionto
AssetPricing
Models
Youhavetoestimatetheintrinsicvalueofthe
investmentatyourrequiredrateofreturnand
thencomparethisestimatedintrinsicvaluetothe
prevailingmarketprice.
▶
▶
IfEstimatedValue>MarketPrice, Buy
IfEstimatedValue<MarketPrice, Don’tBuy
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
311
.
ValuationProcess
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
TheComponentsofMarketAnalysis
MacromarketAnalysis
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Introductionto
AssetPricing
Models
A strongrelationshipexistsbetweentheeconomy
andthestockmarket
Securitymarketsreflectwhatisexpectedtogoon
intheeconomybecausethevalueofan
investmentisdeterminedby
▶
▶
itsexpectedcashflows
requiredrateofreturn(i.e., thediscountrate)
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
ValuationProcess
313
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
EconomicActivity&SecurityMarkets
StockMarketasaLeadingIndicator
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
Stockpricesreflectexpectationsofearnings,
dividends, andinterestrates
Stockmarketreactstovariousleadingindicator
series
Stockpricesconsistentlyturnbeforetheeconomy
does
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
ValuationProcess
314
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
EconomicActivity&StockPrices
Twobroadcategoriesofeconomicseries
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
SetsofeconomicseriessuggestedbytheNational
BureauofEconomicResearch
Alternativemonetaryseriesinfluencedbythe
FederalReserveandcentralbanks
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
ValuationProcess
315
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Cyclical IndicatorApproach to ForecastingtheEconomy
SecurityAnalysis
▶
▶
▶
▶
▶
▶
▶
AnIntroductionto
Investment
Thisapproachcontendsthattheaggregate
economyexpandsandcontractsindiscernable
periods
NationalBureauofEconomicResearch(NBER)
Cyclicalindicatorcategories
leadingindicators
coincidentindicators
laggingindicators
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
ValuationProcess
316
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
Compositeseriesandratioofseries
417
Sigit Wibowo
.
CyclicalIndicatorCategories
SecurityAnalysis
▶
Leadingindicators
▶
▶
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
economicseriesthatusuallyreachpeaksor
troughsbeforecorrespondingpeaksortroughsin
aggregateeconomyactivity
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
Coincidentindicators
▶
economicseriesthathavepeaksandtroughsthat
roughlycoincidewiththepeaksandtroughsin
thebusinesscycle
ValuationProcess
317
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
CyclicalIndicatorCategories
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
Introductionto
AssetPricing
Models
Laggingindicators
economicseriesthatexperiencetheirpeaksand
troughsafterthoseoftheaggregateeconomy
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
Selectedseries
▶
economicseriesthatdonotfallintooneofthe
threemaingroups
ValuationProcess
318
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
AnIntroductionto
Investment
▶
Introductionto
AssetPricing
Models
Analyticalmeasuresofperformance
▶
▶
▶
▶
▶
diffusionindexes
trends
ratesofchange
directionofchange
comparisonwithpreviouscycles
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
ValuationProcess
319
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
AnIntroductionto
Investment
▶
Introductionto
AssetPricing
Models
Limitationsofcyclicalindicatorapproach
▶
▶
▶
▶
▶
falsesignals
currencyofthedataandrevisions
noseriesreflectstheservicesector
noseriesrepresentstheglobaleconomy
politicalandinternationaldevelopmentsarenot
factoredintoastatisticalsystem
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
ValuationProcess
320
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
▶
AnIntroductionto
Investment
Otherleadingindicatorseries
▶
▶
▶
▶
▶
▶
▶
Introductionto
AssetPricing
Models
CIBCR:
Long-leadingindex
Leadingemploymentindex
Leadinginflationindex
Analysisofalternativeleadingindicatorsof
inflation
Internationalleadingindicatorseries
Surveysofsentimentandexpectations
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
ValuationProcess
321
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Monetary Variables, the Economy,
andStockPrices
SecurityAnalysis
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
▶
▶
▶
Moneysupplyandtheeconomy
Moneysupplyandstockprices
Inflation, interestrates, andsecurityprices
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
ValuationProcess
322
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Monetary Variables, the Economy,
andStockPrices
SecurityAnalysis
AnIntroductionto
Investment
▶
Introductionto
AssetPricing
Models
Othereconomicvariablesandstockprices
▶
▶
▶
▶
▶
growthinindustrialproduction
changesintheriskpremium
twistsintheyieldcurve
measuresofunanticipatedinflation
changesinexpectedinflationduringperiodsof
volatileinflation
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
ValuationProcess
323
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Inflation, Interest Rates, and Security
Prices
SecurityAnalysis
▶
▶
▶
▶
Introductionto
AssetPricing
Models
generallymovetogether
investorsarenotgoodatpredictinginflation
Fundamental
Analysis
Inflationratesandbondprices
▶
▶
▶
AnIntroductionto
Investment
Inflationandinterestrates
negativerelationship
moreeffectonlongertermbonds
Macroeconomic
andIndustry
Analysis
ValuationProcess
324
Inflation, Interestratesandstockprices
▶
▶
.
IndustryAnalysis
TechnicalAnalysis
notdirectandnotconsistent
effectvariesovertime
IndexasMarket
Representation
417
Sigit Wibowo
.
Cross-SectionalIndustryPerformance
SecurityAnalysis
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
▶
▶
Widedispersioninratesofreturnindifferent
industries
Performancevariesfromyeartoyear
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
ValuationProcess
326
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
IndustryPerformanceoverTime
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Researchshowsthatthereis almostno
association inindividualindustryperformance
yeartoyearoroversequentialrisingorfalling
markets
Variablesthataffectindustryperformancechange
overtime
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
ValuationProcess
327
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
PerformanceoftheCompanieswithin
anIndustry
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Introductionto
AssetPricing
Models
Thereis widedispersion intheperformanceof
companieswithinanindustry
Thisreinforcestheneedforcompanyanalysisin
additiontoindustryanalysis
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
ValuationProcess
328
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
DifferencesinIndustryRisk
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Empiricalstudieshavefound awiderangeofrisk
amongdifferentindustriesatapointintime, and
thatdifferencesinindustryrisktypicallywidened
duringrisingandfallingmarkets
Althoughriskmeasuresfordifferentindustries
haveshownsubstantialdispersionduringa
periodoftime, individualindustries’risk
measuresarestableovertime
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
ValuationProcess
329
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
TheBusinessCycleandIndustrySectors
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Economictrendscananddoaffectindustry
performance
Byidentifyingandmonitoringkeyassumptions
andvariables, wecanmonitortheeconomyand
gaugetheimplicationsofnewinformationonour
economicoutlookandindustryanalysis
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
ValuationProcess
330
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
TheBusinessCycle&IndustrySectors
CyclicalorStructuralChanges
SecurityAnalysis
▶
▶
▶
Cyclicalchangesintheeconomyarisefromthe
upsanddownsofthebusinesscycle
Structurechangesoccurwhentheeconomy
undergoesamajorchangeinorganisationorhow
itfunctions
Rotationstrategyiswhenoneswitchesfromone
industrygrouptoanotheroverthecourseofa
businesscycle
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
ValuationProcess
331
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
TheBusinessCycle&IndustrySectors
EconomicVariablesandDifferentIndustries
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
▶
Inflation
InterestRates
InternationalEconomics
ConsumerSentiment
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
ValuationProcess
332
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
TheStockMarket&theBusinessCycle
SecurityAnalysis
Economic
cycle
Basic industries excel
Capital
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
goods excel
Fundamental
Analysis
.
Macroeconomic
andIndustry
Analysis
Consumer
durables
Finance
excel
ValuationProcess
Consumer
333
staples excel
.
IndustryAnalysis
TechnicalAnalysis
stocks excel
IndexasMarket
Representation
time
417
Sigit Wibowo
.
StructuralEconomicChangesandAlternativeIndustries
SecurityAnalysis
▶
▶
▶
▶
▶
AnIntroductionto
Investment
SocialInfluences
Introductionto
AssetPricing
Models
Demographics
Lifestyles
Fundamental
Analysis
Technology
PoliticsandRegulations
▶
▶
▶
▶
Economicreasoning
Fairness
Regulatorychangesaffectnumerousindustries
Regulationsaffectinternationalcommerce
Macroeconomic
andIndustry
Analysis
ValuationProcess
334
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
EvaluatingtheIndustryLifeCycle
FiveStageModel
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
▶
▶
Pioneeringdevelopment
Rapidlyacceleratingindustrygrowth
Matureindustrygrowth
Stabilizationandmarketmaturity
Decelerationofgrowthanddecline
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
ValuationProcess
335
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
AnalysisofIndustryCompetition
CompetitionandExpectedIndustryReturns
SecurityAnalysis
▶
▶
▶
Porter’sconceptofcompetitivestrategyis
describedasthesearchbyafirmforafavourable
competitivepositioninanindustry
Tocreateaprofitablecompetitivestrategy, afirm
mustfirstexaminethebasiccompetitivestructure
ofitsindustry
Thepotentialprofitabilityofafirmisheavily
influencedbytheprofitabilityofitsindustry
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
ValuationProcess
336
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
CompetitiveStructureofanIndustry
Porter’sCompetitiveForces
SecurityAnalysis
Public
policies
Threatof
substitutes
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Bargaining
powerof
suppliers
Rivalry
among
.
existing
competitors
Fundamental
Analysis
Bargaining
powerof
users
Macroeconomic
andIndustry
Analysis
ValuationProcess
337
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
Threatof
new
entrants
417
Sigit Wibowo
.
EstimatingIndustryRatesofReturn
▶
▶
▶
SecurityAnalysis
Presentvalueusingrequiredrateofreturnforthe
equityintheindustry
Two-stepP/E ratioapproachusesexpectedvalue
attheendofinvestmenthorizonandcompute
theexpecteddividendreturnduringtheperiod
ValuationusingthereducedformDDM
𝐷􏷠
𝑃𝑖 =
𝑘−𝑔
where
▶
▶
▶
𝑃𝑖 = thepriceofindustry 𝑖 attime 𝑡
𝐷􏷠 = theexpecteddividendforindustry 𝑖 in
period1equalto 𝐷􏷟 /(1 + 𝑔)
𝑘 = therequiredrateofreturnontheequityfor
industry 𝑖
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
ValuationProcess
338
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
EstimatingtheRequiredRateofReturn
SecurityAnalysis
▶
▶
▶
▶
▶
▶
▶
▶
▶
AnIntroductionto
Investment
Influencedbytherisk-freerate
Expectedinflationrate
Riskpremiumfortheindustryversusthemarket
businessrisk(BR)
financialrisk(FR)
liquidityrisk(LR)
exchangeraterisk(ERR)
countrypoliticalrisk(CR)
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
ValuationProcess
339
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
Orcomparesystematicrisk(beta)fortheindustry
tothemarketbetaof1.0
417
Sigit Wibowo
.
EstimatingtheExpectedGrowthRate
SecurityAnalysis
AnIntroductionto
Investment
▶
Earningsanddividendgrowtharedeterminedby
theretentionrateandthereturnonequity
▶
▶
Introductionto
AssetPricing
Models
Fundamental
Analysis
Earningsretentionrateofindustrycomparedto
theoverallmarket
Returnonequityisafunctionof
▶
▶
▶
thenetprofitmargin
totalassetturnover
ameasureoffinancialleverage
Macroeconomic
andIndustry
Analysis
ValuationProcess
340
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
IndustryValuation
TheFreeCashFlowtoEquity(FCFE) Model
SecurityAnalysis
AnIntroductionto
Investment
FCFE =
+
−
−
−
+
Net income
Depreciation Expense
.
Capital Expenditures
Δ in Working Capital
Principal Debt Repayments
New Debt Issues
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
ValuationProcess
341
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
IndustryValuation
TheFreeCashFlowtoEquity(FCFE) Model
SecurityAnalysis
AnIntroductionto
Investment
▶
Introductionto
AssetPricing
Models
TheConstantGrowthFCFE Model
Fundamental
Analysis
𝐹𝐶𝐹𝐸􏷠
𝑉=
𝑘−𝑔
Macroeconomic
andIndustry
Analysis
ValuationProcess
▶
TheTwo-StageGrowthFCFE Model
342
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
TheEarningsMultipleTechnique
Estimatingearningspershare
SecurityAnalysis
▶
Startwithforecastingsalespershare
▶
▶
▶
▶
AnIntroductionto
Investment
Industriallifecycle
Input-outputanalysis
Industry-aggregateeconomyrelationship
Introductionto
AssetPricing
Models
Fundamental
Analysis
Earningsforecastingandanalysisofindustry
competition
▶
▶
▶
▶
▶
competitivestrategy
competitiveenvironment
industryoperatingprofitmargin
industryearningsestimate
industryearningsmultiplier
Macroeconomic
andIndustry
Analysis
ValuationProcess
343
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
IndustryProfitMarginForecast
Industry’soperatingprofitmargin(EBITDA /Sales)
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
▶
▶
▶
Depreciationexpense
interestexpense
taxrate
Regressionanalysis
Timeseriesanalysis
Long-termconsiderationincludingcompetitive
structure
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
ValuationProcess
344
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Depreciationexpense
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
Generallyincreasingtimeseries
Specificestimatetechniqueusingthe
depreciationexpense/PPE ratio
Subtractdepreciationfromoperatingprofit
margintodetermineindustry’snetbeforeinterest
andtaxes
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
ValuationProcess
345
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Interest expense is a function of financial leverage and interest
rates
SecurityAnalysis
AnIntroductionto
Investment
1. Calculatetheannualtotalassetturnover(TATO)
2. Useyourcurrentsalesestimateandanestimate
ofTATO toestimatetotalassetsnextyear
3. Calculatetheannuallong-term(interestbearing)
debtasapercentoftotalassets,
4. Estimatelong-termdebtforthenextyear
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
ValuationProcess
346
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Interest expense is a function of financial leverage and interest
rates
SecurityAnalysis
5. Calculatetheannualinterestcostasapercentof
long-termdebtandanalyzethetrend
6. Estimatenextyear’sinterestcostofdebtforthis
industrybaseduponyourpriorestimateof
marketyields
7. Estimateinterestexpensebasedonthefollowing
estimates: (InterestCostofDebt)(Outstanding
Long-TermDebt)
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
ValuationProcess
347
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Macroanalysis
EstimatinganIndustryEarningsMultiplier
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Relationshipbetweenmultiplierfortheindustry
andthemarket
Variablesthatinfluencethemultiplier:
▶
▶
Fundamental
Analysis
requiredrateofreturn(𝑘)
▶
▶
Introductionto
AssetPricing
Models
Macroeconomic
andIndustry
Analysis
functionofthenominalrisk-freerateplusarisk
premium
expectedgrowthrateofearningsanddividend
dividendpayoutratio
ValuationProcess
348
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
Microanalysis
EstimatinganIndustryEarningsMultiplier
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
▶
▶
Estimatethevariablesthatinfluencetheindustry
earningsmultiplierandcomparethemtothe
comparablevaluesforthemarketP/E
Industrymultiplierversusthemarketmultiplier
Comparingdividend-payoutratios
Estimatingtherequiredrateofreturn(𝑘)
Estimatingtheexpectedgrowthrate(𝑔)
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
ValuationProcess
349
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
GlobalIndustryAnalysis
SecurityAnalysis
▶
▶
▶
▶
Themacroeconomicenvironmentinthemajor
producingandconsumingcountriesforthis
industry
Anoverallanalysisofthesignificantcompanies
intheindustryandtheproductstheyproduce
Whataretheaccountingdifferencesbycountry
andhowdothesedifferencesimpacttherelative
valuationratios?
Whatistheeffectofcurrencyexchangerate
trendsforthemajorcountries?
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
ValuationProcess
350
.
IndustryAnalysis
TechnicalAnalysis
IndexasMarket
Representation
417
Sigit Wibowo
.
TechnicalAnalysis
UnderlyingAssumptions
SecurityAnalysis
AnIntroductionto
Investment
1. Themarketvalueofanygoodorserviceis
determinedsolelybytheinteractionofsupply
anddemand
2. Supplyanddemandaregovernedbynumerous
factors, bothrationalandirrational
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
352
.
TechnicalTradingRulesand
Indicators
Contrary-OpinionRules
UsingR
IndexasMarket
Representation
417
Sigit Wibowo
.
TechnicalAnalysis
SecurityAnalysis
AnIntroductionto
Investment
3. Disregardingminorfluctuations, thepricesfor
individualsecuritiesandtheoverallvalueofthe
markettendtomoveintrends, whichpersistfor
appreciablelengthsoftime
4. Prevailingtrendschangeinreactiontoshiftsin
supplyanddemandrelationships. Theseshifts,
nomatterwhytheyoccur, canbedetected
soonerorlaterintheactionofthemarketitself.
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
353
.
Indicators
UsingR
IndexasMarket
Representation
417
Sigit Wibowo
.
AdvantagesofTechnicalAnalysis
SecurityAnalysis
▶
▶
AnIntroductionto
Investment
Notheavilydependentonfinancialaccounting
statements
Problemswithaccountingstatements:
1. Lackinformationneededbysecurityanalysts
2. GAAP/IFRS allowsfirmstoselectreporting
procedures, resultingindifficultycomparing
statementsfromtwofirms
3. Non-quantifiablefactorsdonotshowupin
financialstatements
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
354
.
Indicators
UsingR
IndexasMarket
Representation
417
Sigit Wibowo
.
AdvantagesofTechnicalAnalysis
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Fundamentalanalystmustprocessnew
informationandquicklydetermineanew
intrinsicvalue, buttechnicalanalystmerelyhas
torecogniseamovementtoanewequilibrium
Technicianstradewhenamovetoanew
equilibriumisunderwaybutafundamental
analystfindsundervaluedsecuritiesthatmaynot
adjusttheirpricesasquickly
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
355
.
Indicators
UsingR
IndexasMarket
Representation
417
Sigit Wibowo
.
ChallengestoTechnicalAnalysis
SecurityAnalysis
▶
▶
▶
AnIntroductionto
Investment
AssumptionsofTechnicalAnalysis
Introductionto
AssetPricing
Models
EmpiricaltestsofEfficientMarketHypothesis
(EMH) showthatpricesdonotmoveintrends
Fundamental
Analysis
TechnicalTradingrules
▶
▶
▶
▶
Thepastmaynotberepeated
Patternsmaybecomeself-fulfillingprophecies
A successfulrulewillgainfollowersandbecome
lesssuccessful
Rulesrequireagreatdealofsubjective
judgement
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
356
.
Indicators
UsingR
IndexasMarket
Representation
417
Sigit Wibowo
.
Technical Trading Rules and Indicators
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Stockcyclestypicallygothroughapeakand
trough
Analysethefollowingchartofatypicalstock
pricecycleandwewillshowarisingtrend
channel, aflattrendchannel, adecliningtrend
channel, andindicationsofwhenatechnical
analystwouldwanttotrade
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
358
.TechnicalTradingRulesand
Indicators
UsingR
IndexasMarket
Representation
417
Sigit Wibowo
.
TypicalStockMarketCycle
SecurityAnalysis
35
AnIntroductionto
Investment
25
Stockprice
30
Peak
Declining
trend channel
Introductionto
AssetPricing
Models
Rising trend
channel
Flat trend
channel
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
Rising trend
channel
Sellpoint
TechnicalAnalysis
20
359
Buypoint
15
Through
0
.
50
100
Declining
trend channel
150
.TechnicalTradingRulesand
Indicators
UsingR
Through
200
IndexasMarket
Representation
250
Date
417
Sigit Wibowo
.
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
Manyanalystsrelyonrulesdevelopedfromthe
premisethatthemajorityofinvestorsarewrong
asthemarketapproachespeaksandtroughs
Technicianstrytodeterminewhetherinvestors
arestronglybullishorbearishandthentradein
theoppositedirection
Thesepositionshavevariousindicators
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
Indicators
361
.
UsingR
IndexasMarket
Representation
417
Sigit Wibowo
.
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
▶
▶
▶
Mutualfundcashpositions
Creditbalancesinbrokerageaccounts
Investmentadvisoryopinions
OTC versusNYSE volume
ChicagoBoardOptionsExchange(CBOE)
Put-Callratio
Futurestradersbullishonstock-indexfutures
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
Indicators
362
.
UsingR
IndexasMarket
Representation
417
Sigit Wibowo
.
FollowtheSmartMoney
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
▶
▶
Indicatorsshowingbehaviourofsophisticated
investors
TheBarron’sConfidenceIndex
T-Bill-Eurodollaryieldspread
Shortsalesbyspecialists
Debitbalancesinbrokerageaccounts(margin
debt)
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
Indicators
363
.
UsingR
IndexasMarket
Representation
417
Sigit Wibowo
.
OtherMarketIndicators
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
MomentumIndicators
Breadthofmarket
▶
▶
▶
▶
▶
Introductionto
AssetPricing
Models
Fundamental
Analysis
Advance-decline
Diffusionindex
Shortinterest
Stocksabovetheir200-daymovingaverage
Blockuptick-downtickratio
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
Indicators
364
.
UsingR
IndexasMarket
Representation
417
Sigit Wibowo
.
StockPriceandVolumeTechniques
SecurityAnalysis
▶
AnIntroductionto
Investment
TheDowtheory–oldesttechnicaltradingrule
Introductionto
AssetPricing
Models
1. Majortrendsareliketidesintheocean
2. Intermediatetrendsresemblewaves
3. Short-runmovementsarelikeripples
▶
▶
Macroeconomic
andIndustry
Analysis
Importanceofvolume
▶
▶
Fundamental
Analysis
Ratioofupside-downsidevolume
Supportandresistancelevels
Movingaveragelines
TechnicalAnalysis
Indicators
365
.
UsingR
IndexasMarket
Representation
417
Sigit Wibowo
.
StockPriceandVolumeTechniques
SecurityAnalysis
AnIntroductionto
Investment
▶
Relative-strength(RS) ratios
▶
▶
▶
▶
▶
Introductionto
AssetPricing
Models
Forindividualstocksandindustrygroups
Barcharting
Multipleindicatorcharts
Point-and-figurecharts
Overallfeelfromaconsensusofnumerous
technicalindicators
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
Indicators
366
.
UsingR
IndexasMarket
Representation
417
Sigit Wibowo
.
TechnicalAnalysisofForeignMarkets
SecurityAnalysis
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
▶
▶
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Foreignstockmarketseries
Technicalanalysisofforeignexchangerates
Technicalanalysisofbondmarkets
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
Indicators
367
.
UsingR
IndexasMarket
Representation
417
Sigit Wibowo
.
TechnicalAnalysisUsingR
http://www.quantmod.com/examples/intro/
SecurityAnalysis
▶
quantmod packagesupportsthefollowing
database:
▶
▶
▶
▶
▶
▶
▶
▶
▶
Yahoo! Finance(OHLC data)
FederalReserveBankofSt. LouisFRED®
GoogleFinance(OHLC data)
Oanda, TheCurrencySite(FX andMetals)
MySQL databases(localdata)
R binaryformats(.RDataand.rda)
CommaSeparatedValuefiles(.csv)
Moretocomeincluding(RODBC,
Rbloomberg,...)
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
Indicators
369
.
UsingR
IndexasMarket
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Nosoftwarewarranty: userbeware!
417
Sigit Wibowo
.
SecurityAnalysis
Tr e n d D e tection/
Strengths
VolumeStudies
Others
GarmanKlass
Aroon
On-Balance
Volume
Bollinger
Bands
Money Flow
Index
Parabolic
S t o p a n d
Reverse
Moving Averages
Oscillators
Volatility
Simple
MA
Convergence/
Divergence
Exponential
Stochastics
Parkinson
Commodity
Channel
Index
Weighted/
VWAP
Relative
Strength
Index
RogersSatchell
VerticalHorizontalFilter
Chaikin
MoneyFlow
Zig-Zag
Zero-Lag
TRIX
(Average)
TrueRange
Trend DetectionIndex
Chaikin Accumulation/
Distribution
Close LocationValue
Elastic,
VolumeWeighted
Stochastic
Momentum
Index
Close Price
Volatility
Average Directional
Index
William’s Accumulation/
Distribution
Split/Dividend
Adjustments
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
Indicators
370
.
UsingR
IndexasMarket
Representation
Source: http://www.joshuaulrich.com/portfolio.html.
417
Sigit Wibowo
.
TrendIndicators
SecurityAnalysis
AnIntroductionto
Investment
Indicator
WellesWilder’sDirectionalMovementIndicator
DoubleExponentialMovingAverage
ExponentialMovingAverage
SimpleMovingAverage
ParabolicStopandReverse
ExponentialVolumeWeightedMovingAverage
MovingAverageConvergenceDivergence
TripleSmoothedExponentialOscillator
WeightedMovingAverage
ZLEMA
TTR
command
quantmode
command
ADX
DEMA
EMA
SMA
SAR
EVWMA
MACD
TRIX
WMA
ZLEMA
addADX
addDEMA
addEMA
addSMA
addSAR
addEVWMA
addMACD
addTRIX
addWMA
addZLEMA
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
Indicators
371
.
UsingR
IndexasMarket
Representation
417
Sigit Wibowo
.
VolatilityandVolumeIndicators
SecurityAnalysis
Indicator
Volatility
AverageTrueRange
BollingerBands
PriceEnvelope
TTR
command
quantmode
command
ATR
BBands
n.a.
addATR
addBBands
addEnvelope
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
Volume
ChaikenMoneyFlow
Volume
CMF
n.a.
addCMF
addVo
Indicators
372
.
UsingR
IndexasMarket
Representation
417
Sigit Wibowo
.
MomentumIndicators
SecurityAnalysis
Indicator
CommodityChannelIndex
ChandeMomentumOscillator
DetrendedPriceOscillator
momentum
RateofChange
RelativeStrengthIndicator
StocasticMomentumIndex
Williams%R
TTR
command
quantmode
command
CCI
CMO
DPO
n.a.
ROC
RSI
SMI
WPR
addCCI
addCMO
addDPO
addMomentum
addROC
addRSI
addSMI
addWPR
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
Indicators
373
.
UsingR
IndexasMarket
Representation
417
Sigit Wibowo
.
Example: ISAT
2014:06–2015:1
SecurityAnalysis
ISAT.JK
[2014−06−02/2015−01−30]
AnIntroductionto
Investment
4500
Introductionto
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Models
Fundamental
Analysis
4000
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
3500
Indicators
374
Jun 02
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2014
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2014
Dec 01
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Jan 01
2015
.
UsingR
IndexasMarket
Representation
3000
Jan 30
2015
417
Sigit Wibowo
.
Example: ISAT
2014:06–2015:1
SecurityAnalysis
▶
quantmod providesafeaturetodownloaddata
directlyfromYahoo! Finance, defaultdatestarts
fromJanuary1st, 2007
library('quantmod')
getSymbols("ISAT.JK")
pdf("isat.pdf", width = 8, height = 5)
chartSeries(ISAT.JK,
subset='2014-06::2015-01',
TA=NULL, theme=chartTheme('white'))
dev.off()
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
Indicators
375
.
UsingR
IndexasMarket
Representation
417
Sigit Wibowo
.
Example: ISAT
Price
SecurityAnalysis
ISAT.JK
[2014−06−02/2015−01−30]
AnIntroductionto
Investment
4500
Last 4095
Introductionto
AssetPricing
Models
4000
Fundamental
Analysis
Macroeconomic
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Analysis
3500
TechnicalAnalysis
12
10
8
6
4
2
0
3000
Indicators
Volume (millions):
2,037,600
376
Jun 02
2014
Jul 01
2014
Aug 01
2014
Sep 01
2014
Oct 01
2014
Nov 03
2014
Dec 01
2014
Jan 01
2015
.
UsingR
IndexasMarket
Representation
Jan 30
2015
417
Sigit Wibowo
.
Example: ISAT
AddBollingerBandsandVolume
SecurityAnalysis
▶
AnIntroductionto
Investment
Wecanselectsomeindicatorsprovidedby
quantmod, forexampleBollingerBands
(addBbands), RSI (addRSI),Momentum
(addMomentum)
Introductionto
AssetPricing
Models
Fundamental
Analysis
pdf("isat.pdf", width = 8, height = 5)
chartSeries(ISAT.JK, subset='2014-06::2015-01',
theme=chartTheme('white'),
TA=c(addVo(), addBBands()))
dev.off()
377
417
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
Indicators
.
UsingR
IndexasMarket
Representation
Sigit Wibowo
.
Example: ISAT
BollingerBandsandVolume
SecurityAnalysis
ISAT.JK
[2014−06−02/2015−01−30]
AnIntroductionto
Investment
4500
Last 4095
Bollinger Bands (20,2) [Upper/Lower]: 4496.084/4011.916
Introductionto
AssetPricing
Models
4000
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
3500
TechnicalAnalysis
12
10
8
6
4
2
0
3000
Indicators
Volume (millions):
2,037,600
378
Jun 02
2014
Jul 01
2014
Aug 01
2014
Sep 01
2014
Oct 01
2014
Nov 03
2014
Dec 01
2014
Jan 01
2015
.
UsingR
IndexasMarket
Representation
Jan 30
2015
417
Sigit Wibowo
.
Example: ISAT
RelativeStrengthIndex
SecurityAnalysis
ISAT.JK
[2014−06−02/2015−01−30]
AnIntroductionto
Investment
4500
Last 4095
Introductionto
AssetPricing
Models
4000
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
3500
TechnicalAnalysis
80
70
60
50
40
30
20
10
3000
Relative Strength Index (14):
43.794
Indicators
379
Jun 02
2014
Jul 01
2014
Aug 01
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Sep 01
2014
Oct 01
2014
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2014
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2015
.
UsingR
IndexasMarket
Representation
Jan 30
2015
417
Sigit Wibowo
.
Example: ISAT
Momentum
SecurityAnalysis
ISAT.JK
[2014−06−02/2015−01−30]
AnIntroductionto
Investment
4500
Last 4095
Introductionto
AssetPricing
Models
4000
Fundamental
Analysis
Macroeconomic
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3500
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400
200
0
−200
−400
3000
Momentum ( 1 ):
0.00
Indicators
380
Jun 02
2014
Jul 01
2014
Aug 01
2014
Sep 01
2014
Oct 01
2014
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2014
Dec 01
2014
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2015
.
UsingR
IndexasMarket
Representation
Jan 30
2015
417
Sigit Wibowo
.
UsesofSecurity-MarketIndexes
SecurityAnalysis
▶
▶
▶
▶
▶
Asbenchmarkstoevaluatetheperformanceof
professionalmoneymanagers
Tocreateandmonitoranindexfund
Tomeasuremarketratesofreturnineconomic
studies
Forpredictingfuturemarketmovementsby
technicians
Asasubstituteforthemarketportfolioofrisky
assetswhencalculatingthesystematicriskofan
asset
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
381
417
.IndexasMarket
Representation
Sigit Wibowo
.
TheSample
DifferentiatingFactorsinConstructingMarketIndexes
SecurityAnalysis
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
▶
▶
▶
▶
Fundamental
Analysis
size
breadth
source
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
382
417
.IndexasMarket
Representation
Sigit Wibowo
.
WeightingofSampleMembers
SecurityAnalysis
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
▶
▶
▶
price-weightedseries
value-weightedseries
unweighted(equallyweighted)series
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
383
417
.IndexasMarket
Representation
Sigit Wibowo
.
ComputationalProcedure
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
arithmeticaverage
computeanindexandhaveallchanges, whether
inpriceorvalue, reportedintermsofthebasic
index
geometricaverage
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
384
417
.IndexasMarket
Representation
Sigit Wibowo
.
Stock-MarketIndexes
SecurityAnalysis
▶
▶
▶
▶
▶
▶
▶
Introductionto
AssetPricing
Models
DowJonesIndustrialAverage(DJIA)
Nikkei-DowJonesAverage
Fundamental
Analysis
Value-WeightedIndex
▶
▶
AnIntroductionto
Investment
PriceWeightedIndex
Macroeconomic
andIndustry
Analysis
NYSE Composite
S&P 500Index
UnweightedIndex
ValueLineAverages
FinancialTimesOrdinaryShareIndex
TechnicalAnalysis
385
417
.IndexasMarket
Representation
Sigit Wibowo
.
DowJonesIndustrialAverage(DJIA)
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
Best-known, oldest, mostpopularseries
Price-weightedaverageofthirtylarge
well-knownindustrialstocks, leadersintheir
industry, andlistedonNYSE
Totalthecurrentpriceofthe30stocksanddivide
byadivisor(adjustedforstocksplitsandchanges
inthesample)
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
386
417
.IndexasMarket
Representation
Sigit Wibowo
.
Example of Change in DJIA Divisor
WhenaSampleStockSplits
SecurityAnalysis
A
B
C
BeforeSplit
AfterThree-forOne
SplitbyStockA
Prices
30
20
10
Prices
10
20
10
60/3=20
40/20=20
X =2(NewDivisor)
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
387
417
.IndexasMarket
Representation
Sigit Wibowo
.
Demonstration
TheImpactofDifferentlyPricedSharesonaPrice-WeightedIndicatorSeries
SecurityAnalysis
AnIntroductionto
Investment
Period 𝑇
A
B
C
Sum
Divisor
Average
Percentagechange
100
50
30
180
3
60
Period 𝑇 + 1
CaseA
CaseB
110
50
30
190
3
63.3
5.5%
100
50
33
183
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
388
3
61
1.7%
417
.IndexasMarket
Representation
Sigit Wibowo
.
CriticismoftheDJIA
SecurityAnalysis
▶
▶
▶
▶
Limitedto30non-randomlyselectedblue-chip
stocks
Doesnotrepresentavastmajorityofstocks
Thedivisorneedstobeadjustedeverytimeone
ofthecompaniesintheindexhasastocksplit
Introducesadownwardbiasbyreducing
weightingoffastestgrowingcompanieswhose
stocksplits
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
389
417
.IndexasMarket
Representation
Sigit Wibowo
.
Nikkei-DowJonesAverage
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
▶
Arithmeticaverageofpricesfor225stocksonthe
FirstSectionoftheTokyoStockExchange(TSE)
Best-knownseriesinJapan
Price-weightedseriesformulatedbyDowJones
andCompany
The225stocksrepresent15percentofallstocks
ontheFirstSection
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
390
417
.IndexasMarket
Representation
Sigit Wibowo
.
Value-WeightedSeries
SecurityAnalysis
▶
AnIntroductionto
Investment
Derivetheinitialtotalmarketvalueofallstocks
usedintheseries
Introductionto
AssetPricing
Models
MarketValue = NumberofSharesOutstanding
× CurrentMarketPrice
▶
▶
▶
Assignanbeginningindexvalue(100)andnew
marketvaluesarecomparedtothebaseindex
Automaticadjustmentforsplits
Weightingdependsonmarketvalue
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
391
417
.IndexasMarket
Representation
Sigit Wibowo
.
Value-WeightedSeries
SecurityAnalysis
Index𝑡 =
AnIntroductionto
Investment
∑ 𝑃 𝑡 𝑄𝑡
× Beginningindexvalue
∑ 𝑃 ℎ 𝑄ℎ
where:
▶ Index𝑡 = indexvalueonday 𝑡
▶ 𝑃𝑡 = endingpricesforstocksonday 𝑡
▶ 𝑄𝑡 = numberofoutstandingsharesonday 𝑡
▶ 𝑃ℎ = endingpriceforstocksonbaseday
▶ 𝑄ℎ = numberofoutstandingsharesonbaseday
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
392
417
.IndexasMarket
Representation
Sigit Wibowo
.
UnweightedPriceIndicatorSeries
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
Allstockscarryequalweightregardlessofprice
ormarketvalue
Maybeusedbyindividualswhorandomlyselect
stocksandinvestthesamedollaramountineach
stock
Someuse arithmeticaverage ofthepercentprice
changesforthestocksintheindex
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
393
417
.IndexasMarket
Representation
Sigit Wibowo
.
UnweightedPriceIndicatorSeries
SecurityAnalysis
AnIntroductionto
Investment
▶
Introductionto
AssetPricing
Models
ValueLineandtheFinancialTimesOrdinary
ShareIndexcomputea geometricmean ofthe
holdingperiodreturnsandderivetheholding
periodyieldfromthiscalculation
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
394
417
.IndexasMarket
Representation
Sigit Wibowo
.
Stock-MarketIndexes
StyleCategories
SecurityAnalysis
▶
▶
▶
▶
▶
▶
▶
Small-capgrowth
MidcapGrowth
Large-capgrowth
Small-capvalue
Midcapvalue
Large-capvalue
Sociallyresponsibleinvestment(SRI) indexes
▶
▶
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
395
.IndexasMarket
Representation
Bycountry
Globalethicalstockindex
417
Sigit Wibowo
.
GlobalEquityIndexes
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
▶
Therearestock-marketindexesavailableformost
individualforeignmarkets
Thesearecloselyfollowedwithineachcountry
Thesearedifficulttocompareduetodifferences
insampleselection, weighting, orcomputational
procedure
Groupshavecomputedcountryindexes
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
396
417
.IndexasMarket
Representation
Sigit Wibowo
.
FT/S&P-ActuariesWorldIndexes
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
JointlycompiledbyTheFinancialTimesLimited,
GoldmanSachs&Company, andStandard&
Poor’sinconjunctionwiththeInstituteof
ActuariesandtheFacultyofActuaries
Measures2,271securitiesin30countries
Covers70%ofthetotalvalueofalllisted
companiesineachcountry
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
397
417
.IndexasMarket
Representation
Sigit Wibowo
.
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
Includesactivelytradedmediumandsmall
corporationsalongwithmajorinternational
equities
Securitiesincludedmustallowdirectholdingsof
sharesbyforeignnationals
Indexismarket-valueweightedwithabasedate
ofDecember31, 1986=100
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
398
417
.IndexasMarket
Representation
Sigit Wibowo
.
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
IndexresultsarereportedinU.S.dollars, U.K.
poundsterling, Japaneseyen, Germanmark, and
thelocalcurrencyofthecountryincluded
ResultsarecalculateddailyaftertheNewYork
marketscloseandpublishedthefollowingdayin
theFinancialTimes
Geographicsubgroupsarealsopublished
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
399
417
.IndexasMarket
Representation
Sigit Wibowo
.
Morgan Stanley Capital International
(MSCI) Indexes
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
Threeinternational, nineteennational, and
thirty-eightinternationalindustryindexes
Include1,375companieslistedonstock
exchangesin19countrieswithacombined
capitalization
representingapproximately60percentofthe
aggregatemarketvalueofthestockexchangesof
thesecountries
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
400
417
.IndexasMarket
Representation
Sigit Wibowo
.
(MSCI) Indexes
SecurityAnalysis
▶
▶
▶
AnIntroductionto
Investment
Alltheindexesaremarket-valueweighted
ReportingisinU.S.dollarsandthecountry’s
localcurrency
Alsoprovides
▶
▶
▶
▶
pricetobookvalue(P/BV) ratio
pricetocashearnings(earningsplus
depreciation)(P/CE) ratio
pricetoearnings(P/E) ratio
dividendyield(YLD)
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
401
417
.IndexasMarket
Representation
Sigit Wibowo
.
(MSCI) Indexes
SecurityAnalysis
AnIntroductionto
Investment
▶
TheMorganStanleygroupindexforEurope,
Australia, andtheFarEast(EAFE) isusedasthe
basisforfuturesandoptionscontractsonthe
ChicagoMercantileExchangeandtheChicago
BoardOptionsExchange
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
402
417
.IndexasMarket
Representation
Sigit Wibowo
.
DowJonesWorldStockIndex
SecurityAnalysis
▶
▶
▶
▶
▶
▶
IntroducedinJanuary1993
2,200companiesworldwide
Organizedinto120industrygroups
Includes33countriesrepresentingmorethan80
percentofthecombinedcapitalizationofthese
countries
Countriesaregroupedintothreemajorregions:
Asia/Pacific, Europe/Africa, andtheAmericas
Eachcountry’sindexiscalculatedinitsown
currencyaswellasintheU.S.dollar
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
403
417
.IndexasMarket
Representation
Sigit Wibowo
.
ComparisonofWorldStockIndexes
SecurityAnalysis
AnIntroductionto
Investment
▶
Introductionto
AssetPricing
Models
Correlationsbetweenthethreeseriessince
December31, 1991toDecember31, 2003,
indicatesanaveragecorrelationcoefficient
amongtheminexcessof0.99
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
404
417
.IndexasMarket
Representation
Sigit Wibowo
.
Bond-MarketIndicatorSeries
SecurityAnalysis
▶
▶
▶
AnIntroductionto
Investment
Relativelynewandnotwidelypublished
Growthinfixed-incomemutualfundsincrease
needforreliablebenchmarksforevaluating
performance
Manymanagershavenotmatchedaggregate
bondmarketreturn
▶
▶
increasinginterestinbondindexfunds
requiresanindextoemulate
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
405
417
.IndexasMarket
Representation
Sigit Wibowo
.
Difficulties in Creating and ComputingBond-MarketIndicatorSeries
SecurityAnalysis
▶
▶
▶
▶
▶
Universeofbondsismuchbroaderthanthatof
stocks
RangeofbondqualityvariesfromU.S.Treasury
securitiestobondsindefault
Bondmarketchangesconstantlywithnewissues,
maturities, calls, andsinkingfunds
Bondpricesareaffectedbyduration, whichis
dependentonmaturity, coupon, andmarketyield
Correctlypricingindividualbondissueswithout
currentandcontinuoustransactionprices
availableposessignificantproblems
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
406
417
.IndexasMarket
Representation
Sigit Wibowo
.
Investment-GradeBondIndexes
SecurityAnalysis
▶
▶
▶
Fourinvestmentfirmsmaintainindexesfor
Treasurybondsandotherinvestmentgrade(rated
BBB orhigher)bonds
Relationshipamongthesebondsisstrong
(correlationsaverage0.95)
Returnsforallthesebondsaredrivenby
aggregateinterestrates-shiftsinthegovernment
yieldcurve
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
407
417
.IndexasMarket
Representation
Sigit Wibowo
.
High-YieldBondIndexes
SecurityAnalysis
▶
▶
▶
▶
Noninvestment-gradebondsrated: BB,B,CCC,
CC,C
Fourinvestmentfirmsandtwoacademicians
createdindexes
Relationshipamongalternativehigh-yieldbond
indexesisweakerthanamonginvestmentgrade
indexes
MerrillLynchConvertibleSecuritiesIndexes
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
408
417
.IndexasMarket
Representation
Sigit Wibowo
.
GlobalGovernmentBondMarketIndexes
SecurityAnalysis
▶
▶
AnIntroductionto
Investment
Globalbondmarketdominatedbygovernment
issues
Severalindexescreatedbymajorinvestment
firms
▶
▶
▶
▶
Measuretotalratesofreturn
Usemarket-valueweighting
Usetraderpricing
Butsamplesizesdifferasdonumbersof
countriesincluded
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
409
417
.IndexasMarket
Representation
Sigit Wibowo
.
GlobalGovernmentBondMarketIndexes
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
Differencesaffectlong-termrisk-return
performance
Lowcorrelationamongseveralcountriesis
similartostocks
Significantexchangerateeffectonvolatilityand
correlations
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
410
417
.IndexasMarket
Representation
Sigit Wibowo
.
CompositeStock-BondIndexes
SecurityAnalysis
▶
▶
Beyondseparatestockindexesandbondindexes
forindividualcountries, anaturalstepisa
compositeseriesthatmeasurestheperformance
ofallsecuritiesinagivencountry
Thisallowsexaminationofbenefitsof
diversificationwithacombinationofassetclasses
suchasstocksandbondsinadditionto
diversifyingwithintheassetclassesofstocksor
bonds
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
411
417
.IndexasMarket
Representation
Sigit Wibowo
.
Merrill Lynch-Wilshire U.S. Capital
MarketsIndex(ML-WCMI)
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
Market-valueweightedindexmeasurestotal
returnperformanceofthecombinedU.S.taxable
fixedincomeandequitymarkets
CombinationofMerrill-Lynchfixed-income
indexesandtheWilshire5000common-stock
index
Tracksover10,000stocksandbonds
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
412
417
.IndexasMarket
Representation
Sigit Wibowo
.
BrinsonPartnersGlobalSecurityMarketIndex(GSMI)
SecurityAnalysis
▶
▶
▶
▶
▶
▶
▶
AnIntroductionto
Investment
Includes:
Introductionto
AssetPricing
Models
U.S.stocksandbonds
Non-U.S.equities
Non-dollarbonds
Allocationtocash
MatchesatypicalU.S.pensionfundallocation
policy
Closetothetheoretical“marketportfolioofrisky
assets”referredtointheCAPM literature
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
413
417
.IndexasMarket
Representation
Sigit Wibowo
.
ComparisonofIndexesOverTime
Correlationsamongmonthlyequitypricechanges
SecurityAnalysis
▶
▶
▶
Mostdifferencesareattributabletosample
differences
DifferentsegmentsofU.S.stockmarketorfrom
differentcountries
LowercorrelationsbetweenNYSE seriesand
AMEX seriesorNASDAQ indexthanbetween
NYSE alternativeseries(S&P 500andNYSE
composite)
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
414
417
.IndexasMarket
Representation
Sigit Wibowo
.
ComparisonofIndexesOverTime
Correlationsamongmonthlybondindexes
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
▶
▶
Amonginvestment-gradebondscorrelations
rangefrom0.90to0.99
Interestratesdifferbyriskpremiums
Ratesofreturnaredeterminedbysystematic
interestratevariables
LowcorrelationinglobalreturnstoU.S.returns
supportglobaldiversification
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
415
417
.IndexasMarket
Representation
Sigit Wibowo
.
Mean Annual Security Risk-Returns
andCorrelations
SecurityAnalysis
AnIntroductionto
Investment
▶
▶
Therearecleardifferencesamongtheseriesdue
todifferentassetclasses(e.g., stocksversus
bonds)andwhentherearedifferentsamples
withinassetclasses
Thereisapositiverelationshipbetweenthe
averagerateofreturnonanassetanditsmeasure
ofrisk
Introductionto
AssetPricing
Models
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
416
417
.IndexasMarket
Representation
Sigit Wibowo
.
Mean Annual Security Risk-Returns
andCorrelations
SecurityAnalysis
AnIntroductionto
Investment
▶
Introductionto
AssetPricing
Models
Thesecuritymarketindexescanbeused
1. tomeasurethehistoricalperformanceofanasset
class
2. asbenchmarkstoevaluatetheperformanceofa
moneymanagerforamutualfund, apersonal
trust, orapensionplan
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
417
417
.IndexasMarket
Representation
Sigit Wibowo
.
References
SecurityAnalysis
AnIntroductionto
Investment
Introductionto
AssetPricing
Models
Reilly, FrankK., andBrown, KeithC.
InvestmentAnalysisandPortfolioManagement,
10thed.
ThomsonSouth-Western, 2012.
Fundamental
Analysis
Macroeconomic
andIndustry
Analysis
TechnicalAnalysis
418
417
.IndexasMarket
Representation
Sigit Wibowo
Thankyou

Security Analysis

Transcription

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