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 . 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 417 Sigit Wibowo . 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 IndexasMarket Representation 417 Sigit Wibowo . Investment HowDoWeMeasureTheRateOfReturnOnAnInvestment? SecurityAnalysis ▶ The purerateofinterest istheexchangerate betweenfutureconsumption(futuredollars)and presentconsumption(currentdollars). Market forcesdeterminethisrate. AnIntroductionto Investment 5 . TheInvestmentSetting InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models $1.00 + 4% = $1.04 Fundamental Analysis ▶ Macroeconomic andIndustry Analysis People’swillingnesstopaythedifferencefor borrowingtodayandtheirdesiretoreceivea surplusontheirsavingsgiverisetoaninterest ratereferredtoasthe puretimevalueofmoney. TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . Investment HowDoWeMeasureTheRateOfReturnOnAnInvestment? SecurityAnalysis ▶ ▶ Ifthefuturepaymentwillbediminishedinvalue becauseof inflation, thentheinvestorwill demandaninterestratehigherthanthepuretime valueofmoneytoalso covertheexpected inflationexpense. Ifthefuturepaymentfromthe investmentisnot certain, theinvestorwilldemandaninterestrate thatexceedsthepuretimevalueofmoneyplus theinflationrateto provideariskpremium to covertheinvestmentrisk. AnIntroductionto Investment 6 . TheInvestmentSetting InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . DefininganInvestment SecurityAnalysis AnIntroductionto Investment 7 ▶ InvestmentsinaGlobal Market A currentcommitmentof$foraperiodoftimein ordertoderivefuturepaymentsthatwill compensatefor: ▶ ▶ ▶ . TheInvestmentSetting AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models thetimethefundsarecommitted theexpectedrateofinflation uncertaintyoffutureflowoffunds. Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . MeasuresofHistoricalRatesofReturn HoldingPeriodReturnandHoldingPeriodYield SecurityAnalysis ▶ HoldingPeriodReturn(HPR) Endingvalueofinvestment HPR = Beginningvalueofinvestment $220 = = 1.10 $200 AnIntroductionto Investment 8 . TheInvestmentSetting InvestmentsinaGlobal Market (1) AnIntroductiontoPortfolio 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 417 Sigit Wibowo . MeasuresofHistoricalRatesofReturn SecurityAnalysis AnIntroductionto Investment ▶ AnnualHoldingPeriodReturn 𝑛 AnnualHPR = √HPR ▶ 9 InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management (3) Appendix Introductionto AssetPricing Models where 𝑛 = numberofyearsinvestmentisheld AnnualHoldingPeriodYield AnnualHPY = AnnualHPR − 1 . TheInvestmentSetting Fundamental Analysis Macroeconomic andIndustry Analysis (4) TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . MeasuresofHistoricalRatesofReturn ArithmeticMeanandGeometricMean SecurityAnalysis ▶ ArithmeticMean(AM) AnIntroductionto Investment 𝐴𝑀 = HPY 𝑛 10 (5) . TheInvestmentSetting InvestmentsinaGlobal Market AnIntroductiontoPortfolio 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 417 Sigit Wibowo . A PortfolioofInvestments SecurityAnalysis AnIntroductionto Investment 11 . TheInvestmentSetting InvestmentsinaGlobal Market ▶ Themeanhistoricalrateofreturnforaportfolio ofinvestmentsismeasuredastheweighted averageoftheHPYsfortheindividual investmentsintheportfolio, ortheoverallchange inthevalueoftheoriginalportfolio AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . 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 . TheInvestmentSetting InvestmentsinaGlobal Market AnIntroductiontoPortfolio 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 417 Sigit Wibowo . ExpectedRatesofReturn SecurityAnalysis ▶ ▶ ▶ Riskisuncertaintythataninvestmentwillearnits expectedrateofreturn Probabilityisthelikelihoodofanoutcome Expectedratesofreturn 𝐸 = (𝑅𝑖 ) AnIntroductionto Investment 13 InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models 𝐸(𝑅𝑖 ) = (Probabilityofreturn) × (Possiblereturn) Fundamental Analysis 𝑛 = 𝑃 𝑅 + 𝑃 𝑅 + ... + (𝑃𝑛 𝑅𝑛 ) . TheInvestmentSetting (7) Macroeconomic andIndustry Analysis 𝑛 TechnicalAnalysis = 𝑃𝑖 𝑅𝑖 IndexasMarket Representation 𝑖= 417 Sigit Wibowo . RiskAversion SecurityAnalysis AnIntroductionto Investment 14 . TheInvestmentSetting InvestmentsinaGlobal Market ▶ AnIntroductiontoPortfolio Management Theassumptionthatmostinvestorswillchoose theleastriskyalternative, allelsebeingequaland thattheywillnotacceptadditionalriskunless theyarecompensatedintheformofhigherreturn Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . ProbabilityDistributions SecurityAnalysis 1.0 AnIntroductionto Investment 15 0.8 InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management 0.6 Appendix 0.4 Introductionto AssetPricing Models Fundamental Analysis 0.2 0.0 . . TheInvestmentSetting Macroeconomic andIndustry Analysis -5% 0% 5% RateofReturn 10% 15% TechnicalAnalysis IndexasMarket Representation Figure 1: Risk-freeInvestment 417 Sigit Wibowo . ProbabilityDistributions SecurityAnalysis 1.0 AnIntroductionto Investment 16 0.8 InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management 0.6 Appendix 0.4 Introductionto AssetPricing Models Fundamental Analysis 0.2 0.0 . . TheInvestmentSetting Macroeconomic andIndustry Analysis -30 -20% -10% 0% 10% RateofReturn 20% 30% TechnicalAnalysis IndexasMarket Representation Figure 2: RiskyInvestmentwith3PossibleReturns 417 Sigit Wibowo . ProbabilityDistributions SecurityAnalysis 1.0 AnIntroductionto Investment 17 0.8 InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management 0.6 Appendix 0.4 Introductionto AssetPricing Models Fundamental Analysis 0.2 0.0 . . TheInvestmentSetting Macroeconomic andIndustry Analysis -40% -30% -20% -10% 0 10% 20% 30% 40% 50% RateofReturn TechnicalAnalysis IndexasMarket Representation Figure 3: Riskyinvestmentwithtenpossibleratesofreturn 417 Sigit Wibowo . MeasuringtheRiskofExpectedRates ofReturn SecurityAnalysis ▶ Variance(𝜎 ) AnIntroductionto Investment 𝜎 = (Probabilityofreturn) × (Possiblereturn − Expectedreturn) 18 AnIntroductiontoPortfolio Management Appendix 𝑛 = 𝑃𝑖 [𝑅𝑖 − 𝐸(𝑅𝑖 )] . TheInvestmentSetting InvestmentsinaGlobal Market (8) Introductionto AssetPricing Models 𝑖= Fundamental Analysis ▶ StandardDeviationisthesquarerootofthe variance 𝑛 ⃓ 𝜎 = ⃓ 𝑃𝑖 [𝑅𝑖 − 𝐸(𝑅𝑖 )] ⎷ 𝑖= Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation (9) 417 Sigit Wibowo . MeasuringtheRiskofExpectedRates ofReturn SecurityAnalysis ▶ AnIntroductionto Investment Coefficientofvariation(CV) ▶ 19 InvestmentsinaGlobal Market ameasureofrelativevariabilitythatindicatesrisk perunitofreturn StandardDeviationofReturns ExpectedRateofReturns 𝜎𝑖 = 𝐸(𝑅) . TheInvestmentSetting AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models 𝐶𝑉 = Fundamental Analysis (10) Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . MeasuringtheRiskofHistoricalRates ofReturn SecurityAnalysis AnIntroductionto Investment 20 𝑛 𝜎 = [HPY𝑖 − 𝐸(HPY)] /𝑛 InvestmentsinaGlobal Market (11) AnIntroductiontoPortfolio Management 𝑖= ▶ ▶ ▶ ▶ . TheInvestmentSetting Appendix Introductionto AssetPricing Models 𝜎 = varianceoftheseries HPY𝑖 = holdingperiodyieldduringperiod 𝑖 𝐸(HPY) =expectedvalueoftheHPY thatisequal tothearithmeticmeanoftheseries 𝑛 = thenumberofobservations Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . DeterminantsofRequiredRatesofReturn SecurityAnalysis AnIntroductionto Investment 21 . TheInvestmentSetting InvestmentsinaGlobal Market ▶ ▶ ▶ AnIntroductiontoPortfolio Management Timevalueofmoneyduringtheperiodof investment Expectedrateofinflationduringtheperiod Riskinvolved Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . TheRealRiskFreeRate(RRFR) SecurityAnalysis ▶ ▶ ▶ ▶ Assumesnoinflation. Assumesnouncertaintyaboutfuturecashflows. Influencedbytimepreferenceforconsumptionof incomeandinvestmentopportunitiesinthe economy Adjustingforinflation 1 + NominalRFR RealRFR = −1 1 + RateofInflation AnIntroductionto Investment 22 . TheInvestmentSetting InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis (12) TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . NominalRisk-FreeRate SecurityAnalysis AnIntroductionto Investment ▶ Dependentupon ▶ ▶ ▶ 23 . TheInvestmentSetting InvestmentsinaGlobal Market ConditionsintheCapitalMarkets ExpectedRateofInflation AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Adjustingforinflation NominalRFR = (1 + RealRFR) × (1 + ExpectedRateofInflation) − 1 (13) Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . FacetsofFundamentalRisk SecurityAnalysis AnIntroductionto Investment 24 ▶ ▶ ▶ ▶ ▶ . TheInvestmentSetting InvestmentsinaGlobal Market Businessrisk Financialrisk Liquidityrisk Exchangeraterisk Countryrisk AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . BusinessRisk SecurityAnalysis AnIntroductionto Investment 25 . TheInvestmentSetting InvestmentsinaGlobal Market ▶ ▶ AnIntroductiontoPortfolio Management Uncertaintyofincomeflowscausedbythe natureofafirm’sbusiness Salesvolatilityandoperatingleveragedetermine thelevelofbusinessrisk. Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . FinancialRisk SecurityAnalysis AnIntroductionto Investment 26 ▶ ▶ ▶ . TheInvestmentSetting InvestmentsinaGlobal Market Uncertaintycausedbytheuseofdebtfinancing. Borrowingrequiresfixedpaymentswhichmust bepaidaheadofpaymentstostockholders. Theuseofdebtincreasesuncertaintyof stockholderincomeandcausesanincreaseinthe stock’sriskpremium. AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . LiquidityRisk SecurityAnalysis AnIntroductionto Investment 27 ▶ InvestmentsinaGlobal Market Uncertaintyisintroducedbythesecondary marketforaninvestment. ▶ ▶ . TheInvestmentSetting AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Howlongwillittaketoconvertaninvestment intocash? Howcertainisthepricethatwillbereceived? Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . ExchangeRateRisk SecurityAnalysis AnIntroductionto Investment 28 ▶ ▶ . TheInvestmentSetting InvestmentsinaGlobal Market Uncertaintyofreturnisintroducedbyacquiring securitiesdenominatedinacurrencydifferent fromthatoftheinvestor. Changesinexchangeratesaffecttheinvestors returnwhenconvertinganinvestmentbackinto the“home”currency. AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . CountryRisk SecurityAnalysis AnIntroductionto Investment ▶ ▶ Politicalriskistheuncertaintyofreturnscaused bythepossibilityofamajorchangeinthe politicaloreconomicenvironmentinacountry. Individualswhoinvestincountriesthathave unstablepolitical-economicsystemsmust includeacountryrisk-premiumwhen determiningtheirrequiredrateofreturn 29 . TheInvestmentSetting InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . RiskPremium SecurityAnalysis AnIntroductionto Investment 30 . TheInvestmentSetting InvestmentsinaGlobal Market ▶ ▶ AnIntroductiontoPortfolio Management 𝑓(BusinessRisk, FinancialRisk, LiquidityRisk, ExchangeRateRisk, CountryRisk) or 𝑓(SystematicMarketRisk) Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . RiskPremiumandPortfolioTheory SecurityAnalysis AnIntroductionto Investment 31 ▶ ▶ ▶ . TheInvestmentSetting InvestmentsinaGlobal Market Therelevantriskmeasureforanindividualasset isitsco-movementwiththemarketportfolio Systematicriskrelatesthevarianceofthe investmenttothevarianceofthemarket Beta(𝛽)measuresthissystematicriskofanasset AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . FundamentalRiskvs. SystematicRisk SecurityAnalysis AnIntroductionto Investment 32 ▶ ▶ . TheInvestmentSetting InvestmentsinaGlobal Market Fundamentalriskcomprisesbusinessrisk, financialrisk, liquidityrisk, exchangeraterisk, andcountryrisk Systematicriskreferstotheportionofan individualasset’stotalvarianceattributabletothe variabilityofthetotalmarketportfolio AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . RelationshipBetweenRiskandReturn SecurityAnalysis 𝐸(return) AnIntroductionto Investment 33 Lowrisk Averagerisk Highrisk . TheInvestmentSetting InvestmentsinaGlobal Market Security Market Line AnIntroductiontoPortfolio 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 417 Sigit Wibowo . RelationshipBetweenRiskandReturn SecurityAnalysis 𝐸(return) AnIntroductionto Investment 34 • AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis RFR . . TheInvestmentSetting InvestmentsinaGlobal Market Security Market Line • Movement along the curve that reflect changes in the risk of the asset Macroeconomic andIndustry Analysis Risk (Businessrisk, etc., orsystematicriskbeta) TechnicalAnalysis IndexasMarket Representation Figure 5: Changesintherequiredrateofreturnduetomovements alongtheSML 417 Sigit Wibowo . ChangesintheSlopeoftheSML SecurityAnalysis AnIntroductionto Investment 35 . TheInvestmentSetting InvestmentsinaGlobal Market 𝑅𝑃𝑖 = 𝐸(𝑅𝑖 ) − 𝑁𝑅𝐹𝑅 ▶ ▶ ▶ (14) AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models 𝑅𝑃𝑖 = riskpremiumforasseti 𝐸(𝑅𝑖 ) = theexpectedreturnforasseti 𝑁𝑅𝐹𝑅 = thenominalreturnonarisk-freeasset Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . MarketPortfolioRisk SecurityAnalysis ▶ Themarketriskpremiumforthemarketportfolio (containsalltheriskyassetsinthemarket)canbe computed: 𝑅𝑃𝑚 = 𝐸(𝑅𝑚 ) − 𝑁𝑅𝐹𝑅 AnIntroductionto Investment 36 InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models (15) Fundamental Analysis where ▶ ▶ ▶ . TheInvestmentSetting Macroeconomic andIndustry Analysis 𝑅𝑃𝑚 = riskpremiumonthemarketportfolio 𝐸(𝑅𝑚 ) = expectedreturnonthemarketportfolio 𝑁𝑅𝐹𝑅 = expectedreturnonarisk-freeasset TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . RelationshipBetweenRiskandReturn SecurityAnalysis 𝐸(return) AnIntroductionto Investment 37 • 𝑅𝑚′ New SML InvestmentsinaGlobal Market Original SML AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models • 𝑅𝑚 . TheInvestmentSetting Fundamental Analysis NRFR . Macroeconomic andIndustry Analysis Risk TechnicalAnalysis (Businessrisk, etc., orsystematicriskbeta) IndexasMarket Representation Figure 6: Changeinmarketriskpremium 417 Sigit Wibowo . TheSML andExpectedInflation SecurityAnalysis 𝐸(return) AnIntroductionto Investment 38 New SML . TheInvestmentSetting InvestmentsinaGlobal Market Original SML AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models NRFR’ Fundamental Analysis NRFR . Macroeconomic andIndustry Analysis Risk (Businessrisk, etc., orsystematicriskbeta) TechnicalAnalysis IndexasMarket Representation Figure 7: Capitalmarketconditions, expectedinflation, andthe SML 417 Sigit Wibowo . Reasons for the expansion of investmentopportunities SecurityAnalysis AnIntroductionto Investment TheInvestmentSetting 40 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management 1. Growthanddevelopmentofforeignfinancial markets 2. Advancesintelecommunicationstechnology 3. Mergersoffirmsandsecurityexchanges Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . TheCaseforGlobalInvestments SecurityAnalysis AnIntroductionto Investment ▶ ▶ Ratesofreturnavailableonnon-U.S.securities oftenexceedU.S.Securitiesduetohighergrowth ratesinforeigncountries, especiallytheemerging markets Diversificationwithforeignsecuritiescanhelp reduceportfolioriskbecauseforeignmarkets havelowcorrelationwithU.S.capitalmarkets TheInvestmentSetting 41 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . GlobalBondPortfolioRisk SecurityAnalysis AnIntroductionto Investment TheInvestmentSetting 1. Macroeconomicdifferencescausethecorrelation ofbondreturnsbetweentheUnitedStatesand foreigncountriestodiffer 2. Thecorrelationofreturnsbetweenasinglepairof countrieschangesovertimebecausethefactors influencingthecorrelationchangeovertime 42 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . Risk of Combined Country Investments SecurityAnalysis AnIntroductionto Investment ▶ ▶ ▶ Diversifiedportfoliosreducevariabilityofreturns overtime Correlationcoefficientsmeasurediversification contribution ComparecorrelationofreturnamongU.S.bonds andstockswithreturnsonforeignbondsand stocks TheInvestmentSetting 43 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . GlobalBondPortfolioRisk SecurityAnalysis ▶ ▶ ▶ ▶ ▶ ▶ Lowpositivecorrelation OpportunitiesforU.S.investorstoreducerisk Correlationchangesovertime Addingnon-correlatedforeignbondstoa portfolioofU.S.bondsincreasestherateof returnandreducestheriskoftheportfolio Lowpositivecorrelation Opportunitiestoreduceriskofstockportfolioby includingforeignstocks AnIntroductionto Investment TheInvestmentSetting 44 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . SummaryonGlobalInvesting SecurityAnalysis AnIntroductionto Investment TheInvestmentSetting 45 ▶ .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Relativelyhighratesofreturncombinedwithlow correlationcoefficientsindicatethatadding foreignstocksandbondstoaU.S.portfoliowill reduceriskandmayincreaseitsaveragereturn Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . GlobalInvestmentChoices SecurityAnalysis AnIntroductionto Investment ▶ ▶ ▶ ▶ ▶ ▶ Fixed-incomeinvestments: bondsandpreferred stocks Equityinvestments Specialequityinstruments: warrantsandoptions Futurescontracts Investmentcompanies Realassets TheInvestmentSetting 46 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . Fixed-IncomeInvestments SecurityAnalysis AnIntroductionto Investment ▶ ▶ ▶ Contractualpaymentschedule Recoursevariesbyinstrument Bonds ▶ ▶ ▶ TheInvestmentSetting 47 AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models investorsarelenders expectinterestpaymentandreturnofprincipal Fundamental Analysis Preferredstocks ▶ .InvestmentsinaGlobal Market Macroeconomic andIndustry Analysis dividendsrequireboardofdirectorsapproval TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . SavingsAccounts SecurityAnalysis ▶ ▶ ▶ ▶ ▶ ▶ Fixedearnings Convenient Liquid Lowrisk Lowrates CertificatesofDeposit(CDs) ▶ ▶ AnIntroductionto Investment TheInvestmentSetting 48 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis instrumentsthatrequireminimumdepositsfor specifiedterms, andpayhigherratesofinterest thansavingsaccounts Penaltyimposedforearlywithdrawal Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . MoneyMarketCertificates SecurityAnalysis AnIntroductionto Investment TheInvestmentSetting 49 ▶ ▶ ▶ ▶ ▶ CompeteagainstTreasurybills(T-bills) Minimum$10,000 Minimummaturityofsixmonths Redeemableonlyatbankofissue Penaltyifwithdrawnbeforematurity .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . CapitalMarketInstruments SecurityAnalysis AnIntroductionto Investment TheInvestmentSetting ▶ ▶ ▶ ▶ ▶ Fixedincomeobligationsthattradeinsecondary market U.S.Treasurysecurities U.S.Governmentagencysecurities Municipalbonds Corporatebonds 50 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . U.S.TreasurySecurities SecurityAnalysis AnIntroductionto Investment ▶ Bills, notes, orbonds-dependingonmaturity ▶ ▶ ▶ ▶ ▶ TheInvestmentSetting 51 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Billsmatureinlessthan1year Notesmaturein1-10years Bondsmatureinover10years Appendix Introductionto AssetPricing Models Highlyliquid BackedbythefullfaithandcreditoftheU.S. Government Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . U.S.GovernmentAgencySecurities SecurityAnalysis ▶ ▶ ▶ ▶ ▶ ▶ AnIntroductionto Investment Soldbygovernmentagencies FederalNationalMortgageAssociation(FNMA or FannieMae) FederalHomeLoanBank(FHLB) GovernmentNationalMortgageAssociation (GNMA orGinnieMae) FederalHousingAdministration(FHA) TheInvestmentSetting 52 AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis NotdirectobligationsoftheTreasury ▶ .InvestmentsinaGlobal Market Stillconsidereddefault-freeandfairlyliquid TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . MunicipalBonds SecurityAnalysis AnIntroductionto Investment ▶ ▶ ▶ Issuedbystateandlocalgovernmentsusuallyto financeinfrastructuralprojects. Exemptfromtaxationbythefederalgovernment andbythestatethatissuedthebond, provided theinvestorisaresidentofthatstate Twotypes: ▶ ▶ TheInvestmentSetting 53 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio 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 TheInvestmentSetting 54 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Indenture Callprovision Sinkingfund Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . CorporateBonds SecurityAnalysis ▶ ▶ ▶ TheInvestmentSetting 55 Appendix Introductionto AssetPricing Models securedbyliensonspecificassets Fundamental Analysis securedbyfinancialassets Macroeconomic andIndustry Analysis Equipmenttrustcertificates ▶ .InvestmentsinaGlobal Market AnIntroductiontoPortfolio 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 TheInvestmentSetting 56 AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Subordinatedbonds ▶ .InvestmentsinaGlobal Market Unsecuredlikedebentures, butholdersofthese bondsmayclaimassetsafterseniorsecuredand debentureholdersclaimshavebeensatisfied Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . CorporateBonds SecurityAnalysis AnIntroductionto Investment ▶ Incomebonds ▶ ▶ TheInvestmentSetting 57 AnIntroductiontoPortfolio Management Interestpaymentcontingentuponearning sufficientincome Appendix Introductionto AssetPricing Models Convertiblebonds ▶ ▶ .InvestmentsinaGlobal 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 TheInvestmentSetting 58 AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Zerocouponbond ▶ ▶ .InvestmentsinaGlobal 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 TheInvestmentSetting 59 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . InternationalBondInvesting SecurityAnalysis AnIntroductionto Investment TheInvestmentSetting 60 ▶ .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Investorsshouldbeawarethatthereisavery substantialfixedincomemarketoutsidethe UnitedStatesthatoffersadditionalopportunity fordiversification Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . InternationalBondInvesting SecurityAnalysis ▶ Bondidentificationcharacteristics ▶ ▶ ▶ ▶ ▶ AnIntroductionto Investment TheInvestmentSetting 61 Countryoforigin Locationofprimarytradingmarket Homecountryofthemajorbuyers Currencyofthesecuritydenomination AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Eurobond ▶ .InvestmentsinaGlobal Market Macroeconomic andIndustry Analysis Aninternationalbonddenominatedinacurrency notnativetothecountrywhereitisissued TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . InternationalBondInvesting SecurityAnalysis ▶ Yankeebonds ▶ ▶ ▶ AnIntroductionto Investment TheInvestmentSetting 62 SoldintheUnitedStatesanddenominatedis U.S.dollars, butissuedbyforeigncorporations orgovernments EliminatesexchangerisktoU.S.investors AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Internationaldomesticbonds ▶ .InvestmentsinaGlobal Market Macroeconomic andIndustry Analysis Soldbyissuerwithinitsowncountryinthat country’scurrency TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . EquityInvestments SecurityAnalysis AnIntroductionto Investment TheInvestmentSetting ▶ ▶ Returnsarenotcontractualandmaybebetteror worsethanonabond CommonStock ▶ ▶ 63 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Representsownershipofafirm Investor’sreturntiedtoperformanceofthe companyandmayresultinlossorgain Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . ClassificationofCommonStockCategorisedByGeneralBusinessLine SecurityAnalysis AnIntroductionto Investment TheInvestmentSetting ▶ ▶ ▶ ▶ Industrial: manufacturersofautomobiles, machinery, chemicals, beverages Utilities: electricalpowercompanies, gas suppliers, waterindustry Transportation: airlines, trucklines, railroads Financial: banks, savingsandloans, creditunions 64 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . AcquiringForeignEquities SecurityAnalysis AnIntroductionto Investment TheInvestmentSetting 1. PurchaseofAmericanDepositoryReceipts (ADRs) 2. PurchaseofAmericanshares 3. DirectpurchaseofforeignshareslistedonaU.S. orforeignstockexchange 4. Purchaseofinternationalmutualfunds 65 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . 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 TheInvestmentSetting 66 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . PurchaseorSaleofAmericanshares SecurityAnalysis AnIntroductionto Investment TheInvestmentSetting 67 ▶ ▶ ▶ .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management IssuedintheUnitedStatesbytransferagenton behalfofaforeignfirm Higherexpenses Limitedavailability Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . Direct Purchase or Sale of Foreign Shares SecurityAnalysis AnIntroductionto Investment TheInvestmentSetting ▶ ▶ Directinvestmentinforeignequitymarketsdifficultandcomplicatedduetoadministrative, information, taxation, andmarketefficiency problems PurchaseforeignstockslistedonaU.S.exchange –limitedchoice 68 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio 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 TheInvestmentSetting 69 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio 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 TheInvestmentSetting 70 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio 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 TheInvestmentSetting 71 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio 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 TheInvestmentSetting 72 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . InvestmentCompanies SecurityAnalysis AnIntroductionto Investment TheInvestmentSetting ▶ ▶ ▶ Ratherthanbuyindividualsecuritiesdirectly fromtheissuertheycanbeacquiredindirectly throughsharesinaninvestmentcompany Investmentcompaniessellsharesinitselfand usesproceedstobuysecurities Investorsownpartoftheportfolioofinvestments 73 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . InvestmentCompanies Moneymarketfunds SecurityAnalysis AnIntroductionto Investment TheInvestmentSetting ▶ ▶ ▶ ▶ ▶ ▶ Acquirehigh-quality, short-terminvestments YieldsarehigherthannormalbankCDs Typicalminimuminvestmentis$1,000 Nosalescommissioncharges Withdrawalisbycheckwithnopenalty Investmentsusuallyarenotinsured 74 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . InvestmentCompanies Bondfunds SecurityAnalysis AnIntroductionto Investment TheInvestmentSetting 75 ▶ ▶ ▶ Investinlong-termgovernment, corporate, or municipalbonds Bondfundsvaryinbondqualityselectedfor investment Expectedreturnsvarywithriskofbonds .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . InvestmentCompanies Commonstockfunds SecurityAnalysis ▶ Manydifferentfundswithvaryingstated investmentobjectives: ▶ ▶ ▶ ▶ ▶ AnIntroductionto Investment TheInvestmentSetting 76 Aggressivegrowth, income, preciousmetals, internationalstocks .InvestmentsinaGlobal Market AnIntroductiontoPortfolio 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 TheInvestmentSetting 77 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management ▶ Appendix Investinacombinationofstocksandbonds dependingontheirstatedobjectives Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . InvestmentCompanies Indexfunds SecurityAnalysis AnIntroductionto Investment TheInvestmentSetting 78 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio 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 TheInvestmentSetting 79 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio 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 TheInvestmentSetting 80 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . DirectRealEstateInvestment Purchaseofahome SecurityAnalysis AnIntroductionto Investment TheInvestmentSetting 81 ▶ ▶ ▶ Averagecostofasingle-familyhouseexceeds $100,000 Financingbymortgagerequiresdownpayment Homeownerhopestosellthehouseforcostplus again .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . DirectRealEstateInvestment Purchaseofrawland SecurityAnalysis AnIntroductionto Investment TheInvestmentSetting ▶ ▶ ▶ Intentionofsellinginfutureforaprofit Ownershipprovidesanegativecashflowdueto mortgagepayments, taxes, andproperty maintenance Riskfromsellingforanuncertainpriceandlow liquidity 82 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . DirectRealEstateInvestment LandDevelopment SecurityAnalysis AnIntroductionto Investment TheInvestmentSetting ▶ ▶ ▶ ▶ ▶ Buyrawland Divideintoindividuallots Buildhousesorashoppingmallonit Requirescapital, time, andexpertise Returnsfromsuccessfuldevelopmentcanbe significant 83 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . DirectRealEstateInvestment RentalProperty SecurityAnalysis AnIntroductionto Investment ▶ ▶ ▶ Acquireapartmentbuildingsorhouseswithlow downpayments Deriveenoughincomefromtherentstopaythe expensesofthestructure, includingthemortgage payments, andgenerateagoodreturn Rentalpropertyprovidesacashflowandan opportunitytoprofitfromthesaleoftheproperty TheInvestmentSetting 84 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . Low-LiquidityInvestments SecurityAnalysis AnIntroductionto Investment TheInvestmentSetting ▶ ▶ ▶ ▶ Someinvestmentsdon’ttradeonsecurities markets Lackofliquiditykeepsmanyinvestorsaway Auctionsalescreatewidefluctuationsinprices Withoutmarkets, dealersincurhightransaction costs 85 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . Antiques SecurityAnalysis AnIntroductionto Investment TheInvestmentSetting ▶ ▶ ▶ Dealersbuyatestatesales, refurbish, andsellata profit Seriouscollectorsmayenjoygoodreturns Individualsbuyingafewpiecestodecoratea homemayhavedifficultyovercomingtransaction coststoeverenjoyaprofit 86 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . Art SecurityAnalysis AnIntroductionto Investment TheInvestmentSetting ▶ ▶ ▶ ▶ Investmentrequiressubstantialknowledgeofart andtheartworld Acquisitionofworkfromawell-knownartist requireslargecapitalcommitmentsandpatience Hightransactioncosts Uncertaintyandilliquidity 87 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . CoinsandStamps SecurityAnalysis AnIntroductionto Investment TheInvestmentSetting ▶ ▶ ▶ ▶ ▶ Enjoyedbymanyashobbyandasaninvestment Marketismorefragmentedthanstockmarket, but moreliquidthanartandantiquesmarkets Pricelistsarepublishedweeklyandmonthly Gradingspecificationsaidsales Widespreadbetweenbidandaskprices 88 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . Diamonds SecurityAnalysis AnIntroductionto Investment TheInvestmentSetting ▶ ▶ ▶ ▶ ▶ Canbeilliquid Gradingdeterminesvalue, butissubjective Investment-gradegemsrequiresubstantial investments Nopositivecashflowuntilsold Costsofinsurance, storage, andappraisal 89 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . ArtandAntiques SecurityAnalysis ▶ ▶ ▶ ▶ Marketdataislimited Resultsvarywidely, andchangeovertime, makinggeneralizationimpossible, butshowinga reasonablyconsistentrelationshipbetweenrisk andreturn Correlationcoefficientsvarywidely, allowingfor greatdiversificationpotential Liquidityisstillaconcern AnIntroductionto Investment TheInvestmentSetting 90 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . RealEstate SecurityAnalysis ▶ ▶ ▶ ▶ Returnsaredifficulttoderiveduetolackof consistentdata Residentialshowslowerriskandreturnthan commercialrealestate DuringsomeshorttimeperiodsREITshave shownhigherreturnsthanstockwithlowerrisk measures Longtermreturnsforrealestatearelowerthan stocks, andhavelowerrisk AnIntroductionto Investment TheInvestmentSetting 91 .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . RealEstate SecurityAnalysis AnIntroductionto Investment TheInvestmentSetting 92 ▶ ▶ ▶ Negativecorrelationbetweenresidentialand farmrealestateandstocks Lowpositivecorrelationbetweencommercial realestateandstocks Potentialfordiversification .InvestmentsinaGlobal Market AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . BackgroundAssumptions SecurityAnalysis ▶ ▶ ▶ ▶ Asaninvestoryouwanttomaximisethereturns foragivenlevelofrisk. Yourportfolioincludesallofyourassetsand liabilities Therelationshipbetweenthereturnsforassetsin theportfolioisimportant. A goodportfolioisnotsimplyacollectionof individuallygoodinvestments. AnIntroductionto Investment TheInvestmentSetting InvestmentsinaGlobal Market 94 .AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . RiskAversion SecurityAnalysis AnIntroductionto Investment ▶ ▶ Givenachoicebetweentwoassetswithequal ratesofreturn, mostinvestorswillselecttheasset withthelowerlevelofrisk. Evidencethatinvestorsareriskaverse: ▶ ▶ TheInvestmentSetting InvestmentsinaGlobal Market 95 .AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Manyinvestorspurchaseinsurancefor: Life, Automobile, Health, andDisabilityIncome. Yieldonbondsincreaseswithriskclassifications fromAAA toAA toA. Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . NotallInvestorsareRiskAverse SecurityAnalysis AnIntroductionto Investment TheInvestmentSetting InvestmentsinaGlobal Market 96 ▶ Riskpreferencemayhavetodowithamountof moneyinvolved—riskingsmallamounts, but insuringlargelosses .AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . DefinitionofRisk SecurityAnalysis AnIntroductionto Investment TheInvestmentSetting InvestmentsinaGlobal Market 97 .AnIntroductiontoPortfolio Management Appendix 1. Uncertaintyoffutureoutcomes, or 2. Probabilityofanadverseoutcome Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . MarkowitzPortfolioTheory SecurityAnalysis ▶ ▶ ▶ ▶ Quantifiesrisk Derivestheexpectedrateofreturnforaportfolio ofassetsandanexpectedriskmeasure Showsthatthevarianceoftherateofreturnisa meaningfulmeasureofportfoliorisk Derivestheformulaforcomputingthevariance ofaportfolio, showinghowtoeffectively diversifyaportfolio AnIntroductionto Investment TheInvestmentSetting InvestmentsinaGlobal Market 98 .AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . MarkowitzPortfolioTheory Assumptions SecurityAnalysis 1. Investorsconsidereachinvestmentalternativeas beingpresentedbyaprobabilitydistributionof expectedreturnsoversomeholdingperiod. 2. Investorsmaximiseone-periodexpectedutility, andtheirutilitycurvesdemonstratediminishing marginalutilityofwealth. 3. Investorsestimatetheriskoftheportfolioonthe basisofthevariabilityofexpectedreturns. AnIntroductionto Investment TheInvestmentSetting InvestmentsinaGlobal Market 99 .AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . MarkowitzPortfolioTheory Assumptions(cont’d) SecurityAnalysis AnIntroductionto Investment 4. Investorsbasedecisionssolelyonexpected returnandrisk, sotheirutilitycurvesarea functionofexpectedreturnandtheexpected variance(orstandarddeviation)ofreturnsonly. 5. Foragivenrisklevel, investorspreferhigher returnstolowerreturns. Similarly, foragiven levelofexpectedreturns, investorspreferlessrisk tomorerisk. TheInvestmentSetting InvestmentsinaGlobal Market 100 .AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . MarkowitzPortfolioTheory SecurityAnalysis AnIntroductionto Investment TheInvestmentSetting ▶ Usingthesefiveassumptions, asingleassetor portfolioofassetsisconsideredtobeefficientif nootherassetorportfolioofassetsoffershigher expectedreturnwiththesame(orlower)risk, or lowerriskwiththesame(orhigher)expected return. InvestmentsinaGlobal Market 101 .AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . AlternativeMeasuresofRisk SecurityAnalysis AnIntroductionto Investment ▶ ▶ ▶ Varianceorstandarddeviationofexpectedreturn Rangeofreturns Returnsbelowexpectations ▶ ▶ TheInvestmentSetting InvestmentsinaGlobal Market 102 .AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Semivariance—ameasurethatonlyconsiders deviationsbelowthemean Thesemeasuresofriskimplicitlyassumethat investorswanttominimisethedamagefrom returnslessthansometargetrate Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . ExpectedRatesofReturn SecurityAnalysis AnIntroductionto Investment TheInvestmentSetting ▶ ▶ Foranindividualasset—sumofthepotential returnsmultipliedwiththecorresponding probabilityofthereturns Foraportfolioofinvestments—weighted averageoftheexpectedratesofreturnforthe individualinvestmentsintheportfolio InvestmentsinaGlobal Market 103 .AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . ExpectedRatesofReturn (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) = TheInvestmentSetting InvestmentsinaGlobal Market 104 .AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis 0.1030 TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . ExpectedRatesofReturn (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 TheInvestmentSetting InvestmentsinaGlobal Market 105 .AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . ExpectedRatesofReturn (cont’d) SecurityAnalysis AnIntroductionto Investment TheInvestmentSetting InvestmentsinaGlobal Market 106 𝑛 𝐸(𝑅𝑝𝑜𝑟𝑡 ) = 𝑊𝑖 𝑅𝑖 (16) Appendix Introductionto AssetPricing Models 𝑖= ▶ ▶ .AnIntroductiontoPortfolio Management Fundamental Analysis 𝑊𝑖 = thepercentoftheportfolioinasset 𝑖 𝐸(𝑅𝑖 ) = theexpectedrateofreturnforasset 𝑖 Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . VarianceofReturnsforanIndividual Investment SecurityAnalysis AnIntroductionto Investment ▶ Varianceisameasureofthevariationofpossible ratesofreturn 𝑅𝑖 , fromtheexpectedrateofreturn [𝐸(𝑅𝑖 )]: TheInvestmentSetting InvestmentsinaGlobal Market 107 Appendix Introductionto AssetPricing Models 𝑛 𝜎 = [𝑅𝑖 − 𝐸(𝑅𝑖 )] 𝑃𝑖 .AnIntroductiontoPortfolio Management (17) Fundamental Analysis 𝑖= where 𝑃𝑖 istheprobabilityofthepossiblerateof return, 𝑅𝑖 Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . StandardDeviationofReturnsforan IndividualInvestment SecurityAnalysis AnIntroductionto Investment TheInvestmentSetting ▶ InvestmentsinaGlobal Market Standarddeviationisthesquarerootofthe variance 𝑛 ⃓ 𝜎 = ⃓ [𝑅𝑖 − 𝐸(𝑅𝑖 )] 𝑃𝑖 ⎷ 𝑖= 108 .AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models (18) Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . Variance (Standard Deviation) of Returns SecurityAnalysis Table 4: Computationofvarianceandstandarddeviationofreturn foranindividualinvestment Possible Rateof Return ( 𝑅𝑖 ) . . . . AnIntroductionto Investment TheInvestmentSetting InvestmentsinaGlobal Market Expected Return 𝐸(𝑅𝑖 ) . . . . 109 .AnIntroductiontoPortfolio 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 417 Sigit Wibowo . CovarianceofReturns SecurityAnalysis AnIntroductionto Investment ▶ ▶ A measureofthedegreetowhichtwovariables “movetogether”relativetotheirindividualmean valuesovertime Fortwoassets, 𝑖 and 𝑗, thecovarianceofratesof returnisdefinedas: 𝐶𝑜𝑣𝑖𝑗 = 𝐸 [𝑅𝑖 − 𝐸(𝑅𝑖 )][𝑅𝑗 − 𝐸(𝑅𝑗 )] TheInvestmentSetting InvestmentsinaGlobal Market 110 .AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis (19) TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . CovarianceandCorrelation SecurityAnalysis ▶ ▶ Thecorrelationcoefficientisobtainedby standardising(dividing)thecovariancebythe productoftheindividualstandarddeviations Correlationcoefficientvariesfrom–1to+1 𝜌𝑖𝑗 = 𝐶𝑜𝑣𝑖𝑗 𝜎𝑖 𝜎𝑗 AnIntroductionto Investment TheInvestmentSetting InvestmentsinaGlobal Market 111 Appendix Introductionto AssetPricing Models (20) Fundamental Analysis Macroeconomic andIndustry Analysis where ▶ ▶ ▶ .AnIntroductiontoPortfolio Management 𝜌𝑖𝑗 = thecorrelationcoefficientofreturns 𝜎𝑖 = thestandarddeviationof 𝑅𝑖𝑡 𝜎𝑗 = thestandarddeviationof 𝑅𝑗𝑡 TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . CorrelationCoefficient SecurityAnalysis ▶ ▶ Itcanvaryonlyintherange+1to–1. A valueof+1wouldindicateperfectpositive correlation. ▶ ▶ AnIntroductionto Investment TheInvestmentSetting InvestmentsinaGlobal Market 112 Appendix Thismeansthatreturnsforthetwoassetsmove togetherinacompletelylinearmanner Introductionto AssetPricing Models Fundamental Analysis A valueof–1wouldindicateperfectcorrelation ▶ .AnIntroductiontoPortfolio Management Thismeansthatthereturnsfortwoassetshave thesamepercentagemovement, butinopposite directions Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . PortfolioStandardDeviationFormula SecurityAnalysis 𝜎𝑝𝑜𝑟𝑡 𝑛 𝑛 𝑛 ⃓ = ⃓ 𝑤𝑖 𝜎𝑖 + 𝑤𝑖 𝑤𝑗 𝐶𝑜𝑣𝑖𝑗 ⃓ 𝑖= 𝑖= 𝑗= ⎷ AnIntroductionto Investment (21) TheInvestmentSetting InvestmentsinaGlobal 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 .AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . PortfolioStandardDeviationCalculation SecurityAnalysis ▶ Anyassetofaportfoliomaybedescribedbytwo characteristics: ▶ ▶ ▶ ▶ AnIntroductionto Investment TheInvestmentSetting InvestmentsinaGlobal Market 114 Theexpectedrateofreturn Theexpectedstandarddeviationsofreturns .AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Thecorrelation, measuredbycovariance, affects theportfoliostandarddeviation Lowcorrelationreducesportfolioriskwhilenot affectingtheexpectedreturn Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . Combining Stocks with Different ReturnsandRisk SecurityAnalysis Table 5: Portfolioreturnandstandarddeviationcalculation Asset 𝐸(𝑅𝑖 ) 𝑤𝑖 𝜎𝑖 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 TheInvestmentSetting InvestmentsinaGlobal Market 115 .AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Covariance Fundamental Analysis Macroeconomic andIndustry Analysis .0070 .0035 .0000 −.0035 −.0070 TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . Combining Stocks with Different ReturnsandRisk SecurityAnalysis AnIntroductionto Investment ▶ ▶ ▶ Assetsmaydifferinexpectedratesofreturnand individualstandarddeviations Negativecorrelationreducesportfoliorisk Combiningtwoassetswith −1.0correlation reducestheportfoliostandarddeviationtozero onlywhenindividualstandarddeviationsare equal TheInvestmentSetting InvestmentsinaGlobal Market 116 .AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . Combining Stocks with Different ReturnsandRisk SecurityAnalysis Table 6: ConstantCorrelationwithChangingWeights Asset 𝐸(𝑅𝑖 ) 1 .10 𝜌𝑖𝑗 = 0.00 2 .20 AnIntroductionto Investment TheInvestmentSetting InvestmentsinaGlobal Market 117 .AnIntroductiontoPortfolio 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 417 Sigit Wibowo . Portfolio Risk-Return Plots for DifferentWeights SecurityAnalysis 𝐸(𝑅) AnIntroductionto Investment • TheInvestmentSetting InvestmentsinaGlobal Market 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 . .AnIntroductiontoPortfolio Management Macroeconomic andIndustry Analysis TechnicalAnalysis 𝜎 IndexasMarket Representation Figure 8: A two-assetportfoliowith 𝜌 = +1.0 417 Sigit Wibowo . Portfolio Risk-Return Plots for DifferentWeights SecurityAnalysis 𝐸(𝑅) AnIntroductionto Investment • TheInvestmentSetting InvestmentsinaGlobal Market 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 . .AnIntroductiontoPortfolio Management Macroeconomic andIndustry Analysis TechnicalAnalysis 𝜎 IndexasMarket Representation Figure 9: A two-assetportfoliowith 𝜌 = 0.0 417 Sigit Wibowo . Portfolio Risk-Return Plots for DifferentWeights SecurityAnalysis 𝐸(𝑅) AnIntroductionto Investment • TheInvestmentSetting InvestmentsinaGlobal Market 120 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 . .AnIntroductiontoPortfolio Management Macroeconomic andIndustry Analysis TechnicalAnalysis 𝜎 IndexasMarket Representation Figure 10: A two-assetportfoliowith 𝜌 = +0.5 417 Sigit Wibowo . Portfolio Risk-Return Plots for DifferentWeights SecurityAnalysis 𝐸(𝑅) AnIntroductionto Investment • TheInvestmentSetting InvestmentsinaGlobal Market 121 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 . .AnIntroductiontoPortfolio Management Macroeconomic andIndustry Analysis TechnicalAnalysis 𝜎 IndexasMarket Representation Figure 11: A two-assetportfoliowith 𝜌 = −0.5 417 Sigit Wibowo . Portfolio Risk-Return Plots for DifferentWeights SecurityAnalysis 𝐸(𝑅) AnIntroductionto Investment • TheInvestmentSetting InvestmentsinaGlobal Market 122 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 . .AnIntroductiontoPortfolio Management Macroeconomic andIndustry Analysis TechnicalAnalysis 𝜎 IndexasMarket Representation Figure 12: A two-assetportfoliowith 𝜌 = −1.0 417 Sigit Wibowo . EstimationIssues SecurityAnalysis ▶ ▶ Resultsofportfolioallocationdependon accuratestatisticalinputs Estimatesof ▶ ▶ ▶ TheInvestmentSetting InvestmentsinaGlobal Market 123 ▶ .AnIntroductiontoPortfolio 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 TheInvestmentSetting InvestmentsinaGlobal Market 124 Appendix Introductionto AssetPricing Models (22) Fundamental Analysis where ▶ ▶ .AnIntroductiontoPortfolio 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 𝜎𝑚 𝜎𝑖 𝜎𝑗 AnIntroductionto Investment TheInvestmentSetting InvestmentsinaGlobal Market 125 .AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models (23) Fundamental Analysis Macroeconomic andIndustry Analysis where 𝜎𝑚 = thevarianceofreturnsforthe aggregatestockmarket TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . TheEfficientFrontier SecurityAnalysis AnIntroductionto Investment ▶ ▶ Theefficientfrontierrepresentsthatsetof portfolioswiththemaximumrateofreturnfor everygivenlevelofrisk, ortheminimumriskfor everylevelofreturn Frontierwillbeportfoliosofinvestmentsrather thanindividualsecurities ▶ TheInvestmentSetting InvestmentsinaGlobal Market 126 .AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis Exceptionsbeingtheassetwiththehighestreturn andtheassetwiththelowestrisk TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . TheEfficientFrontier SecurityAnalysis AnIntroductionto Investment 𝐸(𝑅) Ef i fic Global minimum- • • variance portfolio . en t n f ro tie r TheInvestmentSetting InvestmentsinaGlobal Market • • • • • • • • 127 .AnIntroductiontoPortfolio 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 TheInvestmentSetting InvestmentsinaGlobal Market 128 .AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . TheEfficientFrontier&InvestorUtility SecurityAnalysis AnIntroductionto Investment TheInvestmentSetting ▶ ▶ Theoptimalportfoliohasthehighestutilityfora giveninvestor Itliesatthepointoftangencybetweenthe efficientfrontierandtheutilitycurvewiththe highestpossibleutility InvestmentsinaGlobal Market 129 .AnIntroductiontoPortfolio Management Appendix Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . TheEfficientFrontier&InvestorUtility SecurityAnalysis 𝐸(𝑅) 𝑈 𝑈 𝑈 AnIntroductionto Investment 𝑈′ 𝑈′ 𝑈′ TheInvestmentSetting InvestmentsinaGlobal Market 130 .AnIntroductiontoPortfolio 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 TheInvestmentSetting ▶ ▶ ▶ Therearemanywaystoconstructefficientfrontier Check R codeforconstructingefficientfrontier: http://economistatlarge.com/portfolio-theory/ r-optimized-portfolio/ r-code-graph-efficient-frontier Trytoemployyourowndatausingthecode. InvestmentsinaGlobal Market AnIntroductiontoPortfolio 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 TheInvestmentSetting InvestmentsinaGlobal Market AnIntroductiontoPortfolio 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) . TheInvestmentSetting InvestmentsinaGlobal Market AnIntroductiontoPortfolio 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 TheInvestmentSetting InvestmentsinaGlobal Market AnIntroductiontoPortfolio 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 . Geometric Return & Log Return (cont’d) SecurityAnalysis ▶ 𝑥 Using lim 1 + 𝑥 = 𝑒, thenwecanwrite AnIntroductionto Investment 𝑥→∞ TheInvestmentSetting 𝑦 = 𝑦 (𝑒) = 𝑦 𝑒𝑟 ▶ InvestmentsinaGlobal Market 𝑟 AnIntroductiontoPortfolio 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 . Geometric Return & Log Return (cont’d) SecurityAnalysis ▶ Wecanalsodotheiterationasfollows: 𝑦 = 𝑦 𝑒𝑟 𝑦 = 𝑦 𝑒𝑟 ▶ AnIntroductionto Investment TheInvestmentSetting InvestmentsinaGlobal Market AnIntroductiontoPortfolio 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 TheInvestmentSetting InvestmentsinaGlobal Market AnIntroductiontoPortfolio 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 ▶ TheCapitalAssetPricing Model Theexactlocationontheefficientfrontierand, therefore, thespecificportfolioselected, will dependontheindividualinvestor’srisk-return utilityfunction. Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . AssumptionsofCapitalMarketTheory 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 TheCapitalAssetPricing Model Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . AssumptionsofCapitalMarketTheory SecurityAnalysis AnIntroductionto Investment 3. Allinvestorshavehomogeneousexpectations; thatis, theyestimateidenticalprobability distributionsforfutureratesofreturn. ▶ ▶ Introductionto AssetPricing Models 143 . CapitalMarketTheory RiskandReturn Relationship TheCapitalAssetPricing Model Again, thisassumptioncanberelaxed Aslongasthedifferencesinexpectationsarenot vast, theireffectsareminor. Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . AssumptionsofCapitalMarketTheory 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. TheCapitalAssetPricing Model Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . AssumptionsofCapitalMarketTheory SecurityAnalysis AnIntroductionto Investment 5. Allinvestmentsareinfinitelydivisible, which meansthatitispossibletobuyorsellfractional sharesofanyassetorportfolio. ▶ ▶ Introductionto AssetPricing Models 145 . CapitalMarketTheory RiskandReturn Relationship TheCapitalAssetPricing Model Thisassumptionallowsustodiscussinvestment alternativesascontinuouscurves. Changingitwouldhavelittleimpactonthe theory. Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . AssumptionsofCapitalMarketTheory SecurityAnalysis AnIntroductionto Investment 6. Therearenotaxesortransactioncostsinvolved inbuyingorsellingassets. ▶ ▶ ▶ Thisisareasonableassumptioninmany instances. Neitherpensionfundsnorreligiousgroupshave topaytaxes, andthetransactioncostsformost financialinstitutionsarelessthan1percenton mostfinancialinstruments. Again, relaxingthisassumptionmodifiesthe results, butdoesnotchangethebasicthrust. Introductionto AssetPricing Models 146 . CapitalMarketTheory RiskandReturn Relationship TheCapitalAssetPricing Model Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . AssumptionsofCapitalMarketTheory SecurityAnalysis AnIntroductionto Investment 7. Thereisnoinflationoranychangeininterest rates, orinflationisfullyanticipated. ▶ Introductionto AssetPricing Models 147 Thisisareasonableinitialassumption, anditcan bemodified. RiskandReturn Relationship TheCapitalAssetPricing Model Fundamental Analysis 8. Capitalmarketsareinequilibrium. ▶ . CapitalMarketTheory Macroeconomic andIndustry Analysis Thismeansthatwebeginwithallinvestments properlypricedinlinewiththeirrisklevels. TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . AssumptionsofCapitalMarketTheory SecurityAnalysis AnIntroductionto Investment ▶ ▶ ▶ Someoftheseassumptionsareunrealistic Relaxingmanyoftheseassumptionswouldhave onlyminorinfluenceonthemodelandwould notchangeitsmainimplicationsorconclusions. A theoryshouldbejudgedonhowwellit explainsandhelpspredictbehaviour, notonits assumptions. Introductionto AssetPricing Models 148 . CapitalMarketTheory RiskandReturn Relationship TheCapitalAssetPricing 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 TheCapitalAssetPricing 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 TheCapitalAssetPricing 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 TheCapitalAssetPricing 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 TheCapitalAssetPricing Model (25) Fundamental Analysis Macroeconomic andIndustry Analysis Thisisa linear relationship TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . StandardDeviation CombiningaRisk-FreeAssetwithaRiskyPortfolio SecurityAnalysis ▶ Theexpectedvarianceforatwo-assetportfoliois 𝐸(𝜎𝑝𝑜𝑟𝑡 ) = 𝑤 𝜎 + 𝑤 𝜎 + 2𝑤 𝑤 𝜌, 𝜎 𝜎 AnIntroductionto Investment Introductionto AssetPricing Models (26) CapitalMarketTheory 154 ▶ TheCapitalAssetPricing Model Substitutingtherisk-freeassetforSecurity1, and theriskyassetforSecurity2, equation (26) would become 𝐸(𝜎𝑝𝑜𝑟𝑡 ) = 𝑤𝑅𝐹 𝜎𝑅𝐹 + (1 − 𝑤𝑅𝐹 ) 𝜎𝑖 + 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(𝜎𝑝𝑜𝑟𝑡 ) = (1 − 𝑤𝑅𝐹 ) 𝜎𝑖 Introductionto AssetPricing Models CapitalMarketTheory 155 .RiskandReturn Relationship TheCapitalAssetPricing 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 ) 𝜎𝑖 = (1 − 𝑤𝑅𝐹 )𝜎𝑖 𝐸(𝜎𝑝𝑜𝑟𝑡 ) = ▶ AnIntroductionto Investment Introductionto AssetPricing Models CapitalMarketTheory (29) 156 .RiskandReturn Relationship TheCapitalAssetPricing 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 TheCapitalAssetPricing 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 TheCapitalAssetPricing Model Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . TheEfficientFrontier SecurityAnalysis 𝐸(𝑅𝑝𝑜𝑟𝑡 ) Bo Le n g d in • • • 𝑀• • • • • wi r ro ng • • AnIntroductionto Investment 𝐶𝑀𝐿 Introductionto AssetPricing Models CapitalMarketTheory 159 • .RiskandReturn Relationship TheCapitalAssetPricing Model Fundamental Analysis Macroeconomic andIndustry Analysis RFR . TechnicalAnalysis 𝐸(𝜎𝑝𝑜𝑟𝑡 ) 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 TheCapitalAssetPricing 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 TheCapitalAssetPricing 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 TheCapitalAssetPricing 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 TheCapitalAssetPricing 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 TheCapitalAssetPricing 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 TheCapitalAssetPricing 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 TheCapitalAssetPricing 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 TheCapitalAssetPricing Model Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . TheCML andtheSeparationTheorem SecurityAnalysis AnIntroductionto Investment Introductionto AssetPricing Models ▶ Investorspreferringmoreriskmightborrowfunds attheRFR andinvesteverythinginthemarket portfolio CapitalMarketTheory 168 .RiskandReturn Relationship TheCapitalAssetPricing Model Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . TheEfficientFrontier SecurityAnalysis 𝐸(𝑅𝑝𝑜𝑟𝑡 ) AnIntroductionto Investment 𝐶𝑀𝐿 Introductionto AssetPricing Models • 𝐵 CapitalMarketTheory • 𝑀 169 .RiskandReturn Relationship TheCapitalAssetPricing Model • 𝐴 Fundamental Analysis Macroeconomic andIndustry Analysis RFR . TechnicalAnalysis 𝐸(𝜎𝑝𝑜𝑟𝑡 ) IndexasMarket Representation Figure 18: Financingandinvestmentdecision 417 Sigit Wibowo . TheCML andtheSeparationTheorem SecurityAnalysis ▶ ▶ ▶ Thedecisionofbothinvestorsistoinvestin portfolioM alongtheCML Thefinancingdecision ▶ ▶ AnIntroductionto Investment Theinvestmentdecision Introductionto AssetPricing Models CapitalMarketTheory 170 .RiskandReturn Relationship TheCapitalAssetPricing 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 TheCapitalAssetPricing 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) TheCapitalAssetPricing 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 TheCapitalAssetPricing 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 .TheCapitalAssetPricing 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: 𝜎𝑚 Introductionto AssetPricing Models CapitalMarketTheory RiskandReturn Relationship 177 .TheCapitalAssetPricing Model Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . TheSecurityMarketLine(SML) SecurityAnalysis 𝐸(𝑅𝑖 ) AnIntroductionto Investment 𝑆𝑀𝐿 Introductionto AssetPricing Models CapitalMarketTheory 𝑅𝑚 RiskandReturn Relationship 178 .TheCapitalAssetPricing Model Fundamental Analysis Macroeconomic andIndustry Analysis RFR . TechnicalAnalysis 𝜎𝑚 𝐶𝑜𝑣𝐼 ′ 𝑚 IndexasMarket Representation Figure 19: TheSecurityMarketLine(SML) 417 Sigit Wibowo . TheSecurityMarketLine(SML) SecurityAnalysis ▶ 𝑅𝑀 − 𝑅𝐹𝑅 𝐸(𝑅𝑖 ) = 𝑅𝐹𝑅 + 𝐶𝑜𝑣𝑖,𝑀 𝜎𝑀 𝐶𝑜𝑣𝑖,𝑀 = 𝑅𝐹𝑅 + (𝑅𝑀 − 𝑅𝐹𝑅) 𝜎𝑀 ▶ AnIntroductionto Investment Theequationfortherisk–returnline Wethendefineas 𝐶𝑜𝑣𝑖,𝑀 𝜎𝑀 Introductionto AssetPricing Models CapitalMarketTheory (32) RiskandReturn Relationship 179 Fundamental Analysis Macroeconomic andIndustry Analysis asbeta (𝛽𝑖 ) 𝐸(𝑅𝑖 ) = 𝑅𝐹𝑅 + 𝛽𝑖 (𝑅𝑀 − 𝑅𝐹𝑅) .TheCapitalAssetPricing Model TechnicalAnalysis (33) IndexasMarket Representation 417 Sigit Wibowo . TheSecurityMarketLine(SML) SecurityAnalysis 𝐸(𝑅𝑖 ) AnIntroductionto Investment 𝑆𝑀𝐿 Introductionto AssetPricing Models CapitalMarketTheory 𝑅𝑚 RiskandReturn Relationship 180 .TheCapitalAssetPricing Model Fundamental Analysis Macroeconomic andIndustry Analysis RFR Negative 𝛽 . TechnicalAnalysis 𝛽 = 𝐶𝑜𝑣𝑖,𝑀 /𝜎𝑀 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 .TheCapitalAssetPricing Model Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . DeterminingtheExpectedRateofReturnforaRiskyAsset 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 .TheCapitalAssetPricing 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 .TheCapitalAssetPricing Model Fundamental Analysis Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . DeterminingtheExpectedRateofReturnforaRiskyAsset 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 .TheCapitalAssetPricing 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 .TheCapitalAssetPricing 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: ▶ ▶ ▶ ▶ .TheCapitalAssetPricing 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 .TheCapitalAssetPricing 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 .TheCapitalAssetPricing 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 .TheCapitalAssetPricing 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 ▶ .TheCapitalAssetPricing 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 ▶ .TheCapitalAssetPricing 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 ▶ ▶ .TheCapitalAssetPricing 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 ▶ ▶ .TheCapitalAssetPricing 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 ▶ .TheCapitalAssetPricing 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 .TheCapitalAssetPricing 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 .TheCapitalAssetPricing 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 .TheCapitalAssetPricing 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 .TheCapitalAssetPricing 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 .TheCapitalAssetPricing 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 .TheCapitalAssetPricing 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 .RiskAnalysisandGrowth 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 .RiskAnalysisandGrowth Potential CashFlowTechniques RelativeValuation Techniques Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . ExternalMarketLiquidity DeterminantsofMarketLiquidity SecurityAnalysis AnIntroductionto Investment ▶ Thedollarvalueofsharestraded ▶ ▶ ▶ ▶ Thiscanbeestimatedfromthetotalmarketvalue ofoutstandingsecurities Itwillbeaffectedbythenumberofsecurity owners Numerousbuyersandsellersprovideliquidity Introductionto AssetPricing Models Fundamental Analysis CompanyAnalysisand StockValuation 217 .RiskAnalysisandGrowth Potential CashFlowTechniques RelativeValuation Techniques Tradingturnover(percentageofoutstanding sharestradedduringaperiodoftime) Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . ExternalMarketLiquidity SecurityAnalysis AnIntroductionto Investment ▶ ▶ Introductionto AssetPricing Models A measureofmarketliquidityisthebid-ask spread Certaincorporatevariables ▶ ▶ Totalmarketvalueofoutstandingsecurities (numberofcommonsharesoutstandingtimesthe marketpricepershare) Numberofsecurityowners Fundamental Analysis CompanyAnalysisand StockValuation 218 .RiskAnalysisandGrowth 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 .RiskAnalysisandGrowth 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) RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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) RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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) RiskAnalysisandGrowth Potential 235 RelativeValuation Techniques Macroeconomic andIndustry Analysis where ▶ ▶ ▶ . CashFlowTechniques 𝑉𝑗 = valueofcommonstock 𝑗 𝐷𝑡 = dividendduringtimeperiod 𝑡 𝑘 = requiredrateofreturnonstock 𝑗 TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . TheDividendDiscountModel(DDM) SecurityAnalysis AnIntroductionto Investment ▶ Introductionto AssetPricing Models Ifthestockisnotheldforaninfiniteperiod, a saleattheendofyear2wouldimply: Fundamental Analysis CompanyAnalysisand StockValuation 𝑉𝑗 = 𝑆𝑃𝑗, 𝐷 𝐷 + + (1 + 𝑘) (1 + 𝑘) (1 + 𝑘) RiskAnalysisandGrowth Potential 236 . CashFlowTechniques RelativeValuation Techniques Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . TheDividendDiscountModel(DDM) 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 RiskAnalysisandGrowth 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 . TheDividendDiscountModel(DDM) 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 RiskAnalysisandGrowth Potential 238 where: ▶ ▶ . CashFlowTechniques RelativeValuation Techniques Macroeconomic andIndustry Analysis 𝐷 = 0 𝐷 = 0 TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . TheDividendDiscountModel(DDM) 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 RiskAnalysisandGrowth Potential 239 . CashFlowTechniques RelativeValuation Techniques Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . TheDividendDiscountModel(DDM) SecurityAnalysis ▶ ▶ AnIntroductionto Investment Infiniteperiodmodelassumesaconstantgrowth rateforestimatingfuturedividends (48) canbereducedto: 𝐷 𝑉𝑗 = 𝑘−𝑔 Introductionto AssetPricing Models Fundamental Analysis CompanyAnalysisand StockValuation (49) RiskAnalysisandGrowth 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 RiskAnalysisandGrowth Potential 241 . CashFlowTechniques RelativeValuation Techniques Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . Infinite Period DDM and Growth Companies SecurityAnalysis ▶ ▶ ▶ Growthcompanieshaveopportunitiestoearn returnoninvestmentsgreaterthantheirrequired ratesofreturn Toexploittheseopportunities, thesefirms generallyretainahighpercentageofearningsfor reinvestment, andtheirearningsgrowfasterthan thoseofatypicalfirm ThisisinconsistentwiththeinfiniteperiodDDM assumptions AnIntroductionto Investment Introductionto AssetPricing Models Fundamental Analysis CompanyAnalysisand StockValuation RiskAnalysisandGrowth Potential 242 . CashFlowTechniques RelativeValuation Techniques Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . Infinite Period DDM and Growth Companies SecurityAnalysis AnIntroductionto Investment ▶ ▶ ▶ TheinfiniteperiodDDM assumesconstant growthforaninfiniteperiod, butabnormallyhigh growthusuallycannotbemaintainedindefinitely Riskandgrowtharenotnecessarilyrelated Temporaryconditionsofhighgrowthcannotbe valuedusingDDM Introductionto AssetPricing Models Fundamental Analysis CompanyAnalysisand StockValuation RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth Potential 247 . CashFlowTechniques RelativeValuation Techniques Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . PresentValueofOperatingFreeCash 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 RiskAnalysisandGrowth Potential 248 . CashFlowTechniques RelativeValuation Techniques Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . PresentValueofOperatingFreeCash Flows SecurityAnalysis ▶ ▶ SimilartoDDM,thismodelcanbeusedto estimateaninfiniteperiod Wheregrowthhasmaturedtoastablerate, the adaptationis 𝑂𝐶𝐹𝑡 𝑉𝑗 = WACC𝑗 − 𝑔𝑂𝐶𝐹 AnIntroductionto Investment Introductionto AssetPricing Models Fundamental Analysis CompanyAnalysisand StockValuation (51) RiskAnalysisandGrowth Potential 249 RelativeValuation Techniques Macroeconomic andIndustry Analysis where: ▶ ▶ . CashFlowTechniques 𝑂𝐶𝐹 = operatingfreecashflowinperiod1 𝑔𝑂𝐶𝐹 = long-termconstantgrowthofoperating freecashflow TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . PresentValueofOperatingFreeCash Flows SecurityAnalysis AnIntroductionto Investment ▶ ▶ Assumingseveraldifferentratesofgrowthfor OCF,theseestimatescanbedividedintostages aswiththesupernormaldividendgrowthmodel Estimatetherateofgrowthandthedurationof growthforeachperiod Introductionto AssetPricing Models Fundamental Analysis CompanyAnalysisand StockValuation RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth Potential CashFlowTechniques 258 .RelativeValuation Techniques Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . AnalysisofGrowthCompanies 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 RiskAnalysisandGrowth Potential CashFlowTechniques 259 (54) .RelativeValuation Techniques Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . AnalysisofGrowthCompanies SecurityAnalysis ▶ Long-rungrowthmodels ▶ ▶ AnIntroductionto Investment assumessomeearningsarereinvested Introductionto AssetPricing Models Simplegrowthmodel ▶ Grosspresentvalueofgrowthinvestments 𝑏𝐸𝑚𝑘 𝑏𝐸𝑚 = 𝑘 𝑘 Fundamental Analysis CompanyAnalysisand StockValuation (55) RiskAnalysisandGrowth Potential CashFlowTechniques 260 ▶ Macroeconomic andIndustry Analysis Netpresentvalueofgrowthinvestments 𝑏𝐸𝑚 𝑏𝐸 = 𝑘 𝑘 .RelativeValuation Techniques TechnicalAnalysis (56) IndexasMarket Representation 417 Sigit Wibowo . AnalysisofGrowthCompanies 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 RiskAnalysisandGrowth Potential CashFlowTechniques ▶ 261 Presentvalueofconstantdividendplusthe presentvalueofgrowthinvestment 𝐷 𝑏𝐸𝑚 𝑣= + 𝑘 𝑘 .RelativeValuation Techniques Macroeconomic andIndustry Analysis TechnicalAnalysis (58) IndexasMarket Representation 417 Sigit Wibowo . AnalysisofGrowthCompanies SimpleGrowthModel(cont.) SecurityAnalysis AnIntroductionto Investment ▶ Presentvalueofconstantearningsplusthe presentvalueofexcessearningsfromgrowth investment 𝐸 𝑏𝐸(𝑚 − 1) 𝑣= + (59) 𝑘 𝑘 Introductionto AssetPricing Models Fundamental Analysis CompanyAnalysisand StockValuation RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth Potential EVA Capital ▶ CashFlowTechniques 267 Macroeconomic andIndustry Analysis AlternativemeasureofEVA ▶ .RelativeValuation Techniques TechnicalAnalysis Comparereturnoncapitaltocostofcapital IndexasMarket Representation 417 Sigit Wibowo . MeasuresofValue-Added SecurityAnalysis AnIntroductionto Investment ▶ ▶ ▶ Measureofexternalperformance Howthemarkethasevaluatedthefirm’s performanceintermsofmarketvalueofdebtand marketvalueofequitycomparedtothecapital investedinthefirm RelationshipsbetweenEVA andMVA ▶ Introductionto AssetPricing Models Fundamental Analysis CompanyAnalysisand StockValuation RiskAnalysisandGrowth Potential CashFlowTechniques 268 .RelativeValuation Techniques Macroeconomic andIndustry Analysis mixedresults TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . MeasuresofValue-Added TheFranchiseFactor SecurityAnalysis ▶ BreaksP/E intotwocomponents ▶ ▶ AnIntroductionto Investment P/E basedonongoingbusiness(baseP/E) FranchiseP/E themarketassignstotheexpected valueofnewandprofitablebusiness opportunities Introductionto AssetPricing Models Fundamental Analysis CompanyAnalysisand StockValuation RiskAnalysisandGrowth 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 RiskAnalysisandGrowth Potential CashFlowTechniques 270 .RelativeValuation Techniques Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . 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 AssetPricing Models Fundamental Analysis CompanyAnalysisand StockValuation RiskAnalysisandGrowth Potential 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 Investment Introductionto AssetPricing Models Fundamental Analysis CompanyAnalysisand StockValuation RiskAnalysisandGrowth Potential CashFlowTechniques 272 .RelativeValuation Techniques Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . Intra-IndustryAnalysis SecurityAnalysis ▶ ▶ ▶ AnIntroductionto Investment Directlycomparetwofirmsinthesameindustry Analternativeuseof 𝑇 todetermineareasonable 𝑃/𝐸 ratio Factorstoconsider ▶ ▶ ▶ ▶ A majordifferenceintheriskinvolved Inaccurategrowthestimates Stockwithalow 𝑃/𝐸 relativetoitsgrowthrateis undervalued Stockwithhigh 𝑃/𝐸 andalowgrowthrateis overvalued Introductionto AssetPricing Models Fundamental Analysis CompanyAnalysisand StockValuation RiskAnalysisandGrowth Potential CashFlowTechniques 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 AssetPricing Models Fundamental Analysis CompanyAnalysisand StockValuation RiskAnalysisandGrowth Potential CashFlowTechniques 274 (63) .RelativeValuation Techniques Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . EarningsMultiplierModel SecurityAnalysis ▶ Theinfinite-perioddividenddiscountmodel indicatesthevariablesthatshoulddeterminethe valueoftheP/E ratio 𝐷 𝑃𝑖 = 𝑘−𝑔 ▶ 𝐷 /𝐸 𝑘−𝑔 Introductionto AssetPricing Models Fundamental Analysis (64) CompanyAnalysisand StockValuation RiskAnalysisandGrowth Potential Dividingbothsidesbyexpectedearningsduring thenext12months(E1) 𝑃𝑖 /𝐸 = AnIntroductionto Investment CashFlowTechniques 275 .RelativeValuation Techniques Macroeconomic andIndustry Analysis (65) TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . EarningsMultiplierModel SecurityAnalysis AnIntroductionto Investment ▶ Introductionto AssetPricing Models Thus, the 𝑃/𝐸 ratioisdeterminedby ▶ ▶ ▶ Expecteddividendpayoutratio Requiredrateofreturnonthestock(𝑘) Expectedgrowthrateofdividends(𝑔) Fundamental Analysis CompanyAnalysisand StockValuation RiskAnalysisandGrowth Potential CashFlowTechniques 276 .RelativeValuation Techniques Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . EarningsMultiplierModel 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 RiskAnalysisandGrowth 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 . EarningsMultiplierModel 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 AssetPricing Models Fundamental Analysis CompanyAnalysisand StockValuation RiskAnalysisandGrowth Potential CashFlowTechniques 278 .RelativeValuation Techniques Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . EarningsMultiplierModel 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 AssetPricing Models Fundamental Analysis CompanyAnalysisand StockValuation RiskAnalysisandGrowth Potential CashFlowTechniques 281 .RelativeValuation Techniques Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . ThePrice-BookValueRatio 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 RiskAnalysisandGrowth Potential CashFlowTechniques 282 .RelativeValuation Techniques Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . ThePrice-BookValueRatio SecurityAnalysis AnIntroductionto Investment ▶ ▶ Besuretomatchthepricewitheitherarecent bookvaluenumber, orestimatethebookvalue forthesubsequentyear Canderiveanestimatebaseduponhistorical growthratefortheseriesorusethegrowthrate impliedbythe 𝑅𝑂𝐸 × RetentionRate analysis Introductionto AssetPricing Models Fundamental Analysis CompanyAnalysisand StockValuation RiskAnalysisandGrowth Potential CashFlowTechniques 283 .RelativeValuation Techniques Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . ThePrice-SalesRatio SecurityAnalysis ▶ ▶ Strong, consistentgrowthrateisarequirementof agrowthcompany Salesissubjecttolessmanipulationthanother financialdata 𝑃 𝑃𝑡 = (68) 𝑆 𝑆𝑡+ where ▶ ▶ ▶ AnIntroductionto Investment Introductionto AssetPricing Models Fundamental Analysis CompanyAnalysisand StockValuation RiskAnalysisandGrowth Potential CashFlowTechniques 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 Fundamental Analysis CompanyAnalysisand StockValuation RiskAnalysisandGrowth Potential 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 AssetPricing Models Fundamental Analysis CompanyAnalysisand StockValuation RiskAnalysisandGrowth Potential CashFlowTechniques 286 .RelativeValuation Techniques Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 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 Introductionto AssetPricing Models Fundamental Analysis CompanyAnalysisand StockValuation RiskAnalysisandGrowth Potential CashFlowTechniques 287 .RelativeValuation Techniques Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . RequiredRateofReturn(𝑘) SecurityAnalysis ▶ ▶ ▶ ▶ Theinvestor’srequiredrateofreturnmustbe estimatedregardlessoftheapproachselectedor techniqueapplied Thiswillbeusedasthediscountrateandalso affectsrelative-valuation Thisisnotusedforpresentvalueoffreecashflow whichusestherequiredrateofreturnonequity (𝑘) Itisalsonotusedinpresentvalueofoperating cashflowwhichuses WACC AnIntroductionto Investment Introductionto AssetPricing Models Fundamental Analysis CompanyAnalysisand StockValuation RiskAnalysisandGrowth Potential CashFlowTechniques 288 .RelativeValuation Techniques Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . RequiredRateofReturn(𝑘) SecurityAnalysis AnIntroductionto Investment ▶ Introductionto AssetPricing Models Threefactorsinfluenceaninvestor’srequiredrate ofreturn: ▶ ▶ ▶ Theeconomy’srealrisk-freerate(𝑅𝑅𝐹𝑅) Theexpectedrateofinflation(𝐼 ) A riskpremium(𝑅𝑃) Fundamental Analysis CompanyAnalysisand StockValuation RiskAnalysisandGrowth Potential CashFlowTechniques 289 .RelativeValuation Techniques Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . TheEconomy’sRealRisk-FreeRate SecurityAnalysis AnIntroductionto Investment ▶ ▶ ▶ ▶ Introductionto AssetPricing Models Minimumrateaninvestorshouldrequire Dependsontherealgrowthrateoftheeconomy Fundamental Analysis (Capitalinvestedshouldgrowasfastasthe economy) Rateisaffectedforshortperiodsbytightnessor easeofcreditmarkets CompanyAnalysisand StockValuation RiskAnalysisandGrowth Potential CashFlowTechniques 290 .RelativeValuation Techniques Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . TheExpectedRateofInflation SecurityAnalysis ▶ ▶ Investorsareinterestedinrealratesofreturnthat willallowthemtoincreasetheirrateof consumption Theinvestor’srequirednominalrisk-freerateof return(NRFR) shouldbeincreasedtoreflectany expectedinflation: AnIntroductionto Investment Introductionto AssetPricing Models Fundamental Analysis CompanyAnalysisand StockValuation RiskAnalysisandGrowth Potential CashFlowTechniques 291 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 AssetPricing Models Fundamental Analysis CompanyAnalysisand StockValuation RiskAnalysisandGrowth Potential CashFlowTechniques 292 .RelativeValuation Techniques Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 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 RiskAnalysisandGrowth 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 CompanyAnalysisand StockValuation RiskAnalysisandGrowth Potential CashFlowTechniques 294 .RelativeValuation Techniques Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 RiskAnalysisandGrowth Potential CashFlowTechniques 297 Itindicateshowmanagementhasdecidedto financethefirm .RelativeValuation Techniques Macroeconomic andIndustry Analysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . EstimatingGrowthBasedonHistory Historicalgrowthratesofsales, earnings, cashflow, anddividends SecurityAnalysis AnIntroductionto Investment ▶ 1. arithmeticorgeometricaverageofannual percentagechanges 2. linearregressionmodels 3. log-linearregressionmodels ▶ Introductionto AssetPricing Models Threetechniques Fundamental Analysis CompanyAnalysisand StockValuation RiskAnalysisandGrowth 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 RiskAnalysisandGrowth 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 MacroeconomicAnalysis 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 MacroeconomicAnalysis 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 MacroeconomicAnalysis 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 MacroeconomicAnalysis 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 MacroeconomicAnalysis IndustryAnalysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . TheoryofValuation SecurityAnalysis AnIntroductionto Investment ▶ ▶ Thevalueofanassetisthepresentvalueofits expectedreturnsYouexpectanassettoprovidea streamofreturnswhileyouownit Toconvertthisstreamofreturnstoavalueforthe security, youmustdiscountthisstreamatyour requiredrateofreturn Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis 307 . ValuationProcess MacroeconomicAnalysis IndustryAnalysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . TheoryofValuation SecurityAnalysis AnIntroductionto Investment ▶ ▶ Introductionto AssetPricing Models Toconvertthisstreamofreturnstoavalueforthe security, youmustdiscountthisstreamatyour requiredrateofreturn Thisrequiresestimatesof: ▶ ▶ Thestreamofexpectedreturns, and Therequiredrateofreturnontheinvestment Fundamental Analysis Macroeconomic andIndustry Analysis 308 . ValuationProcess MacroeconomicAnalysis 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 MacroeconomicAnalysis 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 MacroeconomicAnalysis 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 MacroeconomicAnalysis 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 . MacroeconomicAnalysis 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 . MacroeconomicAnalysis 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 . MacroeconomicAnalysis 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 . MacroeconomicAnalysis 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 . MacroeconomicAnalysis 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 . 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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 MacroeconomicAnalysis 339 . IndustryAnalysis TechnicalAnalysis IndexasMarket Representation Orcomparesystematicrisk(beta)fortheindustry tothemarketbetaof1.0 417 Sigit Wibowo . 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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 MacroeconomicAnalysis 344 . IndustryAnalysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . IndustryProfitMarginForecast Depreciationexpense SecurityAnalysis AnIntroductionto Investment ▶ ▶ ▶ Generallyincreasingtimeseries Specificestimatetechniqueusingthe depreciationexpense/PPE ratio Subtractdepreciationfromoperatingprofit margintodetermineindustry’snetbeforeinterest andtaxes Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis ValuationProcess MacroeconomicAnalysis 345 . IndustryAnalysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . IndustryProfitMarginForecast 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 MacroeconomicAnalysis 346 . IndustryAnalysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . IndustryProfitMarginForecast 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 MacroeconomicAnalysis 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 MacroeconomicAnalysis 348 . IndustryAnalysis TechnicalAnalysis IndexasMarket Representation 417 Sigit Wibowo . 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AnIntroductionto Investment Introductionto AssetPricing Models Fundamental Analysis Macroeconomic andIndustry Analysis ValuationProcess MacroeconomicAnalysis 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 . UnderlyingAssumptions TechnicalTradingRulesand Indicators Contrary-OpinionRules UsingR IndexasMarket Representation 417 Sigit Wibowo . TechnicalAnalysis UnderlyingAssumptions 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 . UnderlyingAssumptions TechnicalTradingRulesand Indicators Contrary-OpinionRules 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 . UnderlyingAssumptions TechnicalTradingRulesand Indicators Contrary-OpinionRules 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 . UnderlyingAssumptions TechnicalTradingRulesand Indicators Contrary-OpinionRules 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 . UnderlyingAssumptions TechnicalTradingRulesand Indicators Contrary-OpinionRules 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 UnderlyingAssumptions 358 .TechnicalTradingRulesand Indicators Contrary-OpinionRules 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 UnderlyingAssumptions 359 Buypoint 15 Through 0 . 50 100 Declining trend channel 150 .TechnicalTradingRulesand Indicators Contrary-OpinionRules UsingR Through 200 IndexasMarket Representation 250 Date 417 Sigit Wibowo . 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Contrary-OpinionRules 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 UnderlyingAssumptions TechnicalTradingRulesand Indicators 364 . Contrary-OpinionRules UsingR IndexasMarket Representation 417 Sigit Wibowo . StockPriceandVolumeTechniques SecurityAnalysis ▶ AnIntroductionto Investment TheDowtheory–oldesttechnicaltradingrule Introductionto AssetPricing Models 1. Majortrendsareliketidesintheocean 2. Intermediatetrendsresemblewaves 3. 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Example: ISAT Momentum 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 400 200 0 −200 −400 UnderlyingAssumptions 3000 Momentum ( 1 ): 0.00 TechnicalTradingRulesand Indicators Contrary-OpinionRules 380 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 . 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 DifferentiatingFactorsinConstructingMarketIndexes 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 DifferentiatingFactorsinConstructingMarketIndexes 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 . FT/S&P-ActuariesWorldIndexes 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 . FT/S&P-ActuariesWorldIndexes 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 . Morgan Stanley Capital International (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 . Morgan Stanley Capital International (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
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