liquidity&controlPeru

liquidity&controlPeru - Aswath Damodaran 1 Market...

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Unformatted text preview: Aswath Damodaran 1 Market Frictions: Undiversifed Investors, Illiquidity and Control Aswath Damodaran www.damodran.com Aswath Damodaran 2 Fundamental Assumptions The Diversifed Investor : Investors are rational and attempt to maximize expected returns, given risk taken. In the process, they end up with diversifed portolios and use inormation to make reasoned judgments on value. The Liquid Market : Investments are liquid. Trading is easy, instantaneous and costless. The powerul stockholder : As the owners o companies, stockholders exercise power over managers, who seek mightily to maximize stockholder wealth. Aswath Damodaran 3 I. The Undiversifed Investor Implications For Valuation and Corporate inance Aswath Damodaran 4 Diversifed Investors and the Cost oF Equity The assumption that the marginal investor in a company is diversifed is central to how we measure risk in fnance. Since we assume that the marginal investor is diversifed, we assume that the only risk that will be priced into the cost oF equity is the risk that cannot be diversifed away. When we use a beta to measure risk, we are measuring only that portion oF the risk that cannot be diversifed away. We are assuming that the remaining risk is ignored because it can be diversifed. Is it possible that the marginal investor is not diversifed? IF so, how should we measure risk? Aswath Damodaran 5 80 units of firm specific risk 20 units of market risk Private owner of business with 100% of your weatlth invested in the business Publicly traded company with investors who are diversified Is exposed to all the risk in the firm Demands a cost of equity that reflects this risk Eliminates firm- specific risk in portfolio Demands a cost of equity that reflects only market risk Market Beta measures just market risk Total Beta measures all risk = Market Beta/ (Portion of the total risk that is market risk) Private Owner versus Publicly Traded Company Perceptions of Risk in an Investment Aswath Damodaran 6 Use bottom-up betas of publicly traded Frms to get the unlevered beta of the busines Kristin Kandy is a privately owned, candy manufacturer, in the United States. The owner of the company has all of her wealth tied up in the company and wants to assess its value (to her). The average unlevered beta across publicly traded candy companies in the United States is 0.78. We will assume that this is a fair measure of the market risk in the candy business. Aswath Damodaran 7 Estimating a total beta To get from the market beta to the total beta, we need a measure of how much of the risk in the Frm comes from the market and how much is Frm-speciFc. Looking at the regressions of publicly traded Frms that yield the bottom-up beta should provide an answer....
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liquidity&controlPeru - Aswath Damodaran 1 Market...

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