The historic premium of long term 20 year rates over short term rates for

The historic premium of long term 20 year rates over

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The historic premium of long-term (20-year) rates over short-term rates for government securities is 2%. So, the risk-free rate to be used in the CAPM could be estimated as 2% below the prevailing rate on 20-year treasury securities.
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13-9 Market Risk Premium Method 1: Use historical data Method 2: Use the Dividend Discount Model Market data and analyst forecasts can be used to implement the DDM approach on a market-wide basis gPDRs+=1
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13-10 Beta Market Portfolio - Portfolio of all assets in the economy. In practice, a broad stock market index, such as the S&P 500, is used to representthe market. Beta - Sensitivity of a stock’s return to the return on the market portfolio.
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13-11 Estimation of Beta )(),(MMiRVarRRCovβ=• Problems 1.Betas may vary over time. 2.The sample size may be inadequate. 3.Betas are influenced by changing financial leverage and business risk. • Solutions Problems 1 and 2 can be moderated by more sophisticated statistical techniques. Problem 3 can be lessened by adjusting for changes in business and financial risk. Look at average beta estimates of comparable firms in the industry.
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13-12 Stability of Beta Most analysts argue that betas are generally stable for firms remaining in the same industry. That is not to say that a firm’s beta cannot change. Changes in product line Changes in technology Deregulation Changes in financial leverage
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13-13 Using an Industry Beta It is frequently argued that one can better estimate a firm’s beta by involving the whole industry. If you believe that the operations of the firm are similar to the operations of the rest of the industry, you should use the industry beta. If you believe that the operations of the firm are fundamentally different from the operations of the rest of the industry, you should use the firm’s beta. Do not forget about adjustments for financial leverage.
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13-14 Determinants of Beta Business Risk Cyclicality of Revenues Operating Leverage Financial Risk Financial Leverage
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13-15 Cyclicality of Revenues Highly cyclical stocks have higher betas. Empirical evidence suggests that retailers and automotive firms fluctuate with the business cycle. Transportation firms and utilities are less dependent on the business cycle. Note that cyclicality is not the same as variability—stocks with high standard deviations need not have high betas. Movie studios have revenues that are variable, depending upon whether they produce “hits” or “flops,” but their revenues may not be especially dependent upon the business cycle.
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13-16 Operating Leverage The degree of operating leverage measures how sensitive a firm (or project) is to its fixed costs.
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