Deutsche Bank : Discussing the Equity Risk pension
Summary
Jamil Baz, global manoeuvre of fixed income research at Deutsche Bank, and George Cooper, global fixed income strategian of the same group, are finalizing a client presentation on the danger of overstating the Equity Risk Premium (ERP) when comparing bonds and equities. For this purpose, they quantify two unalike approaches used to calculate the ERP.
Identification of the problem
The world-wide idea behind the calculation of the Equity Risk Premium can be divided in 3 move:
·         idea of the expected total authorise on stocks
·         Estimation of the expected risk-free return of bond coupons
·         Calculating the departure of the above two estimations
Two approaches are proposed for estimating ERP - The first is called the Gordon step-up feigning (GGM). It uses a dividend discount model in roll to estimate the Equity Risk Premium. The expected total return on stocks (%) is considered equal to the summation of the dividend yield (%) and the expected increment in dividends (%). The second approach is based on the price-to-earnings proportion of the company and its reciprocal, the earnings yield. The expected total return on stocks (%) is estimated to be the earnings yield.
However, the two approaches produce highly different results and Jamil Baz is in the tough situation of deciding whether or non he should emphasize one of these approaches during the client meeting or, otherwise, rationalise the apparent differences between their results.
Analysis
Model Details and Assumptions
The Gordon Growth Model uses the menstruation average dividend payout ratio of the entire stock grocery store as a starting point to calculate the ERP. However, the current average dividend payout ratio is very arbitrary, and is subject to variations in macro-economic conditions. For example, when nominative interest rate is high, companies will spend less gold on new projects based on NPV analysis, and therefore find up the...If you want to get a full essay, order it on our website: Ordercustompaper.com
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