LocalCurrencyGovernmentBondRates– January
2017
33
Currency
Govt BondRate12/31/16
Australian$
BrazilianReai
BritishPound
BulgarianLev
Canadian$
ChileanPeso
ChineseYuan
ColombianPeso
CroatianKuna
CzechKoruna
DanishKrone
Euro
HK$
HungarianForint
IcelandKrona
IndianRupee
IndonesianRupiah
IsraeliShekel
JapaneseYen
KenyanShilling
KoreanWon
2.76%
11.37%
1.35%
2.04%
1.70%
4.12%
3.25%
6.76%
3.13%
0.49%
0.42%
0.29%
1.69%
3.41%
5.06%
6.40%
7.60%
2.06%
0.06%
14.02%
2.08%
Aswath Damodaran
Currency
Malyasian Ringgit
MexicanPeso
NigerianNaira
NorwegianKrone
NZ$
PakistaniRupee
PeruvianSol
PhillipinePeso
PolishZloty
RomanianLeu
RussianRuble
Singapore$
SouthAfricanRand
SwedishKrona
SwissFranc
Taiwanese$
ThaiBaht
TurkishLira
US$
VenezuelanBolivar
VietnameseDong
Govt BondRate12/31/16
4.24%
7.63%
15.97%
1.61%
3.25%
8.03%
6.43%
4.75%
3.67%
3.44%
8.38%
2.45%
8.80%
0.62%
-0.19%
1.17%
2.70%
11.00%
2.45%
20.43%
6.10%
33
Approach1:DefaultspreadfromGovernment
Bonds
The Brazil Default Spread
Brazil 2018 Bond: 4.86%
US 2018 T.Bond: 1.22%
Spread:
3.64%
34
Approach2:CDSSpreads– January2017
35
Country
AbuDhabi
Argentina
Australia
Austria
Bahrain
Belgium
Brazil
Bulgaria
Chile
China
Colombia
CostaRica
Croatia
Cyprus
CzechRepublic
Denmark
Egypt
Estonia
Finland
France
Germany
HongKong
CDSSpread
0.97%
5.14%
0.49%
0.52%
3.17%
0.60%
3.59%
1.87%
1.29%
1.65%
2.42%
3.40%
2.60%
2.67%
0.74%
0.41%
4.76%
0.81%
0.45%
0.70%
0.44%
0.58%
Aswath Damodaran
CDSSpreadadj
forUS
0.59%
4.76%
0.11%
0.14%
2.79%
0.22%
3.21%
1.49%
0.91%
1.27%
2.04%
3.02%
2.22%
2.29%
0.36%
0.03%
4.38%
0.43%
0.07%
0.32%
0.06%
0.20%
Country
Hungary
Iceland
India
Indonesia
Ireland
Israel
Italy
Japan
Kazakhstan
Korea
Latvia
Lebanon
Lithuania
Malaysia
Mexico
Morocco
Netherlands
NewZealand
Nigeria
Norway
Pakistan
Panama
CDSSpread
1.67%
1.10%
1.76%
2.25%
1.02%
1.12%
2.22%
0.62%
2.13%
0.67%
1.02%
5.57%
0.94%
1.94%
2.20%
2.11%
0.51%
0.50%
5.76%
0.34%
4.18%
1.94%
CDSSpreadadj
forUS
1.29%
0.72%
1.38%
1.87%
0.64%
0.74%
1.84%
0.24%
1.75%
0.29%
0.64%
5.19%
0.56%
1.56%
1.82%
1.73%
0.13%
0.12%
5.38%
0.00%
3.80%
1.56%
Country
Peru
Philippines
Poland
Portugal
Qatar
Romania
Russia
SaudiArabia
Slovakia
Slovenia
SouthAfrica
Spain
Sweden
Switzerland
Thailand
Tunisia
Turkey
Ukraine
UnitedKingdom
UnitedStates
Venezuela
Vietnam
1.73%
1.61%
1.17%
3.42%
1.17%
1.51%
2.46%
1.45%
0.85%
1.52%
2.87%
1.25%
0.40%
0.50%
1.28%
5.00%
3.44%
7.64%
CDSSpreadadj
forUS
1.35%
1.23%
0.79%
3.04%
0.79%
1.13%
2.08%
1.07%
0.47%
1.14%
2.49%
0.87%
0.02%
0.12%
0.90%
4.62%
3.06%
7.26%
0.38%
30.82%
2.61%
0.00%
30.44%
2.23%
CDSSpread
0.61%
0.23%
35
Approach3:TypicalDefaultSpreads:January
2017
36
Aswath Damodaran
S&PSovereignRating
AAA
AA+
AA
AAA+
A
ABBB+
BBB
BBBBB+
BB
BB
B+
B
BCCC+
CCC
CCCCC+
CC
CCC+
C
C-
Moody'sSovereignRating
Aaa
Aa1
Aa2
Aa3
A1
A2
A3
Baa1
Baa2
Baa3
Ba1
Ba2
Ba3
B1
B2
B3
Caa1
Caa2
Caa3
Ca1
Ca2
Ca3
C1
C2
C3
DefaultSpread
0.00%
0.46%
0.57%
0.70%
0.81%
0.98%
1.39%
1.84%
2.20%
2.54%
2.89%
3.47%
4.16%
5.20%
6.36%
7.51%
8.66%
10.40%
11.55%
13.86%
15.25%
16.50%
18.00%
20.00%
25.00%
36
Gettingtoariskfreerateinacurrency:Example
37
¨
TheBraziliangovernmentbondrateinnominalreais on
January1,2017was11.37%.Togettoariskfree ratein
nominalreais,wecanuseoneofthreeapproaches.
¨
¨
¨
Approach1:GovernmentBondspread
¤ The2018Brazilbond,denominatedinUSdollars,hasaspreadof
3.64%overtheUStreasurybondrate.
¤ Riskfree ratein$R=11.37%- 3.64%=7.73%
Approach2:TheCDSSpread
¤ TheCDSspreadforBrazil,adjustedfortheUSCDSspreadwas
3.21%.
¤ Riskfree ratein$R=11.37%- 3.21%=8.16%
Approach3:TheRatingbasedspread
¤ BrazilhasaBa2localcurrencyratingfromMoody’s.Thedefault
spreadforthatratingis3.47%
¤ Riskfree ratein$R=11.37%- 3.47%=7.90%
Aswath Damodaran
37
Test4:ARealRiskfreeRate
38
¨
¨
¨
Insomecases,youmaywantariskfree rateinrealterms
(inrealterms)ratherthannominalterms.
Togetarealriskfree rate,youwouldlikeasecuritywith
nodefaultriskandaguaranteedrealreturn.Treasury
indexedsecuritiesofferthiscombination.
InJanuary2017,theyieldona10-yearindexedtreasury
bondwas0.50%.Whichofthefollowingstatements
wouldyousubscribeto?
This(0.5%)istherealriskfree ratetouse,ifyouarevaluingUS
companiesinrealterms.
b.
This(0.5%)istherealriskfree ratetouse,anywhereinthe
world
Explain.
a.
Aswath Damodaran
38
Nodefaultfreeentity:Choiceswithriskfreerates….
39
¨
Estimatearangefortheriskfreerateinlocalterms:
¤
¤
¨
Dotheanalysisinrealterms(ratherthannominalterms)usinga
realriskfreerate,whichcanbeobtainedinoneoftwoways–
¤
¤
¨
Approach1:Subtractdefaultspreadfromlocalgovernmentbondrate:
Governmentbondrateinlocalcurrencyterms- Defaultspreadfor
Governmentinlocalcurrency
Approach2:Useforwardratesandtherisklessrateinanindexcurrency
(sayEurosordollars)toestimatetherisklessrateinthelocalcurrency.
fromaninflation-indexedgovernmentbond,ifoneexists
setequal,approximately,tothelongtermrealgrowthrateoftheeconomy
inwhichthevaluationisbeingdone.
Dotheanalysisinacurrencywhereyoucangetariskfreerate,say
USdollarsorEuros.
Aswath Damodaran
39
RiskfreeRate:Don’thaveortrustthe
governmentbondrate?
1.
Buildupapproach:Theriskfreerateinanycurrencycanbe
writtenasthesumoftwovariables:
Riskfreerate=ExpectedInflationincurrency+Expectedrealinterestrate
Theexpectedrealinterestratecanbecomputedinoneoftwoways:from
theUSTIPsrateorsetequaltorealgrowthintheeconomy.Thus,ifthe
expectedinflationrateinacountryisexpectedtobe15%andtheTIPsrate
is1%,theriskfreerateis16%.
2.
US$rate&DifferentialInflation:Alternatively,youcanscaleup
theUS$riskfreeratebythedifferentialinflationbetweentheUS
$andthecurrencyinquestion:
RiskfreerateCurrency=
Thus,iftheUS$riskfreerateis2.00%,theinflationrateintheforeign
currencyis15%andtheinflationrateinUS$is1.5%,theforeigncurrencyrisk
freerateisasfollows:
!.!"
− 1=15.57%
Riskfreerate= 1.02 !.!"#
40
-5.00%
JapaneseYen
0.00%
Aswath Damodaran
RiskfreeRate
NigerianNaira
KenyanShilling
TurkishLira
BrazilianReai
VenezuelanBolivar
SouthAfricanRand
MexicanPeso
RussianRuble
IndonesianRupiah
PeruvianSol
ColombianPeso
IndianRupee
IcelandKrona
ChileanPeso
NZ$
MalyasianRinggit
Australian$
PolishZloty
Singapore$
US$
PhillipinePeso
ChineseYuan
Canadian$
NorwegianKrone
KoreanWon
HK$
IsraeliShekel
RomanianLeu
VietnameseDong
ThaiBaht
BritishPound
HungarianForint
SwedishKrona
PakistaniRupee
Taiwanese$
DanishKrone
Euro
SwissFranc
BulgarianLev
CroatianKuna
CzechKoruna
Whydoriskfreeratesvaryacrosscurrencies?
January2017Riskfreerates
41
RiskfreeRates- January2017
25.00%
20.00%
15.00%
10.00%
5.00%
DefaultSpreadbasedonrating
41
Onemoretestonriskfreerates…
42
¨
OnJanuary1,2017,the10-yeartreasurybondratein
theUnitedStateswas2.45%,lowbyhistoricstandards.
AssumethatyouwerevaluingacompanyinUSdollars
then,butwerewaryabouttheriskfreeratebeingtoo
low.Whichofthefollowingshouldyoudo?
a.
b.
c.
Replacethecurrent10-yearbondratewithamorereasonable
normalizedriskfree rate(theaverage10-yearbondrateover
thelast30yearshasbeenabout5-6%)
Usethecurrent10-yearbondrateasyourriskfree ratebut
makesurethatyourotherassumptions(aboutgrowthand
inflation)areconsistentwiththeriskfree rate
Somethingelse…
Aswath Damodaran
42
Someperspectiveonriskfreerates
43
RiskfreeRates:Ten-yearT.BondversusIntrinsicRiskFreeRate
20%
15%
10%
2016
2014
2012
2010
2008
2006
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
1980
1978
1976
1974
1972
1970
1968
1966
1964
1962
1960
1958
1956
0%
1954
5%
-5%
Inflationrate
Aswath Damodaran
RealGDPgrowth
Ten-yearT.Bondrate
43
NegativeInterestRates?
44
¨
¨
¨
In2016,therewereatleastthreecurrencies(Swiss
Franc,JapaneseYen,Euro)withnegativeinterest
rates.Usingthefundamentals(inflationandreal
growth)approach,howwouldyouexplainnegative
interestrates?
Hownegativecanratesget?(Isthereabound?)
Wouldyouusethesenegativeinterestratesasrisk
freerates?
Ifno,whynotandwhatwouldyoudoinstead?
¤ Ifyes,whatelsewouldyouhavetodoinyourvaluationto
beinternallyconsistent?
¤
Aswath Damodaran
44
45
DiscountRates:II
TheEquityRiskPremium
Aswath Damodaran
Theubiquitoushistoricalriskpremium
46
¨
¨
¨
Thehistoricalpremiumisthepremiumthatstockshavehistorically
earnedoverrisklesssecurities.
Whiletheusersofhistoricalriskpremiumsactasifitisafact(ratherthan
anestimate),itissensitiveto
¤ Howfarbackyougoinhistory…
¤
WhetheryouuseT.bill ratesorT.Bond rates
¤
Whetheryouusegeometricorarithmeticaverages.
Forinstance,lookingattheUS:
ArithmeticAverage
Stocks- T.Bills
Stocks- T.Bonds
7.96%
6.24%
1928-2016
2.13%
2.28%
StdError
6.57%
4.37%
1967-2016
2.42%
2.74%
StdError
7.91%
3.62%
2007-2016
8.66%
StdAswath
Error Damodaran 6.06%
GeometricAverage
Stocks- T.Bills
Stocks- T.Bonds
6.11%
4.62%
5.26%
3.42%
6.15%
2.30%
46
Theperilsoftrustingthepast…….
47
¨
¨
Noisyestimates:Evenwithlongtimeperiodsofhistory,
theriskpremiumthatyouderivewillhavesubstantial
standarderror.Forinstance,ifyougobackto1928
(about80yearsofhistory)andyouassumeastandard
deviationof20%inannualstockreturns,youarriveata
standarderrorofgreaterthan2%:
StandardErrorinPremium=20%/√80=2.26%
SurvivorshipBias:UsinghistoricaldatafromtheU.S.
equitymarketsoverthetwentiethcenturydoescreatea
samplingbias.Afterall,theUSeconomyandequity
marketswereamongthemostsuccessfuloftheglobal
economiesthatyoucouldhaveinvestedinearlyinthe
century.
Aswath Damodaran
47
RiskPremiumforaMatureMarket?Broadening
thesampleto1900-2015
48
Country
Australia
Austria
Belgium
Canada
Denmark
Finland
France
Germany
Ireland
Italy
Japan
Netherlands
New Zealand
Norway
South Africa
Spain
Sweden
Switzerland
U.K.
U.S.
Europe
World-ex U.S.
World
Aswath Damodaran
GeometricERP
5.00%
2.60%
2.40%
3.30%
2.30%
5.20%
3.00%
5.10%
2.80%
3.10%
5.10%
3.30%
4.00%
2.30%
5.40%
1.80%
3.10%
2.10%
3.60%
4.30%
3.20%
2.80%
3.20%
ArithmeticERP
6.60%
21.50%
4.50%
4.90%
3.80%
8.80%
5.40%
9.10%
4.80%
6.50%
9.10%
5.60%
5.50%
5.20%
7.20%
3.80%
5.40%
3.60%
5.00%
6.40%
4.50%
3.90%
4.40%
StandardError
1.70%
14.30%
2.00%
1.70%
1.70%
2.80%
2.10%
2.70%
1.80%
2.70%
3.00%
2.10%
1.70%
2.60%
1.80%
1.90%
2.00%
1.60%
1.60%
1.90%
1.50%
1.40%
1.40%
48
Thesimplestwayofestimatinganadditional
countryriskpremium:Thecountrydefaultspread
49
¨
Defaultspreadforcountry:Inthisapproach,thecountryequityrisk
premiumissetequaltothedefaultspreadforthecountry,
estimatedinoneofthreeways:
¤
¤
¤
¨
Thedefaultspreadonadollardenominatedbondissuedbythecountry.
(InJanuary2017,thatspreadwas3.64%fortheBrazilian$bond)
ThesovereignCDSspreadforthecountry.InJanuary2017,thetenyear
CDSspreadforBrazil,adjustedfortheUSCDS,was3.21%.
Thedefaultspreadbasedonthelocalcurrencyratingforthecountry.
Brazil’ssovereignlocalcurrencyratingisBa2andthedefaultspreadfora
Ba2ratedsovereignwasabout3.47%inJanuary2017.
Addthedefaultspreadtoa“mature”marketpremium:Thisdefault
spreadisaddedontothematuremarketpremiumtoarriveatthe
totalequityriskpremiumforBrazil,assumingamaturemarket
premiumof5.69%.
¤
¤
CountryRiskPremiumforBrazil=3.47%
TotalERPforBrazil=5.69%+3.47%=9.16%
Aswath Damodaran
49
Anequityvolatilitybasedapproachto
estimatingthecountrytotalERP
50
¨
Thisapproachdrawsonthestandarddeviationoftwoequity
markets,theemergingmarketinquestionandabasemarket
(usuallytheUS).Thetotalequityriskpremiumforthe
emergingmarketisthenwrittenas:
¤
¨
Totalequityriskpremium=RiskPremiumUS*sCountryEquity/sUSEquity
Thecountryequityriskpremiumisbaseduponthevolatility
ofthemarketinquestionrelativetoU.Smarket.
¤
¤
¤
¤
AssumethattheequityriskpremiumfortheUSis5.69%.
AssumethatthestandarddeviationintheBovespa (Brazilianequity)is
30%andthatthestandarddeviationfortheS&P500(USequity)is
18%.
TotalEquityRiskPremiumforBrazil=5.69%(30%/18%)=9.48%
CountryequityriskpremiumforBrazil=9.48%- 5.69%=3.79%
Aswath Damodaran
50
Ameldedapproachtoestimatingtheadditional
countryriskpremium
51
¨
¨
Countryratingsmeasuredefaultrisk.Whiledefaultriskpremiums
andequityriskpremiumsarehighlycorrelated,onewouldexpect
equityspreadstobehigherthandebtspreads.
Anotheristomultiplythebonddefaultspreadbytherelative
volatilityofstockandbondpricesinthatmarket.Usingthis
approachforBrazilinJanuary2016,youwouldget:
¤
¤
¤
CountryEquityriskpremium=Defaultspreadoncountrybond*sCountry
Equity /sCountryBond
n StandardDeviationinBovespa (Equity)=30%
n StandardDeviationinBrazilgovernmentbond=20%
n DefaultspreadforBrazil=3.47%
BrazilCountryRiskPremium=3.47%(30%/20%)=5.21%
BrazilTotalERP=MatureMarketPremium+CRP=5.69%+5.21%=
11.00%
Aswath Damodaran
51
ATemplateforEstimatingtheERP
Aswath Damodaran
52
ERP : Jan 2017
Black #: Total ERP
Red #: Country risk premium
AVG: GDP weighted average
FromCountryEquityRiskPremiumsto
CorporateEquityRiskpremiums
54
¨
Approach1:Assumethateverycompanyinthecountryisequally
exposedtocountryrisk.Inthiscase,
¤
¤
¨
Approach2:Assumethatacompany’sexposuretocountryriskissimilar
toitsexposuretoothermarketrisk.
¤
¨
E(Return)=RiskfreeRate+CRP+Beta(MatureERP)
Implicitly,thisiswhatyouareassumingwhenyouusethelocalGovernment’s
dollarborrowingrateasyourriskfreerate.
E(Return)=RiskfreeRate+Beta(MatureERP+CRP)
Approach3:Treatcountryriskasaseparateriskfactorandallowfirmsto
havedifferentexposurestocountryrisk(perhapsbaseduponthe
proportionoftheirrevenuescomefromnon-domesticsales)
¤
E(Return)=RiskfreeRate+b (MatureERP)+l (CRP)
MatureERP=MaturemarketEquityRiskPremium
CRP=Additionalcountryriskpremium
Aswath Damodaran
54
Approaches1&2:Estimatingcountryrisk
premiumexposure
55
¨
¨
LocationbasedCRP:Thestandardapproachinvaluationisto
attachacountryriskpremiumtoacompanybaseduponits
countryofincorporation.Thus,ifyouareanIndiancompany,
youareassumedtobeexposedtotheIndiancountryrisk
premium.Adevelopedmarketcompanyisassumedtobe
unexposedtoemergingmarketrisk.
Operation-basedCRP:Thereisamorereasonablemodified
version.Thecountryriskpremiumforacompanycanbe
computedasaweightedaverageofthecountryrisk
premiumsofthecountriesthatitdoesbusinessin,withthe
weightsbaseduponrevenuesoroperatingincome.Ifa
companyisexposedtoriskindozensofcountries,youcan
takeaweightedaverageoftheriskpremiumsbyregion.
Aswath Damodaran
55
OperationbasedCRP:SingleversusMultiple
EmergingMarkets
56
¨
¨
Singleemergingmarket:Embraer,in2004,reportedthatitderived3%of
itsrevenuesinBrazilandthebalancefrommaturemarkets.Themature
marketERPin2004was5%andBrazil’sCRPwas7.89%.
Multipleemergingmarkets:Ambev,theBrazilian-basedbeverage
company,reportedrevenuesfromthefollowingcountriesduring2011.
Aswath Damodaran
56
Extendingtoamultinational:Regionalbreakdown
CocaCola’srevenuebreakdownandERPin2012
57
Things to watch out for
1. Aggregation across regions. For instance, the Pacific region often includes Australia & NZ with Asia
2. Obscure aggregations including Eurasia and Oceania
57
Twoproblemswiththeseapproaches..
58
¨
¨
Focusjustonrevenues:Totheextentthatrevenuesare
theonlyvariablethatyouconsider,whenweightingrisk
exposureacrossmarkets,youmaybemissingother
exposurestocountryrisk.Forinstance,anemerging
marketcompanythatgetsthebulkofitsrevenues
outsidethecountry(inadevelopedmarket)maystill
haveallofitsproductionfacilitiesintheemerging
market.
Exposurenotadjustedorbaseduponbeta:Totheextent
thatthecountryriskpremiumismultipliedbyabeta,we
areassumingthatbetainadditiontomeasuring
exposuretoallothermacroeconomicriskalsomeasures
exposuretocountryrisk.
Aswath Damodaran
58
AProduction-basedERP:RoyalDutchShell
in2015
59
Country
Denmark
Italy
Norway
UK
RestofEurope
Brunei
Iraq
Malaysia
Oman
Russia
RestofAsia&ME
Oceania
Gabon
Nigeria
RestofAfrica
USA
Canada
Brazil
RestofLatinAmerica
RoyalDutchShell
Aswath Damodaran
Oil&GasProduction
17396
11179
14337
20762
874
823
20009
22980
78404
22016
24480
7858
12472
67832
6159
104263
8599
13307
576
454326
%ofTotal
3.83%
2.46%
3.16%
4.57%
0.19%
0.18%
4.40%
5.06%
17.26%
4.85%
5.39%
1.73%
2.75%
14.93%
1.36%
22.95%
1.89%
2.93%
0.13%
100.00%
ERP
6.20%
9.14%
6.20%
6.81%
7.40%
9.04%
11.37%
8.05%
7.29%
10.06%
7.74%
6.20%
11.76%
11.76%
12.17%
6.20%
6.20%
9.60%
10.78%
8.26%
59
Approach3:Estimatealambdaforcountryrisk
60
¨
Countryriskexposureisaffectedbywhereyougetyour
revenuesandwhereyourproductionhappens,butthereare
ahostofothervariablesthatalsoaffectthisexposure,
including:
¤
¤
¨
Useofriskmanagementproducts:Companiescanusebothoptions/futures
marketsandinsurancetohedgesomeorasignificantportionofcountryrisk.
Government“national”interests:Therearesectorsthatareviewedasvitalto
thenationalinterests,andgovernmentsoftenplayakeyroleinthese
companies,eitherofficiallyorunofficially.Thesesectorsaremoreexposedto
countryrisk.
Itisconceivablethatthereisarichermeasureofcountryrisk
thatincorporatesallofthevariablesthatdrivecountryriskin
onemeasure.ThatwaymyrationalewhenIdevised
“lambda”asmymeasureofcountryriskexposure.
Aswath Damodaran
60