Discount rate is about 7.53% minmum?!

September 08, 2010
Hi y'all, just want to share something interesting (in my opinon)

Say inflation in Singapore is still 3.1%, 10 year government bond is still 4.3%

So what is the return that investors are concern about?
The answer is using fisher's formula 1+R= (1+r) x (1xh)
h=inflation
r=real rate which is stated by bank or government or anaylst
R= nominal rate, which is the rate we want to find, particular for investors
so R= 1-(1+0.043)x(1+0.031)=7.53%
Because investors are particularly concern about what they can buy with their money, they have to be compensated for inflation.
What this means is, your valuation ,under the discount rate, shouldnt be 4.3% but rather that or 7.53% which includes the damaging effects of inflation.
What say you?

Post a Comment

9 comments

Unknown said...

I think the 10 Year bond rate already includes the expected inflation.

Bond Yield = Risk free + Gov Default + Inflation + liquidity risk.

September 8, 2010 at 9:10 AM
Chlorophyll Inc said...

Interesting, where did you get that formula from? Lol.. the risk free rate of a g.bond is maybe their gold holdings + foreign currencies?

September 8, 2010 at 7:16 PM
Unknown said...

Pardon my inability to read between the lines, but was that sarcasm I detect?

It finance 101. Probably any Financial Management textbook will start with risk and will tell you that the interest rate of a gov bond that is considered stable i.e SG bond includes the expected return for the risk the investor expose himself to. Therefor for a 10 year bond, the risk premiums include the risk expected inflation, risk of liquidity, risk of default (some gov has 0 risk premium for this others have) and of course the risk free rate.

September 9, 2010 at 2:27 PM
Unknown said...

By the way your subject is also quite misleading. If the discount rate you calculated is to be used for fundamental analysis, then you need to tell your readers that the discount rate for different industry is different for each industry/ company.

Discount rate basically capture the risk in that investment. It cannot be uniformed. E.g. would you expect the same return investing in JAL and SIA? These 2 companies are in the same industry but one is facing bankrupcy. Also, would you expect the same return on FJ Benjamin that has almost 0 debt compared to say... Esprit - a company with debt essentially faces risk of bankrupcy?

September 9, 2010 at 2:35 PM
Chlorophyll Inc said...

Hey Roy,

No sarcasm intented, apologies if you see any.

Ive ask my professor about it already. She has clarified with me on this matter. Just use the 10 year government bond rate to discount value stocks which has gone thru the screenings of value investing. Yup. Thanks for you comments

September 9, 2010 at 10:01 PM
Chlorophyll Inc said...

Yes i agree with you that discount rate is different for the other companies, in finance i was taught to use CAPM all these. But the main question was whether the risk free rate inside the CAPM , did it include inflation?
Actually i didnt know that the inflation has already been factored into the 10 year bond. But come to think of it, what if the next few years got hyper inflation? Will the 10 year g.bond tag after it?

No idea myself. Well, i'll just stick to what WB have said in his book, use the 10 year g.bond as discount rate. haha =D

September 9, 2010 at 10:14 PM
Unknown said...

Did your prof really asked you to use 10 year bond? That's quite scary because when a company goes bankrupt the bondholders gets an earlier bite at the carcass. The equities holders will be last in line. Additionally some company's debt structure is such that they cannot issue div or do share buyback to benefit the shareholders until their coupons are paid.

In short, if equities holders are holding the shit end of the stick, they should have a greater discount rate.

IMO, CAPM should be used. However, how you calculate the risk premium and the Beta will determine how well your model goes to provide a good valuation. =)

September 11, 2010 at 9:19 PM
Unknown said...

Ref your qn on 10 year bond. Bonds are always issued at par and at issuance the coupon yield = bond yield. Therefore inflation should be captured. If a ten year bond is issued today, it capture the low expected inflation at this point in time to the next ten years. If issued in 2006, the coupon will be higher to include the higher inflation.

September 11, 2010 at 9:23 PM
Chlorophyll Inc said...

Hey Roy,

WB said to use the 10 year government as a basis for your discount rate. He doesnt encourage value investors like me to caculate beta using CAPM or use risk premium, because valuation is usually the last part of buying into a stock, after doing all the diligence into it like check consistency, management, ROE, PBV etc. Then using the 10 year government should suffice, as it is deemed a good stock to you. Well that's my take, of course using CAPM is also possible to me, but too troublesome for every stock i do.

September 12, 2010 at 1:13 PM

Post a Comment

Subscribe to: Post Comments ( Atom )
Powered by Blogger.