8 Priority 2

Front 1

Give the 2 main conclusions from the Utility Function

Back 1

1) Utility increases with higher expected returns and decreases with higher risk levels
2) The degree to which risk-averse investors penalize risky investments is a function of A

Front 2

List the 2 methods to control portfolio risk

Back 2

1) Hedging
2) Diversification

Front 3

List the 5 specific “rules” of portfolio mathematics

Back 3

1) Expected Return
2) Variance
3) Expected Portfolio Return
4) Portfolio Standard Deviation
5) Portfolio Variance

Front 4

List 3 issues associated with “default free” bonds

Back 4

1) It is assumed that only the government can issue default-free bonds
2) The default-free guarantee does not make the bond risk-free in real terms. Thus, the only risk-free asset in real terms would be a perfectly price-indexed bond
3) The real rate offered to an investor from a default-free perfectly indexed bond is guaranteed only in the maturity of the bond coincides with the investor’s holding period

Front 5

List the 3 types of securities that make up Money Market Funds

Back 5

1) Treasury Bills
2) Bank Certificates of Deposit (CDs)
3) Commercial Paper (CP)

Front 6

Give 2 benefits of employing a passive investment strategy

Back 6

1) Reduced Costs
2) Free-rider Benefit

Front 7

Give 4 reasons to distinguish between Asset Allocation and Security Selection

Back 7

1) Demand for sophisticated security selection has increased tremendously due to society’s need and ability to save for the future
2) Amateur investors are at a disadvantage in their ability select the proper securities to be held in their risky portfolio due to the widening spectrum of financial markets and financial instruments.
3) Strong economies of scale result when sophisticated investment analysis is conducted
4) Since large investment companies are likely to invest in both domestic and international markets, management of each asset-class portfolio needs to be decentralized due to the expertise required. This requires that security selection of each asset-class portfolio be optimized independently.

Front 8

List 6 key assumptions about aggregate investor behavior

Back 8

1) No single investor can affect the stock price – from the perspective of a single investor the prices are taken as given
2) Investors focus only on what will happen in a single period
3) Investors can only select from among a limited universe of publicly traded financial assets and from risk free securities, which they can buy or sell in any amount
4) No taxes or transaction costs
5) All investors follow the methods outlined in previous chapters to select their optimal portfolio, attempting to optimize the trade-offs between expected return and standard deviation
6) All investors perform the same analysis and make the same assumptions about the inputs to their portfolio optimization problem – they have homogeneous expectations regarding returns, variances and covariances.

Front 9

List 2 modified assumptions that investors could borrow or lend at the risk free rate

Back 9

1) No Riskless Borrowing or Lending
2) Riskless Lending but No Riskless Borrowing

Front 10

List 2 reasons why it is important for the Capital Asset Pricing Model (CAPM) to predict the relationship between the risk of an asset and its expected return.

Back 10

1) It provides a benchmark rate of return to evaluate investments
2) It facilitates making an educated guess of the expected rate of return on assets that have yet to be traded in the market place

Front 11

List the 3 properties of mean-variance efficient portfolios that Black’s model of the CAPM rests on

Back 11

1) Any portfolio constructed by combining efficient portfolios is itself on the efficient frontier
2) Every portfolio on the efficient frontier has a “companion” portfolio on the bottom half (the inefficient part) of the minimum-variance frontier with which it is uncorrelated
3) The expected return of any asset can be expressed as an exact, linear function of the expected return on any two frontier portfolios

Front 12

List 2 differences between the Security Market Line (SML) and the Capital Market Line (CML)

Back 12

1) It measures risk in terms of Beta, the marginal increase in portfolio risk
2) It applies to all risky assts, not just efficient portfolios

Front 13

List 2 benefits that the Single Index Model has over the Markowitz procedure

Back 13

1) A far smaller number of estimates are required than would otherwise be needed
2) The computation of covariances among securities is greatly simplified

Front 14

List the 6 variables that Rosenberg and Guy found helpful in predicting betas

Back 14

1) Variance in earnings
2) Variance of cash flow
3) Growth in earnings per share
4) Market capitalization (firm size)
5) Dividend yield
6) Debt-to-asset ratio

Front 15

List 3 arbitrage examples worth considering

Back 15

1) Law of One Price
2) Perfectly Correlated Risks
3) Non-Negative Profits in All Scenarios

Front 16

List 2 reasons why APT is an appealing model

Back 16

1) APT’s pricing relationships cause strong pressure to preclude arbitrage opportunities in the capital markets, even if only a limited number of investors become aware of the disequilibrium
2) APT yields an expected return-beta relationship using a well-diversified portfolio that can be constructed from a large number of securities, and does not rely on an unobservable market portfolio

Front 17

Give the 2 principles to help determine what a reasonable list of factors would include

Back 17

1) Limit the list to systematic factors with considerable potential to explain security returns
2) Choose factors that are likely to be important risk factors

Front 18

List the 5 variables used in Chen, Roll and Ross’ 5-factor model

Back 18

1) % change in industrial production
2) % change in expected inflation
3) % change in unanticipated inflation
4) Excess returns of long term bonds over long term government bonds
5) Excess returns of long term government bonds over T-bills

Front 19

List the 6 variations that chartists use to analyze stocks

Back 19

1) Patterns
2) Dow theory
3) Moving Average
4) Relative Strength
5) Resistance & Support Levels
6) Volume Levels

Front 20

List the 5 tests of Weak Form Market Efficiency

Back 20

1) Serial Correlation
2) Intermediate Term Correlation
3) Long Term Correlation
4) Reversals
5) Broad Market Predictors

Front 21

List the 4 types of Information Processing Errors

Back 21

1) Forecasting Errors
2) Overconfidence
3) Conservatism
4) Sample Size Neglect and Representativeness

Front 22

List the 3 types of Behavioral Biases

Back 22

1) Framing
2) Mental Accounting
3) Regret Avoidance

Front 23

List the 3 categories of behavioral issues

Back 23

1) Information processing errors
2) Behavioral biases
3) Limits to arbitrage

Front 24

List the 2 possible imperfections in efficient markets

Back 24

1) Market reactions to earnings announcements take place gradually and not immediately
2) Predictable continuing trends ought to be impossible in an efficient market

Front 25

Give 3 reasons why dividend growth rates produce more reliable estimates of expected capital gains than the average of realized capital gains

Back 25

1) Average realized returns over 1950-1999 exceeded the IRR on corporate investments
2) The estimates of the mean returns under DDM are more reliable than those using average historical returns, since the standard error of the estimates of the risk premium from realized returns is about 2.5 times the standard error from the dividend discount model
3) The reward-to-variability (Sharpe) ratio derived from the DDM is far more stable

Front 26

Having to use “actual” returns to represent “expected” returns, list 3 fundamental concerns about the tests of CAPM

Back 26

1) Statistical accuracy of the beta estimates is suspect
2) There is substantial sampling error
3) The assumption about risk free borrowing and lending is obviously unrealistic

Front 27

Give 2 possible interpretations of the Fama and French Three-Factor Model results

Back 27

1) Size and value factors must be priced factors for risks not captured in CAPM
2) Investors irrationally prefer large firms or high P/E firms, driving up their prices and driving down their returns

Front 28

List 2 main deficiencies with the standard CAPM Model

Back 28

1) It assumes that all assets are tradable, when in fact that is not true (e.g. human capital)
2) It assumes that the Betas are constant

Front 29

List 3 characteristics that preferred stock share with bonds

Back 29

1) Promises to pay a fixed stream of dividends
2) Unpaid dividends cumulate and must be paid before any dividends are paid to common stock holders
3) They do not have any of the voting rights of common stockholders

Front 30

List the 2 categories of international bonds

Back 30

1) Foreign Bonds: Are issued by the borrower from a country other than the one in which the bond is sold
2) Eurobonds: Are issued in the currency of one country but sold in other markets

Front 31

List 2 shortfalls of the “current yield” as a “comprehensive yield”

Back 31

1) Non-consideration of prospective capital gains or losses
2) Non-consideration of income from the reinvestment of coupon payments

Front 32

List 2 ways that a sinking fund call differs from a conventional bond call

Back 32

1) Repurchase of bonds are limited to a fraction of the bond issue at the sinking fund call price
2) The sinking fund call price is usually set at the bond’s par value

Front 33

Give 2 reasons why forward rates may be high

Back 33

1) Investors expect rising interest rates, meaning that E(Rn) is high
2) Investors require a large premium for holding longer-term bonds

Front 34

Give 2 reasons why bond prices do not follow those implied by the discount function

Back 34

1) Tax Purposes
2) Call Provisions

Front 35

List 4 constraints set on d(i) when determining the best fit

Back 35

1) d(0) = 1
2) d(t) <= 1
3) d(t) > 0
4) d(t) < d(t-1) since each discount factor must be lower than the one before it

Front 36

Give 2 problems that occurred when taking average default rates over multiple periods

Back 36

1) It ignored the fact that the population of outstanding bonds changes as some bonds are called or mature and new bonds are issued
2) It failed to provide a way to assess default probabilities based on characteristics of the bond when it was issued. They tended to study either the entire bond market or just the “high-yield” bond market, but did not distinguish among the different classes of bonds.

Front 37

List the 2 main types of traders executing trades

Back 37

1) Commission Brokers: trade for others
2) Locals: trade for themselves

Front 38

List the 6 types of orders

Back 38

1) Market Order
2) Limit Order
3) Stop Order or Stop-Loss Order
4) Stop-Limit Order (combination of limit order and stop order)L
5) Market-if-touched Order (MIT)
6) Discretionary Order or Market-not-held Order

Front 39

Give 2 reasons why tax regulations define a hedging transaction as a transaction entered into in the normal course of business

Back 39

1) To reduce the risk of price changes/currency fluctuations with respect to property held or to be held by the taxpayer for the purposes of producing ordinary income
2) To reduce the risk of price/interest rate/currency fluctuations with respect to borrowings made by the taxpayer

Front 40

Give 3 reasons why hedging using futures contracts works less than perfectly in practice

Back 40

1) The asset whose price is being hedged and the asset underlying the futures contract may not be the same.
2) The exact date when the asset will be bought or sold may be uncertain.
3) The futures contract may need to be closed out well before its expiration date.

Front 41

Give 2 reasons why a hedger uses futures contracts instead of simply selling the portfolio and investing the proceeds in Treasury Bills

Back 41

1) The hedger feels that the stocks in the portfolio have been chosen well and will outperform the market
2) The hedger is planning to hold a portfolio for a long period of time and requires short-term protection.

Front 42

Give 3 reasons for a company not to hedge it’s exposure to a particular risk

Back 42

1) If the company’s competitors are not hedging, the treasurer might feel that the company will experience less risk if it does not hedge
2) The shareholders might not want the company to hedge
3) It might look bad on the treasurer if there is a loss in good times even though the purpose of the hedge is to minimize volatility whether bad or good

Front 43

List the 2 ways that a gain or loss is recognized for tax purposes

Back 43

1) The option expires unexercised
2) The option is sold

Front 44

List 3 properties that show that the Markov property of stock prices is consistent with the weak form of market efficiency

Back 44

1) The present price of a stock impounds all the information contained in past prices
2) The weak form of market efficiency appears to be true, since there is little evidence that technical analysts have made above-average returns by interpreting historical price information
3) Competition in the marketplace that tends to ensure that weak-form market efficiency holds

Front 45

List 2 noteworthy properties of Wiener processes, related to the √∆t property

Back 45

1) The expected length of the path followed by z in any time interval is infinite
2) The expected number of times z equals any particular value in any time interval is infinite

Front 46

List the 3 most actively traded futures options in the U.S.

Back 46

1) T-bond futures
2) T-note futures
3) Eurodollar futures

Front 47

List 2 things that when reflecting the possibility of jumps, the net effect of the option value compared to the Black-Scholes value will depend on

Back 47

1) Lowering the volatility of the Brownian motion process
2) Allowing for symmetric jumps

Front 48

List the 2 effects on option values from takeovers that occur through a cash for stock exchange

Back 48

1) Existing options on the acquired firm expire early, which lowers their value
2) Offsetting this, takeovers typically are done at a premium to the current stock price of the acquired company

Front 49

List 2 compelling reasons why recent realized returns can be highly misleading estimates of expected future returns, but are useful for measuring prospective risk.

Back 49

1) Market efficiency implies that stock prices will be impossible to predict with any accuracy, but no such implication applies to risk measures
2) It is a statistical fact that errors in estimates of standard deviation and correlation from realized data are of a lower order of magnitude than estimates of expected returns

Front 50

List 4 problems in index formation

Back 50

1) The difficulty in purchasing each security in the index in proportion to its market value
2) The difficulty in purchasing securities at fair market price since many bonds are thinly traded
3) Rebalancing problems
4) Reinvestment of interest income further complicates the index fund manager’s job

Front 51

Give 2 problems with Conventional Immunization

Back 51

1) The definition of duration uses a bond’s YTM to calculate the weight applied to the time until each coupon payment
2) Immunization can be an inappropriate goal in an inflationary environment

Front 52

List 2 factors that cause a reduction in the correlation coefficient

Back 52

1) MV of bonds move toward their par value as the time to maturity shortens
2) Newly issued bonds are not affected by past changes in interest rates

Front 53

List 2 risks that interest rate changes expose the insurer to

Back 53

1) Statutory Insolvency: If a rise in interest rates depletes the insurer’s surplus (amortization of long-term bonds reduces the risk, but does not eliminate it).
2) Realization of Capital Losses from the Sale of Long-term Bonds: After liquid assets and short term securities are used to pay claims

Front 54

List the 3 types of targets to manage towards

Back 54

1) Duration Gap of Surplus
2) Duration Gap of Total Return
3) Duration Gap of Leverage

Front 55

List 3 reasons why a company should manage its Market Value Surplus (MVS)

Back 55

1) MVS is a leading indicator of the future book value of the firm (since book value converges to market value as assets and liabilities mature).
2) It helps management to achieve their goals of maximizing shareholder wealth or providing higher future dividends
3) It assists in addressing regulator’s concerns regarding capital adequacy

Front 56

List 2 things that are indicated by a positive duration gap

Back 56

1) Assets are longer than liabilities
2) A risk in interest rates would lower MVS

Front 57

List Panning’s 9 key assumptions on his Simple Model

Back 57

1) All business is written in Jan 1
2) All expenses paid immediately
3) All claims are paid in full at the end of one year
4) Expenses and expected losses are the same each year
5) It maintains the same surplus each year. It does this by paying out all profits at the end of each year and raising new capital (with no frictional costs) to cover any net losses
6) It faces no risk of bankruptcy – surplus is sufficient to cover any deviation of losses from their expected value
7) There are no taxes
8) Term structure of interest rates is flat
9) All calculations done on Jan 1

Front 58

List 4 questions that are addressed by the Simplified Model of an insurance firm

Back 58

1) How significant is franchise value as a component of a firm’s overall value?
2) How sensitive is franchise value to interest rate risk?
3) What effective strategies can firms use to protect franchise value from interest rate risk?
4) Which of these strategies is best?

Front 59

List 2 insights brought about by the author that broaden our understanding of interest rate risk and of ALM

Back 59

1) Relying on traditional accounting rules to identify a firm’s economic assets and liabilities can blind us to the importance of franchise value
2) An appropriately chosen pricing strategy can avoid the potential difficulties in protecting franchise value, and can be flexible in achieving a targeted duration and a targeted return on surplus.

Front 60

List 2 critical points regarding interest sensitivity of Franchise Value

Back 60

1) The larger the firm’s franchise value, the more problematic it will be to manage the interest rate risk for the total economic value using asset investment strategies
2) Because the franchise value is “invisible” to outside parties such as rating agencies and regulators (as well as investors), strategies to manage this risk may actually appear to increase the risk

Front 61

List 3 conclusions on corporate risk management practices based on the surveys

Back 61

1) Corporations do not systematically hedge their exposures
2) The extent to which they hedge depends on their views of future price movements
3) The focus of hedging is primarily on near-term transactions, and the use of derivatives is greater for large firms than small firms

Front 62

List 4 observations based on the surveys conducted regarding the use of risk management and real world hedging

Back 62

1) Large firms hedge more than small firms, even though smaller firms most likely have the more volatile cash flows
2) Firms often engage in selective hedging based in part on their own risk in different markets
3) Most firms hedge the risks associated with executed transactions or near-term exposures, not companywide risks
4) Firms tend to shy away from having to give up gains in order to avoid losses, unless they are concerned about suffering a very large loss

Front 63

Give 2 reasons why VaR is not that useful over longer time horizons

Back 63

1) You would not be able to test whether the results are reasonable or if the model is properly calibrated
2) VaR typically assumes normal distributions and real world data, especially over long time horizons, has much fatter tails than the normal distribution would suggest

Front 64

Give 3 reasons why the gold mining industry is ideal for studying hedging behavior

Back 64

1) Gold mining companies tend to be single-industry firms
2) Gold mining companies produce a single commodity with a large exposure to price changes
3) Gold mining companies have a wide range of hedging vehicles

Front 65

Give 2 reasons why creating put options might be more attractive than buying the put options

Back 65

1) Options markets do not always have the liquidity to absorb large institutional trades
2) Fund managers often require strike prices and exercise dates that are different from those available in the markets

Front 66

List 3 simple approaches a financial institution can take upon writing a European call option

Back 66

1) Do Nothing
2) Cover
3) Stop-Loss

Front 67

Give 2 reasons why theta is a useful measure even though it is not used as a hedging parameter

Back 67

1) It can give you a sense of how quickly your option position will decline in value if all other variables remain constant
2) It is a proxy for Gamma

Front 68

In Portfolio Insurance schemes, list two actions of portfolio managers when the market declines

Back 68

1) Sell stock, which is likely to drive down the market index
2) Sell index futures contracts, which is liable to drive down futures prices

Front 69

Give 2 instances where VaR calculations are straightforward

Back 69

1) Considering a portfolio of assets
2) Changes in the values of asset prices have a multivariate normal distribution

Front 70

List 3 characteristics of VaR that make it a particularly appropriate risk measure for risk managers

Back 70

1) There are interested in the value of their positions over short periods of time
2) They need to limit and control their exposures
3) Many value risk managers are involved in agency transactions where they act primarily as intermediaries rather than take their own proprietary positions

Front 71

List the 4 “Great Derivatives Disasters” of 1993-1995

Back 71

1) Procter & Gamble
2) Barings
3) Orange County
4) Metallgesellschaft

Front 72

List the 3 possible situations a financial institution could have a derivative contract outstanding with a counterparty

Back 72

1) The contract is always a liability to the financial institution (short option)
2) The contract is always an asset to the financial institution (long option)
3) The contract can become either an asset or a liability to the financial institution (forward contract)

Front 73

List 2 reasons why default correlations exist

Back 73

1) Two companies in the same industry or geographic region tend to be affected similarly by external events and may experience financial difficulties at the same time
2) Economic conditions cause average default rates to be higher in some years than in others

Front 74

List 4 measures that explicitly reflect risk-adjustments, to varying degrees

Back 74

1) Regulatory Required Capital
2) Rating Agency Required Capital
3) Economic Capital
4) Risk Capital

Front 75

Give 3 points worth noting regarding the Myers-Read Method (Marginal Allocation)

Back 75

1) The method was not developed as a means for determining risk-adjusted capital requirements
2) Because this method requires the valuation of the default option, its application may require substantially more quantitative resources compared to other methods, except in certain limited circumstances
3) Significant mathematical challenges have been raised that suggest that the Myers-Read method is not appropriate for most insurance applications

Front 76

List the 2 measures that are not risk-adjusted

Back 76

1) Actual Committed Capital
2) Market Value of Equity

Front 77

List 3 common methods used to measure dependency

Back 77

1) Empirical Analysis of Historical Data
2) Subjective Estimates
3) Explicit Factor Models

Front 78

List 3 specific issues using RAROC for pricing

Back 78

1) Multi-Period Capital Commitment
2) Cost of Capital (Target RAROC Rate)
3) Investment Income on Allocated Capital

Front 79

List the 2 elements that the insurance securitization process involves

Back 79

1) The transformation of underwriting cash flows into tradable securities
2) The transfer of underwriting risks to the capital markets via security trading

Front 80

List 4 costs of Catastrophe Bonds Issuance

Back 80

1) Offered yields have tended to be rather high
2) Setup costs involves the Special Purpose Vehicle
3) Investment banking costs
4) Legal fees involved for setting up and issuing catastrophe bonds

Front 81

List 3 issues associated with the use of CAPM for capital allocation

Back 81

1) Capital requirements for insurers are driven by policyholders who are not diversified in the same fashion and therefore may not be concerned with line-specific tail risks in addition to systematic risk
2) Estimating CAPM-type betas by line of business is very difficult to do given data limitations
3) CAPM may not even be a good model for equity prices, let alone businesses within the firm

Front 82

List 3 issues associated with VaR as a mechanism for the allocation of capital

Back 82

1) Firms may not have enough capital in total to equalize the probability across all lines of business
2) It is difficult to reflect the diversification effect in this approach
3) The VaR approach ignores the amount by which the losses exceed the available capital

Front 83

List the 7 conclusions of the paper

Back 83

1) EPD is better than VaR, even though both might be useful to calculate
2) The option models are better than EPD or VaR because they allow recognition of diversification benefits and he prefers the Myers-Read to the Merton-Perold method
3) The economic cost of capital (including frictional costs) is what should be allocated to the lines of business
4) Capital allocation must reflect both the asset and liability risks and in particular the covariance between them
5) The duration and maturity of the liabilities should be reflected in the capital allocation
6) The decision making system should dictate the data needs, not the other way around
7) Capital allocation will lead to better pricing, underwriting and strategy decisions and will lead to shareholder value creation for the winning firms

Front 84

List 4 pitfalls of using P/E ratios to value the stock price of a firm

Back 84

1) E is based on arbitrary accounting rules and can be distorted
2) Firms often seek to “manage” their earnings by taking advantage of various sources of accounting flexibility to show results in the best possible light
3) The E in this model is the expected earnings next year, but all we can really observe is the actual earnings this year, which could be impacted by the business cycle or one-time events
4) The simple model assumes constant growth forever at rate g – which is easy to correct for in the DDM formulas but not so easy to get the right P/E

Front 85

List 4 reasons why stocks are not a hedge against inflation

Back 85

1) Economic shocks (oil price hikes) cause increases in inflation and simultaneous decreases in earnings and dividends
2) Higher inflation leads to greater uncertainty and higher discount rates
3) Because the tax system is not inflation neutral, inflation leads to lower after tax real earnings
4) Investors tend to undervalue stocks in periods of high inflation because of money illusion (they mistake a rise in nominal rates for a rise in real rates)

Front 86

List the 3 practical considerations when determining the Discount Rate using CAPM

Back 86

1) Estimating Beta
2) Estimating the Risk-free Rate
3) Estimating the Equity Market Risk Premium

Front 87

List 3 strengths of the DCF Method

Back 87

1) Simple to understand
2) Focuses attention directly on the net cash flow generating capacity of the firm
3) Encourages careful consideration of the cash flow generating activities of the

Front 88

List 3 reasons why reliable forecasts of publicly traded insurers are extremely difficult for outsiders to build

Back 88

1) An outsider or minority investor may not have access to data in sufficient detail to properly parameterize the model
2) Without the kind of market knowledge and specific planning data used by company executives, growth and rate adequacy estimates may be difficult to obtain
3) Even a relatively short horizon such as 5 years may stretch the limits of one’s forecasting ability

Front 89

List 3 alternative uses of P-E Ratios

Back 89

1) Validation of Assumptions
2) Shortcut to Valuation
3) Terminal Value

Front 90

List the 2 related approaches to using option pricing theory to value the equity of a firm

Back 90

1) Valuing the equity as a call option rather than as a discounted stream of future dividends, cash flow and abnormal earnings
2) The Valuation of real options as an additional source of value to be added to the DCF, AE or relative valuation results

Front 91

Give 2 reasons why the FCFE method is preferred to the FCFF method when performing a discounted cash flow valuation of a P&C insurer

Back 91

1) Policyholder liabilities function much like debt but are significantly more difficult to value than traditional debt instruments
2) When using the FCFF method, we would need to use a discount rate that reflected the unlevered risk to the whole firm. For insurance companies, this is harder due to the leverage effect caused by the policyholder liabilities

Front 92

List the 2 methods to estimate the terminal growth rates in the DDM and DCF valuation methods

Back 92

1) Simply observe the growth rate during the forecast horizon
2) Assume a growth rate that is consistent with the plowback ratio and the ROE of the firm, using the formula g = plowback * ROE

Front 93

List the 2 important distinctions between the AE Method and the DDM and DCF Methods

Back 93

1) The DDM and DCF methods adjust the accounting-based net income measure into a cash flow measure
2) The AE method focuses on the source of value creation, the firm’s ability to earn a return on equity in excess of investors’ required returns, while the DCF and DDM models focus only on the effect of value creation, the firm’s ability to pay cash flows to its owners

Front 94

List 3 key assumptions required to implement the DDM

Back 94

1) Expected Dividends During Forecast Horizon
2) Dividend Growth Rates Beyond Forecast Horizon
3) Appropriate Risk-Adjusted Discount Rate

Front 95

List 2 benefits of the AE (Abnormal Earnings) approach

Back 95

1) The AE approach makes use of assumptions more directly tied to value creation by emphasizing the firm’s ability to earn abnormal profits
2) The AE approach de-emphasizes the importance of the terminal value estimates and the assumptions that drive those