Use Gordon Growth model to calculate ERP. Hint: P0 = D1/(r-g).
I thought it was Y + GEPS - rf ?
ERP = r_ce - r_f, so set up the above equation so that you solve for r_ce - r_f.
What is going on here? Am I still in level II forum?
yes you are on L2…it’s a very reasonable question. There is a whole section on where to get ERP from.
Just subtract Rf from r to get ERP. Here goes:
P0 = D1/(r-g)
P0(r-g) = D1, divide by P0
(r-g) = D1/P0
subtract Rf from both sides:
r-Rf-g = D1/P0 - Rf
ERP = D1/P0 - Rf + g
This is news to me…where are you seeing this?
Yes this is very much in the curriculum under the section on equity risk premiums (under Return Concepts). This equation also features prominently in the back of the Schweser Equity book as well as Secret Sauce (midway down page 94).
This concept is NOT difficult if you think about it logically. ERP is simply the additional risk from investing in equities over the risk free rate. So basically you are solving for the required return on equity (re) using the GG model and subtracting off the risk free rate, to get ERP.
Found it, just presented in a different way
gordon growth equation must support atleast 20 different derivations in our curriculum. i think the only way to know about them is through practise, so that when an actual problem comes with 20 variables, you know which ones to use and which ones to ignore to get where you are going.
a lot of equity questions are going to feel like you know how to solve, but when you get to solve, you won’t know what the hell just happened. a seemingly benign question becomes noman’s land in the exam.
i have given up hope for this exam. just finished reading multinationals chap of fra, i think it has atleast 50 different relationship one could ask ou the questions on.