Starting this year early. Really hope I won’t fail again. Looking for study buddies (I’m based in LA) to prep for the morning session by grading each other’s work. Please PM me if interested.
R15Q5B asks which industry is most attractive from a valuation perspective.
If we tweak the formula of the Singer-Terhaar approach by dividing both sides by the standard deviation of the asset
We get Sharpe Ratio of Asset i = Correlation between Asset i and Market * Sharpe Ratio of Market
So the higher the correlation, the higher the Sharpe Ratio of Asset i, the better.
However, the solution thinks it’s indeterminate. Why?
they also say why. This is only the risk premium that is being calculated. Does not tell you anything about the valuation piece.
It tells you the expected return if you know the Risk free rate.
Even with a high expected return - the industry may have sufficiently high cash flows to make the valuation of this high expected return industry more “valuable” than another industry with a smaller risk premium (hence expected return).
Valuation depends on both the expected return component (calculated by the singer terhaar model) and the valuation cashflows (which is the numerator in a dividend discount model)…