Cumulative approach to modeling the investment barrier rate - Investments

The cumulative approach to modeling the investment barrier rate

After studying this chapter, the student must:


■ how is the borrowing rate determined for public companies

■ what alternative approaches do analysts use in modeling the investment barrier rate to reflect the investor's position with weak portfolio building capabilities

■ what is the peculiarity of the use of cumulative (accumulative) methods of forming a barrier investment rate

■ how the risk-free rate can be fixed within the cumulative structure;

■ what modifications within the cumulative construction can be applied depending on the information available to the investor (analyst);

■ what is meant by the spread of corporate default;

■ rating methods for estimating credit risk (S & amp; R) and justification of yield on borrowed capital;

be able to

■ rank risk companies according to five characteristics;

■ implement the borrowed capital rate + & quot ;;

■ realize the calculation of the premium for credit risk by groups of volatility of stock returns;

own skills

■ constructing a synthetic rating of reliability of issuers of debt financial assets;

■ justification of market borrowing rates for non-public companies;

■ Calculating the required yield of borrowing for additional conditions imposed by the lender (presence of a compensation balance, etc.).

Key terms and concepts

■ cumulative construction of the investment barrier rate

■ formula of cumulative construction

■ rating methodology for assessing credit risk and justifying the yield on borrowed capital

■ synthetic rating of reliability of issuers of debt assets

The design of CAPM comes from the portfolio position of the investor. A significant investment challenge in emerging capital markets with high segmentation and a small set of investment assets is the construction of a diversified portfolio for a local investor (for example, a private one, with a relatively small amount of capital). For such a non-diversified investor, the designs based on the portfolio approach are inapplicable, the attention of analysts is shifted to so-called cumulative (accumulative) constructions.

The cumulative construction of the barrier investment rate is considered as an alternative to portfolio models, although outwardly it has a number of similar features. For example, it also proceeds from the principle: "The required yield is equal to the rate of return of risk-free assets plus the risk premium." There is similarity between the individual components that form the risk premium. But there is also a fundamental difference: the profitability of investments in cumulative construction is considered as compensation for all risks inherent in this investment option (company, project, separate material asset). Portfolio designs take into account remuneration only for systematic (not eliminated by diversification) risks.

The cumulative (accumulative) construction of a barrier investment rate as the lower limit of profitability considers a risk-free rate for a given market, and the risk premium forms based on the need to compensate for both systematic and non-systematic (specific) risks.

thematic pictures

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