Deutsche Bank Essay

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Executive Summary – HBS Case Deutsche Bank: Discussing the Equity Risk Premium Sunwoo Hwang Case Summary Situation Jamil Baz, a global head of fixed income research at Deutsche Bank, and George Cooper, a global strategist of the same division, is putting together a presentation for a client on the asset side with a theme of equity risk premium (ERP). Identified Problem Cooper estimated ERP using two alternative methods. The first one is using a dividend discount model, the so-called Gordon Growth Model, and the second one is using the P/E ratio, a novel one the research group has elaborated. But it turned out that the estimated values of ERP were quite different as different methods were applied. Key Questions Which of the two methods should Baz emphasize in the client meetings? Should he emphasize one over the other at all? If he didn’t how could he best explain the apparent difference in the results of the two methods? Analysis For more sophisticated analysis, first we decompose the ERP into common and model-specific variables. Common variables include current share price and riskless long-term real yield that are observed in the market. Model-specific variables include two estimates – dividend growth rate and earnings - and one deterministic variable – the current dividend yield that is determined by a company’s dividend policy. Among all variables, we focus on the earnings estimate , an estimate of an I/B/E/S analyst, that enables corrections for idiosyncratic characteristics of the capital market and for problems of accounting treatment. Table 1 compares the decomposed models Table 1. Comparison of the two alternative methods Method I Golden Growth Model Method II Earnings Yield vs. Real Bond Yield Formula Common Variables : Current Share Price : 30-Year TIPS Yield : Current Share Price : 30-Year TIPS Yield Model- Specific

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