Masters Degrees (Business Management)

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Browsing Masters Degrees (Business Management) by Author "Barnard, Ian"

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    The equity duration of South African growth companies : a theoretical and empirical evaluation
    (Stellenbosch : Stellenbosch University, 2002-12) Barnard, Ian; De Villiers, J. U.; Stellenbosch University. Faculty of Economic & Management Sciences . Dept. of Business Management.
    ENGLISH ABSTRACT: This assignment sets out to address the concept of equity duration, where equity duration is viewed as a measure of the interest rate sensitivity of common stock's market value. The traditional use of standard dividend discount models, results in extremely long duration estimates for equities - in the order of 10 years for income stocks to 25 years and more for growth companies whose cash flows are not expected to materialize until some future period. Leibowitz (1986) identified an alternative approach for assessing equity duration empirically. These empirical estimates of actual stock price sensitivity to underlying changes in interest rates imply that equities behave as if they are much shorter duration instruments. Various attempts have been made to reconcile the difference between theoretical predictions of equity duration and empirical findings. The differences in duration of assets in place and growth opportunities are given as a possible reason for the above mentioned differences. It is argued that investment opportunities are similar to options a company has. These option-like characteristics of growth opportunities may alter the basic relationship between equity valuation and interest rate changes. The option framework suggests that the duration of growth companies may be shorter (not longer) than those of assets in place. The results from option theory can however not be applied directly to growth options, since some of the assumptions may not be valid in the case of growth options. The presence of these growth options makes it virtually impossible to calculate equity duration theoretically. This study empirically tests the relationship between growth opportunities and equity duration by focussing the attention on the interest rate sensitivity of South African growth companies. The following hypotheses regarding equity duration and growth companies are postulated: • There is a significant difference in interest rate sensitivity between growth companies and low-growth companies. • There is a significant difference between duration of growth companies measured using nominal interest rates and duration of growth companies using real interest rates. All non-mining companies on the Johannesburg Securities Exchange SA, for the period 1980 to 2000, were analysed. These companies were sorted into different portfolios that reflected their growth opportunities. Market capitalisation, book-to-market and price-earnings ratios were used as proxies to rank companies according to growth opportunities. The results from univariate regressions suggest positive duration for common equities. The negative relationship between equity returns and changes in nominal interest rates are independent of size, book-to-market or price-earnings ratios of the sampled companies. Including the market factor as an independent variable results in markedly different equity duration. The duration is correlated with size, as both coefficients and t-statistics increase when moving from small companies to larger companies. In addition, the small companies have negative not positive duration, as was the case for simple univariate regressions. There is also some evidence that high growth portfolios, as measured by low book-to-market and high price-earnings ratios, are less sensitive to interest rate changes than low growth portfolios. Employing all three Fama and French's factors, there is no longer a cross-sectional dependence on company size, with the mean duration being close to zero and statistically insignificant in virtually all cases. Also, when dividing changes in the nominal interest rate into changes in real rates and changes in inflation, it does not significantly affect the estimates of equity duration. The author found no evidence to support the stated hypotheses, when employing the Fama and French's three factor model. This may mean that the relationships are subsumed in the Fama and French risk factors.