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Mercers’ School Memorial Professor of Commerce Michael Mainelli. Take My Profits, Please! Volatility Reduction and Ethics. Outline. Shouldn’t ethics cost? Shouldn’t ethics pay? Calculated risks Valuing shape changers - volatility Sustainability = Stable?

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Mercers school memorial professor of commerce michael mainelli

Mercers’ School Memorial Professor of CommerceMichael Mainelli

Take My Profits, Please!

Volatility Reduction and Ethics


Outline
Outline

  • Shouldn’t ethics cost?

  • Shouldn’t ethics pay?

  • Calculated risks

  • Valuing shape changers - volatility

  • Sustainability = Stable?

  • Measuring the immeasurable benefits of CSR

  • Societal gains

“Get a detailed grip on the big picture.”Chao Kli Ning






What is an option
What Is An Option?

S = current stock price, say £100

T = time till expiration, 3 months

K = option striking price, say £100

C = call premium, £5 or £65?


Stable or wild which is worth more
Stable or Wild: Which Is Worth More?

  • Stable:

    • almost certainly between £90 and £110 at end of three months

    • stable = £110 - £100 = £10

    • stable = £90 - £100 = -£10

    • not a lot of chance to make money

  • Wild:

    • anything from £30 to £300 at end of three months

    • Wild (1) = £30 - £100 = -£70

    • Wild (2) = £300 - £100 = £200

    • average of Wild (1) and Wild (2) = £65

  • Option on Wild worth more than option on Stable


Black scholes equation
Black-Scholes Equation

where d1 and d2 are:

C = call premium of an option on stock S with duration T

S = current stock price, say £100

T = time till expiration, 3 months

K = option striking price, say £110

r = risk free interest rate, say 4%

s = standard deviation of stock returns, say 20%

N = cumulative standard normal distribution


Two cases priced by black scholes
Two Cases Priced By Black-Scholes

  • Stable:

    • standard deviation 10%

    • option = £2.51

  • Wild

    • standard deviation 300%

    • option = £54.90

S = current stock price, say £100

T = time till expiration, 3 months

K = option striking price, say £100

r = risk-free interest rate, say 4%


100 years of instability
100 Years Of Instability

Risk-Return from 1900 to 1999

12

US Shares

10

UK Shares

8

US T-bonds

Return

6

French Shares

4

2

US T-bills

0

0

10

20

30

40

Volatility

Source http://www.economist.com/displaystory.cfm?story_id=268876


Sustainable stable

Average Premium/Discount to Market by GMO Composite Valuation

Top 1000 UK stocks, mcap-weighted quintiles, Dec-69 to Aug-03, 5-year earnings volatility

+20%

+17.0%

+15%

+10.0%

+10%

+5%

0%

-2.1%

-3.3%

-5%

-10%

-10.9%

-15%

Low Earnings Volatility

Quintile 2

Quintile 3

Quintile 4

High Earnings Volatility

Sustainable = Stable?

Source: GMO


Volatility loss equity gain
Volatility Loss = Equity Gain Valuation

  • Move perceptions of future profit volatility from 50% to 20% on £10 billion market capitalisation

  • Estimated gain of 15% on share price from profit volatility reduction

  • Estimated gain of 10% on share price from share price volatility reduction

  • Price/earnings ratio of 8 justifies investing up to £125 million for the lower figure (£187.5 million for the higher)



Societal gains
Societal Gains Valuation


Sustainability
Sustainability Valuation

Risk

Avoidance

Reward

Enhancement

‘Margin’

Sustainability

‘Stability’

‘Flexibility’

Volatility

Reduction


Discussion
Discussion Valuation

  • Is there anything intrinsically wrong with being ‛good for profit’?

  • If NGO activism on an issue increases uncertainty for companies, is this rational for the NGO?

“Get a big picture grip on the details.”Chao Kli Ning


Take my profits please
Take My Profits, Please! Valuation

Thank you!


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