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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 CommerceMichael Mainelli

Volatility Reduction and Ethics

• 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

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:

• 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

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

• 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%

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

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 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 Valuation

Sustainability Valuation

Risk

Avoidance

Reward

Enhancement

‘Margin’

Sustainability

‘Stability’

‘Flexibility’

Volatility

Reduction

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