\text{Equity Return} = \text{Risk Free Rate} + \text{Volatility} x \text{Outperformance}
\]
- returns from publicly traded stocks
**** Risk Free Rate includes inflation
- This is the return on an investment with zero risk, typically represented by government bonds like U.S. Treasury bills.
- It accounts for inflation and is considered the baseline rate of return.
- Example: If the current inflation rate is 2% and Treasury bonds yield 3%, then the Risk-Free Rate is 3%.
**** Volatility: The volatility of the company versus the market
- measures how much the stock price fluctuates relative to the overall market.
- It's often represented by beta (β) in the Capital Asset Pricing Model (CAPM), where β > 1 means the stock is more volatile than the market.
- For example, a volatility of 1.2 indicates the stock is 20% more volatile than the market.
**** Outperformance: how much we expect stocks to outperform government bonds
- This is the expected premium that equity holders expect stocks to generate over government bonds.
- It reflects the idea that since stocks are riskier than government bonds, investors expect higher returns.
- This value could be determined from historical stock market returns minus bond returns. For example, if stocks historically outperform bonds by 4%, the Outperformance might be set to 4%.
** cost of capital if we use equity and debt
*** WACC: Weighted Average Cost Of Capital
** securities law and ventures financing
- serious jail sentences
- ignorance is no excuse
*** basic laws
- potential investors must receive all relevant information before investing
- all risks
- this is called an S1
- if you have been defrauded you should receive compensation
- class action lawsuits
- insider information for publicly traded stocks is illegal and results in prison (no excuses)
