Valuation of asset classes and portfolios

required return and expected return formulae

what risk premium reflects

derivation of yield gap and simplifying assumptions

two sources of variability in an asset portfolio

problems associated with volatile asset values (is consistency with the valuation of the liabilities more important?)

Government bonds

corporate bonds

equities

property

GRY= rf +E(inflation) +IRP (2)

GRY= rf + E(inflation) +CBRP

d + g = rf + E(inflation) +ERP (1)

ry+rg = rf + E(inflation) + PRP

If assets fairly priced, can equate required and expected returns

(2)- (1)
GRY-d-g = IRP-ERP

Rearrange
d-GRY=ERP-IRP-g (yield gap)

Reverse yield gap:
GRY-d= IRP-ERP +g

equities

possible default

lower marketability and liquidity

higher volatility of share prices and dividend income

market movements

a change in the composition of the portfolio for example due to a tactical switch in investment policy

volatility affects reality

inconsistency of asset values with liability values

An unstable asset value is hard to communicate

Valuing liabilities on a consistent "market-related" basis is hard to achieve (i.e. the discount rate is hard to determine

alternative is smoothed market value