Grinold and Kroner change, question, correct

Howd

Despite discussions on the treatment for the change in outstanding shares, there remains some doubt on the correct approach. The answer to a question in the Schweser exam kit Vol 2 Exam 2 Afternoon session 22.1 shown that a negative change must be added which is keeping with the -S. However in the CFA exams where the change is negative it is deducted. Which is correct or are both correct depending on who you respond to?

lcai

It makes sense to remember what the term is. Companies return capital to shareholders directly in one of two ways :

1. By making dividend payments, which usually come out of earnings
2. By buying back shares of stock , thus reducing capital employed

Since the act of reducing shareholding makes the company more valuable to the remaining shareholders ( because their interests in future profits are increased , given lower number of shares) , we treat a change in shares to the negative as a good thing.

while a change to the positive i.e. a net issuance of additional shares ( representing a dilution of the current shareholders interest) as a bad thing.

So delta S is simply the period to period change in shares ( signed ) ,while the meaning to the shareholder is attributed with a negative sign in GK's formula.

+ve delta S ( net increase of shares) = bad thing i.e. has an effect of -( delta S)
-ve delta S ( net reduction of shares) = god thing i.e. has an effect of -( delta S)
where the term in parenthesis is a negatively signed quantity

canadiananalyst

janakisri, what's "+ve"? thanks.

bboo

my fellow analist ........no matter how it is presented just ask urself how it affects the stock price......................share buyback = share appreication so contribs positively to E(R) for

Unforseen

Share purchases do not change the shareholder share of the company. But what has changed is that the company transfers cash to the shareholder. Transferring cash to the shareholder is the same as a dividend payout. Thus, share purchases is *equivalent to a dividend distribution. Thus, the % reduction of shares outstanding has a positive effect to the expected return just as the dividend yield has the positive effect on the expected return.

*This is L2 material.

mik82

If the question gives the equity repurchase yeild as negative.5% should that be added or taken away from the Dividend yield?

ohai

cfahead , sure you're in the right thread? This is about GK and shares , but you're asking about credit risk? Answer is zero credit risk as the option is out-of-the-money

PalacioHill

janakisri Wrote:
-------------------------------------------------------
> cfahead , sure you're in the right thread? This is
> about GK and shares , but you're asking about
> credit risk? Answer is zero credit risk as the
> option is out-of-the-money

He is asking of the potential credit risk, not at the current moment. He mentioned in his question that it is six month European option.

Btw, why would you say that it is out of money now. It is a JPY put making the option in-the-money right now. The convention he quoted is JPY/CAD not CAD/JPY.

Please let me know.

nannan66

you're right , sucker me. Not thinking clearly

JPY put is in the money if the JPY depreciates . So the company faces credit risk if it is a non-exchange option

wake2000

Different question,should have been separate. My apologies. Trying to work and do this at the same time does provide a fair amout of challenge.