ETF Overview: Risk Premiums for Some Countries.

"RUSSIAN RTS INDEX $ (priced in USD)" trades at eight times earning, meanwhile S&P500 has 14.891 (approximately 13-14 P/E for next year). Assume that US Equity market is correctly priced. So, based on the comparative P/E ratio we conclude that investors agree to pay only 54 cents for one dollar of profit. Is it normal? Actually I don't know. Let's estimate risk premium for some countries.

Equity Risk Premium (US).

First metric is difference between the geometric average of historical rates of returnable on equity market and 10-years Treasury Bonds - 9.26% and 4.97% respectively (for the period 1928-2009). Premium is equal 4.29% (see Historical Returns on Stocks, Bonds and Bills - United States, for instance).

Second one - difference between current or expected Earn-Price ratio and current 10-years Treasury Bonds Yield (we used current Earn-Price ratio). It's aproximately 4.09%. If we assume that expected P/E is equal 14, given this, we get 4.52%.

At the third, Implied Equity Risk Premium. Parameters used in model and results see in following table.

Table 1: Implied Equity Risk Premium (US)

At Nov 25th 2010.

S&P 500 INDEX (20-Day Average), pts	1199.58
Dividends and Buybacks Trailing 12-m, pts	48.2
Expected growth rate in earnings for next 5-y, %	7.2
Expected growth rate in the long term, %	2.84
CBOE Interest Rate 10-Year (5-Day Average), %	2.84
Expected income rate, %	7.51
Implied Equity Risk Premium, %	4.67

see "Implied Equity & Counrty Risk Premium weekly report"

Sources: finance.yahoo.com, standardandpoors.com, damodaran.com

Calculations: invest2russia.blogspot.com

So we have three estimates of equity risk premium, which are enough closely each to other. Let us assume that risk premium is 4.67% and expected rate of return on equity is equal 7.75% (free risk "plus" risk premium) for US market.


Country Risk Rates.

There are many approaches to estimate Country Risk Premia. We use following ones: approach based on Moody's Long-Term Credit Rating, based upon AAA-JPM CEMBI yield spread market volatility adjusted and upon the CDS-rates volatility adjusted.

Table 2: Bonds and rates

Country	Moody's LT Rating	10Y-Gov bond local currency, %	JPM CEMBI, pts	CDSs, %
Brazil	Baa3	12.50	5.94	1.15
China	A1	3.99	7.99	0.74
Hong Kong	Aa2	2.66	4.78	0.43
India	Ba2	8.38	5.34	1.26
Indonesian	Ba2	7.50	7.15	1.02
Mexico	Baa1	6.27	5.75	1.18
Russia	Baa1	7.73	5.79	1.63
Australia	Aaa	5.500		0.83
Japan	Aa2	1.160		0.61
U.K.	Aaa	3.361		0.70
USA	Aaa	2.91

Sources: wsj.com, markit.com, bloomberg.com

Table 3: Equity Markets (local currency)

Country	Index	Risk, %	P/E	E/P, %
Brazil	IBOV	17.85	13.75	7.28
China	SHSZ300	26.41	18.95	5.28
Hong Kong	HSI	15.84	11.75	8.51
India	SENSEX	15.59	14.12	7.08
Indonesian	INDEXCF	15.77	17.55	5.70
Mexico	MEXBOL	12.71	17.48	5.72
Russia	INDEXCF	15.30	8.76	11.41
Australia	AS52	13.64	39.41	2.54
Japan	TPX	17.31	15.62	6.40
U.K.	UKX	15.15	16.87	5.93
USA	SPX	15.34	14.89	6.72

Sources:bloomberg.com

Table 4: Equity Markets (US dollars)

Country	Index	Risk, %	P/E	E/P, %
Brazil	MXBR	22.47	12.47	8.02
China	MXCN	17.02	14.59	6.85
Hong Kong	MXHK	14.48	12.81	7.80
India	MXIN	16.07	17.41	5.74
Mexico	MXMX	17.35	19.70	5.08
Russia	MXRU	19.72	8.13	12.31
Australia	MXAU	13.85	16.34	6.12
Japan	MXJP	17.53	15.50	6.45
U.K.	MXGB	15.06	16.88	5.92
USA	SPX	15.34	14.89	6.72

Sources:bloomberg.com

Table 5: Country Risk Premium

Country	Based upon   Moody's rating	Based upon JPM CEMBI-AAA Spread	Based upon JPM CEMBI-AAA Spread, Volatility adjusted	Based upon CDSs, Volatility adjusted
Brazil	3.00	1.44	5.45	6.47
China	1.35	3.49	7.43	3.51
Hong Kong	0.90	0.28	0.85	1.90
India	4.50	0.84	2.53	4.93
Indonesian	4.50	2.65
Mexico	2.40	1.25	3.77	5.08
Russia	2.40	1.29	4.39	7.18
Australia				3.13
Japan	0.90			3.11
U.K.				2.99
USA				0.00

Sources: damodaran.com

Calculations: invest2russia.blogspot.com

Table 6: Total Risk Premium

Country	Based upon   Moody's rating	Based upon JPM CEMBI-AAA Spread	Based upon JPM CEMBI-AAA Spread, Volatility adjusted	Based upon CDSs, Volatility adjusted
Brazil	7.67	6.11	10.12	11.14
China	6.02	8.16	12.10	8.18
Hong Kong	5.57	4.95	5.52	6.57
India	9.17	5.51	7.20	9.60
Indonesian	9.17	5.92
Mexico	7.07	5.92	8.44	9.75
Russia	7.07	5.96	9.06	11.85
Australia	4.67			7.80
Japan	5.57			7.78
U.K.	4.67			7.66
USA	4.67			4.67

Calculations: invest2russia.blogspot.com

Table 7: Expected Rate of Return (free risk rate "plus" total premium)

Country	Based upon Moody's rating	Based upon JPM CEMBI-AAA Spread, Volatility adjusted	Based upon CDSs, Volatility adjusted	Average
Brazil	10.51	12.96	13.98	12.48
China	8.86	14.94	11.02	11.61
Hong Kong	8.41	8.36	9.41	8.73
India	12.01	10.04	12.44	11.50
Indonesian	12.01			12.01
Mexico	9.91	11.28	12.59	11.26
Russia	9.91	11.90	14.69	12.17
Australia	7.51		10.64	9.08
Japan	8.41		10.62	9.52
U.K.	7.51		10.50	9.01
USA	7.51		7.51	7.51

Calculations: invest2russia.blogspot.com

What does it means? (Conclusion)

We can use these results as estimation of required rates of return for equity markets, for the risk weighting purposes and P/E forecasting.

Actual current P/E for S&P500 is equal 14.891 times earning. Expecting P/E is 13.32. Its very close to some forecasts. Russia has 8.22 current and 8.13 estimated P/E. It's close to actual ratio too. In other words 55 cents for one dollar of current profit in Russia is normal. Also Hong Kong trades near its P/E estimation.

Following our results, required rates of return on equity are 12.48, 11.61 and 11.5 for Brazil, China and India respectively. Current earn-prices marks are equal 8.02, 6.85 and 5.74. So Brazilian, Chinese and Indian companies should increase their profit. The expecting GDP's growth looks like the great opportunity for companies from these countries to demonstrate the rising of their earning. Otherwise if they will not use it Investors will be very disappointed (it looks very risky). In a nutshell there are no significant upside potential and very weak downside protection at this moment.