 Hey guys, it's MJ the student's actuary and I'm here with another CA1 video on chapter 24 Which is the valuation of asset classes and portfolios This is a very difficult chapter and it is very long Inside the chapter there's expected returns comparisons various methods of valuing asset liability relationships variability of prices this whole thing known as the notional portfolio and This would take quite a few lectures to to get across all of it So what I'm going to do in this video is I'm just going to be focusing on expected return and What I'm going to be looking at in depth is the risk premium So when it comes to to investors and they need to make their decision on What do they want to invest in? They're going to be looking at two things. They're going to be saying what is my required return as an investor So what do I need to to get back by putting my money out there? And they're going to look at that by themselves like within themselves say what do we what is required and Then they're going to look at the various assets and say well what is the expected return of these various assets and If the expected return is greater than their required return Then that's something that they're interested in if expected return is less than required return Then they're not going to be interested in it. So let's look at this required return Required return consists of the risk-free real yield Plus expected inflation plus a risk premium So let's talk about this very quickly your risk-free yield is the amount of money It's a theoretical amount But we normally take the the interest rate that you'd get in a bank where it's almost Guaranteed to get that money back Now that's why I'm saying it's theoretical because nothing in life is guaranteed or super safe like that But let's say banks are giving 6% But depositing your money with them then your risk-free yield will be 6% Then you're expected inflation It's inflation is going to grow by 2% then that 2% will be the expected inflation and Then the risk premium will be that additional amount that The investor is prepared to take on So that is required return Expected return this comes down to the various asset classes Assets can yield return in two ways through income and Through capital growth. So with a share, it's the dividends and it's the price increasing With property, it's the rent and it's the value of the building going up We're gonna see this quite a lot that expected return has got that Continuous like income yield and that expected capital growth and Then remember there's something completely different and that is the actual return That is realized at the end of the day and it could be different to the expected return But we're hoping it will be very close to expected return depending on how risky that asset was This is just a very Very small chart I got of the internet saying that the higher the Risk the more return we want so a small business should give you a high return But it has a high risk whereas a bond will have a low risk and Will have a low return Just some assumptions we need to keep in the back of our mind is that investors want real return That's why we are considering inflation We want to make sure that all our calculations are done in the same time horizon. So this is the amount of return in one year We don't say this amount of turns six months is the amount of return in two years We want to standardize it at the same time horizon for the time being just to make it a little bit simpler tax differences are ignored and We do assume that you reinvest the return and also Especially when you're coming to to big banks or big life insurance and all those type of companies It is very important to keep the investors liabilities in mind at all times Because they are going to be wanting to match their liabilities with their assets So let's quickly go through some of the main asset classes and this this equation which you'll It's very important that you understand it and a lot of questions can be asked around it So let's look at bonds Hopefully by watching this video you're so far in the course that you know what a bond is The expected return of a bond is the gross redemption yield And we're saying that for that needs to be equal to the risk-free rate of return or the risk-free yield plus expected inflation plus an inflation risk premium and The idea behind this inflation risk premium is that inflation might misbehave It might be much higher than what we were anticipating and this could have consequences on our real return and This inflation risk premium will vary between different governments African countries where inflation is much higher than say European countries will have a higher risk premium built into it You also get corporate bonds very similar, but this time there is a bond risk premium And we are anticipating Corporate bonds to yield a higher return because of this bond risk premium Which not only needs to incorporate inflation but needs to incorporate the risk that the company that issues it may default and The fact that it's not as marketable as a government bond So they might not be as many buyers and sellers in this market Which is a factor to take into consideration If we look at equities the expected return is equal to D plus G now D is the income stream or the the dividends and G I've used to to denote the capital gains or the increase in the share price and again We're going to see the risk-free yield plus expected inflation Plus something known as the equity risk premium now equity risk premium We're going to see marked ability we're going to see default, but now we're going to be looking at something known as volatility So the stock market has this extra volatility in it caused by you know irrational investors or herd mentality and all of that and that needs to be considered in The whole risk premium Now let's look at property the expected return of property is the rental yield plus the expected growth in rent and This is going to be equal to Although I've got the expected growth in rent, but it could also be the expected growth in The value of the property which will Cause the rent to to increase so those two are very closely connected, but let's focus in now at the property risk premium This is going to be quite high as and it's going to actually shouldn't say it's going to be quite high It depends very much on the property where it is what city it is What are the rules what type of building it is and all those type of things this will have a direct effect on voids. That's How long does this building go without a tenant? Markets ability is there are there a lot of people looking for this type of building Is it a large unit in the sense that you can only get one or two people at a time? What are the costs like is there high maintenance doesn't need some new paint every every single year? Will maybe go obsolete, you know, is it a type of factory and we're moving towards a smaller type of factories? What is the leasehold zero value? You know property gets very complicated very quickly and the property risk premium needs to incorporate all of these factors But like I said property in say South Africa is going to be very different to property in America But even property in South Africa a property around the city of Cape Town will be very different to like set property in another province Like the free state or in another city like Johannesburg So it is something that is very specialized and you need to to realize this when you're doing these questions Now this is where I want to end the video because this is where it does get very complicated And I'm probably not the best qualified for teaching the subject at this level But I'll just go through it some stuff that you need to know is the yield gap the reverse yield gap how it works with dividend yields Rental yields versus dividend yields why there might be a change between them you can see there's a lot of comparisons that you can do and The rest of the chapter just or you can just see it goes into very a lot of complicated stuff But like I said, I don't think I am qualified to to be teaching this So I'm just going to end off the video there, but I hope I've given you a solid introduction to risk premiums And the required and expected return so that you can tackle the rest of the material On your own, but y'all guys. Thanks so much for watching and hopefully I will be better equipped for the next chapter Or hopefully it's a little bit easier. Thanks. Cheers