September 26, 2014
DFR 1: Estimating Discount Rates - Revision
Company Name, Brief Description
HSBC Holdings plc (^HSBC) is headquartered in London, but has origins which lie in Hong
Kong and Shanghai where branches were first opened in 1865. It is one of the world's largest banking and
financial services organizations with assets of $2,754 billion as of June 30 2014. HSBC serves
approximately 52 million customers through four Global Businesses: Retail Banking and Wealth
Management, Commercial Banking, Global Banking and Markets, and Global Private Banking.
Listed on the London, Hong Kong, New York, Paris and Bermuda stock exchanges, shares in
HSBC Holdings plc are held by about 216,000 in 129 countries and territories.
Stock Price, Market Capitalization
As of September 26, 2014, the stock price of HSBC is 53.06 and market capitalization is
estimated at 202.88 billion.
Geographic Breakdown
HSBC serves customers worldwide from over 6,200 offices in 74 countries and territories.
Contribution to reported profit before tax by geographical region is as follows: Europe 18.3%, Asia
64.0%, Middle East and North Africa 8.0%, North America 6.7%, and Latin America 3.0%. HSBC has
about 256,000 employees.
Cost of Equity
A summary of my inputted values for cost of equity are as follows:
Mature market
Risk free rate
Beta
premium
Lambda
CRP Cost of Equity
Europe
0.7362500%
1.416
5.48%
2.03333
2.13%
12.83%
Asia
1.6200000%
1.416
5.48%
3.04762
1.51%
13.98%
Middle East
1.4018750%
1.416
5.48%
1.14286
1.14%
10.46%
North America
2.5700000%
1.416
5.48%
0.15227
0.00%
10.33%
Latin America
0.5733333%
1.416
5.48%
0.15789
3.62%
8.90%
𝑐𝑜𝑠𝑡 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 = 𝑟𝑖𝑠𝑘 𝑓𝑟𝑒𝑒 𝑟𝑎𝑡𝑒 + 𝑏𝑒𝑡𝑎 ∗ (𝑚𝑎𝑡𝑢𝑟𝑒 𝑚𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑒𝑚𝑖𝑢𝑚) + 𝑙𝑎𝑚𝑏𝑑𝑎 ∗ (𝑐𝑜𝑢𝑛𝑡𝑟𝑦 𝑟𝑖𝑠𝑘 𝑝𝑟𝑒𝑚𝑖𝑢𝑚)
For North America, I used the 10-year Treasury yield curve rate to obtain a risk free rate of
2.57% since it is easier to estimate equity risk premiums and default spreads against this 10-year rate
compared to the 30-year rate in mature markets. For the rest of the four geographical regions, to obtain an
estimation of the risk-free rate, I subtracted the default spread from their local government bond rate. I
didn’t use this approach for North America, as suggested by a group member, because the 2.57% is the
real risk free rate to use in real terms. To calculate beta, I regressed three years of HSBC’s monthly stock
returns against S&P 500’s returns. I used a relatively short time period of 3 years to mitigate the risk of
beta reflecting HSBC’s historical mix, not current mix. I chose a monthly return interval since using daily
or weekly return intervals are likely to have significant bias. Daily or even weekly return intervals can
reduce the measured correlations with the market index because of non-trading which consequently
reduces the beta estimate. It was suggested by a group member to not use the S&P 500 since HSBC is not
a member of the S&P 500. This is an incorrect statement—we choose an index fund as a measure of
market performance, not because our chosen firm is or isn’t a member of that index fund. A mature
market premium, or equity risk premium (ERP), of 5.48% was obtained from Aswath Damodaran’s
historical monthly ERP database for September 1, 2014. Lambdas were estimated by considering Citi
group as the average global banking firm—Citi was ranked 21 out of 50 top global banks based on assets.
Each country risk premium listed above was obtained from Aswath Damodaran’s country risk premium
database. The final cost of equity of 13.09% was calculated using the weighted average of the five
geographical regions.
September 26, 2014
Cost of Debt
A summary of my inputted values for cost of debt are as follows:
Europe
Asia
Middle East
North America
Latin America
Risk Free Rate
0.736%
1.620%
1.402%
2.570%
0.573%
Company default
spread*
0.65%
0.65%
0.65%
0.65%
0.65%
Lambda
2.03333333
3.04761905
1.14285714
0.15227273
0.15789474
Adjusted country
default spread
2.344%
2.450%
3.278%
0.000%
3.617%
Tax Rate
26.30%
28.20%
27.15%
37.30%
31.70%
After Tax Cost
of Debt
4.53%
6.99%
4.22%
2.02%
1.23%
The long term/senior rating and outlook given to HSBC by Fitch, Moody’s, and Standard &
Poor’s are AA- Stable, Aaa3 Negative, and A+ Negative, respectively. A company default spread of 0.65%
was thus chosen. Adjusted country default spreads were taken from Aswath Damodaran’s country risk
premium database. Marginal tax rates were used which were calculated by using the weighted averages of
each geographic region’s countries as based on the Tax Foundation. A final cost of debt of 5.81% was
calculated using weighted average of the after tax cost of debt for each of the five geographical regions.
Please see the next page for the Appendix.
September 26, 2014
Appendix
Excel File
Embedded is the Excel file for beta, lambda, cost of equity, and cost of debt calculations. Each
calculation is in a separate tab.
chu.revision1_excel.xl
sx
Sources
https://www.us.hsbc.com/1/2/home/about/corporate/facts
http://www.hsbc.com/investor-relations
http://www.google.com/finance?q=NYSE%3AHSBC&ei=KVkgVLDqAcmP8AbGn4DIAw
http://www.bloomberg.com/quote/HSBC:US
http://www.hsbc.com/investor-relations/fixed-income-securities/credit-ratings#HSBC Holdings plc|All
rating agencies|All rating types
http://analysisreport.morningstar.com/stock/research?t=HSBA&region=gbr&culture=enUS&productcode=MLE
http://www.hsbc.com/investor-relations/financial-and-regulatory-reports
http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield
http://people.stern.nyu.edu/adamodar/pdfiles/papers/riskfreerate.pdf
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/ctryprem.html
http://pages.stern.nyu.edu/~ADAMODAR/New_Home_Page/datafile/implpr.html
http://www.stern.nyu.edu/~adamodar/pc/datasets/ctryprem.xls
http://www.citigroup.com/citi/investor/quarterly/2014/ar13c_en.pdf?ieNocache=461
http://www.accuity.com/useful-links/bank-rankings/
http://taxfoundation.org/article/corporate-income-tax-rates-around-world-2014
http://www.investing.com/rates-bonds/world-government-bonds?maturity_from=60&maturity_to=290
http://www.stern.nyu.edu/~adamodar/pc/USsovratingeffect.xlsx