July 2013

July 2013

US Macroeconomic Outlook, Funding Strategies,

and a Sixty-Year History of MarketsBy Niso Abuaf

1. US Macroeconomic Outlook2. Efficient-Frontier Funding Strategies3. A Sixty-Year History of Interest Rates4. History of Economic Growth: GDP and the Stock

Market

Executive Summary

The current macroeconomic outlook presents a duality: exceedingly low short-term interest rates in the medium term, offset by inflation and correspondingly higher interest-rate risk due to globally ballooning Central Bank balance sheets. Federal Open Market Committee (FOMC) forecasters’ views show that the fed-funds rate has a central tendency of 4%–2% real rate plus 2% inflation only beyond 2015.

According to the well-known Okun rule, GDP has to grow by approximately two percentage points over and above its run-rate to soak up one percentage point of unemployment. This rule means that for unemployment to fall to its steady-state level of 5%, GDP has to grow by 9% in one year or by 4% for six years (assuming that the run rate of GDP is 3% per year). This is not happening!

The main reasons behind this very low interest-rate environment are twofold: first, the unemployment rate is significantly higher than its steady state level (slightly below 8% versus 5%), and second inflation is not significantly higher (maybe even lower depending on how you measure it) than its policy level of about 2% to 2.5% p.a.

The Federal Reserve follows some version of the frequently-cited Taylor rule, or framework , which suggests that the Fed-Funds rate equals the long-run real rate (about 2%) plus the steady-state inflation rate (approximately 2% to 2.5%) and a weighted average of the gross domestic product (GDP) gap and the inflation gap. Though there are many interpretations of the Taylor rule, most economists would agree that the current environment implies a very low or even negative Fed Funds rate, and that the environment will remain as such until the unemployment rate is on its way to reaching its full-employment level.

Currently the Federal Reserve is using two instruments of monetary policy The Fed-Funds rate (stressing not time forecasts, but data dependent forecasts) Purchases of Treasuries and Agencies (to taper or not?)

Under normal circumstances such an increase in base (or high-powered) money would have resulted in significant levels of inflation. Currently, however, because the money multiplier has declined significantly due to the 2007-2009 contraction, M1 and M2 have not grown as fast as high-powered money. And, heretofore inflation has not materialized. Nonetheless, global economic history suggests that inflation may hit suddenly and violently. Thus, this is the current macroeconomic duality: very low interest rates projecting into the medium-term future offset by high-levels of inflation risk.

The US Macro Outlook and Efficient Funding Strategies

Executive Summary

This duality intuitively suggests that an optimal funding strategy might consist of short term borrowings (to exploit the low short-term rates) coupled with long-term borrowings (to hedge against rising inflation and interest rates).

In this presentation, we empirically demonstrate that a barbell funding strategy is indeed on the efficient frontier, and most efficient frontier strategies consist of the barbell plus the 5-year, particularly under increased liquidity or funding risk eventualities. Once we delineate the barbell with episodic inclusions of the 5-year, the Chief Financial Officer (CFO) can choose the optimal fixed versus floating mix based on his pain tolerance for declines in earnings per share (EPS) given the likely moves in short-term rates.

In addition to pain tolerance considerations in choosing his fixed versus floating strategy, the CFO also looks at comparable analysis of the industry he is operating at. Various industries will have differing fixed versus floating characteristics depending on their capital structures and the sensitivity of the particular industry to interest rates.

Most CFOs that I have had conversations with state that the most important choice in liability management is the fixed versus floating mix and not the maturity mix. Nonetheless, I posit that the maturity mix should be predicated on an efficient frontier type analysis combined with a probabilistic and economic determination of which instrument would be the likely winner over a planning horizon.


Executive Summary

A major caveat for floating-rate funders is that interest rates can jump violently. For example, in the period from 1990 to the present, we have experienced three major periods where short-term rates (3M Libor) have moved significantly over a few years

3.19% (2/93) to 6.50% (12/94), or 331 bps in one year ten months. 4.97% (1/99) to 6.81% (9/00), or 184 bps in one year eight months. 1.11% (3/04) to 5.48% (6/06), or 437 bps in two years and three months.

On the good news side, corporate spreads are negatively correlated with quarter-on-quarter annualized percentage changes in GDP (R2 of 59%). In this respect, the CFO is partially hedged in that when the economy does well, the risk-free rate will likely go up, but credit spreads will likely go down; and conversely.


When analyzing the history of interest rates, we have to bear in mind that the nominal interest rate consists of three building blocks.

The real rate of interest (i.e. inflation adjusted, or TIPS) Inflationary expectations Credit Spreads

The long term real rate of interest approaches long-term GDP growth, both of which converge to 3% per year.

Because the short-term interest rate approaches 2% in the long-run, we conclude that the TIPS yield curve has a 100 bps spread (3M-30Y) under normal conditions.

We present the statistical distributions of various interest rate spreads in the graphs that follow. Conventional wisdom suggests that the yield curve flattens before a recession, and steepens

during a recession.

Page 6

A Sixty-Year History of Interest RatesExecutive Summary

S&P 500 Real Earnings are about 100(mean) – 250(median) bps higher than real GDP growth. This may suggest that throwing out underperformers may improve portfolio returns significantly.

As expected, S&P 400 Real Earnings are higher than that of the S&P 500. Specifically, S&P 400 Real Earnings are about 7% higher than real GDP growth.

Investors may use various metrics such as the P/E multiple to ascertain whether the stock market is rich or cheap.

The Capital Asset Pricing Model is the classic academic model used for stock valuation. As such practitioners universally rely on betas and their decomposition into correlation and relative volatility.

When discussing share repurchase assignments, cost of capital considerations, and equity valuation with clients, we spend considerable time on the robustness and components of beta; and the equity market risk premium.

Page 7

GDP and the Stock MarketExecutive Summary

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

-15.0

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

Change in Unemploym

ent (%)

Gro

wth

Rat

e (%

)

Recession Real GDP (QoQ, %) Change in Unemployment (QoQ, %)

Economic Growth Leads the Unemployment Rate and is More Volatile – The Okun Rule

GDP growth = 3.33 – 1.82*(change in unemployment)t statistics: (18.22) (15.38)

Adj. R2 = 48.50%

This confirms the study by Abel and Bernanke, 2005

US Unemployment Rate and Rate of Growth of U.S. GDP, Dec 1949 – Mar 2013

Source: Bloomberg.

-8

-3

2

7

12

17

22

-8

-3

2

7

12

17

22Ra

tes/

Spre

ad (%

)

Recession Spread: Fed Funds - Taylor Estimate Fed Funds Rate Target Taylor Rule Estimate

Following the bursting of the TMT bubble, the Fed kept rates lower than the Taylor rule to fight dreaded deflation

Source: Bloomberg, NBER.

The Fed’s Reaction Function and the Taylor Rule, 1971-2013

The Taylor rule is widely used to explain Fed-fund targets rates Real Rate+Core Inflation+½*(Inflation–Target Inflation)+½*Okun Factor*(Normal Unemployment–

Unemployment)

In the recent past, with unusually high unemployment and low inflation, the rule called for negative rates This is yet another indication that short rates may stay low for some time

FOMC Outlook on Timing of Policy Firming

Source: Federal Reserve

FOMC Outlook on Pace of Policy Firming

Note: March & June 2013 Minutes

FOMC Overview of Monetary Policy

Since its December 2012 meeting, FOMC maintained that low rates are appropriate atleast as long as the unemployment rate remains above 6-1/2%, inflation between one and two years ahead isprojected to be no more than a half percentage point abovethe Committee's 2% longer-run goal, and longer-terminflation expectations continue to be well anchored.

0

2

4

6

8

10

12

14

2013 2014 2015 2016

1

3

14

1Num

ber o

f Par

ticip

ants

••••••••••••••••••0

1

2

3

4

5

2013 2014 2015 Long Run

Targ

et F

ed F

unds

Rat

e (%

)

• ••••••••••••••••••

••••••••••••

•

••• ••••

•••••••••••••••

•••

••••••••••••••••••0

1

2

3

4

5

2013 2014 2015 Long Run

Targ

et F

ed F

unds

Rat

e (%

)

•

••••••••••••••••••

•

••••••••••••••••

•••

•••••••••••••••••••

March 2013 June 2013

March 2013 June 2013

0

2

4

6

8

10

12

14

2013 2014 2015 2016

1

4

13

1Num

ber o

f Par

ticip

ants

Economic Forecasts

Source: Wall Street research, Bloomberg.

Historical & Forecasted US Real GDP Growth Rate, 1Q07 – 2Q14 Historical & Forecasted 10-Year Treasury Rate, 1Q07 – 2Q14

Bloomberg consensus and the selected economists project that the economy will continue expansion in 2013, albeit with a slow starting 2013

Most forecasters are optimistic because they think that the negative effects of sequestration will wear off, adding 100–150 bps to GDP; in addition to good news about US energy supplies.

Note: Upper and lower bounds represent Bloomberg’s survey of approximately 80 economists

-10.00

-8.00

-6.00

-4.00

-2.00

0.00

2.00

4.00

6.00

8.00

10.00

US

Real

GD

P (Q

oQ %

)

Median High Low BOA BC C GS JPM Nomura

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

US

10-Y

r. N

ote

(%)

Median High Low

BC BOA C

GS JPM Nomura

Following the onset of the financial crisis, the Federal Reserve used a variety of tools at its disposal to stimulate economic growth and pump liquidity into the financial sector. As a result of the Fed’s open market operations (OMOs), by the end of 2012 the size of the Federal Reserve balance sheet has tripled

As of the end of June 2013, the Fed is continuing to purchase $40 billion of MBS and $45 billion of LT Treasury securities on a monthly basis, accounting for about 7.5% of the US annual nominal GDP. In comparison, the US budget deficit peaked in 2009 at around 10% of annual GDP and has since been steadily declining. As of Mar 2013, the US budget deficit was 5.7% of the nominal GDP, on an annualized basis

Federal Reserve Balance Sheet Size, Dec 2007 – Jul 2013

Source: Bloomberg

US Money Supply Growth (Assets of the Fed)

Note: Other assets = Repo agreements + assets related to the financial crisis + central bank liquidity swaps + other assets + gold + special drawing rights + treasury currency

-

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000De

c-07

Feb-

08

Apr-0

8

Jun-

08

Aug-

08

Oct

-08

Dec-

08

Feb-

09

Apr-0

9

Jun-

09

Aug-

09

Oct

-09

Dec-

09

Feb-

10

Apr-1

0

Jun-

10

Aug-

10

Oct

-10

Dec-

10

Feb-

11

Apr-1

1

Jun-

11

Aug-

11

Oct

-11

Dec-

11

Feb-

12

Apr-1

2

Jun-

12

Aug-

12

Oct

-12

Dec-

12

Feb-

13

Apr-1

3

Jun-

13

Bala

nce

Shee

t Size

($ B

illio

n)

US Treasury Securities Held Outright Mortgage-Backed Securities Held Outright Federal Agency Debt Securities Held OutrightLoans (Incl. Term Asset-Backed Securities Loan Facility) Term Auction Faciliity Commercial Paper Funding FacilityOther Assets

QE IAgency Debt: +175BN

MBS: + $1.25TNLT Treasuries: + $300BN

QE IILT Treasuries:

+ $600BN

Op. TwistST Treasuries: -

$667BNLT Treasuries: +

$667BN(Ups ized i n June

2012)

QE IIISep 12, 2012 - CurrentMBS: + $40BN/Month

QE IVJan 30, 2013 - Current

LT Treeasuries: + $45BN/Month

Nov 25, 2008 Mar 2010 Nov 3, 2010 Jun 2011

Sep 21, 2011 Dec 2012

-

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

Dec-

07

Feb-

08

Apr-0

8

Jun-

08

Aug-

08

Oct

-08

Dec-

08

Feb-

09

Apr-0

9

Jun-

09

Aug-

09

Oct

-09

Dec-

09

Feb-

10

Apr-1

0

Jun-

10

Aug-

10

Oct

-10

Dec-

10

Feb-

11

Apr-1

1

Jun-

11

Aug-

11

Oct

-11

Dec-

11

Feb-

12

Apr-1

2

Jun-

12

Aug-

12

Oct

-12

Dec-

12

Feb-

13

Apr-1

3

Jun-

13

Bala

nce

Shee

t Size

($ B

illio

n)

Currency In Circulation Other Factors Absorbing Reserve Funds Reserve Balances with Federal Reserve Banks

QE IAgency Debt: +175BN

MBS: + $1.25TNLT Treasuries: + $300BN

QE IILT Treasuries:

+ $600BN

Op. TwistST Treas uries: -

$667BNLT Treasuries: +

$667BN(Upsized in June

2012)

QE IIISep 12, 2012 - CurrentMBS: + $40BN/Month

QE IVJan 30, 2013 - Current

LT Treeasuries: + $45BN/Month

Nov 25, 2008 Mar 2010 Nov 3, 2010 Jun 2011

Sep 21, 2011 Dec 2012

The expansion of the Federal Reserve’s balance sheet since the onset of the financial crisis has been matched on the liabilities side primarily through the expansion in deposits of depository institutions

Federal Reserve Liabilities, Dec 2007 – Jul 2013

Source: Bloomberg

US Money Supply Growth (Liabilities of the Fed)

Interest Rate Environment Following the Financial Crisis

Source: Bloomberg, Federal Reserve.

10-Year Nominal Interest Rate, Nov 2007 - Jul 2013

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep-

08

Nov

-08

Jan-

09

Mar

-09

May

-09

Jul-0

9

Sep-

09

Nov

-09

Jan-

10

Mar

-10

May

-10

Jul-1

0

Sep-

10

Nov

-10

Jan-

11

Mar

-11

May

-11

Jul-1

1

Sep-

11

Nov

-11

Jan-

12

Mar

-12

May

-12

Jul-1

2

Sep-

12

Nov

-12

Jan-

13

Mar

-13

May

-13

Jul-1

3

10-Y

ear R

eal R

ate

No Policy QE I QE II Op Twist Op Twist + QE III QE III + QE IV

0.72%0.59%

-0.10% 0.03% 0.73%

QE IV BeginsJan 30, 2013

Op Twist ExtensionJun 20, 2012

FOMC MeetingJun 19, 2013

QE II: Nov 3, 2010 - Jun 2011LT Treasuries: + $600BN

Twist: Sep 21, 2011 - Dec 2012ST Treasuries: - $667BNLT Treasuries: + $667BN

QE III: Sep 12, 2012 - CurrentMBS: + $40BN/Month

QE IV: Jan 30, 2013 - CurrentLT Treasuries + $45BN/Month

Economists surmise the following: QE during extreme crisis has been more effective than at other times QE has diminishing marginal returns The question is: when are diminishing marginal returns offset by marginal costs?


-2.0%

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep-

08

Nov

-08

Jan-

09

Mar

-09

May

-09

Jul-0

9

Sep-

09

Nov

-09

Jan-

10

Mar

-10

May

-10

Jul-1

0

Sep-

10

Nov

-10

Jan-

11

Mar

-11

May

-11

Jul-1

1

Sep-

11

Nov

-11

Jan-

12

Mar

-12

May

-12

Jul-1

2

Sep-

12

Nov

-12

Jan-

13

Mar

-13

May

-13

Jul-1

3

10-Y

ear R

eal R

ate


-1.16%

0.28%

-0.63% 0.01% 1.27%









Real rates have been steadily declining following the recession. We observe that in the long-run, real rates loosely match the growth in GDP. 2010 to date, the US GDP growth rate has hovered in the vicinity of 2%, yet the 10-year TIPS rate has been substantially below that mark

Even with the recent pullback, real rates remain considerably below their long-term average of 2.5%. It appears that the Fed’s aggressive asset purchase response to the financial crisis manifested itself primarily through severe compression in the real rates, which would also explain the violent spike in rates following the QE taper talks

10-Year Real Rate Interest (TIPS), Nov 2007 - Jul 2013


-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep-

08

Nov

-08

Jan-

09

Mar

-09

May

-09

Jul-0

9

Sep-

09

Nov

-09

Jan-

10

Mar

-10

May

-10

Jul-1

0

Sep-

10

Nov

-10

Jan-

11

Mar

-11

May

-11

Jul-1

1

Sep-

11

Nov

-11

Jan-

12

Mar

-12

May

-12

Jul-1

2

Sep-

12

Nov

-12

Jan-

13

Mar

-13

May

-13

Jul-1

3

10-Y

ear B

reak

even

Rat

e


1.93%

0.23%0.53%

-0.03%-0.40%


FOMC MeetingJun 19, 2013QE I: Nov 25, 2008 - Mar 2010

Agency Debt: + $175BNMBS: + $1.25TN

LT Treasuries: + $300BN







10-year breakeven rates have generally risen through the QE periods and have decreased in the periods between Fed asset purchases, probably reflective of the expansive monetary policy needed to sustain additional asset purchases

Since May 1st and the beginning of the tapering talks, the breakeven 10-year rate has declined by 25 bps. 10-year expected inflation is currently at 2%, below historical average change in Core CPI (CCPI), but in-line with Fed’s current target inflation rate

10-Year Breakeven Rate (Inflationary Expectations), Nov 2007 - Jul 2013



0

50

100

150

200

250

300

350

400

450

500N

ov-0

7

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep-

08

Nov

-08

Jan-

09

Mar

-09

May

-09

Jul-0

9

Sep-

09

Nov

-09

Jan-

10

Mar

-10

May

-10

Jul-1

0

Sep-

10

Nov

-10

Jan-

11

Mar

-11

May

-11

Jul-1

1

Sep-

11

Nov

-11

Jan-

12

Mar

-12

May

-12

Jul-1

2

Sep-

12

Nov

-12

Jan-

13

Mar

-13

May

-13

10-Y

ear C

redi

t Spr

ead

No Policy QE I QE II Op Twist Op Twist + QE III Series8

-277 -29 -27 -10 6








0

50

100

150

200

250

300

350

400

450

500

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep-

08

Nov

-08

Jan-

09

Mar

-09

May

-09

Jul-0

9

Sep-

09

Nov

-09

Jan-

10

Mar

-10

May

-10

Jul-1

0

Sep-

10

Nov

-10

Jan-

11

Mar

-11

May

-11

Jul-1

1

Sep-

11

Nov

-11

Jan-

12

Mar

-12

May

-12

Jul-1

2

Sep-

12

Nov

-12

Jan-

13

Mar

-13

May

-13

Jul-1

3

10-Y

ear C

redi

t Spr

ead


-277 -29 -27 -10 6








10-year credit spreads contracted sharply during QE I, which coincided with the end of the recession and have remained relatively stable subsequent to that. Still, we can observe credit spreads tightening during QE periods and widening in-between QE periods, possibly reflective of the downward pressure on rates caused by the Fed asset purchases

10-Year BBB Industrial Credit Spread, Nov 2007 - Jul 2013

Behavior of Credit Spreads

As expected, credit spreads are negatively correlated with GDP Moreover, spread movements seem to significantly offset movements

in treasuries

162.5

-14.5

-56 -51

-100

-50

0

50

100

150

200

-1.61% to -0.43% -0.43% to -0.02% -0.02% to 0.35% 0.35% to 0.87%

Med

ian

Chan

ge in

HG

Spre

ad (b

ps)

Change in 10Y UST

Mar-13

Dec-12Sep-12

Jun-12Mar-12

Dec-11Sep-11

Jun-11Mar-11

Sep-09

Jun-09

Mar-09Dec-08

Sep-08

Jun-08

Jun-07

Dec-02Sep-00

Jun-97

R² = 0.5578

0

100

200

300

400

500

600

700

-10 -8 -6 -4 -2 0 2 4 6 8 10

High

Gra

de O

ptio

n A

djus

ted

Spre

ad (b

ps)

US GDP (QoQ,%)


Market

Behavior of US Interest Rates, Jun 1954 - Present

Until the early 1980s, US interest rates trended up, primarily driven by rising inflation. Since then, the trend has reversed itself, primarily by falling inflation, but also by declining real interest rates, particularly after the onset of the 2007 great contraction.Because issuing long-term is beneficial in a rising rate environment, the liability management decision is effectively a forecasting exercise.

Gov

ernm

ent R

ates

Cor

pora

te R

ates

(Moo

dy’s

)

Source: Federal Reserve.

0%

5%

10%

15%

20%

Dec-

54

Dec-

56

Dec-

58

Dec-

60

Dec-

62

Dec-

64

Dec-

66

Dec-

68

Dec-

70

Dec-

72

Dec-

74

Dec-

76

Dec-

78

Dec-

80

Dec-

82

Dec-

84

Dec-

86

Dec-

88

Dec-

90

Dec-

92

Dec-

94

Dec-

96

Dec-

98

Dec-

00

Dec-

02

Dec-

04

Dec-

06

Dec-

08

Dec-

10

Dec-

12

Yiel

d, S

prea

d (%

)

Recession 3M UST 20Y UST

0%

5%

10%

15%

20%

Dec-

54

Dec-

56

Dec-

58

Dec-

60

Dec-

62

Dec-

64

Dec-

66

Dec-

68

Dec-

70

Dec-

72

Dec-

74

Dec-

76

Dec-

78

Dec-

80

Dec-

82

Dec-

84

Dec-

86

Dec-

88

Dec-

90

Dec-

92

Dec-

94

Dec-

96

Dec-

98

Dec-

00

Dec-

02

Dec-

04

Dec-

06

Dec-

08

Dec-

10

Dec-

12

Yiel

d, S

prea

d (%

)

Recession AAA Long Term Rate BAA Long Term Rate

The Efficient Frontier: A Corporate Treasurer’s Perspective (Cont’d)

Liability Portfolio Efficient Frontier in a Rising Interest Rate Environment, Apr 1953 – Apr 1973, (Using Treasury Rates)

Source: Federal Reserve, calculations by Ramirez & Co.

During periods of rising interest rates, as observed in the US from 1953 to 1973, issuing long-term debt proves to be an outright winner over shorter-term options. This strategy provides issuers with the lowest interest rate volatility and the lowest cost of funding. Stated differently, the efficient frontier consists of one point.

Efficient FrontierBarbells (3M and 20Y)

10% 3M, 90% 20Y20% 3M, 80% 20Y

30% 3M, 70% 20Y40% 3M, 60% 20Y

50% 3M, 50% 20Y60% 3M, 40% 20Y

70% 3M, 30% 20Y80% 3M, 20% 20Y

90% 3M, 10% 20Y

100% 3-Month

100% 3-Year

100% 5-Year

100% 10-Year

100% 20-Year

2.90%

3.10%

3.30%

3.50%

3.70%

3.90%

4.10%

4.30%

0.00% 0.50% 1.00% 1.50% 2.00%

Cost

of F

undi

ng

Standard Deviation

20% 3M, 20% 3Y, 20% 5Y, 20% 10Y, 20% 20Y

25% 3M, 25% 5Y, 25% 10Y, 25% 20Y

10% 3Y, 90% 20Y

20% 3Y, 80% 20Y

30% 3Y, 70% 20Y

40% 3Y, 60% 20Y

50% 3Y, 50% 20Y

20% 3M, 80% 3Y40% 3M, 60% 3Y

60% 3M, 40% 3Y80% 3M, 20% 3Y 100% 3-Month

100% 3-Year

100% 5-Year

100% 10-Year

100% 20-Year

1.50%

2.50%

3.50%

4.50%

5.50%

6.50%

7.50%

0.00% 0.50% 1.00% 1.50% 2.00% 2.50%

Cost

of F

undi

ng

Standard Deviation

25% 3M, 25% 5Y, 25% 10Y, 25% 30Y

20% 3M, 20% 3Y, 20% 5Y, 20% 10Y, 20% 30Y


Liability Portfolio Efficient Frontier in a Falling Interest Rate Environment, Jan 1993 – Jul 2013,(Using Treasury Rates)


During periods of falling interest rates as observed in the US from 1991 to 2013, the issuer faces a tradeoff between lowest funding cost volatility (achieved by issuing long-term debt) and lowest funding cost (achieved by issuing short-term debt).


20% 3M, 80% 20Y

90% 3M, 10% 20Y

80% 3M, 20% 20Y

70% 3M, 30% 20Y

60% 3M, 40% 20Y

50% 3M, 50% 20Y

40% 3M, 60% 20Y

30% 3M, 70% 20Y

100% 3-Month

100% 3-Year

100% 5-Year

100% 10-Year100% 20-Year

4.80%

4.90%

5.00%

5.10%

5.20%

5.30%

5.40%

5.50%

5.60%

5.70%

5.80%

5.90%

1.25% 1.45% 1.65% 1.85% 2.05% 2.25% 2.45% 2.65% 2.85% 3.05% 3.25%

Cost

of F

undi

ng

Standard Deviation

25% 3M, 25% 5Y, 25% 10Y, 25% 20Y

20% 3M, 20% 3Y,20% 5Y, 20% 10Y, 20% 20Y


Liability Portfolio Efficient Frontier in a Mixed Interest Rate Environment, Apr 1953 – Jul 2013,(Using Treasury Rates)


During periods of both rising and falling interest rates as observed in the US from 1953 to 2013, the issuer faces a tradeoff similar to a falling interest rate environment. As such, the efficient frontier consists of a barbell strategy of 3M and 20Y instruments (except for the 100% 20-Year point).

Efficient Frontier


Liability Portfolio Efficient Frontier, May 1994 – Jul 2013,(Using Shock-Adjusted SWAP Rates)

Source: Bloomberg, calculations by Ramirez & Co.


Using shock-adjusted SWAP rates (500 bps in September 2008 – September 2009), the barbell strategy moves away from the efficient frontier. The evenly distributed 3M, 5Y, and 20Y portfolio is exactly on the efficient frontier. This observation suggests that the 3M, 5Y, and 20Y instruments may be the principle instruments in determining the efficient frontier. 100% 3-Month

100% 3-Year

100% 5-Year

100% 10-Year

100% 20-Year

10% 3M, 10% 5Y, 80% 20Y

20% 3M, 10% 5Y, 70% 20Y

20% 3M, 20% 5Y, 60% 20Y

50% 3M, 40% 5Y, 10% 20Y

60% 3M, 40% 5Y

80% 3M, 20% 5Y90% 3M, 10% 5Y

3.50%

4.00%

4.50%

5.00%

5.50%

6.00%

6.50%

7.00%

7.50%

8.00%

8.50%

0.00% 0.50% 1.00% 1.50% 2.00% 2.50%

Cost

of F

undi

ng

Standard Deviation

20% 3M, 20% 3Y, 20% 5Y, 20% 10Y, 20% 20Y

25% 3M, 25% 5Y, 25% 10Y, 25% 20Y

Debt Portfolio (% Floating)

Floating Debt ($ Mil)

Fixed Rate Debt ($ Mil)

Consensus EPS FY13 ($ per Share)

FY13E EPS($ per Share) % Change

FY13E EPS ($ per Share) % Change

10.30 541.6 4,718.9 2.44 2.40 -1.61 2.36 -3.22

0.00 0.0 5,260.5 2.37 2.37 0.00 2.37 0.0010.00 526.1 4,734.5 2.44 2.40 -1.57 2.36 -3.1320.00 1,052.1 4,208.4 2.51 2.43 -3.05 2.35 -6.1030.00 1,578.2 3,682.4 2.57 2.46 -4.45 2.35 -8.9040.00 2,104.2 3,156.3 2.64 2.49 -5.78 2.34 -11.5650.00 2,630.3 2,630.3 2.71 2.52 -7.04 2.33 -14.0860.00 3,156.3 2,104.2 2.78 2.55 -8.24 2.32 -16.4870.00 3,682.4 1,578.2 2.85 2.58 -9.38 2.31 -18.7780.00 4,208.4 1,052.1 2.92 2.61 -10.47 2.31 -20.9490.00 4,734.5 526.1 2.99 2.64 -11.51 2.30 -23.02100.00 5,260.5 0.0 3.06 2.67 -12.50 2.29 -25.00

3M LIBOR +1 Standard Deviation = 2.86% 3M LIBOR +2 Standard Deviations = 5.45%

EPS Sensitivity Under Varying Funding Scenarios

2013 EPS Estimate vs. % Floating Rate Debt Mix Under Varying 3-Month LIBOR Assumptions

Source: Company Filings, Bloomberg.

Floating rate debt generally provides firms with lower cost of funding during upward-sloping yield curve environments, however, issuing floating-rate debt leaves firms with added cash flow volatility

With 3-Month LIBOR near its all-time lows, assuming a one standard deviation move up in LIBOR still makes floating-rate debt appear relatively more attractive

Note: 3-Month LIBOR standard deviation calculated based on 25-years of historical data.Variable borrowing spread of 20 bps used; weighted-average borrowing cost on WEC variable-rate LT debt as of 12/31/12.2013 Consensus EPS and weighted average long-term cost of funding figures as per Bloomberg.

Issuing 30Y vs. 10Y Plus 20Y

Currently, 10Y, 20Y and 30Y Single A rated Utility yields are 3.59%, 4.64% and 4.54%, respectively.If the 20Y rate increases to 5.67% and beyond in 10 years, a current 30Y funding would be more cost efficient.This represents an 103 bps increase from today’s 20Y level.

30Y Financing vs. 10Y and Subsequent 20Y: Break-Even Rates

Source: Bloomberg, Ramirez & Co. estimates.Note: Based on indicative data for the Utilities index, the Company’s yields may be different.

Cash FlowDiscount Rate

(30Y Coupon Yield) DCF Cash FlowDiscount Rates (Bootstrapped) DCF

1 $3.59 4.54% $3.43 $3.59 0.38% $3.582 3.59 4.54% 3.29 3.59 0.71% 3.543 3.59 4.54% 3.14 3.59 1.13% 3.474 3.59 4.54% 3.01 3.59 1.61% 3.375 3.59 4.54% 2.88 3.59 2.06% 3.246 3.59 4.54% 2.75 3.59 2.46% 3.107 3.59 4.54% 2.63 3.59 2.86% 2.958 3.59 4.54% 2.52 3.59 3.27% 2.789 3.59 4.54% 2.41 3.59 3.54% 2.6210 3.59 4.54% 2.30 3.59 3.84% 2.4611 5.43 4.54% 3.34 5.67 4.02% 3.6812 5.43 4.54% 3.19 5.67 4.20% 3.4613 5.43 4.54% 3.05 5.67 4.38% 3.2514 5.43 4.54% 2.92 5.67 4.56% 3.0415 5.43 4.54% 2.79 5.67 4.74% 2.8316 5.43 4.54% 2.67 5.67 4.84% 2.6617 5.43 4.54% 2.56 5.67 4.94% 2.5018 5.43 4.54% 2.45 5.67 5.03% 2.3419 5.43 4.54% 2.34 5.67 5.13% 2.1920 5.43 4.54% 2.24 5.67 5.23% 2.0521 5.43 4.54% 2.14 5.67 5.19% 1.9622 5.43 4.54% 2.05 5.67 5.15% 1.8823 5.43 4.54% 1.96 5.67 5.11% 1.8024 5.43 4.54% 1.87 5.67 5.07% 1.7325 5.43 4.54% 1.79 5.67 5.02% 1.6726 5.43 4.54% 1.71 5.67 4.98% 1.6027 5.43 4.54% 1.64 5.67 4.94% 1.5428 5.43 4.54% 1.57 5.67 4.90% 1.4929 5.43 4.54% 1.50 5.67 4.86% 1.4330 105.43 4.54% 27.86 105.67 4.82% 25.76

$100.00 $100.00

Interest Rates Scenarios

Reverting to the Mean, 10Y Horizon Neutral, 10Y Horizon

From 1984 to the present, corporate yields have trended down at an approximate rate of 20 bps per year. Mean-reversion of rates would suggest that the likelihood of an increase of over 103 bps in long-term rates is approximately 66%

With zero trend, the likelihood of an over increase over 103 bps is around 30%

Source: Ramirez & Co. estimates.Note: Based on volatility of 3.09% per month (10.71% annualized), per ML BBB/A 15+ Industrial Index.

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

22%

24%

Jan-

13Ju

l-13

Jan-

14Ju

l-14

Jan-

15Ju

l-15

Jan-

16

Jul-1

6Ja

n-17

Jul-1

7Ja

n-18

Jul-1

8Ja

n-19

Jul-1

9Ja

n-20

Jul-2

0

Jan-

21Ju

l-21

Jan-

22Ju

l-22

Jan-

23Ju

l-23

Yiel

d (%

)

Simulated Path Trend 20 bps pa +2 StDev -2 StDev

Probability of Rate Increase by Over 103.0 bps: 66.1%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

22%

24%

Jan-

13

Jul-1

3Ja

n-14

Jul-1

4

Jan-

15Ju

l-15

Jan-

16Ju

l-16

Jan-

17Ju

l-17

Jan-

18Ju

l-18

Jan-

19

Jul-1

9Ja

n-20

Jul-2

0Ja

n-21

Jul-2

1Ja

n-22

Jul-2

2Ja

n-23

Jul-2

3

Yiel

d (%

)Simulated Path Trend 0 bps pa +2 StDev -2 StDev


Interest Rates Scenarios (Cont’d)

High Inflation, 10Y Horizon

While inflation does not seem to be an immediate threat, a number of factors suggest that it may be a future threat

Inflated Fed balance sheet High commodity prices (e.g. gold and oil)

Source: Ramirez & Co. estimates.Note: Based on volatility of 3.09% per month (10.71% annualized), per ML BBB/A 15+ Industrial Index.

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

22%

24%

Jan-

13Ju

l-13

Jan-

14Ju

l-14

Jan-

15Ju

l-15

Jan-

16

Jul-1

6Ja

n-17

Jul-1

7Ja

n-18

Jul-1

8Ja

n-19

Jul-1

9Ja

n-20

Jul-2

0

Jan-

21Ju

l-21

Jan-

22Ju

l-22

Jan-

23Ju

l-23

Yiel

d (%

)

Simulated Path Trend 50 bps pa +2 StDev -2 StDev



Market

Short-Term Interest Rates

Page 30

0%

5%

10%

15%

20%

25%

Jan-

54Ju

n-55

Nov

-56

Apr-5

8Se

p-59

Feb-

61Ju

l-62

Dec-

63M

ay-6

5O

ct-6

6M

ar-6

8Au

g-69

Jan-

71Ju

n-72

Nov

-73

Apr-7

5Se

p-76

Feb-

78Ju

l-79

Dec-

80M

ay-8

2O

ct-8

3M

ar-8

5Au

g-86

Jan-

88Ju

n-89

Nov

-90

Apr-9

2Se

p-93

Feb-

95Ju

l-96

Dec-

97M

ay-9

9O

ct-0

0M

ar-0

2Au

g-03

Jan-

05Ju

n-06

Nov

-07

Apr-0

9Se

p-10

Feb-

12

US Recession UST 3M LIBOR 3M Central Bank Target Rate

Short-term rates decline during recessions

US Treasury Rates

5Y T-Note Yield, Apr 1953 – Jun 2013

3M T-Bill Yield, Jan 1954 – Jun 2013 3Y T-Note Yield, Apr 1953 – Jun 2013

Source: Ramirez & Co. calculations, Federal Reserve, Bloomberg.

Note: The data start on Jan 1954 for the 3M UST

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

14.0

%13

.0%

12.0

%11

.0%

10.0

%9.

0%8.

0%7.

0%6.

0%5.

0%4.

0%3.

0%2.

0%1.

0%0.

0%-1

.0%

-2.0

%-3

.0%

-4.0

%

Freq

uenc

y

June 2013: 0.04% Mean: 4.77%Median: 4.69%Standard Deviation: 3.04%Kurtosis: 1.13%Skewness: 0.81%

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

16.0

%15

.0%

14.0

%13

.0%

12.0

%11

.0%

10.0

%9.

0%8.

0%7.

0%6.

0%5.

0%4.

0%3.

0%2.

0%1.

0%0.

0%-1

.0%

-2.0

%-3

.0%

-4.0

%

Freq

uenc

y


0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

17.0

%16

.0%

15.0

%14

.0%

13.0

%12

.0%

11.0

%10

.0%

9.0%

8.0%

7.0%

6.0%

5.0%

4.0%

3.0%

2.0%

1.0%

0.0%

-1.0

%-2

.0%

-3.0

%

Freq

uenc

y


US Treasury Rates (Cont.)10Y T-Note Yield, Apr 1953 – Jun 2013 20Y T-Bond Yield, Apr 1953 – Jun 2013


Note: Data for the 30Y UST are not available for Mar 02 – Jan 06. For this period Bloomberg substitutes CUSIP 912810FP, issued 2/15/01 with maturity date 2/15/31. Moreover, data for the 30Y are not available for Apr 53 – Mar 77.

Note: Data for the 20Y UST are not available for Jan 87 – Sep 93. We compute the missing data by linearly interpolating the 10Y and the 30Y. No data available for June 2013 as of July 1, 2013.

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%16

.0%

15.0

%

14.0

%

13.0

%

12.0

%

11.0

%

10.0

%

9.0%

8.0%

7.0%

6.0%

5.0%

4.0%

3.0%

2.0%

1.0%

0.0%

-1.0

%

Freq

uenc

y

June 2013: 3.40%Median: 6.88%Standard Deviation: 2.76%Kurtosis: -0.19%Skewness: 0.66%

Mean: 7.20%

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

15.5

%

14.5

%

13.5

%12

.5%

11.5

%

10.5

%9.

5%

8.5%

7.5%

6.5%

5.5%

4.5%

3.5%

2.5%

1.5%

0.5%

-0.5

%-1

.5%

-2.5

%

Freq

uenc

y


30Y T-Bond Yield, Feb 1977 – Jun 2013

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

16.0

%

15.0

%

14.0

%

13.0

%

12.0

%

11.0

%

10.0

%

9.0%

8.0%

7.0%

6.0%

5.0%

4.0%

3.0%

2.0%

1.0%

0.0%

-1.0

%

Freq

uenc

y


US Treasury Spreads

10Y – 5Y, Apr 1953 – Jun 2013

3Y – 3M, Jan 1954 – Jun 2013 10Y – 3Y, Apr 1953 – Jun 2013


0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

1.60

%

1.45

%

1.30

%

1.15

%

1.00

%

0.85

%

0.70

%

0.55

%

0.40

%

0.25

%

0.10

%

-0.0

5%

-0.2

0%

-0.3

5%

-0.5

0%

-0.6

5%

-0.8

0%

-0.9

5%

Freq

uenc

y

June 2013: 1.10%Mean: 0.29%Median: 0.20%Standard Deviation: 0.41%Kurtosis: 0.18%Skewness: 0.74%

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

10.00%

2.70

%2.

50%

2.30

%2.

10%

1.90

%1.

70%

1.50

%1.

30%

1.10

%0.

90%

0.70

%0.

50%

0.30

%0.

10%

-0.1

0%-0

.30%

-0.5

0%-0

.70%

-0.9

0%-1

.10%

-1.3

0%-1

.50%

Freq

uenc

y

June 2013: 1.72%Mean: 0.52%Median: 0.38%Standard Deviation: 0.68%Kurtosis: -0.02%Skewness: 0.68%

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

3.30

%

3.00

%

2.70

%

2.40

%

2.10

%

1.80

%

1.50

%

1.20

%

0.90

%

0.60

%

0.30

%

0.00

%

-0.3

0%

-0.6

0%

-0.9

0%

-1.2

0%

Freq

uenc

y


US Treasury Spreads (Cont.)

30Y – 20Y, Feb 1977 – Jun 2013

20Y – 10Y, Apr 1953 – Jun 2013 30Y – 10Y, Feb 1977 – Jun 2013


0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

10.00%

1.60

%

1.45

%

1.30

%

1.15

%

1.00

%

0.85

%

0.70

%

0.55

%

0.40

%

0.25

%

0.10

%

-0.0

5%

-0.2

0%

-0.3

5%

-0.5

0%

-0.6

5%

-0.8

0%

Freq

uenc

y

June 2013: 1.11% Mean: 0.33%Median: 0.26%Standard Deviation: 0.42%Kurtosis: -0.27%Skewness: 0.39%

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

10.00%

1.60

%1.

45%

1.30

%1.

15%

1.00

%0.

85%

0.70

%0.

55%

0.40

%0.

25%

0.10

%-0

.05%

-0.2

0%-0

.35%

-0.5

0%-0

.65%

-0.8

0%-0

.95%

-1.1

0%

Freq

uenc

y

June 2013: 0.78%Mean: 0.22%Median: 0.17%Standard Deviation: 0.41%Kurtosis: 1.26%Skewness: -0.01%

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

10.00%

1.10

%1.

00%

0.90

%0.

80%

0.70

%0.

60%

0.50

%0.

40%

0.30

%0.

20%

0.10

%0.

00%

-0.1

0%-0

.20%

-0.3

0%-0

.40%

-0.5

0%-0

.60%

-0.7

0%-0

.80%

-0.9

0%-1

.00%

-1.1

0%

Freq

uenc

y

June 2013: 0.33%Mean: -0.02%Median: -0.01%Standard Deviation: 0.34%Kurtosis: 1.90%Skewness: -0.23%

US Treasury Spreads

Page 35

-3

-2

-1

0

1

2

3

4

5

Apr-5

3

Apr-5

5

Apr-5

7

Apr-5

9

Apr-6

1

Apr-6

3

Apr-6

5

Apr-6

7

Apr-6

9

Apr-7

1

Apr-7

3

Apr-7

5

Apr-7

7

Apr-7

9

Apr-8

1

Apr-8

3

Apr-8

5

Apr-8

7

Apr-8

9

Apr-9

1

Apr-9

3

Apr-9

5

Apr-9

7

Apr-9

9

Apr-0

1

Apr-0

3

Apr-0

5

Apr-0

7

Apr-0

9

Apr-1

1

Apr-1

3

US Recession 10Y-3M 10Y-3Y 20Y-10Y 30Y-10Y

Conventional wisdom suggests that the yield curve flattens before a recession, and steepens during one

LIBOR Rates and SpreadsLIBOR 3M, Dec 1984 – Jun 2013 LIBOR – UST 3M Spread, Dec 1984 – Jun 2013


0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

14.0

%13

.0%

12.0

%11

.0%

10.0

%9.

0%8.

0%7.

0%6.

0%5.

0%4.

0%3.

0%2.

0%1.

0%0.

0%-1

.0%

-2.0

%-3

.0%

-4.0

%

Freq

uenc

y

June 2013: 0.27%

Median: 6.88%Standard Deviation: 2.76%Kurtosis: -0.19%Skewness: 0.66%

Mean: 4.50%

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

16.00%

18.00%

20.00%

1.9%

1.7%

1.5%

1.3%

1.1%

0.9%

0.7%

0.5%

0.3%

0.1%

-0.1

%

-0.3

%

-0.5

%

-0.7

%

Freq

uenc

y


LIB

OR

– U

ST 3

M S

prea

d

-0.5

0

0.5

1

1.5

2

2.5

3

3.5

Dec-

84

Jun-

86

Dec-

87

Jun-

89

Dec-

90

Jun-

92

Dec-

93

Jun-

95

Dec-

96

Jun-

98

Dec-

99

Jun-

01

Dec-

02

Jun-

04

Dec-

05

Jun-

07

Dec-

08

Jun-

10

Dec-

11

Jun-

13

Note: US Recession periods in gray

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

Inte

rest

Rat

es (%

)

Recession Fed 3M Libor 10Y Swap

Velocity of Interest Rates3M Libor and Fed Funds Target Rate vs. 10Y Swap

Source: Bloomberg.

Short-term rates may increase rapidly as the economy recovers

Following the Fed’s tightening cycle in 2004, short-term rates increased approximately 440 bps in 27 months

peak - trough 331 bps in 1 yr and 10 mos, 180.5 bps/yr

peak - trough 184.3 bps in 1 yr and 8 mos, 110.4 bps/yr

peak - trough 437 bps in 2 yrs and 3 mos, 194.2 bps/yr

Note: Peak to trough LIBOR

Moody’s Corporate Bond Yields

Page 38

Moody’s Aaa (30Y), Apr 1953 – Jun 2013 Moody’s Baa (30Y), Apr 1953 – Jun 2013

Moody’s Aaa Spread vs UST 30Y, Feb 1977 – Jun 2013 Moody’s Baa Spread vs UST 30Y, Feb 1977 – Jun 2013

Note: Credit ratings are for bonds with maturities as close to 30 yrs as possible and no sooner than 20 yrs.

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

18.0

%17

.0%

16.0

%15

.0%

14.0

%13

.0%

12.0

%11

.0%

10.0

%9.

0%8.

0%7.

0%6.

0%5.

0%4.

0%3.

0%2.

0%1.

0%0.

0%-1

.0%

Freq

uenc

y


0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

16.0

%

15.0

%

14.0

%

13.0

%

12.0

%

11.0

%

10.0

%

9.0%

8.0%

7.0%

6.0%

5.0%

4.0%

3.0%

2.0%

1.0%

0.0%

-1.0

%

Freq

uenc

y


0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

2.20

%

2.00

%

1.80

%

1.60

%

1.40

%

1.20

%

1.00

%

0.80

%

0.60

%

0.40

%

0.20

%

0.00

%

-0.2

0%

-0.4

0%

Freq

uenc

y


0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

4.50

%

4.20

%

3.90

%

3.60

%

3.30

%

3.00

%

2.70

%

2.40

%

2.10

%

1.80

%

1.50

%

1.20

%

0.90

%

0.60

%

0.30

%

0.00

%

-0.3

0%

Freq

uenc

y


Inflation Indicators

Page 39

US HCPI Inflation, Apr 1953 – May 2013 US CCPI Inflation, Feb 1957 – May 2013

Note: CCPI Inflation is defined as HCPI excluding food and energy.

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

16.00%

18.00%

20.00%

17.0

%

15.0

%

13.0

%

11.0

%

9.0%

7.0%

5.0%

3.0%

1.0%

-1.0

%

-3.0

%

-5.0

%

-7.0

%

Freq

uenc

y


0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

14.0

%13

.0%

12.0

%11

.0%

10.0

%9.

0%8.

0%7.

0%6.

0%5.

0%4.

0%3.

0%2.

0%1.

0%0.

0%-1

.0%

-2.0

%-3

.0%

-4.0

%-5

.0%

-6.0

%

Freq

uenc

y

Mean: 3.84%Median: 3.66%Standard Deviation: 3.23%Kurtosis: 3.16%Skewness: 1.44%

June 2013: 2.43%

Treasury Inflation Protected Securities (TIPS)

Page 40

TIPS 5Y, Jul 1997 – Jun 2013 TIPS 10Y, Jan 1997 – Jun 2013

TIPS 30Y (Calculated), Jan 1999 – Jun 2013

Note: TIPS 30Y calculated as the difference between UST 30Y and the 30Y breakeven index as reported by Bloomberg.

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

6.5%

6.0%

5.5%

5.0%

4.5%

4.0%

3.5%

3.0%

2.5%

2.0%

1.5%

1.0%

0.5%

0.0%

-0.5

%

-1.0

%

-1.5

%

-2.0

%

Freq

uenc

y

June 2013: 0.46%Mean: 2.16%Median: 2.10%

Standard Deviation: 1.35%

Kurtosis: -0.53%

Skewness: -0.39%

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

16.00%

18.00%

20.00%

5.6%

5.2%

4.8%

4.4%

4.0%

3.6%

3.2%

2.8%

2.4%

2.0%

1.6%

1.2%

0.8%

0.4%

0.0%

-0.4

%

Freq

uenc

y

June 2013: 1.20%Mean: 2.33%Median: 2.17%Standard Deviation: 0.98%Kurtosis: -0.42%Skewness: 0.12%

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

6.5%

6.0%

5.5%

5.0%

4.5%

4.0%

3.5%

3.0%

2.5%

2.0%

1.5%

1.0%

0.5%

0.0%

-0.5

%-1

.0%

-1.5

%-2

.0%

-2.5

%-3

.0%

Freq

uenc

y

June 2013: -0.42%Mean: 1.60%Median: 1.41%Standard Deviation: 1.65%Kurtosis: -0.95%Skewness: -0.22%

Computed UST Real Rates

Page 41

CCPI Adjusted 3M Real Rate, Feb 1957 – Jun 2013

HCPI Adjusted 3Y Real Rate, Apr 1953 – Jun 2013 CCPI Adjusted 3Y Real Rate, Feb 1957 – Jun 2013

HCPI Adjusted 3M Real Rate, Jan 1954 – Jun 2013

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

13.0

%12

.0%

11.0

%10

.0%

9.0%

8.0%

7.0%

6.0%

5.0%

4.0%

3.0%

2.0%

1.0%

0.0%

-1.0

%-2

.0%

-3.0

%-4

.0%

-5.0

%-6

.0%

-7.0

%-8

.0%

-9.0

%-1

0.0%

Freq

uenc

y

June 2013: -6.13% Mean: 1.02%Median: 1.29%Standard Deviation: 3.48%Kurtosis: 2.61%Skewness: -0.05%

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

10.0

%

9.0%

8.0%

7.0%

6.0%

5.0%

4.0%

3.0%

2.0%

1.0%

0.0%

-1.0

%

-2.0

%

-3.0

%

-4.0

%

-5.0

%

-6.0

%

-7.0

%

Freq

uenc

y


June 2013: -2.38%

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

13.5

%12

.5%

11.5

%10

.5%

9.5%

8.5%

7.5%

6.5%

5.5%

4.5%

3.5%

2.5%

1.5%

0.5%

-0.5

%-1

.5%

-2.5

%-3

.5%

-4.5

%-5

.5%

-6.5

%-7

.5%

-8.5

%

Freq

uenc

y

June 2013: -5.60% Mean: 1.85%Median: 2.10%Standard Deviation: 3.68%Kurtosis: 2.70%Skewness: -0.12%

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

10.00%

12.0

%11

.0%

10.0

%9.

0%8.

0%7.

0%6.

0%5.

0%4.

0%3.

0%2.

0%1.

0%0.

0%-1

.0%

-2.0

%-3

.0%

-4.0

%-5

.0%

-6.0

%-7

.0%

Freq

uenc

y


June 2013: -1.86%

Computed UST Real Rates (cont.)

Page 42


0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

14.5

%

13.0

%

11.5

%

10.0

%

8.5%

7.0%

5.5%

4.0%

2.5%

1.0%

-0.5

%

-2.0

%

-3.5

%

-5.0

%

-6.5

%

-8.0

%

-9.5

%

Freq

uenc

y

Mean: 2.12%Median: 2.38%Standard Deviation: 3.64%Kurtosis: 2.85%Skewness: -0.04%

June 2013: -4.97%

HCPI Adjusted 10Y Real Rate, Apr 1953 – Jun 2013

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

11.5

%10

.5%

9.5%

8.5%

7.5%

6.5%

5.5%

4.5%

3.5%

2.5%

1.5%

0.5%

-0.5

%-1

.5%

-2.5

%-3

.5%

-4.5

%-5

.5%

-6.5

%

Freq

uenc

y


June 2013: -1.23%

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

10.00%

14.5

%

13.0

%

11.5

%

10.0

%

8.5%

7.0%

5.5%

4.0%

2.5%

1.0%

-0.5

%

-2.0

%

-3.5

%

-5.0

%

-6.5

%

-8.0

%

Freq

uenc

y


June 2013: -3.88%

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

11.5

%

10.5

%

9.5%

8.5%

7.5%

6.5%

5.5%

4.5%

3.5%

2.5%

1.5%

0.5%

-0.5

%

-1.5

%

-2.5

%

-3.5

%

-4.5

%

-5.5

%

Freq

uenc

y


June 2013: -0.14%

CCPI Adjusted 10Y Real Rate, Feb 1957 – Jun 2013

Computed UST Real Rates (cont.)

Page 43


HCPI Adjusted 30Y Real Rate, Feb 1977 – Jun 2013 CCPI Adjusted 30Y Real Rate, Feb 1977 – Jun 2013

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

15.5

%

14.0

%

12.5

%

11.0

%

9.5%

8.0%

6.5%

5.0%

3.5%

2.0%

0.5%

-1.0

%

-2.5

%

-4.0

%

-5.5

%

-7.0

%

-8.5

%

Freq

uenc

y

June 2013: -3.10%Mean: 2.63%Median: 2.81%Standard Deviation: 3.59%Kurtosis: 3.29%Skewness: -0.09%

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

12.0

%11

.0%

10.0

%9.

0%8.

0%7.

0%6.

0%5.

0%4.

0%3.

0%2.

0%1.

0%0.

0%-1

.0%

-2.0

%-3

.0%

-4.0

%-5

.0%

-6.0

%

Freq

uenc

y


June 2013: 0.64%

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

10.00%

16.5

%

15.0

%

13.5

%

12.0

%

10.5

%

9.0%

7.5%

6.0%

4.5%

3.0%

1.5%

0.0%

-1.5

%

-3.0

%

-4.5

%

-6.0

%

-7.5

%

Freq

uenc

y

June 2013: -2.76% Mean: 3.27%Median: 3.36%Standard Deviation: 3.87%Kurtosis: 2.47%Skewness: 0.10%

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

12.0

%

11.0

%

10.0

%

9.0%

8.0%

7.0%

6.0%

5.0%

4.0%

3.0%

2.0%

1.0%

0.0%

-1.0

%

-2.0

%

-3.0

%

-4.0

%

Freq

uenc

y


June 2013: 0.98%

HCPI vs CCPI Adjusted Real Rates

Page 44

HCPI Adjusted 10Y Real Rate, Jan 1997 – Jun 2013 CCPI Adjusted 10Y Real Rate, Jan 1997 – Jun 2013

TIPS 10Y, Jan 1997 – Jun 2013

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

6.5%

6.0%

5.5%

5.0%

4.5%

4.0%

3.5%

3.0%

2.5%

2.0%

1.5%

1.0%

0.5%

0.0%

-0.5

%

-1.0

%

-1.5

%

-2.0

%

Freq

uenc

y

June 2013: 0.45%Mean: 2.16%Median: 2.10%

Standard Deviation: 1.35%

Kurtosis: -0.53%

Skewness: -0.39%

For the period during which the TIPS 10Y is available the mean and standard deviation of the CCPI adjusted rate are 2.18% and 1.44% respectively.

This is a divergence of 2 percentage points from the TIPS mean and 9 percentage points from the TIPS standard deviation. In contrast to the HCPI adjusted rate, this represents a better estimation of the real rate.

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

6.50

%

6.00

%

5.50

%

5.00

%

4.50

%

4.00

%

3.50

%

3.00

%

2.50

%

2.00

%

1.50

%

1.00

%

0.50

%

0.00

%

-0.5

0%

-1.0

0%

-1.5

0%

-2.0

0%

Freq

uenc

y

Mean: 2.18%Median: 2.29%Standard Deviation: 1.44%Kurtosis: -0.44%Skewness: -0.25%

June 2013: -0.14%

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

10.00%

14.5

%

13.0

%

11.5

%

10.0

%

8.5%

7.0%

5.5%

4.0%

2.5%

1.0%

-0.5

%

-2.0

%

-3.5

%

-5.0

%

-6.5

%

-8.0

%

Freq

uenc

y


June 2013: -3.88%

CCPI Adjusted UST Real Rates

Page 45

-15

-10

-5

0

5

10

15

20

Feb-

57

Feb-

59

Feb-

61

Feb-

63

Feb-

65

Feb-

67

Feb-

69

Feb-

71

Feb-

73

Feb-

75

Feb-

77

Feb-

79

Feb-

81

Feb-

83

Feb-

85

Feb-

87

Feb-

89

Feb-

91

Feb-

93

Feb-

95

Feb-

97

Feb-

99

Feb-

01

Feb-

03

Feb-

05

Feb-

07

Feb-

09

Feb-

11

Feb-

13

US Recession CCPI 10Y CCPI 3M CCPI 20Y CCPI 30Y


Market

GDP Growth, Jun 1953 – Mar 2013

Page 47

Note: All GDP data are quarterly.

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

15.0

%14

.0%

13.0

%12

.0%

11.0

%10

.0%

9.0%

8.0%

7.0%

6.0%

5.0%

4.0%

3.0%

2.0%

1.0%

0.0%

-1.0

%-2

.0%

-3.0

%-4

.0%

-5.0

%-6

.0%

-7.0

%-8

.0%

Freq

uenc

y


March 2013: 1.80%

S&P 500 Earnings

Page 48

S&P 500 Nominal Earnings YoY, Dec 1954 – Dec 2012

S&P 500 Real Earnings YoY (HCPI Adjusted), Dec 1954 – Dec 2012 S&P 500 Real Earnings YoY (CCPI Adjusted) , Dec 1958 – Dec 2012

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

10.00%

52.0

%48

.0%

44.0

%40

.0%

36.0

%32

.0%

28.0

%24

.0%

20.0

%16

.0%

12.0

%8.

0%4.

0%0.

0%-4

.0%

-8.0

%-1

2.0%

-16.

0%-2

0.0%

-24.

0%-2

8.0%

-32.

0%-3

6.0%

Freq

uenc

y

December 2012: 2.21% Mean: 7.50%Median: 7.75%Standard Deviation: 15.29%Kurtosis: 0.51%Skewness: -0.10%

0.00%1.00%2.00%3.00%4.00%5.00%6.00%7.00%8.00%9.00%

10.00%11.00%12.00%13.00%14.00%15.00%

52.8

%48

.6%

44.4

%40

.2%

36.0

%31

.8%

27.6

%23

.4%

19.2

%15

.0%

10.8

%6.

6%2.

4%-1

.8%

-6.0

%-1

0.2%

-14.

4%-1

8.6%

-22.

8%-2

7.0%

-31.

2%-3

5.4%

-39.

6%

Freq

uenc

y

December 2012: 0.50%Mean: 3.59%Median: 4.54%Standard Deviation: 14.81%Kurtosis: 0.38%Skewness: 0.00%

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

49.0

%45

.0%

41.0

%37

.0%

33.0

%29

.0%

25.0

%21

.0%

17.0

%13

.0%

9.0%

5.0%

1.0%

-3.0

%-7

.0%

-11.

0%-1

5.0%

-19.

0%-2

3.0%

-27.

0%-3

1.0%

Freq

uenc

y

December 2012: 0.31% Mean: 3.94%Median: 5.43%Standard Deviation: 14.94%Kurtosis: 0.56%Skewness: -0.13%

S&P 500 P/E Multiples

Page 49

Trailing P/E, Jan 1954 – Jun 2013 Current P/E, Jan 2006 – Jun 2013

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

32.0

30.0

28.0

26.0

24.0

22.0

20.0

18.0

16.0

14.0

12.0

10.08.0

6.0

4.0

2.0

Freq

uenc

y

June 2013: 15.69 Mean: 16.36Median: 16.46Standard Deviation: 4.92Kurtosis: -0.01Skewness: 0.36

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

18.5

18.0

17.5

17.0

16.5

16.0

15.5

15.0

14.5

14.0

13.5

13.0

12.5

12.0

11.5

11.0

10.5

Freq

uenc

y


Next Year P/E, Jan 2006 – Jun 2013

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

25.5

24.0

22.5

21.0

19.5

18.0

16.5

15.0

13.5

12.0

10.59.0

7.5

6.0

4.5

3.0

1.5

0.0

-1.5

Freq

uenc

y


S&P 400 Earnings

Page 50

S&P 400 Nominal Earnings YoY, May 1993 – Jun 2012

S&P 400 Real Earnings YoY (HCPI Adjusted), Dec 1993 – Dec 2012 S&P 400 Real Earnings YoY (CCPI Adjusted) , Dec 1993 – Dec 2012

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

67.5

%62

.5%

57.5

%52

.5%

47.5

%42

.5%

37.5

%32

.5%

27.5

%22

.5%

17.5

%12

.5%

7.5%

2.5%

-2.5

%-7

.5%

-12.

5%-1

7.5%

-22.

5%-2

7.5%

-32.

5%-3

7.5%

Freq

uenc

y

June 2013: 5.94% Mean: 11.97%Median: 12.73%Standard Deviation: 15.83%Kurtosis: 1.39%Skewness: -0.23%

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

62.0

%57

.2%

52.4

%47

.6%

42.8

%38

.0%

33.2

%28

.4%

23.6

%18

.8%

14.0

%9.

2%4.

4%-0

.4%

-5.2

%-1

0.0%

-14.

8%-1

9.6%

-24.

4%-2

9.2%

-34.

0%-3

8.8%

Freq

uenc

y


0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

61.6

%56

.8%

52.0

%47

.2%

42.4

%37

.6%

32.8

%28

.0%

23.2

%18

.4%

13.6

%8.

8%4.

0%-0

.8%

-5.6

%-1

0.4%

-15.

2%-2

0.0%

-24.

8%-2

9.6%

-34.

4%-3

9.2%

Freq

uenc

y


S&P 400 P/E Multiples

Page 51

Trailing P/E, Dec 1990 – Jun 2013 Current P/E, Jan 1995 – Jun 2013

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

10.00%

37.0

35.0

33.0

31.0

29.0

27.0

25.0

23.0

21.0

19.0

17.0

15.0

13.0

11.09.0

7.0

5.0

3.0

1.0

Freq

uenc

y

June 2013: 20.55 Mean: 19.09Median: 20.43Standard Deviation: 5.06Kurtosis: 1.77Skewness: -1.59

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

25.2

524

.50

23.7

523

.00

22.2

521

.50

20.7

520

.00

19.2

518

.50

17.7

517

.00

16.2

515

.50

14.7

514

.00

13.2

512

.50

11.7

511

.00

10.2

59.

50

Freq

uenc

y

June 2013: 18.10 Mean: 17.34Median: 17.37Standard Deviation: 2.30Kurtosis: -0.09Skewness: -0.21

Next Year P/E, 1995 – Jun 2013

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

21.5

0

20.7

5

20.0

0

19.2

5

18.5

0

17.7

5

17.0

0

16.2

5

15.5

0

14.7

5

14.0

0

13.2

5

12.5

0

11.7

5

11.0

0

10.2

5

9.50

8.75

8.00

Freq

uenc

y

June 2013: 15.46 Mean: 14.62Median: 14.93Standard Deviation: 1.92Kurtosis: -0.09Skewness: -0.48

0%

20%

40%

60%

80%

100%

120%

140%

160%

Jan-

03Ju

l-03

Jan-

04Ju

l-04

Jan-

05Ju

l-05

Jan-

06Ju

l-06

Jan-

07Ju

l-07

Jan-

08Ju

l-08

Jan-

09Ju

l-09

Jan-

10Ju

l-10

Jan-

11Ju

l-11

Jan-

12Ju

l-12

Jan-

13Ju

l-13

Stan

dard

Dev

iatio

n

US Recession PFG S&P 500 Life S&P 500 Prop

Components of Beta: Insurance Industry

Page 52

0.50.55

0.60.65

0.70.75

0.80.85

0.90.95

1

Jan-

03Ju

l-03

Jan-

04Ju

l-04

Jan-

05Ju

l-05

Jan-

06Ju

l-06

Jan-

07Ju

l-07

Jan-

08Ju

l-08

Jan-

09Ju

l-09

Jan-

10Ju

l-10

Jan-

11Ju

l-11

Jan-

12Ju

l-12

Jan-

13Ju

l-13

Corr

elati

on W

ith S

&P

500


1Y Daily Correlation, Jan 2003 – Jul 2013 1Y Daily Volatility (Annualized), Jan 2003 – Jul 2013

5Y Weekly Correlation, Oct 2006 – Jul 2013 5Y Weekly Volatility (Annualized), Oct 2006 – Jul 2013

Note: PFG went public on 10/31/01, therefore the calculated 5-yr corr. and st. dev. data begin 5 years hence in Oct 2006.Corr. and st. dev. calculated for the % change in list price at the end of the day for the frequency denoted (Daily, Weekly)

0.4

0.5

0.6

0.7

0.8

0.9

1

Oct

-06

Apr-0

7

Oct

-07

Apr-0

8

Oct

-08

Apr-0

9

Oct

-09

Apr-1

0

Oct

-10

Apr-1

1

Oct

-11

Apr-1

2

Oct

-12

Apr-1

3

Corr

elati

on W

ith S

&P

500


0%

10%

20%

30%

40%

50%

60%

70%

80%

Oct

-06

Apr-0

7

Oct

-07

Apr-0

8

Oct

-08

Apr-0

9

Oct

-09

Apr-1

0

Oct

-10

Apr-1

1

Oct

-11

Apr-1

2

Oct

-12

Apr-1

3

Stan

dard

Dev

iatio

n


0.000.501.001.502.002.503.003.504.004.50

Oct

-02

Apr-0

3

Oct

-03

Apr-0

4

Oct

-04

Apr-0

5

Oct

-05

Apr-0

6

Oct

-06

Apr-0

7

Oct

-07

Apr-0

8

Oct

-08

Apr-0

9

Oct

-09

Apr-1

0

Oct

-10

Apr-1

1

Oct

-11

Apr-1

2

Oct

-12

Apr-1

3

US Recession Correlation Relative Volatility Calculated Beta

PFG Deconstructed Rolling Beta

5Y Weekly, Oct 2006 – Present

Source: Bloomberg, Ramirez Calculations.Note: Corr. and st. dev. calculated for the % change in list price at the end of the day for the frequency denoted (Daily, Weekly) Relative Volatility defined as the ratio of the st. dev. of the change in stock price to the st. dev. of the change in the S&P500 Index.

0.000.501.001.502.002.503.003.504.00

Oct

-06

Apr-0

7

Oct

-07

Apr-0

8

Oct

-08

Apr-0

9

Oct

-09

Apr-1

0

Oct

-10

Apr-1

1

Oct

-11

Apr-1

2

Oct

-12

Apr-1

3

US Recession Correlation Relative Volatility Calculated Beta

1Y Daily, Oct 2002 – Present

Market

TargetMarket Target, DeviationStandard

DeviationStandardnCorrelatioBeta


Page 54

Pre-Crisis 1Y Daily Beta Components, Jan 2007 – Jan 2008 Current 1Y Daily Beta Components, Jul 2012 – Jul 2013

Note: Corr. and st. dev. calculated for the annualized % change in list price at the end of the day for the frequency denoted (Daily, Weekly)

0%

5%

10%

15%

20%

25%

30%

35%

40%

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

1.00

AFL

LNC

MET PFG PL

PRU

SFG

TMK

UNM AC

EAH

LAL

LCB

CIN

FFN

FM

CY ORI

PGR

THG

TRV

WRB XL

Variation

Corr

elati

on

Correlation Variation

Property InsuranceLife Insurance

0%

5%

10%

15%

20%

25%

30%

35%

40%

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

1.00

AFL

LNC

MET PFG PL

PRU

SFG

TMK

UNM AC

EAH

LAL

LCB

CIN

FFN

FM

CY ORI

PGR

THG

TRV

WRB XL

Variation

Corr

elati

on




Page 55

Pre-Crisis 5Y Weekly Beta Components, Jan 2003 – Jan 2008 Current 5Y Weekly Beta Components, Jul 2008 – Jul 2013

Note: Corr. and st. dev. calculated for the annualized % change in list price at the end of the day for the frequency denoted (Daily, Weekly)

0%

20%

40%

60%

80%

100%

120%

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

1.00

AFL

LNC

MET PFG PL

PRU

SFG

TMK

UNM AC

EAH

LAL

LCB

CIN

FFN

FM

CY ORI

PGR

THG

TRV

WRB XL

Variation

Corr

elati

on



0%

20%

40%

60%

80%

100%

120%

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

1.00

AFL

LNC

MET PFG PL

PRU

SFG

TMK

UNM AC

EAH

LAL

LCB

CIN

FFN

FM

CY ORI

PGR

THG

TRV

WRB XL

Variation

Corr

elati

on



Cost of Equity: Current Utility Betas

As would be expected, the median beta for a sampling of diversified utility companies is higher than the median beta for regulated utilities and lower than the median beta for selected E&P and merchant power companies.

2-Yr. Daily Betas, Jul 2011 – Jul 2013

5-Yr. Weekly Betas, Jul 2008 – Jul 2013

Source: Bloomberg.

50.1

241.

8

79.8

0

5

10

15

20

25

30

35

40

45

50

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

1.80

Market Cap ($, Bln)

Beta

Market Cap ($, Bln) 2-Year Beta +2 Standard Deviations -2 Standard Deviations

Diversif ied Utilities Median = 0.6

Regulated Utilities Median = 0.58

Selected E&P and Merchant Median = 0.96

241.

8

79.8

0

10

20

30

40

50

60

0.00

0.50

1.00

1.50

2.00

2.50

3.00

Market C

ap ($, Bln)

Beta

Market Cap ($, Bln) 5-Year Beta +2 Standard Deviations -2 Standard Deviations

Diversif ied Utilities Median = 0.69

Regulated Utilities Median = 0.5

Selected E&P and Merchant Median = 1.14

2-Yr. Daily Betas, Jul 2011 – Jul 2013

Cost of Equity: Leverage vs. Beta5-Yr. Weekly Betas, Jul 2008 – Jul 2013

Using MVL as a measure of leverage shows that there is correlation between levered beta and leverage in the utility space

Looking at 2-Yr. betas shows a lack of statistical relationship between market risk and leverage If MVL increases by 10%, 5-Yr. Beta increases by approximately 7 bps

Source: Bloomberg.

EXC AEE

FE

DTE

CNP

PNM

VVCD

EIX

ETR

NEEPEG

PPL

SRE

AEPCNL

CMS

ITC

WR

NVE

POR

WEC

GXP

NU

XEL

PNW

NST

SCG

UIL

DUK

EDPCG

y = 0.72x + 0.35R² = 0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

1.00

0.25 0.30 0.35 0.40 0.45 0.50 0.55 0.60

Beta

Market Value of Leverage (%)

EXC

AEE

FEDTE

CNP

PNM

VVC

D

EIX

ETRNEE

PEG

PPL

SRE

AEP

CNL

CMS

ITC

WR

NVE

POR

WEC

GXP

NU

XEL

PNWNST SCG

UIL

DUK

ED

PCG

y = 0.21x + 0.53R² = 0.01

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

1.00

0.25 0.30 0.35 0.40 0.45 0.50 0.55 0.60

Beta


2-Yr. Daily Unlevered Betas, Jul 2011 – Jul 2013

Cost of Equity: Unlevered Betas

5-Yr. Weekly Unlevered Betas, Jul 2008 – Jul 2013

Unlevering 5-Yr. Utility sector Betas produces coefficients that are close to zero, which suggests that calculating unlevered Beta fairly estimates the expected effect of leverage on Beta

BL = BU x [1+ (1-T) x (D/E)]

Source: Bloomberg.

EXC

AEE

FE

DTE

CNP

PNM

VVC

D

EIX

ETR

NEE

PEG

PPL

SRE

AEP

CNL

CMSITCWR

NVE

POR

WEC

GXPNU

XEL

PNW

NSTSCG

UILDUK

ED

PCG

y = -0.42x + 0.59R² = 0.10

0.20

0.25

0.30

0.35

0.40

0.45

0.50

0.55

0.60

0.65

0.25 0.30 0.35 0.40 0.45 0.50 0.55 0.60

Unle

vere

d Be

ta


EXCAEE

FE

DTE

CNP

PNM

VVC

D

EIX

ETR

NEE

PEG

PPL

SRE

AEP

CNL

CMS

ITC

WRNVEPOR

WEC

GXP

NU

XEL

PNW

NST

SCG

UIL

DUK

ED

PCG

y = -0.10x + 0.48R² = 0.00

0.20

0.25

0.30

0.35

0.40

0.45

0.50

0.55

0.60

0.65

0.25 0.30 0.35 0.40 0.45 0.50 0.55 0.60

Unle

vere

d Be

ta


July 2013

Documents

Transcript of July 2013