Valuation

As noted in the Overview of Yield Measures, there are no less than five different measures of yield used in the HIMIPref™ analytical system. These five elements are weighted through simulations (see the Simulations page) and scaled so that the combined relative weights of the yields is 1.0; this helps provide a physical meaning to the overall valuation and ensures that there will be a unique "best" set of parameters for the given set of portfolio constraints.

Absolute Yield

There is only a minor influence of this effect on total valuation, as shown in the graph.

Yield Curve Effects

There are two manners in which yield curve calculations influence the valuation of individual securities:

• through a prediction of how reversion to mean of the various yield curve factors will affect the price of the individual securities
• Through a determination of a "fair" price of the security based on its relationship to the curve

Yield Curve Reversion

As has been noted in the Overview of the Yield Curve Calculation, several possible risk factors that could influence a decision on the fair level of an instrument's yield are quantified by HIMIPref™. The fundamental assumption inherent in the Analytical Philosophy cannot be overstated:

The preferred share market is weakly efficient.

• It is assumed that a fair value for each instrument exists and is calculable by reference to similar instruments.
• It is presumed that divergences from this fair value will occur, but the market price for each instrument will not be too far from this fair value and will sometimes be higher, sometimes lower.

This assumption also applies to the risk components of the yield curve - it is assumed that "reversion to mean" is a sufficiently common phenomenon that valuation based on an assumption that each of these risk premia will revert to mean will, ultimately, lead to more gains than losses (provided, of course, that a sufficiently conservative level of likelihood is demanded prior to taking actual market action). Hence, for example, in an environment in which floating-rate issues are cheaper relative to the curve than they have been historically (i.e., the value of the floating rate premium is more positive or less negative than it has been historically), these issues will valued somewhat more highly than they would be otherwise.

It has been found, however, that "Yield Curve Reversion" has only a minor effect on overall valuation, as shown in the graph.

Disparity

"Disparity" is the name used to describe the intrument's relationship to the yield curve. Two tendencies are assumed to be at work when evaluating a projected influence of the current market situation on future returns:

• A tendency for the instrument's valuation to adjust so that it becomes fairly valued relative to its peers ("Spot" Disparity)
• A tendency to adjust so that its value relative to its peers approaches its historical levels ("Reversion" disparity)

"Reversion Disparity" accounts for the possibility that there is an element of valuation that is not accounted for in the programme; if, for instance, the market assigned discounts and premia to preferred share prices based on the industry of the issuer, irrespective of other attributes which are accounted for by HIMIPref™, we would expect to find that stocks would gravitate towards a point relative to the yield curve determined by the issuer's industry, rather than towards the yield curve itself, since industry classifications are not examined.

"Disparity" is calculated on both a price and yield basis and has a major influence on overall valuation, as shown in the graph.

Miscellaneous Effects

"Disparity" is the name used to describe the intrument's relationship to the yield curve. Two tendencies are assumed to be at work when evaluating a projected influence of the current market situation on future returns:

• A tendency for the instrument's valuation to adjust so that it becomes fairly valued relative to its peers ("Spot" Disparity)
• A tendency to adjust so that its value relative to its peers approaches its historical levels ("Reversion" disparity)

"Reversion Disparity" accounts for the possibility that there is an element of valuation that is not accounted for in the programme; if, for instance, the market assigned discounts and premia to preferred share prices based on the industry of the issuer, irrespective of other attributes which are accounted for by HIMIPref™, we would expect to find that stocks would gravitate towards a point relative to the yield curve determined by the issuer's industry, rather than towards the yield curve itself, since industry classifications are not examined.

A number of miscellaneous effects are examined by HIMIPref™ including "Dividend Capture", which measures the possibility that market prices do not fully reflect the effects of the passing of a dividend ex-date, and "Flat Price Reversion", measuring the significance of the possibility of market prices returning to historical levels.

A minor correlation can be observed in the graph.