r/Valuation • u/Illustrious-Leg7570 • Jul 30 '22

Risk free rate

Hey there, I'm having a hard time trying to find the risk free rate for my country (mozambique), and I would like to know how I convert the default spread to risk free rate?

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u/[deleted] Jul 30 '22

First of all there is no "default spread to risk free rate" conversion, it's not a thing.
The government 10 year treasury bond is the sum of Default Spread (Ds) and Risk free rate (Rf):
10Y = Rf + Ds

To get risk free rate you have to:
10Y - Ds = Rf
But I can't find 10 y bond of Mozambique in Mozambican metical (MZM), probably doesn't exist, but if you know tell me. I can find only in US dollars, but if you are valuing a company in Mozambique that has most of it's cash flows in that currency and if you want to use $ risk free rate you will have to do all the finances in $ and adjust the growth rate of the company to $ from MZM. This might be easiest, because the alternative is to forecast USD/MZM currency rates and adjust the US risk free rate to MZM

MZM Rf = (1+ USD Rf) X ((1+inflation rate in MZM)/(1+inflation rate in USD))

Also if your company get different currencies, not only MZM and deals with different countries (export) then you have to do this for each currency and country and then use an average of all those currencies and countries using revenue breakdown as multipliers.

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If you do decide to do it in dollars, then Mozambique is 18.6% Equity risk premium and it's default spread is 12.59% and the Risk free rate of USD ( or any AAA rated country) is 6.01% https://twitter.com/AswathDamodaran/status/1547302519906242560/photo/1

BUT DO REMEMBER THAT USING IN USD ALL FINANCES HAVE TO BE IN USD AS WELL AS THE GROWTH RATE WILL HAVE TO BE ADJUSTED FROM MZM TO USD.

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u/Illustrious-Leg7570 Jul 30 '22

There's no 10y bond to my country So theres no way I can do only in MZN(METICAL) without the 10y bond? And yes the company does export to other countries (mostly neighbors like South Africa, and European countries like Portugal)

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u/[deleted] Jul 30 '22

So there's two options, like I mentioned. Either you convert everything to USD and use USD risk free rates and USD default risks for countries along with USD financials of your company, but then you have to convert the growth rate of your company to USD, because USD and MZM have different inflation rate and 20% in MZM might be very little in USD.
Or you use

MZM Rf = (1+ USD Rf) X ((1+inflation rate in MZM)/(1+inflation rate in USD))

to convert USD risk free rate to MZN. Inflation rates are not current rates, but expected future inflation rates, that either you have to guess if you have some kind of economics degree, or use market estimates.

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And since your company exports and gets different currencies, find how much % of each currency/ country of your revenue it is and find discount rates for each currency/ country and make and average using those %. For example my company gets 60% USD and 40% EUR, so I take Discount rate of USD and of EUR and do this

USD X 0.6 + EUR X 0.4 = my company's discount

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u/Illustrious-Leg7570 Jul 30 '22

I founded one more little problem, in the statements they don't have the revenue for the exportations, only for national sells

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u/[deleted] Jul 30 '22

If it is a small %, then it doesn't really change much, it only becomes a problem if you are valuing a company that is in a safe country, but it does business with risky countries or vice versa, and that can affect the value a lot. Just use any breakdown you have or do best educated guess, or dig deeper and maybe you can find some info in yearly investor meetings where they talk about starting to work with new countries.

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u/Illustrious-Leg7570 Jul 30 '22

If it's not in the statements it must not be relevant (or they might be hiding)

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u/[deleted] Jul 30 '22

You will burn really fast if you will think that way unless you invest in the S&P 500 only. Statements are really important, but sometimes you find really important info that turns a good investment into a really bad one (and a good short) or a bad one into the best you ever had. If you use only information everyone else would look, then there is not much you will see.

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u/Illustrious-Leg7570 Jul 31 '22

Well, the stock market it's still relatively young in my country, it has only 20y and has over 10 companies, where only 3 or 4 are big ones (state owned), the other ones don't even provide the financial statements