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 FUNDAMENTAL ANALYSIS
British land and INTU were chosen as two of the most important competitors based
on market capitalization criteria, where British Land has a larger capitalization than
Hammerson, and INTU has a lower one.
1. Corporative news:
In Appendix 1.1 you will find a brief summary about the most important recent news
relating to the companies activities, which might affect the value of the companies’
shares for the upcoming years. Additionally the link to the most relevant news can be
found in this section.

2. Financial Statement Analysis:

Hammerson grew their rental income by 15.7% from £184m to £213m, while net
income improved by 107% from £337m to £699m. In addition, profitability ratios
showed impressive improvements especially in ROE and ROA compared with past
years. Moreover, Hammerson’s P/E ratio is the highest compared with other
competitors, which is a good indicator for potential higher earnings growth in the
future. It also has the highest earning yield of 14%. Hammerson kept a stable
dividend yield growth of 5%; dividends are paid twice per year and were in total
£20.4 pence per share.

All the financial information, profitability measures and investor ratios of HMSO and
its competitors can be found summarized in Appendix 1.2.

 RISK MANAGEMENT
1. Country Risk:
Broadly speaking, country risk involves the analysis of the country political and
economic stability, the credit worthiness of the country’s government, policies for
foreign direct investment, and many more aspects. However, for the scope of this
report and the nature of the investment a brief economic overview is sufficient.
Investing in the UK is a rewarding investment opportunity with an inflation of nearly
zero until March of 2015, low interest rates and trivial political risks. However, due to
the upcoming elections and to the lack of agreement among parties regarding their
policies toward staying in the European Union. It is advised to consider any
investment opportunity after the announcement of the election results, in order to

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avoid any volatility and fluctuations in the share price which could result in trading
losses without a genuine fundamental justification.

2. Industry Risk:
The industry risk is the one that the company face by the virtue of the industry they
are in. HMSO operates in the real estate investment trust (REIT) industry.
Taking into consideration a highly leveraged firm is common among this sector; and
an upward shift in interest rates might trigger additional borrowing costs which could
result in a reduction of profits and in limitations to make further investments.
It is important to notice that HMSO is partially hedging this risk by taking interest rate
swaps and attempting to increase the percentage of their fixed interest debts (more
on this in interest rate risk).
UK-REITs are tax exempted. Hence, any change in this tax exemption status would
damage the growth of the industry. A less obvious exposure threatening to limit the
growth of this industry is the increasing popularity of online shopping. Online multi-
purpose stores like eBay or Amazon, or market leaders that are adopting online
shopping services such as Marks and Spencer or Asda, might take away part of the
demand for physical outlets or shopping spaces. This would reduce the profits from
this specific sub-sector, which compromises a non-trivial proportion in REITs.

3. Investment Risk:
3.1. Market Interest Rate Risk:
This risk is defined by the impact of changes in the market interest rates on the
institution’s earnings or ability to borrow funds. Hammerson is exposed to this risk
because it depends on short-term borrowing to finance its acquisitions. Hammerson
uses derivatives and interest rate swaps to amend this risk. In addition, Hammerson
strategy is to fix at least 50% of its debt’s interest payments.Interest rate swaps
valued at £250m maturating in 2020, which will give Hammerson the opportunity to
hedge this risk for the coming medium term. In this way, 79% of Hammerson’s debts
are at fixed interest rate compared with 70% last year 2013.

3.2. Exchange Rate Risk:

The risk of an investment's value changing due to changes in currency exchange

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rates. Hammerson’s exposure to this risk arises due to its portfolio of retail properties
in France which occupies 27% of its portfolio. Furthermore, all the assets and
liabilities of foreign operations in Hammerson are exchanged into sterling at the
exchange rate of the date of the transaction. Subsequently, Hammerson uses
derivatives and loans in euros from French banks to mitigate the exposure to
exchange rate changes. In this way, 88% of these assets were hedged in 2014 .

3.3. Market Risk:

According to Basel committee “market risk is the risk that the value of the investment
will decrease due to movement in market factors”. A decrease in property prices or in
Hammerson’s share price is simple examples of this risk. Management efforts in
selective investments opportunities and choosing the right locations are one of the
ways that the company is seeking to limit its exposure.Over the last 4 years
Hammerson presented a total annual return of 10.4% and standard deviation of
1.355%. Hammerson almost always over-performed the return of benchmark FTSE
100 Index and its main competitors for the past three years.
The graph of the performance of these four securities from April 2011 to April 2015
can be found in (Appendix 2.1.1).
The dividend yield can be interpreted by the investor as a fixed return over a stock.
When a company has a high dividend yield, its sensitivity to changes in market
prices is lower. The average dividend yield of Hammerson for the last 4 years has
been 3.61%, lower than the one offered by their main competitors.
(Appendix 2.1.2) shows a summary of these statistics for Hammerson, its main
competitors and its benchmark.
3.3.1. Hedging using options:
A simple way an investor can reduce his exposure to market risk is by taking long
position in put options on Hammerson stock, a decrease in Hammerson shares price
would cause a loss for the investor, however, with the purchase of the put options
and exercising them a profit will result which will offset the loss incurred by the
capital losses. . Please refer to Appendix 2.2.1 to know the values of these figures
taken from the nearest put option contracts available for Hammerson
3.3.2. Value at Risk:
Value at Risk gives a single number in which are contained all the risks faced by a

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portfolio. In other words, “VaR is the loss level during a time period of length Ṭ that
we are X% certain will not be exceeded” (Hull, 2012). A more extreme risk measure
than VaR is Expected Shortfall, which is the projected level of losses given that the
losses are larger than the value at risk (Chance, Brooks, 2010). This measure gives
a value for the expected loss in the worst-case scenario. The historical simulation
approach was used in calculating the VaR and shortfall, it involves using the daily
changes of the price of Hammerson’s stock observed in the last four years to
estimate the probability distribution of the price change from today to tomorrow. In
this report the VaR for Hammerson is calculated using a one-day and one year time
horizon and 1044 days of data.

The time period chosen to calculate the VaR starts from 1/4/2011 until 1/4/2015, the
adjusted prices that are used are taken from Bloomberg. Holding all other equal, a
larger sample size gives more robust results. Moreover, 2011 was chosen as the
starting year under the assumption that financial markets had already recovered
from the financial crisis of 2008. Furthermore, the first two years of this period the
company’s performance was unstable compared to the last two years, where the
company showed steady and impressive improvement in its performance. Hence,
taking only the past couple of years would reflect a biased optimistic or under-
estimated VaR. With theoretical position of £100,000 we are 99% confident that the
investor will not lose more than £4,024, £63,874, in one day and one year
respectively, with corresponding shortfall of £4,756, £76,100 in one day and one
year as well. In addition to the procedure of equal weighting of observations,
weighted VaR grants recent observations more weight than older ones.

Another extension to historical VaR is Volatility Embedded VaR. Here the volatility of
the stock is taken into consideration and the results showed a reduced VaR in
comparison with normal VaR. One final extension is stressed VaR which is
calculated during unstable market conditions. A fine example of stressed market
conditions is the 2008 financial crisis. This value will inform the investor of the
expected amount of loss in one day if a financial crisis of the same scale were to
happen again. For computing this value a 250 days period was chosen from
1/4/2008 till 31/3/2009, and the results were almost twice the amount in normal
conditions (£9,331). Finally, a straightforward method of calculating the VaR is the
Model Building Approach (Parametric VaR), which assumes that the data follows a

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normal distribution. However, the data used in this report are not normally
distributed, and the calculation of the parametric VaR was conducted just for
comparison purposes.

The summary of these values can be found in the tables bellow. For further
information about estimations please refer to Appendix 2.3.1.

VALUE Historical Historical Simulation VaR Historical Simulation VaR Stress

Parametric VaR1
AT RISK Simulation VaR (Weighting Scheme)2 (Volatility Updating)3 VaR

Conf.
Daily Yearly Daily Yearly Daily Yearly Daily Yearly Daily
Level
99% £3,151 £50,026 £4,024 £63,874 £2,980 £47,300 £2,847 £45,197 £9,331
95% £2,229 £35,380 £2,051 £32,566 £1,684 £26,729 £1,774 £28,157 £6,609
90% £1,734 £27,530 £1,444 £22,921 £1,242 £19,712 £1,278 £20,288 £4,992

EXPECTED Historical Weighting Volatility

SHORTFALL Simulation Scheme Updating

Conf. Level Daily Yearly Daily Yearly Daily Yearly

99% £4,756 £76,100 £3,617 £57,866 £3,821 £61,130
95% £3,171 £50,738 £2,529 £40,466 £2,501 £40,009
90% £2,434 £38,942 £2,007 £32,111 £2,018 £32,282

 Example of Calculations:
 VaR example

Daily Historical Simulation VaR99% of total position

1st of April 2015 Stock Price (V1043)= £ 6.680 - V144= £ 3.888 - V143= £ 4.051
with equal weighted probability for all scenarios of 0.00095877
Scenario #: 144 is on 20th of October 2011 Scenario144 value= 6.680x (3.888/4.051)= £ 6.4112

Losses Per Share from scenario144 = 6.680-6.4112= 0.2688 Losses Per Position = 0.2688x14970share= £ 4023.93

With the cumulative probability of 1% obtained from 11 highest daily losses scenarios, the VaR 99% is £4023.93

1
We assumed that returns are normally distributed for calculating the Parametric VaR.
2
For weighting scheme we have used lambda equals to 0.995 (λ=0.995)
3
For incorporating volatility updating we have used lambda equals to 0.94 (λ=0.94) to calculate the
volatility of the daily returns.

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 Shortfall example

Daily Historical Simulation Shorfall99%of total position

𝑃𝑟𝑜𝑏𝑎𝑏𝑖𝑙𝑖𝑡𝑦∗𝐿𝑜𝑠𝑠𝑒𝑠 0.003177
Expected Shorfall99% Per Share = ∑ 0.01
= 0.01
= 0.31771

Expected Shorfall99% Per Position = 0.31771 * 14970share = £ 4756.11

3.3.3. Accuracy:
Historical method results depend on finite number of data, which gives room for
error. In the table below, a confidence interval is constructed for the 99% daily VaR,
with the lower bound of £ 3716.57, and upper one of £ 4330.79

Accuracy 4

Estimating 99th percentile of loss distribution by using excel functions, so that n=1043, q=0.99, 𝝁= -0.314,  =9.054.
99th percentile is NORMINV (0.99,-0.314,9.054)= 20.750 ƒ(𝑥) is NORMDIST (20.75,-0.314,9.054,FALSE) = 0.00294
1 (0.01∗0.99) 95% 𝑐𝑜𝑛𝑓𝑖𝑑𝑒𝑛𝑐𝑒 𝑖𝑛𝑡𝑒𝑟𝑣𝑎𝑙 𝑖𝑠 𝑓𝑟𝑜𝑚
Standard Error= 0.00294 x√ 1043
= 1.0466 → 4023.68 – (1.96x1.0466)= £ 3716.57
95% 𝑐𝑜𝑛𝑓𝑖𝑑𝑒𝑛𝑐𝑒 𝑖𝑛𝑡𝑒𝑟𝑣𝑎𝑙 𝑖𝑠 𝑡𝑜
→ 4023.68 + (1.96x1.0466)= £ 4330.79

3.3.4. Back Testing:

To further validate these report findings, a back-testing procedure was applied to
check the robustness of the model used to calculate the VaR. A randomly selection
of 500 days from our sample were used to check the model, from the 15th of August
2011, till the 12th of July 2013. Six exceptions were found in that period where the
actual losses exceeded the predicted VaR.

4
in order to check the accuracy of our VaR99%, we have assumed that our loss distribution is a normal
distribution.

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Back-Testing (Hypothesis)
H0: the probability of an exception on any given day is Ϸ. Where Ϸ= 1-(99/100) = 0.01
H1: the probability of an exception on any given day is greater than Ϸ.
Using Binominal Distribution function Using Kupiec (1995) two tails test
Number of exceptions exceeded the VaR99% 6 Number of exceptions exceeded the VaR99% 6
494 6 494 6
1-BINOMDIST(6,500,0.01,TRUE) 0.237078 -2ln[(0.99) x0.01 ]+2ln[(0.988 x0.012 ] 0.189880
0.237>0.05, At 5% confident level we should not reject 0.189<3.84, 4 At 5% confident level we should not reject H0,
H0, therefore we should not reject the model. therefore we should not reject the model.

3.4. Liquidity Risk:

3.4.1. Liquidity Funding Risk:
This risk is related with the sources and costs of financing available for a firm in the
short term to cover its obligations. It is important for an investor to be aware of how
the company is managing its sources of liquidity in order to face stressed market
conditions. Hammerson has demonstrated to its investors a good ability to manage
its financing strategy through borrowing on an unsecured basis to maintain
operational flexibility, which gives the firm an appropriate maturity profile and allows
it to keep short-term liquidity. In the last results report, HMSO showed a higher
interest cover and a lower gearing ratio than any since the 1980s. Additionally, lines
of credit from a range of banks with which HMSO maintain strong working
relationships are available at short notice, principally through syndicated revolving
credit. Alternatives to the traditional bank lending and bond markets, such as private
placement, also remain open to the Group. (Hammerson)
3.4.2. Liquidity Trading Risk:
The liquidity trading risk refers to the cost of quickly buying or selling a position in a
certain asset. This risk can be measured by the bid-offer spread presented by HMSO
in the UK stock market, which proportionally of its size is 0.085%.

The cost of liquidation for the investor with a theoretical position of £100,000 in this
security is £ 42.55p. Furthermore, unwinding the position in stressed market
conditions and times of illiquidity would cost £1365.426.

Cost of Market Liquidity

Normal Market Stressed Market

(μ=0.000123, =0.011688) of proportional bid-spread with λ*=2.326
Average proportional bid-offer spread = 0.000851
(99% confident level)

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Cost=∑(0.000851*100,000)/2= 42.55 Cost=∑(0.000123+0.011688x2.326)x100,000/2= 1365.426

Liquidity-Adjusted VaR
Normal Market= 4023.68+42.55=4066.23 Stressed Market= 4023.68+1365.42=5389.1
.

3.5. Credit Risk:

It’s the possibility of a loss due to failure of the counterparty in financial contract in
meeting contractual obligation (Bielecki, Kowski, 2002). Due to the nature of
operations of Hammerson, a tenant's inability to pay rental installments is one of the
corporation major concerns.Tenants' credit worthiness are assessed prior the signing
of lease agreements. Additionally, the majority of clients are large renowned firms in
some cases a deposit is required when leasing contracts are signed, which largely
mitigates the credit exposure. Hammerson’s credit rating was recently upgraded by
Moody's to Baa1 from Baa2. To evaluate the implications of this news please refer to
Appendix 2.3.1.
In addition, in Appendix 2.3.2 you can find all the information regarding the credit
risk of Hammerson and its main competitors. This includes credit default spreads.

4. Operational Risk:
It has been defined by Basel II as “the risk of loss resulting from inadequate or failed
processes, people and systems or from external events. This definition includes legal
risk, but excludes strategic and reputational risk” Basel Committee, Jan 2001.
4.1. Management and human resources risk:
Management and human resources can become a major source of operational risk,
including issues such as poor management performance, poorly trained employees,
and deliberate employee’s disruptive behaviour such as fraud, conflict of interest.
Hammerson’s exposure to this risk by making wrong investment decisions,
underestimated costs of new projects made by engineers and staff or hiring
unqualified employees. All these issues lead to failed projects which affect negatively
the share price. The Board of Directors in Hammerson have lately approved
significant changes in their management structure and aimed to create a talent
management by recruiting more qualified people and put in action new training plans
in order to motivate the staff and improve their skills.

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4.2. IT system risk:

This is the risk of complex and poorly designed IT systems. Hammerson may
experience a wide range of problems including hardware and software failures, fraud
and information security failures. However, the process implemented by Hammerson
IT department , of monitoring the performance of the IT system and trying to develop
it regularly, and using the most modern security protections, to mitigate this
exposure.
4.3. Ownership structure risk:
This kind of risk rises when any institution is a participant of joint ventures with other
institutions and 40% of Hammerson portfolio is held by joint ventures. Consequently,
the company reduced the number of joint ventures and have raised its acquisitions.
4.4. Catastrophic event risk:
Catastrophic events have a major impact on any company. Events such as
environmental incidents, extreme weather and terrorist attacks. Hammerson
evaluated potential costs of this risk, hence, purchased insurance policies on its
properties to hedge this risk.

All the formulas used in this coursework are related in Appendix 3.

BIBLIOGRAPHY

 Hammerson. 2014 Annual Report.

 John,c,Hull,(2012). Risk management and financial institutions, third edition,
chapter forteen, market risk historical stimulation approach, page 303.
 Don M.Chance, Robert.Brooks, 2010, Introduction to derivatives and risk
management, 9th edition, chapter fifteen, financial risk management
techniques and applications, p543-522.
 Tomasz.R.Bielecki, Marekrut,Kowski,2002, credit risk modelling valuation and
hedging, chapter one, introduction to credit risk, p 1-3.

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