FIN435 Class Web Page, Spring '20
Instructor: Maggie Foley
Exit Exam Questions (will be posted
in week 10 on blackboard)
Weekly SCHEDULE, LINKS, FILES and Questions
Coverage, HW, Supplements
Marketwatch Stock Trading Game (Pass code: havefun)
1. URL for your game:
2. Password for this private game: havefun.
3. Click on the 'Join Now' button to get started.
4. If you are an existing MarketWatch member, login. If you are a new user, follow the link for a Free account - it's easy!
5. Follow the instructions and start trading!
6. Game will be over on 4/17/2019
Chapter 3 Financial Statement
Finviz.com/screener for ratio analysis (https://finviz.com/screener.ashx
Capital expenditure = increases in NFA + depreciation
Or, capital expenditure = increases in GFA
Note: All companies, foreign and domestic, are required to file registration statements, periodic reports, and other forms electronically through EDGAR.
Case study of chapter 3:
· Excel File here (due with the first mid term exam) ‘
· Video available on blackboard collaborate
***** How much does Amazon worth?”
FYI: Amazon.com Inc. (AMZN) https://www.stock-analysis-on.net/NASDAQ/Company/Amazoncom-Inc/DCF/Present-Value-of-FCFF
Present Value of Free Cash Flow to the Firm (FCFF)
In discounted cash flow (DCF) valuation techniques the value of the stock is estimated based upon present value of some measure of cash flow. Free cash flow to the firm (FCFF) is generally described as cash flows after direct costs and before any payments to capital suppliers.
Intrinsic Stock Value (Valuation Summary)
Amazon.com Inc., free cash flow to the firm (FCFF) forecast
Weighted Average Cost of Capital (WACC)
Amazon.com Inc., cost of capital
1 USD $ in millions
(fair value) = No. shares of common stock outstanding × Current share price
Debt (fair value). See Details »
2 Required rate of return on equity is estimated by using CAPM. See Details »
Required rate of return on debt. See Details »
Required rate of return on debt is after tax.
(average) effective income tax rate
WACC = 16.17%
FCFF Growth Rate (g)
FCFF growth rate (g) implied by PRAT model
Amazon.com Inc., PRAT model
expense, after tax = Interest expense × (1 – EITR)
– EITR) = Net income (loss) + Interest expense, after tax
= [EBIT(1 – EITR) – Interest expense (after tax) and dividends] ÷ EBIT(1 –
= 100 × EBIT(1 – EITR) ÷ Total capital
6 g = RR × ROIC
FCFF growth rate (g) forecast
Amazon.com Inc., H-model
g2 = g1 +
(g5 – g1) × (2
– 1) ÷ (5 – 1)
g3 = g1 +
(g5 – g1) × (3
– 1) ÷ (5 – 1)
g4 = g1 +
(g5 – g1) × (4
– 1) ÷ (5 – 1)
Chapter 4 Ratio Analysis
****** DuPont Identity *************
ROE = (net income / sales) * (sales / assets) * (assets / shareholders' equity)
This equation for ROE breaks it into three widely used and studied components:
ROE = (net profit margin) * (asset turnover) * (equity multiplie)
Chapter 4 case study (updated, due with first mid term)
· Video is available on blackboard collaborate
Ratio Analysis template
Below are Benjamin Graham’s seven time-tested criteria to identify strong value stocks.
Value Stock Criteria List:
VALUE CRITERIA #1:
Look for a quality rating that is average or better. You don’t need to find the best quality companies–average or better is fine. Benjamin Graham recommended using Standard & Poor’s rating system and required companies to have an S&P Earnings and Dividend Rating of B or better. The S&P rating system ranges from D to A+. Stick to stocks with ratings of B+ or better, just to be on the safe side.
VALUE CRITERIA #2:
Graham advised buying companies with Total Debt to Current Asset ratios of less than 1.10. In value investing it is important at all times to invest in companies with a low debt load. Total Debt to Current Asset ratios can be found in data supplied by Standard & Poor’s, Value Line, and many other services.
VALUE CRITERIA #3:
Check the Current Ratio (current assets divided by current liabilities) to find companies with ratios over 1.50. This is a common ratio provided by many investment services.
VALUE CRITERIA #4:
Criteria four is simple: Find companies with positive earnings per share growth during the past five years with no earnings deficits. Earnings need to be higher in the most recent year than five years ago. Avoiding companies with earnings deficits during the past five years will help you stay clear of high-risk companies.
VALUE CRITERIA #5:
Invest in companies with price to earnings per share (P/E) ratios of 9.0 or less. Look for companies that are selling at bargain prices. Finding companies with low P/Es usually eliminates high growth companies, which should be evaluated using growth investing techniques.
VALUE CRITERIA #6:
Find companies with price to book value (P/BV) ratios less than 1.20. P/E ratios, mentioned in rule 5, can sometimes be misleading. P/BV ratios are calculated by dividing the current price by the most recent book value per share for a company. Book value provides a good indication of the underlying value of a company. Investing in stocks selling near or below their book value makes sense.
VALUE CRITERIA #7:
Invest in companies that are currently paying dividends. Investing in undervalued companies requires waiting for other investors to discover the bargains you have already found. Sometimes your wait period will be long and tedious, but if the company pays a decent dividend, you can sit back and collect dividends while you wait patiently for your stock to go from undervalued to overvalued.
One last thought. We like to find out why a stock is selling at a bargain price. Is the company competing in an industry that is dying? Is the company suffering from a setback caused by an unforeseen problem? The most important question, though, is whether the company’s problem is short-term or long-term and whether management is aware of the problem and taking action to correct it. You can put your business acumen to work to determine if management has an adequate plan to solve the company’s current problems.
For class discussion: Times have changed. Mr. Granham’s book about value investing was published sixty years ago. Do you think the criteria in his book are still working in today’s environment?
Chapter 6 Interest rate
Market data website:
http://finra-markets.morningstar.com/BondCenter/Default.jsp (FINRA bond market data)
Market watch on Wall Street Journal has daily yield curve and interest rate information.
In Class Exercise:
· Please draw the yield curve based on the above information;
· What can be predicted from the current yield curve?
For Daily Treasury rates such as the following, please visit https://www.treasury.gov/resource-center/data-chart-center/interest-rates/pages/textview.aspx?data=yield
For class discussion: Why do interest rates change daily? Who determines interest rate?
“ interest rates are determined by the Federal Open Market Committee (FOMC), which consists of seven governors of the Federal Reserve Board and five Federal Reserve Bank presidents. The FOMC meets eight times a year to determine the near-term direction of monetary policy and interest rates.”
Who Determines Interest Rates?
By NICK K. LIOUDIS Updated Aug 15, 2019
Interest rates are the cost of borrowing money. They represent what creditors earn for lending you money. These rates are constantly changing, and differ based on the lender, as well as your creditworthiness. Interest rates not only keep the economy functioning, but they also keep people borrowing, spending, and lending. But most of us don't really stop to think about how they are implemented or who determines them. This article summarizes the three main forces that control and determine interest rates.
Short-Term Interest Rates: Central Banks
In countries using a centralized banking model, short-term interest rates are determined by central banks. A government's economic observers create a policy that helps ensure stable prices and liquidity. This policy is routinely checked so the supply of money within the economy is neither too large, which causes prices to increase, nor too small, which can lead to a drop in prices.
In the U.S., interest rates are determined by the Federal Open Market Committee (FOMC), which consists of seven governors of the Federal Reserve Board and five Federal Reserve Bank presidents. The FOMC meets eight times a year to determine the near-term direction of monetary policy and interest rates. The actions of central banks like the Fed affect short-term and variable interest rates.
If the monetary policymakers wish to decrease the money supply, they will raise the interest rate, making it more attractive to deposit funds and reduce borrowing from the central bank. Conversely, if the central bank wishes to increase the money supply, they will decrease the interest rate, which makes it more attractive to borrow and spend money.
The Fed funds rate affects the prime rate—the rate banks charge their best customers, many of whom have the highest credit rating possible. It's also the rate banks charge each other for overnight loans.
The U.S. prime rate remained at 3.25% between Dec. 16, 2008 and Dec. 17, 2015, when it was raised to 3.5%.
Long-Term Interest Rates: Demand for Treasury Notes
Many of these rates are independent of the Fed funds rate, and, instead, follow 10- or 30-year Treasury note yields. These yields depend on demand after the U.S. Treasury Department auctions them off on the market. Lower demand tends to result in high interest rates. But when there is a high demand for these notes, it can push rates down lower.
If you have a long-term fixed-rate mortgage, car loan, student loan, or any similar non-revolving consumer credit product, this is where it falls. Some credit card annual percentage rates are also affected by these notes.
These rates are generally lower than most revolving credit products but are higher than the prime rate.
Many savings account rates are also determined by long-term Treasury notes.
Other Rates: Retail Banks
Retail banks are also partly responsible for controlling interest rates. Loans and mortgages they offer may have rates that change based on several factors including their needs, the market, and the individual consumer.
For example, someone with a lower credit score may be at a higher risk of default, so they pay a higher interest rate. The same applies to credit cards. Banks will offer different rates to different customers, and will also increase the rate if there is a missed payment, bounced payment, or for other services like balance transfers and foreign exchange.
For daily yield curve, please visit http://finra-markets.morningstar.com/BondCenter/Default.jsp
Normal Yield Curve
Steep Curve –
Economy is improving
Inverted Curve – Recession
To become inverted, the yield curve must pass through a period where long-term yields are the same as short-term rates. When that happens the shape will appear to be flat or, more commonly, a little raised in the middle.
Unfortunately, not all flat or humped curves turn into fully inverted curves. Otherwise we'd all get rich plunking our savings down on 30-year bonds the second we saw their yields start falling toward short-term levels.
On the other hand, you shouldn't discount a flat or humped curve just because it doesn't guarantee a coming recession. The odds are still pretty good that economic slowdown and lower interest rates will follow a period of flattening yields.
Formula --- Break down of interest rate
r = r* + IP + DRP + LP + MRP
r = required return on a debt security
r* = real risk-free rate of interest
IP = inflation premium
DRP = default risk premium
LP = liquidity premium
MRP = maturity risk premium
MRPt = 0.1% (t – 1)
DRPt + LPt = Corporate spread * (1.02)(t−1)
Chapter six case study (due with first mid term exam)
· Video available on blackboard collaborate and
www.jufinance.com/video/fin435_c6_case_p2.mp4 (term structure)
What is interest rates
Gerald Celente: Low Interest Rates are Building the Biggest Bubble in Modern History - 9/21/14
How interest rates are set
What happens if Fed raise interest rates
What Is the Relationship Between Inflation and Interest Rates?
By JEAN FOLGERdated Dec 6, 2019
Inflation and interest rates are often linked and frequently referenced in macroeconomics. Inflation refers to the rate at which prices for goods and services rise. In the United States, the interest rate, or the amount charged by a lender to a borrower, is based on the federal funds rate that is determined by the Federal Reserve (sometimes called "the Fed").
By setting the target for the federal funds rate, the Fed has at its disposal a powerful tool that it uses to influence the rate of inflation. This tool enables the Fed to expand or contract the money supply as needed to achieve target employment rates, stable prices, and stable economic growth.
The Inverse Correlation Between Interest Rates and Inflation
Under a system of fractional reserve banking, interest rates and inflation tend to be inversely correlated. This relationship forms one of the central tenets of contemporary monetary policy: Central banks manipulate short-term interest rates to affect the rate of inflation in the economy.
The below chart demonstrates the inverse correlation between interest rates and inflation. In the chart, CPI refers to the Consumer Price Index, a measurement that tracks changes in prices. Changes in the CPI are used to identify periods of inflation and deflation.
In general, as interest rates are reduced, more people are able to borrow more money. The result is that consumers have more money to spend, causing the economy to grow and inflation to increase.
The opposite holds true for rising interest rates. As interest rates are increased, consumers tend to save as returns from savings are higher. With less disposable income being spent as a result of the increase in the interest rate, the economy slows and inflation decreases.
To better understand how the relationship between inflation and interest rates works, it's important to understand the banking system, the quantity theory of money, and the role interest rates play.
Fractional Reserve Banking
The world currently uses a fractional reserve banking system. When someone deposits $100 into the bank, they maintain a claim on that $100. The bank, however, can lend out those dollars based on the reserve ratio set by the central bank. If the reserve ratio is 10%, the bank can lend out the other 90%, which is $90 in this case. A 10% fraction of the money stays in the bank vaults.
As long as the subsequent $90 loan is outstanding, there are two claims totaling $190 in the economy. In other words, the supply of money has increased from $100 to $190. This is a simple demonstration of how banking grows the money supply.
Quantity Theory of Money
In economics, the quantity theory of money states that the supply and demand for money determines inflation. If the money supply grows, prices tend to rise, because each individual piece of paper becomes less valuable.
Hyperinflation is an economic term used to describe extreme inflation where price increases are rapid and uncontrolled. While central banks generally target an annual inflation rate of around 2% to 3% as an acceptable rate for a healthy economy, hyperinflation goes well beyond this. Countries that experience hyperinflation have an inflation rate of 50% or more per month.
Interest Rates, Savings, Loans, and Inflation
The interest rate acts as a price for holding or loaning money. Banks pay an interest rate on savings in order to attract depositors. Banks also receive an interest rate for money that is loaned from their deposits.
When interest rates are low, individuals and businesses tend to demand more loans. Each bank loan increases the money supply in a fractional reserve banking system. According to the quantity theory of money, a growing money supply increases inflation. Thus, low interest rates tend to result in more inflation. High interest rates tend to lower inflation.
This is a very simplified version of the relationship, but it highlights why interest rates and inflation tend to be inversely correlated.
The Federal Open Market Committee
The Federal Open Market Committee (FOMC) meets eight times each year to review economic and financial conditions and decide on monetary policy. Monetary policy refers to the actions taken that affect the availability and cost of money and credit. At these meetings, short-term interest rate targets are determined.
Using economic indicators such as the Consumer Price Index (CPI) and the Producer Price Indexes (PPI), the Fed will establish interest rate targets intended to keep the economy in balance. By moving interest rate targets up or down, the Fed attempts to achieve target employment rates, stable prices, and stable economic growth. The Fed will raise interest rates to reduce inflation and decrease rates to spur economic growth.
Investors and traders keep a close eye on the FOMC rate decisions. After each of the eight FOMC meetings, an announcement is made regarding the Fed's decision to increase, decrease, or maintain key interest rates. Certain markets may move in advance of the anticipated interest rate changes and in response to the actual announcements. For example, the U.S. dollar typically rallies in response to an interest rate increase, while the bond market falls in reaction to rate hikes.
· 15 January 2020
The UK's inflation rate fell to its lowest for more than three years in December, increasing speculation that interest rates could be cut.
The rate dropped to 1.3% last month, down from 1.5% in November, partly due to a fall in the price of women's clothes and hotel room costs.
December's inflation rate was the lowest since November 2016.
Analysts said it raised the chances of a rate cut, with inflation below the Bank of England's target of 2%.
"Very soft UK inflation data for December leaves the door wide open for a Bank of England rate cut on 30 January," said Melissa Davies, an economist at stock broker Redburn.
The Bank's main interest rate is used by banks and other lenders who set borrowing costs.
It affects everything from mortgages to business loans and has a big effect on the finances of individuals and companies.
City traders who spend their working lives trying to anticipate moves in interest rates are convinced of it today: the Bank of England is likely to cut the official interest rate when it meets later this month. Market indicators suggest a 60% chance of it happening.
Here's the thinking: at 1.3%, the official measure of consumer price inflation in the year to December was lower than expected and well below the 2% target. With the economy barely growing (even shrinking if you are prepared to rely on the official November estimate of a 0.3% contraction) there's little sign of inflationary pressure in the near future.
Granted, there was a sharp rise in the price of crude oil - a barrel was up 4.9% in the month and 17.4% on the year. But in spite of that, producers were still paying slightly less for their raw materials and supplies than they were last year.
The assumption has been that the November contraction was a temporary period of weakness induced by pre-election political uncertainty - and that there will be a recovery as businesses and consumers regain a new-found confidence to spend and invest.
The risk the MPC will have to contend with is that that hoped-for post-election recovery does not materialise.
Earlier on Wednesday, Michael Saunders, one of the rate setters on the Bank's Monetary Policy Committee (MPC), reiterated his view that borrowing costs should be lowered.
"It probably will be appropriate to maintain an expansionary monetary policy stance and possibly to cut rates further, in order to reduce risks of a sustained undershoot of the 2% inflation target," he said.
Last week, two other rate setters and Bank governor Mark Carney also suggested that rates could be cut, depending on how the economy performs.
On Sunday, MPC member Gertjan Vlieghe told the Financial Times he would consider voting for a rate cut depending on how the economy has performed since the December election.
However, members of the MPC could take the latest inflation figure with a pinch of salt, said Samuel Tombs, chief UK economist at Pantheon Macroeconomics.
"Half of the decline in the headline rate was driven by a sharp fall in volatile airline fares inflation," he said.
He expects inflation to rise to 1.6% in the first three months of 2020, and this could mean enough MPC members will decide to wait rather than voting to cut rates.
Emma-Lou Montgomery, associate director for personal investing at money manager Fidelity International, said the inflation data painted a bleaker picture for the UK economy than before.
"Today's UK CPI figures simply add to the growing sense of unease many feel when considering the outlook for the UK economy, with the rate of inflation continuing to lag well below the Bank of England's target of 2%."
A cut would ease the finances of borrowers, but create a tougher environment for savers, she added.
Chapter 6 Interest rate Part II: Term Structure of Interest rate
Question for discussion: If a% and b% are both known to investors, such as the bank rates, how much is the future interest rate, such as c%?
(1+a)^N = (1+b)^m *(1+c)^(N-M)
Either earning a% of interest rate for N years,
or b% of interest rate for M years, and then c% of interest rate for (N-M) years,
investors should be indifferent. Right?
(1+a)^N = (1+b)^m *(1+c)^(N-M)č c = ((1+a)^N / (1+b)^m)^(1/(N-M))-1
N*a = M*b +(N-M)*(c)č c = (N*a – M*b) /(N-M)
What Is Expectations Theory (video)
Expectations theory attempts to predict what short-term interest rates will be in the future based on current long-term interest rates. The theory suggests that an investor earns the same amount of interest by investing in two consecutive one-year bond investments versus investing in one two-year bond today. The theory is also known as the "unbiased expectations theory.”
Understanding Expectations Theory
The expectations theory aims to help investors make decisions based upon a forecast of future interest rates. The theory uses long-term rates, typically from government bonds, to forecast the rate for short-term bonds. In theory, long-term rates can be used to indicate where rates of short-term bonds will trade in the future (https://www.investopedia.com/terms/e/expectationstheory.asp)
By CHRIS B. MURPHY Updated Apr 21, 2019
Example of Calculating Expectations Theory
Let's say that the present bond market provides investors with a two-year bond that pays an interest rate of 20% while a one-year bond pays an interest rate of 18%. The expectations theory can be used to forecast the interest rate of a future one-year bond.
In this example, the investor is earning an equivalent return to the present interest rate of a two-year bond. If the investor chooses to invest in a one-year bond at 18% the bond yield for the following year’s bond would need to increase to 22% for this investment to be advantageous.
Expectations theory aims to help investors make decisions by using long-term rates, typically from government bonds, to forecast the rate for short-term bonds.
Disadvantages of Expectations Theory
Investors should be aware that the expectations theory is not always a reliable tool. A common problem with using the expectations theory is that it sometimes overestimates future short-term rates, making it easy for investors to end up with an inaccurate prediction of a bond’s yield curve.
Another limitation of the theory is that many factors impact short-term and long-term bond yields. The Federal Reserve adjusts interest rates up or down, which impacts bond yields including short-term bonds. However, long-term yields might not be as impacted because many other factors impact long-term yields including inflation and economic growth expectations. As a result, the expectations theory doesn't take into account the outside forces and fundamental macroeconomic factors that drive interest rates and ultimately bond yields.
Chapter 6 In class exercise (solution on blackboard recording)
1 You read in The Wall Street Journal that 30-day T-bills are currently yielding 5.5%. Your brother-in-law, a broker at Safe and Sound Securities, has given you the following estimates of current interest rate premiums:
On the basis of these data, what is the real risk-free rate of return? (answer: 2.25%)
2 The real risk-free rate is 3%. Inflation is expected to be 2% this year and 4% during the next 2 years. Assume that the maturity risk premium is zero. What is the yield on 2-year Treasury securities? What is the yield on 3-year Treasury securities?(answer: 6%, 6.33%)
3 A Treasury bond that matures in 10 years has a yield of 6%. A 10-year corporate bond has a yield of 8%. Assume that the liquidity premium on the corporate bond is 0.5%. What is the default risk premium on the corporate bond? (answer: 1.5%)
4 The real risk-free rate is 3%, and inflation is expected to be 3% for the next 2 years. A 2-year Treasury security yields 6.2%. What is the maturity risk premium for the 2-year security? (answer: 0.2%)
5 One-year Treasury securities yield 5%. The market anticipates that 1 year from now, 1-year Treasury securities will yield 6%. If the pure expectations theory is correct, what is the yield today for 2-year Treasury securities? (answer: 5.5%)
Market data website:
http://finra-markets.morningstar.com/BondCenter/Default.jsp (FINRA bond market data)
Market watch on Wall Street Journal has daily yield curve and bond yield information.
3. Bond Online
Simplified Balance Sheet of WalMart
· What is this “long term debt”?
· Who is the lender of this “long term debt”?
So this long term debt is called bond in the financial market. Where can you find the pricing information and other specifications of the bond issued by WMT?
How Bonds Work (video)
FINRA – Bond market information
WAL-MART STORES INC
Credit and Rating Elements
For class discussion:
Fed has hiked interest rates. So, shall you invest in short term bond or long term bond?
1. Find bond sponsored by WMT
just go to www.finra.org, č Investor center č market data č bond č corporate bond
For class discussion:
· Fed has kept interest rates low. So, shall you invest in short term bond or long term bond?
· Which of the three WMT bonds are the most attractive one to you? Why?
· Referring to the price chart of the above bond, the price was reaching peak in the middle of 2015. Why? The price was really low in the middle of 2014. Why? Interest rate is not the reason.
· Video on blackboard
In class exercises
1. AAA firm’ bonds will mature in eight years, and coupon is $65. YTM is 8.2%. Bond’s market value? ($903.04, abs(pv(8.2%, 8, 65, 1000))
2. AAA firm’s bonds’ market value is $1,120, with 15 years maturity and coupon of $85. What is YTM? (7.17%, rate(15, 85, -1120, 1000))
3. Sadik Inc.'s bonds currently sell for $1,180 and have a par value of $1,000. They pay a $105 annual coupon and have a 15-year maturity, but they can be called in 5 years at $1,100. What is their yield to call (YTC)? (7.74%, rate(15, 105, -1180, 1100))
4. Malko Enterprises’ bonds currently sell for $1,050. They have a 6-year maturity, an annual coupon of $75, and a par value of $1,000. What is their current yield? (7.14%, 75/1050)
5. Assume that you are considering the purchase of a 20-year, noncallable bond with an annual coupon rate of 9.5%. The bond has a face value of $1,000, and it makes semiannual interest payments. If you require an 8.4% nominal yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond? ($1,105.69, abs(pv(8.4%/2, 20*2, 9.%*1000/2, 1000)) )
6. Grossnickle Corporation issued 20-year, non-callable, 7.5% annual coupon bonds at their par value of $1,000 one year ago. Today, the market interest rate on these bonds is 5.5%. What is the current price of the bonds, given that they now have 19 years to maturity? ($1,232.15, abs(pv(5.5%, 19, 75, 1000)))
7. McCue Inc.'s bonds currently sell for $1,250. They pay a $90 annual coupon, have a 25-year maturity, and a $1,000 par value, but they can be called in 5 years at $1,050. Assume that no costs other than the call premium would be incurred to call and refund the bonds, and also assume that the yield curve is horizontal, with rates expected to remain at current levels on into the future. What is the difference between this bond's YTM and its YTC? (Subtract the YTC from the YTM; it is possible to get a negative answer.) (2.62%, YTM = rate(25, 90, -1250, 1000), YTC = rate(5, 90, -1250, 1050))
8. Taussig Corp.'s bonds currently sell for $1,150. They have a 6.35% annual coupon rate and a 20-year maturity, but they can be called in 5 years at $1,067.50. Assume that no costs other than the call premium would be incurred to call and refund the bonds, and also assume that the yield curve is horizontal, with rates expected to remain at current levels on into the future. Under these conditions, what rate of return should an investor expect to earn if he or she purchases these bonds? (4.2%, rate(5, 63.5, -1150, 1067.5))
9. A 25-year, $1,000 par value bond has an 8.5% annual payment coupon. The bond currently sells for $925. If the yield to maturity remains at its current rate, what will the price be 5 years from now? ($930.11, rate(25, 85, -925, 1000), abs(pv( rate(25, 85, -925, 1000), 20, 85, 1000))
10. Read the attached prospects and answer the following questions: “We are offering $500,000,000 of our 1.000% notes due 2017 (symbol WMT4117476), $1,000,000,000 of our 3.300% notes due 2024 (symbol WMT4117477) and $1,000,000,000 of our 4.300% notes due 2044 (symbol WMT4117478)
1) What is the purpose for the money raised?
2) Which of the two outstanding WMT bonds are more attractive one to you? Why?
3) Who are the underwriters for the WMT bonds?
Bond Pricing Formula (FYI)
Bond Pricing Excel Formula
To calculate bond price in EXCEL (annual coupon bond):
Price=abs(pv(yield to maturity, years left to maturity, coupon rate*1000, 1000)
To calculate yield to maturity (annual coupon bond)::
Yield to maturity = rate(years left to maturity, coupon rate *1000, -price, 1000)
To calculate bond price (semi-annual coupon bond):
Price=abs(pv(yield to maturity/2, years left to maturity*2, coupon rate*1000/2, 1000)
To calculate yield to maturity (semi-annual coupon bond):
Yield to maturity = rate(years left to maturity*2, coupon rate *1000/2, -price, 1000)*2
Redemption Features (FYI)
While the maturity date indicates how long a bond will be outstanding, many bonds are structured in such a way so that an issuer or investor can substantially change that maturity date.
Bonds may have a redemption – or call – provision that allows or requires the issuer to redeem the bonds at a specified price and date before maturity. For example, bonds are often called when interest rates have dropped significantly from the time the bond was issued. Before you buy a bond, always ask if there is a call provision and, if there is, be sure to consider the yield to call as well as the yield to maturity . Since a call provision offers protection to the issuer, callable bonds usually offer a higher annual return than comparable non-callable bonds to compensate the investor for the risk that the investor might have to reinvest the proceeds of a called bond at a lower interest rate.
A bond may have a put provision, which gives an investor the option to sell the bond to an issuer at a specified price and date prior to maturity. Typically, investors exercise a put provision when they need cash or when interest rates have risen so that they may then reinvest the proceeds at a higher interest rate. Since a put provision offers protection to the investor, bonds with such features usually offer a lower annual return than comparable bonds without a put to compensate the issuer.
Some corporate bonds, known as convertible bonds, contain an option to convert the bond into common stock instead of receiving a cash payment. Convertible bonds contain provisions on how and when the option to convert can be exercised. Convertibles offer a lower coupon rate because they have the stability of a bond while offering the potential upside of a stock.
Mid Term exam (chapters 3, 4, 6, 7) on 2/11 and 2/13
First Mid Term Exam – Problems Solving Study Guide
Multiple Choice: Problems (25*2=50)
[i]. Calculate for FCF, given EBIT, depreciation, FA, NOWC, tax rate.
[ii]. Calculate for NI, given sales, costs, tax rate, interest.
3. Calculate NOWC, given balance sheet.
4. Calculate for debt, given TA, debt ratio.
5. Calculate for times-interest-earned (TIE), given sales, costs.
6. Calculate for BEP, given TA, EBIT.
7. Calculate PE ratio, given price and EPS.
8. Calculate for PM, given ROE, TA, sales.
9. Calculate for ROE, given assets, sales, NI, debt ratio.
10. Calculate for real risk free rate of return, given T-bill rate, inflation premium.
11. Calculate for T-bill rate, given real risk free rate of return, inflation premium.
12. Calculate for T-notse rate, given real risk free rate of return, inflation premium, maturity risk premium.
13. Calculate for corporate bond rate, given real risk free rate of return, inflation premium, maturity risk premium, default premium and liquidity premium.
14. Calculate for liquidity premium, given corporate bond rate, real risk free rate of return, inflation premium, maturity risk premium, default premium.
15. Calculate for inflation premium, given corporate bond rate, real risk free rate of return, maturity risk premium, default premium, liquidity premium,.
16. Calculate for maturity premium, given corporate bond rate, real risk free rate of return, inflation premium, default premium, liquidity premium.
17. Expectation theory calculation question.
18. Expectation theory calculation question.
19. Calculate for bond price, given all required information.
20. Calculate for YTM, given all required information.
20. Calculate for YTC, given all required information.
21. Calculate for current yield.
22. Calculate for YTC.
23. Calculate for coupon rate, given all required information.
24. Bond pricing
25. Given Debt ratio, ROA, ROE, TE, TA calculate NI.
First Mid Term Exam Conceptual Section
Multiple Choice (25*2=50)
1. balance sheet structure question True / false
2. What is RE, NI? Where can find them? True / false
3. Balance sheet and income statement basic question. True / false
4. What is EBIT? What is operating income? What is EBITDA? What is gross income? What is NI? True / false
5. What is EBIT? What is operating income? What is EBITDA? What is gross income? What is NI? True / false
6. balance sheet structure question True / false
7. balance sheet structure question True / false
8. What is yield curve? True / false
9. A downward sloping yield --- True / false
10. An upward-sloping yield curve -- True / false
11. Compare interest rates among T bonds, T bill, T notes, and corporate bonds. True / false
12. Break down interest rates. True / false
13. Break down interest rates. True / false
14. Break down interest rates. True / false
15. Callable bond. True / false
16. Bond sensitivity to interest rate changes. True / false
17. The price risk of bonds with different maturities. True / false
18. Bond basic question. True / false
19-20. What is callable bond? Difference between callable and noncallable bond?
21. What is the capital gain yield of a bond?
22-23. What is the differences between current yield and ytm?
24-25. What type of bond is more sensitive to interest rate change?
Chapter 8 Risk and Return
Videos --- available on blackboard collaborate Ultra under Recording
And also available below
2. class video excel solver part 2 (solver, for 5 extra points)
Excel File here (with solver solution)
3. Case video
1. Expected return and standard deviation
Given a probability distribution of returns, the expected return can be calculated using the following equation:
Given an asset's expected return, its variance can be calculated using the following equation:
The standard deviation is calculated as the positive square root of the variance.
2. Two stock portfolio equations:
W1 and W2 are the percentage of each stock in the portfolio.
3.. Historical returns
Holding period return (HPR) = (Selling price – Purchasing price + dividend)/ Purchasing price
4. CAPM model
· What Is the Capital Asset Pricing Model?
The Capital Asset Pricing Model (CAPM) describes the relationship between systematic risk and expected return for assets, particularly stocks. CAPM is widely used throughout finance for pricing risky securities and generating expected returns for assets given the risk of those assets and cost of capital.
Ri = Rf + βi *( Rm - Rf) ------ CAPM model
Ri = Expected return of investment
Rf = Risk-free rate
βi = Beta of the investment
Rm = Expected return of market
(Rm - Rf) = Market risk premium
· What is Beta? Where to find Beta?
· SML – Security Market Line
In Class Exercise
1. An investor currently holds the following portfolio: He invested 30% of the fund in Apple with Beta equal 1.1. He also invested 40% in GE with Beta equal 1.6. The rest of his fund goes to Ford, with Beta equal 2.2. Use the above information to answer the following questions.
1) The beta for the portfolio is? (1.63)
2) The three month Treasury bill rate (this is risk free rate) is 2%. S&P500 index return is 10% (this is market return). Now calculate the portfolio’s return. 15.04%
Refer to the following graph. The three month Treasury bill rate (this is risk free rate) is 2%. S&P500 index return is 10% (this is market return).
2. What is the value of A? 2%
3. What is the value of B? 10%
4. How much is the slope of the above security market line? 8%
5. Your uncle bought Apple in January, year 2000 for $30. The current price of Apple is $480 per share. Assume there are no dividend ever paid. Calculate your uncle’s holding period return. 15 times
6. Your current portfolio’s BETA is about 1.2. Your total investment is worth around $200,000. You uncle just gave you $100,000 to invest for him. With this $100,000 extra funds in hand, you plan to invest the whole $100,000 in additional stocks to increase your whole portfolio’s BETA to 1.5 (Your portfolio now worth $200,000 plus $100,000). What is the average BETA of the new stocks to achieve your goal? (hint: write down the equation of the portfolio’s Beta first) 2.10
Years Market r Stock A Stock B
1 3% 16% 5%
2 -5% 20% 5%
3 1% 18% 5%
4 -10% 25% 5%
5 6% 14% 5%
· Calculate the average returns of the market r and stock A and stock B. (Answer: -1%, 18.6%, 5%)
· Calculate the standard deviations of the market, stock A, & stock B (Answer: 6.44%, 4.21%; 0 )
· Calculate the correlation of stock market r and stock a. (Answer: -0.98)
· Assume you invest 50% in stock A and 50% in stock B. Calculate the average return and the standard deviation of the portfolio. (Answer: 11.8%; 2.11%)
Calculate beta of stock A and beta of stock B, respectively (Answer: -0.64, 0)
Beating the Historical Odds: Recession Risk in 2019 and Beyond
We have long highlighted the risks that have historically been associated with large overshoots of full employment. We have noted that the Fed has never engineered a soft landing from beyond full employment, that few other advanced economy central banks have either, and that countries that have achieved very long expansions often used countercyclical policy to prevent a large overshoot in the first place. In practice it hasn’t been easy to nudge up the unemployment rate just so. While we take this lesson seriously, we think it is being applied too mechanically by market participants today. The key difference with the past is that the Phillips curve is flatter and better anchored on the Fed’s target today. As a result, where labor market overshoots once led to high and accelerating inflation and consequently had to be unwound urgently with a forceful policy response, today an overshoot will more likely mean inflation persistently but only moderately above target. The Fed could probably live with this for a while, permitting it to tighten gradually and unwind the overshoot slowly. This gives the Fed a good chance of beating the historical odds. How worried should we be about recession risk today? The history of US recessions points to two classic causes of US recessions, overheating and financial imbalances. While overheating risks could emerge down the road, they look quite limited for now: core inflation is at 2%, trend unit labor cost growth is at 2%, and both household inflation expectations and market-implied inflation compensation are below average (Exhibit 9).
(Please refer to https://www.goldmansachs.com/insights/pages/outlook-2019/us-outlook/report.pdf for a better quality graph)
We also see little risk from financial imbalances at the moment. At a high level, the private sector financial balance—a very good predictor of recession risk—looks quite healthy (Exhibit 10). Digging deeper, our financial excess monitor looks for elevated valuations and stretched risk appetite across major asset classes, and for financial imbalances and vulnerabilities in the household, business, banking, and government sectors. Overall, the message is mostly reassuring. On the valuations side, while commercial real estate prices look somewhat frothy, lending terms and standards have tightened in recent years. On the sectoral imbalances side, fiscal sustainability remains a long-run concern, but we see this less as a recession trigger than as something that could prolong a downturn if policymakers perceive a lack fiscal space to respond. These two classic recession risks are complementary—overheating and the associated risk of a more abrupt shift in monetary policy is more threatening when financial imbalances are elevated and less threatening when they are limited. With neither risk looking worrisome at the moment, we do not think it makes sense to characterize the economy as “late cycle” at this point.