FIN435 Class Web
Page, Spring '20
Jacksonville
University
Instructor:
Maggie Foley
Exit Exam Questions (will be posted
in week 10 on blackboard)
Weekly SCHEDULE, LINKS, FILES and Questions
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Week |
Coverage, HW, Supplements -
Required |
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Videos (optional) |
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Week 1 |
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 |
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Chapter
3 Financial Statement Using a Balance Sheet to Analyze a
Company (VIDEO)
What is an Income
Statement? (Video)
How Do You Read a Cash
Flow Statement? | (VIDEO)
Finviz.com/screener for ratio analysis (https://finviz.com/screener.ashx
http://www.jufinance.com/10k/bs http://www.jufinance.com/10k/is http://www.jufinance.com/10k/cf https://www.jufinance.com/ratio FCF calculator What is free cash flow
(video)
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 And at https://www.jufinance.com/video/fin435_c3_case.mp4 |
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*****
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
1 Weighted
Average Cost of Capital (WACC)
Amazon.com Inc., cost of capital
1 USD $ in millions Equity
(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. Estimated
(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
2017 Calculations 2 Interest
expense, after tax = Interest expense × (1 – EITR) 3 EBIT(1
– EITR) = Net income (loss) + Interest expense, after tax 4 RR
= [EBIT(1 – EITR) – Interest expense (after tax) and dividends] ÷ EBIT(1 –
EITR) 5 ROIC
= 100 × EBIT(1 – EITR) ÷ Total capital 6 g = RR × ROIC FCFF growth rate (g) forecast
Amazon.com Inc., H-model
where: Calculations g2 = g1 +
(g5 – g1) × (2
– 1) ÷ (5 – 1) g3 = g1 +
(g5 – g1) × (3
– 1) ÷ (5 – 1) g4 = g1 +
(g5 – g1) × (4
– 1) ÷ (5 – 1) |
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Chapter 4 Ratio Analysis Reference: Commonly used ratio
explained ****** 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) ·
PPT affiliated with this
case study FYI ·
Video is available on blackboard collaborate Ratio Analysis template https://www.jufinance.com/ratio |
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Below are Benjamin Graham’s seven time-tested
criteria to identify strong value stocks.
https://cabotwealth.com/daily/value-investing/benjamin-grahams-value-stock-criteria/
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? |
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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. http://www.marketwatch.com/tools/pftools/ http://www.youtube.com/watch?v=yph8TRldW6k The
yield curve (Video, Khan academy)
Treasury Yields
https://www.bloomberg.com/markets/rates-bonds/government-bonds/us 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?
https://www.investopedia.com/ask/answers/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. KEY TAKEAWAYS
Short-Term Interest Rates: Central BanksIn 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. Monday 1/15/2020 For
daily yield curve, please visit http://finra-markets.morningstar.com/BondCenter/Default.jsp
Understanding
the yield curve (video)
Introduction to
the yield curve (khan academy)
Normal Yield Curve
Steep Curve –
Economy is improving
Inverted Curve – Recession
is coming
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_p1.mp4 www.jufinance.com/video/fin435_c6_case_p2.mp4
(term structure) |
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What is interest rates https://www.youtube.com/watch?v=Pod73wrvdSQ Gerald Celente: Low Interest Rates are Building the
Biggest Bubble in Modern History - 9/21/14
https://www.youtube.com/watch?v=pTpK6Te6tYI How interest rates are set https://www.youtube.com/watch?v=Oz5hNemSdWc What happens if Fed raise interest rates https://www.youtube.com/watch?v=4OP-3Ui6K1s What Is the Relationship Between Inflation and
Interest Rates?
By JEAN FOLGERdated Dec 6, 2019Inflation 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. KEY TAKEAWAYS
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. Fall in inflation raises prospects of interest rate
cut (BBC news)
·
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. |
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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? Then,
(1+a)^N = (1+b)^m *(1+c)^(N-M)è c = ((1+a)^N / (1+b)^m)^(1/(N-M))-1 Or
approximately, N*a
= M*b +(N-M)*(c)è 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 TheoryThe 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) |
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Expectations Theory
By CHRIS B. MURPHY Updated Apr 21, 2019 Example of Calculating Expectations TheoryLet'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. |
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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%) |
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Chapter 7 Market data website: 1. FINRA http://finra-markets.morningstar.com/BondCenter/Default.jsp (FINRA bond market
data) 2. WSJ Market watch on Wall
Street Journal has daily yield curve and bond yield information. http://www.marketwatch.com/tools/pftools/ http://www.youtube.com/watch?v=yph8TRldW6k 3. Bond Online http://www.bondsonline.com/Todays_Market/ Simplified Balance Sheet of WalMart
https://finance.yahoo.com/quote/WMT/balance-sheet/ For discussion: · 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) Investing Basics: Bonds(video) FINRA – Bond market information http://finra-markets.morningstar.com/BondCenter/Default.jsp WAL-MART STORES INC
http://finra-markets.morningstar.com/BondCenter/BondDetail.jsp?ticker=C104227&symbol=WMT.GP Coupon Rate
7.550 % Maturity Date
02/15/2030
Credit
and Rating Elements
Classification Elements
Special
Characteristics
Issue Elements
Bond Elements
For class discussion: Fed
has hiked interest rates. So, shall you invest in short term bond or long
term bond? Study guide 1. Find bond sponsored by WMT just go to www.finra.org, è Investor center è market data è bond è corporate bond 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. http://finra-markets.morningstar.com/BondCenter/BondDetail.jsp?ticker=C610043&symbol=WMT4117477 Case study
of chapter 7 Associated
PPT (Due with
first mid term) · Video on blackboard · Also at www.jufinance.com/video/fin435_c7_case.mp4 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? |
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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. Call Provision
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. Put Provision
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. Conversion
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. |
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Mid Term exam (chapters 3, 4, 6, 7)
on 2/11
and 2/13 Study Guide 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. |
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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? |
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Chapter 8 Risk and
Return Chapter 8
case study (due
with Final) Videos --- available on
blackboard collaborate Ultra under Recording And also available below 1. class video excel
solver part I 2. class video excel
solver part 2 (solver, for 5
extra points) Excel File here (with solver solution) 3. Case video Equations 1. Expected return and standard deviation Given
a probability distribution of returns, the expected return can be calculated
using the following equation:
where
http://www.zenwealth.com/businessfinanceonline/RR/ExpectedReturn.html Given
an asset's expected return, its variance can be calculated using the
following equation:
where
The
standard deviation is calculated as the positive square root of the variance.
http://www.zenwealth.com/businessfinanceonline/RR/MeasuresOfRisk.html 2.
Two stock portfolio equations: 3.
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
RISK and Return General Template 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 7. 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) |
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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.
The most obvious recession risk beyond 2019 is a mundane
and technical one. With a low potential growth rate and a possible need to
operate the economy a touch below potential to gradually unwind the
overshoot—we forecast 1.5% growth in 2020 and 2021—the likelihood that normal
fluctuations will tip growth negative is mechanically somewhat higher. We
would interpret this as simply highlighting the arbitrariness of defining
recessions as negative growth, rather than as a material rise in the
unemployment rate. Of course, even a less severe recession could see a large
sell-off in risk assets. Accounting for these and other considerations, our
recession risk model indicates that recession risk is still quite low
(Exhibit 11). The expansion is therefore on course to become the longest in
US history next year, and even in subsequent years recession is not our base
case.
(Please refer to https://www.goldmansachs.com/insights/pages/outlook-2019/us-outlook/report.pdf for a better quality graph) · 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 Investors
expect to be compensated for risk and the time value of money.
The risk-free rate in the CAPM formula accounts for the time value
of money. The other components of the CAPM formula account for the investor
taking on additional risk. The beta of
a potential investment is a measure of how much risk the investment will add
to a portfolio that looks like the market. If a stock is riskier than the
market, it will have a beta greater than one. If a stock has a beta of less
than one, the formula assumes it will reduce the risk of a portfolio. A
stock’s beta is then multiplied by the market risk premium, which is the
return expected from the market above the risk-free rate. The risk-free rate
is then added to the product of the stock’s beta and the market risk
premium. The result should give an investor the required
return or discount rate they can use to find the value of an
asset. The
goal of the CAPM formula is to evaluate whether a stock is fairly valued when
its risk and the time value of money are compared to its expected return. For example, imagine an investor is
contemplating a stock worth $100 per share today that pays a 3% annual
dividend. The stock has a beta compared to the market of 1.3, which means it
is riskier than a market portfolio. Also, assume that the risk-free rate is
3% and this investor expects the market to rise in value by 8% per year. The
expected return of the stock based on the CAPM formula is 9.5%. The
expected return of the CAPM formula is used to discount the expected
dividends and capital appreciation of the stock over the expected holding
period. If the discounted value of those future cash flows is equal to $100
then the CAPM formula indicates the stock is fairly valued relative to risk. (https://www.investopedia.com/terms/c/capm.asp) Finding
Beta Value (https://finance.zacks.com/stock-beta-value-8004.html) The current beta
value of a company stock is provided for free by many online financial news
services, including Morningstar, Google Finance and Yahoo Finance. Online
brokerage services provide more extensive tracking of a company's beta
measurements, including historical trends. Beta is sometimes listed under
"market data" or other similar headings, as it describes past market
performance. A stock with a beta of 1.0 has the same price volatility as the
market index, meaning if the market gains, the stock makes gains at the same
rate. A stock with a beta of greater than 1.0 is riskier and has greater
price fluctuations, while stocks with beta values of less than 1.0 are
steadier and generally larger companies. Examples
of Beta Beta is often
measured against the S&P 500 index. An S&P 500 stock with a beta of
2.0 produced a 20 percent increase in returns during a period of time when
the S&P 500 Index grew only 10 percent. This same measurement also means
the stock would lose 20 percent when the market dropped by only 10 percent.
High beta values, including those more than 1.0, are volatile and carry more
risk along with greater potential returns. The measurement doesn't
distinguish between upward and downward movements. Investing Daily notes that
investors try to use stocks with high beta values to quickly recoup their
investments after sharp market losses. Small-Cap
Stocks Beta
values are useful to evaluate stock prices of smaller companies. These
small-capitalization stocks are attractive to investors because their price
volatility can promise greater returns, but Market Watch recommends only
buying small-cap stocks with beta values of less than 1.0. The beta value is
also a component of the Capital Asset Pricing Model, which helps investors
analyze the risk of an investment and the returns needed to make it
profitable. The Importance of Diversification
http://www.youtube.com/watch?v=RoqAcdTFVFY
Understanding Diversification in Stock Trading to Avoid Losses
http://www.youtube.com/watch?v=FrmoXog9zig
How to Build a Portfolio | by Wall
Street Survivor
http://www.youtube.com/watch?v=V48NECmT3Ns
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Chapter
9 Stock
Return Evaluation For class discussion: · What is dividend growth model? Why can
we use dividend to estimate a firm’s intrinsic value? · Are
future dividends predictable? · Refer
to the following table for WMT’s dividend history http://stock.walmart.com/investors/stock-information/dividend-history/default.aspx
Can you estimate the expected dividend in 2021? And in 2022? And
on and on…
Can
you write down the math equation now? WMT
stock price = ? Can
you calculate now? It is hard right because we assume dividend payment goes
to infinity. How can we simplify the calculation? We
can assume that dividend grows at certain rate, just as the table on the
right shows. Discount
rate is r (based on Beta and CAPM learned in chapter 6) Dividend growth model:
Refer to http://www.calculatinginvestor.com/2011/05/18/gordon-growth-model/ · Now let’s apply this
Dividend growth model in problem solving. Dividend Growth Model Calculator (www.jufinance.com/stock) Equations Po = D1/(r-g) = Do*(1+g)/(r-g), Where D1= next dividend; Do = just paid dividend;
r=stock return; g= dividend growth rate; Po= current market price Dividend Yield = D1/Po = Do*(1+g) / Po Capital gain yield = (P1/Po) -1 = g Total return = dividend yield + capital gain yield = D1/Po + g Non-constant dividend growth model (www.jufinance.com/dcf) Equations Pn = Dn+1/(r-g) = Dn*(1+g)/(r-g), since
year n, dividends start to grow at a constant rate. Where Dn+1= next dividend in year
n+1; Do = just paid dividend in year n; r=stock return; g= dividend growth rate; Pn= current market price in year n; Po = npv(r, D1, D2, …, Dn+Pn) Or, Po = D1/(1+r) + D2/(1+r)^2 + … +
(Dn+Pn)/(1+r)^n Video on blackboard and here (www.jufinance.com/video/fin435_c9_case.mp4) In class exercise (video) 1.
You expect AAA Corporation to generate the following
free cash flows over the next five years:
Since year 6,
you estimate that AAA's free cash flows will grow at 6% per year. WACC of AAA
= 15% ·
Calculate the enterprise value for DM Corporation. ·
Assume that AAA has $500 million debt and 14
million shares outstanding, calculate its stock price. 2. AAA’s
divided yield = 2.5%, equity cost = 10%, and its dividends will grow at a
constant rate of g. How much is g? A) 2.5% B) 5.0% C) 10.0% D) 7.5% Answer: 3. AAA pays no dividend currently. However, you
expect it pay an annual dividend of $0.56/share 2 years from now with a
growth rate of 4% per year thereafter. Its equity cost = 12%, then its stock
price=? A) $4.67 B) $5.00 C) $6.25 D) $7.00 Answer: 4. AAA expects to have earnings of $2.50 per share
this coming year. It will retain all of the earnings for the next year. For
the following 3 years, it will retain 50% of its earnings. It will ten retain
25% of its earnings after that. Each year, retained earnings will be used in
new projects with a return of 20% per year as expected. The rest of retained
earnings will paid to shareholders as dividends. Its equity cost = 10%. Its
stock price=? A) $40.80 B) $44.60 C) $59.80 D) $63.50
Hint: after year 5, the growth rate =0.2/3.99 = 5% Answer:
after year 5,
the growth rate =0.2/3.99 = 5% = growth in earnings / EPS So price at
year 4 = 3/(10%-5%) =60 So current
stock price = 1.5/(1+10%)^2 + 1.65/(1+10%)^3 + 1.82/(1+10%)^4 + 60/(1+10%)^4 =
44.60 Or price =
npv(10%, 0, 1.5, 1.65, 1.82+44.60) Live
session on 3/17 (on blackboard collaborate ultra recording as well) Class notes
FYI · In class exercise of chapter 9 |
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Stock screening tools ·
Reuters stock screener to help select stocks http://stockscreener.us.reuters.com/Stock/US/ ·
FINVIZ.com http://finviz.com/screener.ashx ·
WSJ stock screen http://online.wsj.com/public/quotes/stock_screener.html ·
Simply the Web's Best Financial Charts You can find analyst rating
from MSN money For instance, ANALYSTS RATINGS Zacks average brokerage recommendation is Moderate
Buy
Summary of stock screening rules from class discussion PEG<1 PE<15 (? FB’s PE>100?) Growth rate<20 ROE>10% Analyst ranking: strong buy only Zacks average =1 (from Ranking stocks
using PEG ratio) current price>5 How to
pick stocks Capital Asset Pricing Model
(CAPM)Explained http://www.youtube.com/watch?v=JApBhv3VLTo Ranking stocks using PEG ratio http://www.youtube.com/watch?v=bekW_hTehNU P/E Ratio Summary by industry (FYI) (http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/pedata.html
Details
about how to derive the model mathematically (FYI) The Gordon growth model is a simple
discounted cash flow (DCF) model which can be used to value a stock, mutual
fund, or even the entire stock market. The model is named after Myron
Gordon who first published the model in 1959. The Gordon model assumes that a
financial security pays a periodic dividend (D) which
grows at a constant rate (g). These growing dividend payments are
assumed to continue forever. The future dividend payments are discounted at
the required rate of return (r) to find the price (P) for the stock
or fund. Under these simple assumptions, the
price of the security is given by this equation:
In this equation, I’ve used
the “0” subscript on the price (P) and the “1” subscript
on the dividend (D) to indicate that the price is calculated at time zero and
the dividend is the expected dividend at the end of period one. However, the
equation is commonly written with these subscripts omitted. Obviously, the assumptions built
into this model are overly simplistic for many real-world valuation
problems. Many companies pay no dividends, and, for those that do,
we may expect changing payout ratios or growth rates as the
business matures. Despite these limitations, I believe spending some
time experimenting with the Gordon model can help develop intuition
about the relationship between valuation and return. Deriving the Gordon Growth Model
Equation
The Gordon growth model calculates the
present value of the security by summing an infinite series of discounted
dividend payments which follows the pattern shown here:
Multiplying both sides of the previous
equation by (1+g)/(1+r) gives:
We can then subtract the second equation
from the first equation to get:
Rearranging and simplifying:
Finally, we can simplify further to get
the Gordon growth model equation |
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Chapter 10 WACC
One option (if beta is given)
Another option (if dividend is given):
WACC Formula
WACC calculator (annual coupon bond) (www.jufinance.com/wacc)
WACC calculator (semi-annual coupon bond) WACC Calculator help videos FYI Summary of Equations Discount rate to figure out the value of projects is called WACC
(weighted average cost of capital) WACC = weight of debt * cost of debt + weight
of equity *( cost of equity) ·
Wd= total debt / Total capital
= total borrowed / total capital ·
We= total equity/ Total capital
·
Cost of debt = rate(nper, coupon, -(price – flotation costs),
1000)*(1-tax rate) ·
Cost of Equity = D1/(Po – Flotation Cost) + g
·
D1: Next period dividend; Po: Current stock price; g: dividend
growth rate ·
Note: flotation costs = flotation percentage * price ·
Or if beta is given, use CAPM model 1.
Cost of equity = risk free rate + beta *(market return – risk
free rate) 2.
Cost of equity = risk free rate + beta * market risk premium Discussion: · Cheaper to raise capital from debt market.
Why? Why not 100% financing via borrowing? · Why tax rate cannot reduce firms’ cost of
equity? · Please refer to the following excel worksheet
to learn how to calculate WACC of Hertz (7.99%). Excel file is here. Thanks to Chris, Brian and Hanna,
the CFA competition team of 2017. (FYI: Hertz Global Holdings Inc (NYSE:HTZ) WACC
%:-6.02% As of Today As of today, Hertz Global
Holdings Inc's weighted average cost of capital is -6.02%. Hertz
Global Holdings Inc's ROIC % is -16.07% (calculated
using TTM income statement data). Hertz Global Holdings Inc generates higher
returns on investment than it costs the company to raise the capital needed
for that investment. It is earning excess returns. A firm that expects to
continue generating positive excess returns on new investments in the future
will see its value increase as growth increases. https://www.gurufocus.com/term/wacc/HTZ/WACC/Hertz+Global+Holdings+Inc) In Class Exercise (Class
notes 3-24-2020) 1.
IBM financed 10m via debt coupon 5%, 10 year, price is $950 and
flotation is 7% of the price, tax 40%. IBM financed 20m via equity. D1=$5. Po=50, g
is 5%. Flotation cost =0. So WACC? Wd=1/3. We=2/3. Kd = rate(10, 5%*1000, 950-950*7%,
1000)*(1-40%) Ke = 5/(50 – 0) + 5% WACC = Wd*Kd +We*Ke = 2. Firm AAA sold a
noncallable bond now has 20 years to maturity. 9.25% annual coupon
rate, paid semiannually, sells at a price = $1,075, par =
$1,000. Tax rate = 40%, calculate after tax cost of debt (5.08%) 3.
Firm AAA’s equity condition is as follows. D1 =
$1.25; P0 = $27.50; g = 5.00%; and Flotation = 6.00% of
price. Calculate cost of equity (9.84%) 4.
Firm AAA raised 10m from the capital market. In it, 3m is from
the debt market and the rest from the equity market. Calculate WACC. WACC Case study (due with
final) Live
session 3-19 (also on blackboard) · Case
study of chapter 10 part I Live
session 3-24 (also on blackboard) · Case
study of chapter 10 part II · In
class exercise Class notes |
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FYI As of today, Walmart Inc's
weighted average cost of capital is 4.81%. Walmart Inc's ROIC % is 11.04% (calculated
using TTM income statement data). Walmart Inc generates higher returns on
investment than it costs the company to raise the capital needed for that
investment. It is earning excess returns. A firm that expects to continue
generating positive excess returns on new investments in the future will see
its value increase as growth increases. https://www.gurufocus.com/term/wacc/WMT/WACC/Walmart%2BInc Amazon.com Inc (NAS:AMZN) WACC %:10.06% As of
Today As of today, Amazon.com Inc's
weighted average cost of capital is 10.06%. Amazon.com
Inc's ROIC % is 19.58% (calculated
using TTM income statement data). Amazon.com Inc generates higher returns on
investment than it costs the company to raise the capital needed for that
investment. It is earning excess returns. A firm that expects to continue
generating positive excess returns on new investments in the future will see
its value increase as growth increases. https://www.gurufocus.com/term/wacc/AMZN/WACC-Percentage/Amazon.com%20Inc Apple Inc (NAS:AAPL) WACC %:7.96% As of
Today As of today, Apple Inc's
weighted average cost of capital is 7.64%. Apple Inc's ROIC % is 48.13% (calculated
using TTM income statement data). Apple Inc generates higher returns on
investment than it costs the company to raise the capital needed for that
investment. It is earning excess returns. A firm that expects to continue
generating positive excess returns on new investments in the future will see
its value increase as growth increases. https://www.gurufocus.com/term/wacc/AAPL/WACC/Apple%2Binc Cost of Capital
by Sector (US) Date
of Analysis:
Data used is as of January 2019
http://people.stern.nyu.edu/adamodar/New_Home_Page/datafile/wacc.htm |
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Chapter 11: Capital Budgeting Case
study questions (due with final) 3-26 live
session (also on blackboard) ·
Chapter 11 case study part I 3-31 live
session(also on blackboard) · Chapter 11 case study part II 1. NPV Excel syntax Syntax NPV(rate,value1,value2, ...) Rate is the rate of discount over
the length of one period. Value1, value2, ... are 1 to 29 arguments
representing the payments and income. · Value1, value2, ... must be equally spaced in
time and occur at the end of each period. NPV uses the
order of value1, value2, ... to interpret the order of cash flows.
Be sure to enter your payment and income values in the correct sequence. 2. IRR Excel syntax Syntax IRR(values, guess) Values is an array or a reference to cells
that contain numbers for which you want to calculate the internal rate of
return. Guess is a number that you guess is
close to the result of IRR.
Or, PI =
NPV / CFo +1 Profitable
index (PI) =1 + NPV / absolute value of CFo 3. MIRR( values, finance_rate, reinvest_rate ) Where the function arguments are as follows:
Modified Rate of Return:
Definition & Example (video)
https://study.com/academy/lesson/modified-rate-of-return-definition-example.html
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Weighted Average Cost of Capital (WACC) Calculator
(FYI) http://www.ultimatecalculators.com/weighted_average_cost_of_capital_WACC_calculator.html ‘Simple Rules’ for Running a Business
From the 20-page cellphone contract to the five-pound employee
handbook, even the simple things seem to be getting more complicated. Companies have been
complicating things for themselves, too—analyzing
hundreds of factors when making decisions, or consulting reams of data to
resolve every budget dilemma. But those requirements might be wasting time
and muddling priorities. So argues Donald Sull, a lecturer at the Sloan School
of Management at the Massachusetts Institute of Technology who has also
worked for McKinsey & Co. and Clayton, Dubilier & Rice LLC. In the book Simple
Rules: How to Thrive in a Complex World, out this week from Houghton Mifflin Harcourt HMHC -1.36%, he and Kathleen Eisenhardt of Stanford University claim that
straightforward guidelines lead to better results than complex formulas. Mr. Sull recently spoke with At Work about
what companies can do to simplify, and why five basic rules can beat a
50-item checklist. Edited excerpts: WSJ: Where, in the business context, might “simple
rules” help
more than a complicated approach? Donald Sull: Well, a common decision that people face in organizations is
capital allocation. In many organizations, there will be thick procedure
books or algorithms–one company I worked with had an
algorithm that had almost 100 variables for every project. These are very
cumbersome approaches to making decisions and can waste time. Basically, any
decision about how to focus resources—either people
or money or attention—can benefit from simple rules. WSJ: Can you give an example of how that simplification works in a company? Sull: There’s a German company called Weima GmBH that makes shredders. At one point,
they were getting about 10,000 requests and could only fill about a thousand
because of technical capabilities, so they had this massive problem of
sorting out which of these proposals to pursue. They had a very detailed
checklist with 40 or 50 items. People had to gather data and if there were
gray areas the proposal would go to management. But because the data was hard
to obtain and there were so many different pieces, people didn’t
always fill out the checklists completely. Then management had to discuss a
lot of these proposals personally because there was incomplete data. So top
management is spending a disproportionate amount of time discussing this
low-level stuff. Then Weima came up with guidelines that the
frontline sales force and engineers could use to quickly decide whether a
request fell in the “yes,” “no” or “maybe” category. They did it with five
rules only, stuff like “Weima had to
collect at least 70% of the price before the unit leaves the factory.” After that, only the “maybes” were sent
to management. This dramatically decreased the amount of time management
spend evaluating these projects–that time was
decreased by almost a factor of 10. Or, take Frontier Dental
Laboratories in Canada. They were working with a sales force of two covering
the entire North American market. Limiting their sales guidelines to a few
factors that made someone likely to be receptive to Frontier—stuff
like “dentists
who have their own practice” and “dentists
with a website”—helped focus their efforts and
increase sales 42% in a declining market. WSJ: Weima used five factors—is
that the optimal number? And how do you choose which rules to follow? Sull: You should have four to six rules. Any more than that, you’ll spend too
much time trying to follow everything perfectly. The entire reason simple
rules help is because they force you to prioritize the goals that matter.
They’re easy to remember, they don’t
confuse or stress you, they save time. They should be tailored to
your specific goals, so you choose the rules based on what exactly you’re trying to achieve. And you should of course talk to
others. Get information from different sources, and ask them for the top
things that worked for them. But focus on whether what will work for you and
your circumstances. WSJ: Is there a business leader you can point to who has embraced
the “simple
rules” guideline? Donald Sull: Let’s look at when Alex Behring took over America Latina Logistica SARUMO3.BR +1.59%, the Brazilian railway
and logistics company. With a budget of $15 million, how do you choose among
$200 million of investment requests, all of which are valid? The textbook business-school
answer to this is that you run the NPV (net present value) test on each
project and rank-order them by NPV. Alex Behring knows this. He was at the
top of the class at Harvard Business School. But instead Similarly, the global-health
arm of the Gates Foundation gets many, many funding requests. But since they
know that their goal is to have the most impact worldwide, they focus on
projects in developing countries because that’s where
the money will stretch farther. |
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Chapter 12: Cash Flow Estimation Chapter 12 case study (due
with final. Monte Carol simulation part is not required. FYI only)
Terminal
Year Cash Flows Recovery
of net working capital
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Live
session 4/2 (on blackboard as well) ·
Chapter 12 case study I Live
session 4/7 (on blackboard as well) ·
Chapter 12 case study II ·
For the sensitivity analysis part, there is an easy fix. Just type the
new numbers directly into the cell for the units sold, the unit costs, and
the salvage value, and you will get the correct NPVs. I made a mistake in the
video. I used the equations to get the numbers for those columns. This is
wrong. For example, just type in 700, 850, 1000, 1150, 1300, for new units
sold. Do not use equations. ·
Instead of earning 10
points for this case study, you can earn a total of 15 points for this case
study, if you could get the sensitivity analysis part done correctly. |
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Chapter 18 Derivatives Chapter 18 Case Study - due with final 1st, understand what is call
and put option 2nd, understand the pay off of call and put option 3rd, can draw payoff profile of call and put option Call and Put Option Calculator www.jufinance.com/option
Call and Put Option Diagram
Illustration Excel (Thanks
to Dr. Greence at UAH) 4th,
can calculate call option price using black-scholes model Black-Scholes Option
Calculator
http://www.tradingtoday.com/black-scholes Black-Scholes
Model Illustration Excel (Thanks
to Dr. Greence at UAH) 5th, can calculate option pricing using binomial
model (FYI) Binomial option Calculator (FYI) http://janroman.dhis.org/calc/Binomial2.php |
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Black-Scholes model (reference only)
Puts and Calls - How to Make Money When Stocks are
Going Up or Down
https://www.youtube.com/watch?v=D9-_Jar2UpQ Call Options Trading for Beginners in 9 min. - Put
and Call Options Explained
https://www.youtube.com/watch?v=q_z1Zx_BALo Gambling on Derivatives, Hedging Risk
or Courting Disaster?
Bullish option strategies example on optionhouse Bearish option strategies example on optionhouse |
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Live
session 4/9 (on blackboard as
well) ·
Chapter 18 case study I – intrinsic value of option and binomial
option pricing ·
FRM: Binomial (one step)
for option price (video, fyi)
·
Chapter 18 case study II – Black Scholes Model and sensitivity
analysis ·
Introduction to
the Black-Scholes formula | | Khan Academy (fyi)
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4/16 – No class 4/17 – Final exam and case studies due ·
will be posted at 8am on blackboard under course introduction ·
due at 11:59pm ·
All case studies due (videos for each
case study could be found on this website and on blackboard under blackboard
collaborate/recording) ·
Check list for all case
studies after the midterm exam 1. Chapter 8 2. Chapter 9 3. Chapter 10 4. Chapter 12 5. Chapter 18 Winner!
(Congraduations!)
Hossam Alomim
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Warmest congratulations on your graduation!
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