FIN435 Class Web Page, Spring '21

Jacksonville University, DCOB #263

Instructor: Maggie Foley

 

The Syllabus

Weekly SCHEDULE, LINKS, FILES and Questions

Week

Coverage, HW, Supplements

-        Required

 

Videos (optional)

Intro

Live Stream web link

 

Tuesday: https://us.bbcollab.com/guest/567be252ba94457cb9df31266c1961c3 ---- ON course room blackboard collaborate

Thursday: https://us.bbcollab.com/guest/c3525316a9bd4c659a766f8360b7100b ---- ON course room blackboard collaborate

 

Saturday office hour 5pm 6pm https://us.bbcollab.com/guest/24d0317fe94f45c58cd2e7ea450c960e

 

 

Tuesday - Group 1 in classroom Thursday - Group 2 in classroom

1/26 (Video) syllabus, set up market watch game

1/28 (Video) - Review of chapters 3, Case Study

2/2 (Video) - review of chapter 4, case study

2/4 (Video) - chapter 6 - break down interest rate

2/9 (Video) chapter 6 expectation theory, in class exercise

2/11 (Video) chapter 6 case study

2/16 (Video) - Chapter 7, in class exercise

2/18 (Video) chapter 7 case study

2/23(Video) - first mid term and homework due

2/25 (Video) Chapter 8

3/2 (Video) Chapter 8 in class exercise part I and case study

3/4 (Video) Chapter 8 in class exercise part ii, chapter 9

3/9 (Video) - chapter 9 case study

3/11 (Video) - chapter 9 in class exercise

3/16 (Video) chapter 10 WACC concept, theory, examples

WACC in each sector; negative WACC

3/18 (Video) chapter 10 case study

3/23(Video) - review of the 2nd midterm

3/25 (Video) second mid term exam and homework due (chapters 8, 9 10)

On blackboard collaborate at 3 pm

3/30 (Video) chapter 11capitl budgeting theory, in class exercise

4/1 (Video) chapter 11 case study

4/6 (Video) chapter 12 discounted cash flow in class exercise

4/8 (Video) chapter 12 case study part i

4/13(Video) chapter 12 case study part ii

4/15 (Video) chapter 18 call put option

4/20 (Video) - chapter 18 case study part I (call put option and Black-Scholes model

4/22 (Video) chapter 18 case study part ii Binomial model

4/27 (Video) final review

4/30 (Friday) (no video) final exam on blackboard under final exam folder (chapters 11, 12, 18). Homework due (chapters 11, 12, 18)

Final Week: Exit Exam on blackboard exit exam folder

 

5/3 5/4, similar to ETS exams

 

 

 

 

 

Marketwatch Stock Trading Game (Pass code: havefun)

Use the information and directions below to join the game.

1.     URL for your game: 
https://www.marketwatch.com/game/fin435-21spring

 

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!

 

Discussion: How to pick stocks (finviz.com)

Daily earning announcement: http://www.zacks.com/earnings/earnings-calendar

IPO schedule: http://www.marketwatch.com/tools/ipo-calendar

 

 

First Name

Last Name

Group 1 Tuesday

Group 2

Thursday

Aaerishna

Bala Krishnan

1

William

Burckley

1

Reed

Davis

1

William

Dean

1

Mack

Dickie

1

Julianne

Hutchison

1

Centraya

Kenny

1

DeUmee

Liburd

1

Narvin

Williams

1

Keith

Lundy

2

Adia

McMillian

2

Karol

Preneta

2

Christian

Rasmussen

2

Hunter

Smith

2

Elizabeth

Ulrick

2

Jordan

Ward

2

Narvin

Williams

2

Nicholas

Zipperer

2

Chapters 3 and 4

Chapter 3 Financial Statement

 

ppt

 

Using a Balance Sheet to Analyze a Company (VIDEO)

What is an Income Statement? (Video)

How Do You Read a Cash Flow Statement? | (VIDEO)

 

image001.jpg

 


Balance Sheet Template 
 

http://www.jufinance.com/10k/bs

 

Income Statement Template  

http://www.jufinance.com/10k/is

  

Cash flow template

http://www.jufinance.com/10k/cf

 

 

FCF calculator What is free cash flow (video)

http://www.jufinance.com/fcf

image003.jpg

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 First case study

        Excel File here (due with the first midterm exam,)

 

 

***** 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

 

Year

Value

FCFFt or Terminal value (TVt)

Calculation

Present value at 16.17%

01

FCFF0

(4,286)

1

FCFF1

(4,286)  (1 + 0.00%)

2

FCFF2

  (1 + 0.00%)

3

FCFF3

  (1 + 0.00%)

4

FCFF4

  (1 + 0.00%)

5

FCFF5

  (1 + 0.00%)

5

Terminal value (TV5)

  (1 + 0.00%) (16.17%  0.00%)

Intrinsic value of Amazon.com's capital

Less: Debt (fair value)

45,696 

Intrinsic value of Amazon.com's common stock

Intrinsic value of Amazon.com's common stock (per share)

$

Current share price

$1,642.81

1 


Weighted Average Cost of Capital (WACC)

Amazon.com Inc., cost of capital

 

Value1

Weight

Required rate of return2

Calculation

Equity (fair value)

803,283 

0.95

16.97%

Debt (fair value)

45,696 

0.05

2.10%

2.99% (1  29.84%)

1 USD $ in millions

   Equity (fair value) = No. shares of common stock outstanding Current share price
488,968,628  $1,642.81 = $803,282,551,764.68

   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
= (20.20% + 36.61% + 60.59% + 0.00% + 31.80%) 5 = 29.84%

WACC = 16.17%


FCFF Growth Rate (g)

FCFF growth rate (g) implied by PRAT model

Amazon.com Inc., PRAT model

 

Average

Dec 31, 2017

Dec 31, 2016

Dec 31, 2015

Dec 31, 2014

Dec 31, 2013

Selected Financial Data (USD $ in millions)

Interest expense

848 

484 

459 

210 

141 

Net income (loss)

3,033 

2,371 

596 

(241)

274 

Effective income tax rate (EITR)1

20.20%

36.61%

60.59%

0.00%

31.80%

Interest expense, after tax2

677 

307 

181 

210 

96 

Interest expense (after tax) and dividends

677 

307 

181 

210 

96 

EBIT(1 EITR)3

3,710 

2,678 

777 

(31)

370 

Current portion of long-term debt

100 

1,056 

238 

1,520 

753 

Current portion of capital lease obligation

5,839 

3,997 

3,027 

2,013 

955 

Current portion of finance lease obligations

282 

144 

99 

67 

28 

Long-term debt, excluding current portion

24,743 

7,694 

8,235 

8,265 

3,191 

Long-term capital lease obligations, excluding current portion

8,438 

5,080 

4,212 

3,026 

1,435 

Long-term finance lease obligations, excluding current portion

4,745 

2,439 

1,736 

1,198 

555 

Total stockholders' equity

27,709 

19,285 

13,384 

10,741 

9,746 

Total capital

71,856 

39,695 

30,931 

26,830 

16,663 

Ratios

Retention rate (RR)4

0.82

0.89

0.77

0.74

Return on invested capital (ROIC)5

5.16%

6.75%

2.51%

-0.12%

2.22%

Averages

RR

0.80

ROIC

3.31%

Growth rate of FCFF (g)6

0.00%

1 See Details

2017 Calculations

2 Interest expense, after tax = Interest expense (1 EITR)
848  (1  20.20%) = 677

3 EBIT(1 EITR) = Net income (loss) + Interest expense, after tax
3,033 + 677 = 3,710

4 RR = [EBIT(1 EITR) Interest expense (after tax) and dividends] EBIT(1 EITR)
= [3,710  677]  3,710 = 0.82

5 ROIC = 100 EBIT(1 EITR) Total capital
= 100  3,710  71,856 = 5.16%

6 g = RR ROIC
0.80  3.31% = 0.00%


FCFF growth rate (g) forecast

Amazon.com Inc., H-model

 

Year

Value

gt

1

g1

0.00%

2

g2

0.00%

3

g3

0.00%

4

g4

0.00%

5 and thereafter

g5

0.00%

where:
g
1 is implied by PRAT model
g
5 is implied by single-stage model
g
2g3 and g4 are calculated using linear interpoltion between g1 and g5

Calculations

g2 = g1 + (g5  g1) (2 1) (5 1)
0.00% + (0.00%  0.00%) (2 1) (5 1) = 0.00%

g3 = g1 + (g5  g1) (3 1) (5 1)
0.00% + (0.00%  0.00%) (3 1) (5 1) = 0.00%

g4 = g1 + (g5  g1) (4 1) (5 1)
0.00% + (0.00%  0.00%) (4 1) (5 1) = 0.00%

 

Chapter 4 Ratio Analysis

 

Ppt

 

Reference: Ratio Formulas

 

Reference: Commonly used ratio explained

 

 

Ratio Analysis  template

http://www.jufinance.com/ratio

 

 

Finviz.com/screener for ratio analysis (https://finviz.com/screener.ashx

 

Financial ratio analysis (VIDEO)

 

 

****** DuPont Identity *************

video 

 

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 (Second Case Study, due with first midterm exam)

Chapter 4 case study

 

 

 

 

 

 

Below are Benjamin Grahams 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 donneed to find the best quality companiesaverage or better is fine. Benjamin Graham recommended using Standard & Poors 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 & Poors, 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 companys  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 companys current problems.

For class discussion: Times have changed. Mr. Granhams book about value investing was published sixty years ago. Do you think the criteria in his book are still working in todays environment?

Chapter 6 Interest rate

 

ppt

 

 

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 (yield curve 2002-2012)

The yield curve (Video, Khan academy)

 

 

 

Treasury Yields

NAME

COUPON

PRICE

YIELD

1 MONTH

1 YEAR

TIME (EST)

GB3:GOV

3 Month

0.00

0.05

0.05%

-4

-150

4:59 PM

GB6:GOV

6 Month

0.00

0.07

0.07%

-3

-149

4:59 PM

GB12:GOV

12 Month

0.00

0.08

0.08%

-2

-142

4:59 PM

GT2:GOV

2 Year

0.13

100.03

0.11%

-2

-130

4:59 PM

GT5:GOV

5 Year

0.38

99.78

0.42%

+4

-99

4:59 PM

GT10:GOV

10 Year

0.88

98.23

1.07%

+13

-52

4:59 PM

GT30:GOV

30 Year

1.63

95.33

1.83%

+15

-21

4:59 PM

 

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

  • Interest rates are the cost of borrowing money and represent what creditors earn for lending money.
  • Central banks raise or lower short-term interest rates to ensure stability and liquidity in the economy.
  • Long-term interest rates are affected by demand for 10- and 30-year U.S. Treasury notes.
  • Low demand for long-term notes leads to higher rates, while higher demand leads to lower rates.
  • Retail banks also control rates based on the market, their business needs, and individual customers.

 

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 ratethe 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.

http://finra-markets.morningstar.com/BondCenter/Default.jsp

image004.jpg

image068.jpg

image064.jpg

image070.jpg

image072.jpg

 

 

What is interest rates

https://www.youtube.com/watch?v=Pod73wrvdSQ

 

 

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

 

 

 

 

The Fed wont keep interest rates near zero forever heres what to do now

PUBLISHED WED, JAN 27 20212:01 PM EST

Jessica Dickler

SHAREShare Article via FacebookShare Article via TwitterShare Article via LinkedIn

The Federal Reserve said Wednesday it would keep its benchmark interest rate near zero until the economic recovery gains ground. 

As the federal government rolls out a mass vaccination plan and weighs additional stimulus in the midst of the corona virus, the central bank is keeping its commitment to help everyday Americans through the pandemic.

That means rock-bottom rates will stick around, for now.

Even if everyone gets the vaccine, it will take a while for the economy to get rolling again, said Yiming Ma, an assistant finance professor at Columbia University Business School.

That will happen, but the time horizon is not likely to be this year, she added. Take this time to look for opportunities.

With millions of people out of work and a growing number of Americans feeling severely cash-strapped, the Feds policies can help, even without another Covid relief package.

Although the federal funds rate, which is what banks charge one another for short-term borrowing, is not the rate that consumers pay, the Feds moves still affect the borrowing and saving rates they see every day.

For example, the economy, the Fed and inflation all have some influence over long-term fixed mortgage rates, which generally are pegged to yields on U.S. Treasury notes.

https://image.cnbcfm.com/api/v1/image/106361684-15803101253712020012830-yrmortgagesvfederalfunds.png?v=1580310139&w=678&h=381

Currently, the average 30-year fixed rate home mortgage is near a record low at 3%, down from 3.77% a year ago, according to Bankrate. 

Homeowners can shave a few hundred dollars off their monthly payment by refinancing at a lower rate, if they havent already.

That is the most impactful on the household budget, said Greg McBride, chief financial analyst at Bankrate. The drop from last year to this year is so substantial that the refinancing savings is pretty compelling.

The same goes for other types of debt, particularly credit cards.

Most credit cards have a variable rate, which means theres a direct connection to the Feds benchmark rate.

Since the central bank started cutting rates a year ago, credit card rates have fallen to 16.03%, down from a high of 17.85%, according to Bankrate.

https://image.cnbcfm.com/api/v1/image/106359665-158030915711220200128creditcardratesvfederalfunds.png?v=1580309176&w=678&h=381

Its a great time to try to refinance your high-interest debt, said Matt Schulz, chief credit analyst at LendingTree, an online loan marketplace.

Zero-percent balance transfer credit cards are available, especially if you have good credit, he said. Weve also seen a decrease recently in APRs with personal loans, which can be a great tool for refinancing and consolidating debts.

The average interest rate on personal loans is now down to 11.84%, according to Bankrate.

Other borrowing costs are even lower. A home equity line of credit is as low as 4.73% and anyone shopping for a car will find the average five-year new car loan rate down to 4.20%.

The key to fully benefiting from the Feds actions is to compare rates from different lenders across all financial products in order to find your best deal, said Tendayi Kapfidze, chief economist at LendingTree.

Doing so could save you thousands in interest costs and better help you ride the waves of this economic storm.

Even college students can pay less on their student loan debt.

Based on an earlier auction of 10-year Treasury notes, the interest rates on federal student loans taken out during the 2020-21 academic year are at an all-time low.

For those struggling with outstanding balances, the new administration offered some relief by pausing payments on federal student loans through at least September 2021.

If possible, McBride advises borrowers to keep up payments anyway to knock down that balance while theres a reprieve in interest charges. Make hay while the sun shines, he said.

Private loans may have a variable rate tied to Libor, prime or T-bill rates, which means that when the Fed holds rates down, those borrowers can benefit as well, depending on the benchmark and the terms of the loan. 

That also makes it a good time to refinance private student loans or ask your lender what options are available.

https://image.cnbcfm.com/api/v1/image/106806669-1607113666758-20201204_student_loans.png?v=1607113687&w=678&h=390

As the economy recovers, paying down high-cost debt and building up emergency savings are the biggest moves consumers can make, McBride said. 

Currently, fewer than 4 in 10 people have enough savings to pay for an unexpected $1,000 expense in cash, according to a recent survey from Bankrate.

Theres a lot of work to be done and between stimulus checks and tax refunds, this is a good time of year to do it, McBride said. That can go a long way toward establishing your savings cushion.  

Just dont expect to earn anything from a standard savings account.

Although the Fed has no direct influence on deposit rates, those tend to be correlated to changes in the target federal funds rate.

As a result, the average savings account rate is down to a mere 0.05%, or even less, at some of the largest retail banks, according to the Federal Deposit Insurance Corp.

The potential for another round of stimulus checks could drive these rates even lower, according to Ken Tumin, founder of DepositAccounts.com.

The 2020 stimulus checks contributed to record levels of deposits at banks, he said. If new stimulus checks add to deposit levels at banks, the demand for deposits will further fall which will put more downward pressure on deposit rates.

When the inflation rate is higher than savings account rates, the money in savings loses purchasing power over time. 

 

 

Chapter 6 Interest rate Part II: Term Structure of Interest rate

 

Calculator Term Structure

 

image020.jpg

 

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) c = ((1+a)^N / (1+b)^m)^(1/(N-M))-1

 

Or approximately,

N*a = M*b +(N-M)*(c) 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)

 

 

Expectations Theory

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.

  • The first step of the calculation is to add one to the two-year bonds interest rate. The result is 1.2.
  • The next step is to square the result or (1.2 * 1.2 = 1.44).
  • Divide the result by the current one-year interest rate and add one or ((1.44 / 1.18) +1 = 1.22).
  • To calculate the forecast one-year bond interest rate for the following year, subtract one from the result or (1.22 -1 = 0.22 or 22%).

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 years bond would need to increase to 22% for this investment to be advantageous.

  • 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
  • In theory, long-term rates can be used to indicate where rates of short-term bonds will trade in the future

 

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 bonds 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

 

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:

    • Inflation premium = 3.25%
    • Liquidity premium = 0.6%
    • Maturity risk premium = 1.8%
    • Default risk premium = 2.15%

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%)

 

 

Chapter six case study

 

 

 

Chapter 7

 

ppt

 

 

 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

 

In Millions of USD 

As of 2020-01-31

Total Assets

236,495,000

Total Current Liabilities

16,203,000

Long Term Debt

64,192,000

Total Liabilities

154,943,000

Total Equity

81,552,000

Total Liabilities & Shareholders' Equity

236,495,000

https://www.wsj.com/market-data/quotes/WMT/financials/annual/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?

image004.jpg 

 

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

Symbol

WMT.GP

CUSIP

931142BF9

Next Call Date

Callable

Last Trade Price

$150.75

Last Trade Yield

1.498%

Last Trade Date

02/12/2021

US Treasury Yield

 

 

Trade History

Credit and Rating Elements

Moody's Rating

Aa2 (5/9//2018)

Standard & Poor's Rating

AA (02/10/2000)

TRACE Grade

Investment Grade

Default

Bankruptcy

N

Insurance

Mortgage Insurer

Pre-Refunded/Escrowed

Additional Description

Senior Unsecured Note

Classification Elements

Bond Type

US Corporate Debentures

Debt Type

Senior Unsecured Note

Industry Group

Industrial

Industry Sub Group

Retail

Sub-Product Asset

CORP

Sub-Product Asset Type

Corporate Bond

State

Use of Proceeds

Security Code

Special Characteristics

Medium Term Note

N

Issue Elements

*dollar amount in thousands

Offering Date

02/09/2000

Dated Date

02/15/2000

First Coupon Date

08/15/2000

Original Offering*

$1,000,000.00

Amount Outstanding*

$1,000,000.00

Series

Issue Description

Project Name

Payment Frequency

Semi-Annual

Day Count

30/360

Form

Book Entry

Depository/Registration

Depository Trust Company

Security Level

Senior

Collateral Pledge

Capital Purpose

Bond Elements

*dollar amount in thousands

Original Maturity Size*

1,000,000.00

Amount Outstanding Size*

1,000,000.00

Yield at Offering

7.56%

Price at Offering

$99.84

Coupon Type

Fixed

Escrow Type


 

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 Investor center  market data  bond  corporate bond

 

Corporate Bond

Issuer Name

Callable

Coupon

Maturity

Moody

S&P

Fitch

Price

Yield

WMT

No

7.55

2/15/2030

Aa2

AA

AA

150.748

1.4988

WMT

yes

6.75

4/2/2043

Aa2

AA

AA

116.188

0.688

(see below for details)

 

WALMART INC

+ ADD TO WATCHLIST

Coupon Rate

4.750

%

Maturity Date

10/02/2043

Symbol

WMT4055720

CUSIP

931142DK6

Next Call Date

04/02/2043

Callable

Yes

Last Trade Price

$131.19

Last Trade Yield

2.842%

Last Trade Date

02/08/2021

US Treasury Yield

 

Trade History

Prospectus


 

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

 

 

In class exercises

 

1.      AAA firm bonds will mature in eight years, and coupon is $65. YTM is 8.2%. Bonds market value? ($903.04, abs(pv(8.2%, 8, 65, 1000))

 

2.                  AAA firms 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? 

 

 

Case study of chapter 7  (Due with first mid term)

      Case study of chapter 7 (excel)

 

 

 

Bond Pricing Formula (FYI)

 

image033.jpg

 

 

 

image035.jpg

 

 

 

image036.jpg

 

 

 

 

image037.jpg

 

 

 

 

image038.jpg

 

 

 

 

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

 

 

 

 

 

 

 

 

Bond Calculator

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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.

First Mid Term exam (chapters 3, 4, 6, 7)

 

 

Chapter 8 Risk and Return

 

ppt

 

 

Part I: Expected Return and Standard Deviation

 

Calculator: https://www.jufinance.com/return/

 

Given a probability distribution of returns, the expected return can be calculated using the following equation:

http://www.zenwealth.com/businessfinanceonline/RR/images/ER.gif

where

  • E[R] = the expected return on the stock,
  • N = the number of states,
  • pi = the probability of state i, and
  • Ri = the return on the stock in state i.

Given an asset's expected return, its variance can be calculated using the following equation:

http://www.zenwealth.com/businessfinanceonline/RR/images/Var.gif

where

  • N = the number of states,
  • pi = the probability of state i,
  • Ri = the return on the stock in state i, and
  • E[R] = the expected return on the stock.

The standard deviation is calculated as the positive square root of the variance.

http://www.zenwealth.com/businessfinanceonline/RR/images/SD.gif

 http://www.zenwealth.com/businessfinanceonline/RR/MeasuresOfRisk.html

 

 

Part II: Two stock portfolio

 

Calculator https://www.jufinance.com/portfolio/

 

image026.jpg

W1 and W2 are the percentage of each stock in the portfolio.

image028.jpg

 

image031.gif

  • r12 = the correlation coefficient between the returns on stocks 1 and 2,
  • s12 = the covariance between the returns on stocks 1 and 2,
  • s1 = the standard deviation on stock 1, and
  • s2 = the standard deviation on stock 2.

image076.jpg

image022.jpg

  • s12 = the covariance between the returns on stocks 1 and 2,
  • N = the number of states,
  • pi = the probability of state i,
  • R1i = the return on stock 1 in state i,
  • E[R1] = the expected return on stock 1,
  • R2i = the return on stock 2 in state i, and
  • E[R2] = the expected return on stock 2.

 

Historical returns Calculator https://www.jufinance.com/hpr/

 

Holding period return (HPR) = (Selling price Purchasing price + dividend)/ Purchasing price

 

Part III:    CAPM model 

 

  

Calculator: https://www.jufinance.com/capm/

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?

image018.gif

 

 

How do you compute the Beta of a company

First, we need to have two samples of the same size: The returns for a company, and the returns of the market for the same period of time. Note: You need to provide the returns and NOT the actual stock values in order for the calculations to be correct.

Then, a linear regression is conducted and the estimated slope of the regression model using the returns of the company as the dependent variable and the returns of the market as the independent variable will be the beta we are looking for.

Alternative formulas to compute the beta https://mathcracker.com/beta-calculator

The actual definition of beta is :

image035.jpg

 

This formula is less clear for many people because the covariance is a less understood measure and some people do not know how to compute it.

Ultimately, the calculation of the beta as a slope coefficient of the regression between company and market returns has a stronger intuitive appeal.

Beta Calculator Excel

Calculation beta in Excel is easy. You need to go to a provider of historical prices, such as Yahoo finance. Then you clean all you need to clean and leave only adjusted prices.

Your market data could be the S&P 500 or any other market proxy. Then, by subtracting and dividing by the base value, you will get the returns, for both your company and the market.

Then, you will run a regression with the company returns as the dependent variable, and the market returns as the independent variable.

Finally, you will examine your regression output, and select the estimated slope coefficient. That will be the beta you are looking for.

Beta calculator and the CAPM

Why is it useful to compute the beta of a firm? Because it gives a measure of how risky the firm's stock is with respect to the market, and it tells us how much should be our expected return based ion that level of risk, via de CAPM model.

 

 

 

        SML Security Market Line

image043.jpg

 

 

RISK and Return General Template (standard deviation, correlation, beta)

 

 

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 portfolios 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). 

image045.jpg

 

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 uncles holding period return. (15 times)

6. Your current portfolios 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 portfolios 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 portfolios Beta first) (2.1)

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)

       The Solution in Excel and in Math equations (FYI)

 

 

8. A $40 million portfolio with a beta of 1.00. Risk-free rate= 4.25%, and the market risk premium= 6.00%. With an additional $60 million invested, the funds required return = 13.00%. The beta of stock that the $60 million dollars invested in?

ANSWER:

 

Old funds (millions) $40.00 40.00%

New funds (millions) $60.00 60.00%

Total new funds $100.00 100.00%

 

Beta on existing portfolio 1.00

Risk-free rate 4.25%

Market risk premium 6.00%

Desired required return 13.00% 13% = rRF + b(RPM); b = (13% − rRF)/RPM

Required new portfolio beta 1.4583 beta = (return − risk-free)/RPM

Required beta on new stocks 1.76 Req b = (old$/total$) old b + (new$/total$) new b

 

Beta on new stocks = (Req b − (old$/total$) old b)/(new$/total$)

 

 

9. What is the coefficient of variation on the company's stock?

 

Probability Stock's

State of of State

the Economy Return

Boom 0.45 25%

Normal 0.50 15%