FIN435 Class Web
Page, Spring '22
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 4/22/2022 How to Use Finviz
Stock Screener (youtube, FYI)
How To Win The
MarketWatch Stock Market Game (youtube, FYI)
How Short
Selling Works (Short Selling for Beginners)
(youtube, FYI)
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1/11Class video:
syllabus and market watch game 1/13 class video: interest rate and inflation, yield curve,
TIPs, Treasury rates 1/18 Class video: chapter 6 case study
(due with first mid term exam) Critical thinking
challenge: why are TIPS’ yields negative? (optional for
extra credits) 1/20 class
video: chapter 6 case study – expectation theory;
in class exercise 1/25 Class
video: Duration definition,
equations, excel syntax Critical
thinking challenge: how to trade bonds when interest rates rise? (optional for
extra credits) 1/27 class video: chapter 7 case
study part I (due
with first mid term exam) 2/1 Class video: chapter 7 case study part II, in class
exercise 2/3 class
video: chapter 8, in class exercise 2/8 Class video:
chapter 8 case study
part I 2/10 class
video: chapter 8 case study part
II, in class exercise 2/15 Class video efficient frontier (FYI only, template here) Critical
thinking challenge: based on 8 stocks of your choice, generate an efficient
frontier
(optional for extra credits) 2/17 class
video: first mid-term
exam (in class and online, on black board) 2/22 Class video:
chapter 9, stock valuation, in class exercise 2/24 class video:
chapter 9 case study
(due with 2nd mid term exam) 3/1 Class video:
chapter 9 case study part II, chapter 10 in class exercise 3/3 Class video
chapter 10 case
study 3/8 Class video
chapter 11 in class exercise 3/10 Class video
chapter 11 case study 3/15 Class video Spring Break 3/17 Class video Spring Break 3/22 Class video
chapter 11 case study II and Exit Exam Review 3/24 Class video Second mid term exam, case
studies due 3/29 Class video chapter 3 review and chapter 3 case study Critical
thinking challenge: Will the sanctions against Russia work? 3/31 Class video chapter 12 in class exercise 4/5 Class video chapter 12 case study part I 4/7 Class video
Class is cancelled.
Instructor will attend the EFA conference. 4/12 Class video chapter 12 case study part II, Monte Carlo
Simulation Critical
thinking challenge: Monte Carlo simulation practice based on chapter 12 case
study: randomly change tax rate and cost of capital, calculate NPVs. 4/14 Class video: charter day 4/19 Class video chapter 19 – Black-Sholes Model only Critical
thinking challenge: Shall the Fed raise interest rate by 0.5%
in May?
Why or why not? 4/21 Class video chapter 15, chapter 21 (briefly) · What is the indifference theory? What is the bird in hand theory? · Why did Amazon acquire Whole Foods? Critical
thinking challenge: Twitter adopts
poison pill defense to block Elon Musk takeover. Is that going to work? Why
or why not? ·
Final Exam, and Exit Exam on
4/26 on blackboard; · case studies due |
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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
Treasury Inflation Protected Securities (TIPS)
Hint: based on spread between
Treasury securities and TIPS è
Inflation Federal Reserve Rates
Municipal Bonds
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? ·
What is TIPs? What is municipal bond? What
is Fed Fund Rate? ·
Why are the TIPS’ rates negative? 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? Interest rates are
determined by whom 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.” 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)
Assignments: ·
Chapter
six case study (due with first mid term exam) ·
Critical thinking question: Why are TIPS yields
negative? (optional for extra credits) |
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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. Goldman predicts the Fed will hike rates four times this year, more than
previously expected PUBLISHED MON, JAN 10 20227:35 AM ESTUPDATED
MON, JAN 10 20229:32 AM EST, Jeff Cox KEY POINTS · Goldman
Sachs expects the Federal Reserve to raise rates four times this year, one
more than previously forecast. · The
estimate comes amid rising inflation and a tightening job market. · Along with
the rate hikes, Goldman sees the Fed shrinking its bond holdings soon. Federal Reserve Chairman Jerome Powell
testifies during the House Financial Services Committee hearing titled
Oversight of the Treasury Department’s and Federal
Reserve’s Pandemic Response, in Rayburn Building on
Wednesday, December 1, 2021. Persistently
high inflation combined with a labor market near full employment will push
the Federal Reserve to raise interest rates more than expected this year, according
to the latest forecast from Goldman Sachs. The Wall Street firm’s
chief economist, Jan Hatzius, said in a note Sunday that he now figures the Fed to enact four quarter-percentage
point rate hikes in 2022, representing an even more aggressive path than
the central bank’s indications of just a month ago. The Fed’s benchmark
overnight borrowing rate is currently anchored in a range between 0%-0.25%,
most recently around 0.08%. “Declining
labor market slack has made Fed officials more sensitive to upside inflation
risks and less sensitive to downside growth risks,”
Hatzius wrote. “We continue to see hikes in March,
June, and September, and have now added a hike in December for a total of
four in 2022.” Goldman had previously forecast three hikes,
in line with the level Fed officials had penciled in following their December
meeting The firm’s outlook for a more hawkish Fed
comes just a few days ahead of key inflation readings this week that are
expected to show prices rising at their fastest pace in nearly 40 years. If the Dow Jones estimate of 7.1%
year-over-year consumer price index growth in December is correct, that would
be the sharpest gain since June 1982. That figure is due out Wednesday. At the same time, Hatzius and other
economists do not expect the Fed to be deterred by declining job growth. The Fed will have to raise rates which
will increase volatility in markets, says Solus Asset’s Dan Greenhaus Nonfarm payrolls rose by 199,000 in December,
well below the 422,000 estimate and the second month in a row of a report
that was well below consensus. However, the unemployment rate fell to 3.9% at
a time when employment openings far exceed those looking for work, reflecting
a rapidly tightening jobs market. Hatzius thinks those converging factors will
cause the Fed not only to raise rates a full percentage point, or 100 basis
points, this year but also to start
shrinking the size of its $8.8 trillion balance sheet. He pointed
specifically to a statement last week from San Francisco Fed President Mary
Daly, who said she could see the Fed starting to shed some assets after the
first or second hike. “We are
therefore pulling forward our runoff forecast from December to July, with
risks tilted to the even earlier side,” Hatzius
wrote. “With inflation probably still far above
target at that point, we no longer think that the start to runoff will
substitute for a quarterly rate hike.” Up until a
few months ago, the Fed had been buying $120 billion a month in Treasurys and
mortgage-backed securities. As
of January, those purchases are being sliced in half and are likely to be
phased out completely in March. The asset
purchases helped hold interest rates low and kept financial markets running
smoothly, underpinning a nearly 27% gain in the S&P 500 for 2021. The Fed
most likely will allow a passive runoff of the balance sheet, by allowing
some of the proceeds from its maturing bonds to roll off each month while
reinvesting the rest. The process has been nicknamed “quantitative
tightening,” or the opposite of the quantitative
easing used to describe the massive balance sheet expansion of the past two
years. Goldman’s forecast is in line with market
pricing, which sees a nearly 80% chance of the first pandemic-era rate hike coming in March and close to a 50-50
probability of a fourth increase by December, according to the CME’s FedWatch Tool. Traders in the fed funds futures market
even see a nonnegligible 22.7% probability of a fifth rise this year. Still, markets only see the funds rate
increasing to 2.04% by the end of 2026, below the 2.5% top reached in the
last tightening cycle that ended in 2018. Markets
have reacted to the prospects of a tighter Fed, with government bond yields
surging higher. The benchmark 10-year Treasury note most recently yielded
around 1.77%, nearly 30 basis points higher than a month ago. |
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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 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 Simplified Balance Sheet of WalMart Balance Sheet
of WalMart https://www.nasdaq.com/market-activity/stocks/wmt/financials
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?
Investing Basics: Bonds(video) Relationship
between bond prices and interest rates (Khan academy)
FINRA – Bond market information http://finra-markets.morningstar.com/BondCenter/Default.jsp Go to http://finra-markets.morningstar.com/BondCenter/Default.jsp , the bond market data website of
FINRA to find bond information. For example, find bond sponsored by Wal-mart Or, just go to www.finra.org, è Investor
center è market data è bond è corporate
bond https://finra-markets.morningstar.com/BondCenter/Results.jsp 2. Understand what is coupon, coupon rate, yield, yield to
maturity, market price, par value, maturity, annual bond, semi-annual bond,
current yield. Refer to the following bond at http://finra-markets.morningstar.com/BondCenter/BondDetail.jsp?ticker=C104227&symbol=WMT.GP
Reading
material: Interest rate risk — When Interest rates Go up, Prices of Fixed-rate Bonds Fall, issued by SEC at https://www.sec.gov/files/ib_interestraterisk.pdf Question: What shall investors do as interest rates are
expected to rise in March 2022? All Bonds are Subject to
Interest Rate Risk—Even If the Bonds Are Insured or Government
Guaranteed There
is a misconception that, if a bond is insured or is a u.s. government
obligation, the bond will not lose value. In fact, the U.S. government does not guarantee the market price or value of
the bond if you sell the bond before it matures. This is because the
market price or value of the bond can change over time based on several
factors, including market interest rates. https://www.sec.gov/files/ib_interestraterisk.pdf Relationship
between bond prices and interest rates (Khan academy) Here’s how rising interest rates may affect your bond
portfolio in retirement PUBLISHED WED, JAN 19
20228:00 AM EST, Kate Dore, CFP® https://www.cnbc.com/2022/01/19/heres-how-rising-interest-rates-may-affect-your-bond-portfolio-.html KEY POINTS ·
Generally, market interest
rates and bond prices move in opposite directions, meaning as rates increase,
bond values will typically fall. ·
Retirees may reduce interest
rate risk by choosing bonds with a shorter duration, which are less sensitive
to rate hikes. ·
However, rising interest rates
may still be good for retirees with a longer timeline, experts say. Many retirees rely on bonds for income, lower risk and portfolio
growth. However, as the Federal Reserve prepares to raise interest rates,
some worry about the effects on their nest egg. The cost of living has swelled for months, with the Consumer
Price Index, the key measure of inflation, rising 7% year over year in
December, the fastest since 1982, according to the U.S. Department of Labor. Last week, Federal
Reserve Chairman Jerome Powell said he expects a series of rate hikes this
year, with reduced pandemic support from the central bank, to quell rising
inflation. This may alarm investors since
market interest rates and bond prices typically move in opposite directions,
meaning higher rates generally cause bond values to fall, known as interest
rate risk. For example, let’s say you have a 10-year $1,000 bond paying a
3% coupon. If market interest rates rise to 4% in one year, the asset will
still pay 3%, but the bond’s value may drop to $925. The reason for
the price dip is new bonds may be issued with the higher 4% coupon, making
the original 3% bond less attractive unless someone can buy it at a
discount. With higher yields elsewhere, investors tend to sell their
current bonds to purchase the higher-paying ones, and heavy selling causes
prices to slide, explained certified financial planner Brad Lineberger,
president of Carlsbad, California-based Seaside Wealth Management. Why bond
duration matters Another
fundamental concept of bond investing is so-called duration, measuring a
bond’s sensitivity to interest rate changes. Although it’s expressed in
years, it’s different from the bond’s maturity since it factors in the
coupon, time to maturity and yield paid through the term. As a rule of thumb, the longer a bond’s duration, the more
sensitive it will be to interest rate hikes, and the more its price will
decline, Lineberger said. Generally, if you’re
trying to reduce interest rate risk, you’ll want to consider bonds or bond
funds with a shorter duration, said Paul Winter, a CFP and owner of Five Seasons Financial
Planning in Salt Lake City. “Also, bonds with higher coupon rates and lower credit quality
tend to be less sensitive to higher interest rates, other factors being
equal,” he said. A longer timeline While rising
interest rates will cause bond values to decrease, eventually, the declines
will be more than offset as bonds mature and can be reinvested for higher
yields, said CFP Anthony Watson,
founder and president of Thrive Retirement Specialists in Dearborn, Michigan. “Rising interest
rates are good for retirees with a longer-term time frame,” he said, and that’s most people in their retirement years. The best way to
manage interest rate risk is with a diversified portfolio, including
international bonds, with short to immediate maturities that are less
affected by rate hikes and can be reinvested sooner, Watson said. For class discussion: What is duration? How to calculate a bond’s duration? a
portfolio’s duration? Bond Portfolio Duration (FYI) There are two ways to calculate the duration of a bond
portfolio: 1)
The weighted average of the
time to receipt of aggregate cash flows. This method is based on the cash
flow yield, which is the internal rate of return on the aggregate cash flows. Limitations: This method cannot be used for bonds with embedded
options or for floating-rate notes due to uncertain future cash flows. The
cash flow yield is not commonly calculated. The change in cash flow yield is
not necessarily the same as the change in the yields-to-maturity on the
individual bonds. Interest rate risk is not usually expressed as a change in
the cash flow yield. 2)
The weighted average of the
durations of individual bonds that compose the portfolio. The weight is the
proportion of the portfolio that a bond comprises. 3)
Portfolio Duration = w1D1 + w2D2
+ w3D3 + ... + wkDk wi = the market value of bond i / market value of the
portfolio Di = the duration of bond i k = the number of bonds in the portfolio This method is simpler to use and quite accurate when the yield
curve is flat. Its main limitation is that it assumes a parallel shift in the
yield curve. 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(5, 105, -1180, 1100)) What is
their yield to maturity (YTM)? 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)) Assignment:
Chapter 7 Case Study – Due
with first mid term exam ·
Critical thinking question: How to trade bonds when
market interest rates rise? (optional for extra credits) |
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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 Bond Duration Calculator
(FYI) https://exploringfinance.com/bond-duration-calculator/ Duration (FYI) By ADAM HAYES Updated August 18, 2021, Reviewed by GORDON
SCOTT, Fact checked by KIRSTEN ROHRS SCHMITT https://www.investopedia.com/terms/d/duration.asp What Is Duration? Duration is a measure of the sensitivity of the price of a
bond or other debt instrument to a change in interest rates. A bond's
duration is easily confused with its term or time to maturity because certain
types of duration measurements are also calculated in years. However, a bond's term is a linear measure of the years until
repayment of principal is due; it does not change with the interest rate
environment. Duration, on the other hand, is non-linear and accelerates as
the time to maturity lessens. KEY TAKEAWAYS ·
Duration measures a bond's
or fixed income portfolio's price sensitivity to interest rate changes. ·
Macaulay duration estimates
how many years it will take for an investor to be repaid the bond’s price by its total cash flows. ·
Modified duration measures
the price change in a bond given a 1% change in interest rates. ·
A fixed income portfolio's
duration is computed as the weighted average of individual bond durations
held in the portfolio. How Duration Works Duration can measure how
long it takes, in years, for an investor to be repaid the bond’s price by the bond’s total cash
flows. Duration can also measure the sensitivity of a bond's or fixed income
portfolio's price to changes in interest rates. In general, the higher the
duration, the more a bond's price will drop as interest rates rise (and the
greater the interest rate risk). For example, if rates were to rise 1%, a
bond or bond fund with a five-year average duration would likely lose
approximately 5% of its value. Certain factors can
affect a bond’s duration, including: Time to maturity: The longer
the maturity, the higher the duration, and the greater the interest rate risk. Consider two bonds that each yield 5% and cost $1,000, but
have different maturities. A bond that matures faster—say,
in one year—would repay its true cost faster than a
bond that matures in 10 years. Consequently, the shorter-maturity bond would
have a lower duration and less risk. Coupon rate: A bond’s coupon rate is a key factor
in calculation duration. If we have two bonds that are identical with the
exception of their coupon rates, the bond with the higher coupon rate will
pay back its original costs faster than the bond with a lower yield. The higher the coupon rate, the lower the
duration, and the lower the interest rate risk. Types of Duration The duration of a bond in practice can refer to two different
things. The Macaulay duration is the
weighted average time until all the bond's cash flows are paid. By
accounting for the present value of future bond payments, the Macaulay duration helps an investor
evaluate and compare bonds independent of their term or time to maturity. The second type of duration is called modified duration.
Unlike Macaulay's duration, modified
duration is not measured in years. Modified duration measures the expected
change in a bond's price to a 1% change in interest rates. In order to understand modified duration, keep in mind that
bond prices are said to have an inverse relationship with interest rates.
Therefore, rising interest rates
indicate that bond prices are likely to fall, while declining interest rates
indicate that bond prices are likely to rise. Macaulay Duration Macaulay duration finds the present value of a bond's future
coupon payments and maturity value. Because Macaulay duration is a partial
function of the time to maturity, the
greater the duration, the greater the interest-rate risk or reward for bond
prices. Macaulay duration can be calculated manually as follows:
https://exploringfinance.com/bond-duration-calculator/ Modified Duration The modified duration of a
bond helps investors understand how much a bond's price will rise or fall if
the YTM rises or falls by 1%. This is an important number if an investor is worried that
interest rates will be changing in the short term. The modified duration of a
bond with semi-annual coupon payments can be found with the following
formula:
Usefulness of Duration Investors need to be aware of two main risks that can affect a
bond's investment value: credit risk (default) and interest rate risk
(interest rate fluctuations). Duration
is used to quantify the potential impact these factors will have on a bond's
price because both factors will affect a bond's expected YTM. For example, if a company begins to struggle and its credit
quality declines, investors will require a greater reward or YTM to own the
bonds. In order to raise the YTM of an existing bond, its price must fall.
The same factors apply if interest rates are rising and competitive bonds are
issued with a higher YTM. The duration of a
zero-coupon bond equals its time to maturity since it pays no coupon. Duration Strategies However, a
long-duration strategy describes an investing approach where a bond investor
focuses on bonds with a high duration value. In this situation, an
investor is likely buying bonds with a long time before maturity and greater
exposure to interest rate risks. A
long-duration strategy works well when interest rates are falling, which
usually happens during recessions. A short-duration strategy is
one where a fixed-income or bond investor is focused on buying bonds with a
small duration. This usually means the investor is focused on bonds with a
small amount of time to maturity. A strategy like this would be employed when investors think
interest rates will rise or when they are very uncertain about interest rates
and want to reduce their risk. Why Is It Called Duration? Duration measures a bond price's sensitivity to changes in
interest rates—so why is it called duration? A bond with a longer time to maturity
will have a price that is more sensitive to interest rates, and thus a larger
duration than a short-term bond. What Else Does Duration Tell You? As a bond's duration rises, its interest rate risk also rises
because the impact of a change in the interest rate environment is larger
than it would be for a bond with a smaller duration. Fixed-income traders will use duration, along with convexity, to
manage the riskiness of their portfolio and to make adjustments to it. Bond Duration Calculator
(FYI) https://exploringfinance.com/bond-duration-calculator/ Computing
Duration Excel (video, FYI)
DURATION
function in Excel The DURATION function, one of the Financial functions,
returns the Macauley duration for an assumed par value of $100. Duration is
defined as the weighted average of the present value of cash flows, and is
used as a measure of a bond price's response to changes in yield. Syntax DURATION(settlement, maturity, coupon, yld, frequency,
[basis]) Important: Dates should be entered by using the DATE
function, or as results of other formulas or functions. For example, use
DATE(2018,5,23) for the 23rd day of May, 2018. Problems can occur if dates
are entered as text. The DURATION function syntax has the following arguments: Settlement: The security's settlement date. The security
settlement date is the date after the issue date when the security is traded
to the buyer. Maturity: The security's maturity date. The maturity date
is the date when the security expires. Coupon: The security's annual coupon rate. Yld Required.
The security's annual yield. Frequency: The number of coupon payments per year. For
annual payments, frequency = 1; for semiannual, frequency = 2; for quarterly,
frequency = 4. Basis Optional. The type of day count basis to use. https://support.microsoft.com/en-us/office/duration-function-b254ea57-eadc-4602-a86a-c8e369334038 0:02 / 1:54
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Chapter 8 Risk and
Return Equations 1. Expected return and standard deviation Given
a probability distribution of returns, the expected return can be calculated
using the following equation:
where
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:
W1 and W2 are the
percentage of each stock in the portfolio.
Portfolio Variance Part 1
(youtube)
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) Efficient
Frontier Exercise ? (FYI only) Chapter 8 Case study –
due with the first mid term exam |
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Nov 2, 2021,07:30am EDT|86,690 views No Recession In
2022—But Watch Out In 2023 Bill Conerly A recession will come to the United States economy, but not in
2022. Federal Reserve policy will lead to more business cycles, which many
businesses are not well prepared for. The
downturn won’t come in 2022, but could arrive as early as 2023. If the Fed
avoids recession in 2023, then look for a more severe slump in 2024 or 2025. Recessions
usually come from demand weakness, but supply problems can also trigger a
downturn. In 2022 demand for goods and
services will be strong. Consumers have plenty of money, thanks to past
earnings, stimulus payments and extra unemployment insurance. They have paid
down their credit card balances. Even though they also increased their car
loans outstanding as they upgraded their rides, their general condition is
good. Employment will increase thanks to the spending, reinforcing the income
gains that enable expenditures. Businesses, too, have plenty of cash on hand. Not only have
profits been good, but the Paycheck Protection Program gave nearly $800
billion to businesses. Companies want to buy computers, equipment and
machinery to substitute for the workers they cannot find, and this spending
will help manufacturers of the equipment. Homebuilders will construct as many homes as they can, though
that will be limited by buildable lots, skilled labor and building materials.
Non-residential construction will slowly gain ground, especially in warehouse
space and suburban offices. The government will spend, not only at the federal level but
also among state and local entities. The federal government has no worries
about deficits, while state and local governments are flush with federal
money. The spending
side of the economy has little risk of recession in 2022, but could supply
problems trigger a recession? Supply chain
problems can have negative impacts when factories have to shut down for lack
of parts, as happened in the automobile industry. Recently Ford Europe’s Gunnar Herrmann told CNBC, “It’s not only semiconductors. You find shortages or
constraints all over the place,” mentioning lithium,
plastics and steel in particular. The automobile industry has laid off
workers at multiple plants, mostly for a few weeks, but some long term. When
workers are laid off for lack of materials to assemble, then the economy
suffers. Most of the shortages under
discussion, however, are limiting growth rather than cutting back on current
production. So the supply
challenge we have is not an actual reduction in materials available, just
insufficient materials to meet the stronger demand. Despite the snarls at the ports of Long Beach and Los Angeles,
more inbound containers are hitting the docks than in 2019. Mostly we are seeing
supply as a limit on growth rather than a cause of recession. Much of the
supply limitation prevents growth, but does not push spending downward. Businesses are cutting back on variety. A shirt in a
particular size may only be available in a few colors, not 16. That is
unfortunate, and may discourage a few shoppers, but for the most part we’ll still be buying goods. Job losses from
vaccine mandate layoffs could push the economy toward recession, given that 31% of people over age 18 are not fully vaccinated.
The various mandates cover about 100 million workers. Some of those 31
million unvaccinated workers subject to mandates will get their shots, but
others certainly won’t. In the worst of the pandemic
recession, the country lost 22 million jobs. Losing 31 million jobs because
of vaccine mandates—or even half that number—would be disastrous. And because it would be disastrous,
it will not happen. The Biden administration almost certainly will pull back
the mandate before accepting such a harsh result rise in unemployment. Though 2022 is
unlikely to host a recession, 2023 and 2024 are extremely risky. The Federal Reserve will
start tapering its quantitative stimulus soon, and sometime in mid-2022 it
will begin raising short-term interest rates. The economy reacts with a time
lag of about one year, plus or minus. The greatest risk in the near term
is that the Fed realizes that much of
the recent inflation is long-lasting rather than transitory. They will then
hit the brakes. Because of the
time lag, the Fed may decide to stomp down harder on the brakes, triggering a
recession. If the Fed avoids an over-reaction recession, it risks not
bringing inflation down at all. The longer the Fed waits, the more work they
will need to do later. We’ll still have massive fiscal stimulus plus the
lagged effects of past monetary stimulus. Public anger over inflation will
provoke a stronger Fed response by 2025 at the latest, but probably earlier. Can a recession
be completely avoided in the next few years? Theoretically it’s possible. The
Fed would have to tighten at just the right time, in just the right
magnitude, then return to neutral at just the right time. It could happen, but the odds are very, very slim. The people
at the Fed are smart and knowledgeable, but the task is too difficult for
mere mortals. So businesses should enjoy their gains in 2022 while developing
contingency plans to be ready for the nearly-inevitable recession. 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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Efficient Frontier
(FYI only) Excel template (www.jufinance.com/efficient_frontier_excel) Efficient Portfolio Frontier explained: Solver (Excel)
- YouTube
Critical thinking
challenge: Based on 8 stocks of your choice, generate an efficient frontier |
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Firm Mid Term
exam 2/17/2022 on blackboard under
first exam folder |
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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 2022? And in 2023? 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 In class exercise 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. Answer: Enterprise value = npv(15%, 75, 84, 96, 111,
120+120*(1+6%)/(15%-6%)) = 1017.66 (or, equity value = 75/(1+15%) + 84/(1+15%)^2 + 96/(1+15%)^3 +
111/(1+15%)^4 + (120+120*(1+6%)/(15%-6%))/(1+15%)^5 Equity value = 1017.66-500 = 517.66 Stock price = 517.66/14=37 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: Dividend yield + capital gain yield = total return
= 10%, and g= capital yield = dividend growth rate, so g = 10% - 2.5% = 7.5% 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: Stock price = Po = npv(12%, 0, 0.56 +
0.56*(1+4%)/(12%-4%)) = 6.25 Or, Po = 0.56/(1+12%)^2 + 0.56*(1+4%)/(12%-4%)
/(1+12%)^2 = 6.25 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 4 years, it will retain 50% of its earnings. It will 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) |
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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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Stock Splits
https://stock.walmart.com/investors/stock-information/dividend-history/default.aspx Wal-Mart
Stores, Inc. was incorporated on Oct. 31, 1969. On Oct. 1, 1970, Walmart
offered 300,000 shares of its common stock to the public at a price of $16.50
per share. Since that time, we have had 11 two-for-one (2:1) stock splits. On
a purchase of 100 shares at $16.50 per share on our first offering, the
number of shares has grown as follows:
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Elon Musk’s SpaceX to split its private stock 10-for-1 PUBLISHED FRI, FEB 18 20221:43 PM ESTUPDATED FRI, FEB 18
20222:38 PM EST Michael Sheetz https://www.cnbc.com/2022/02/18/elon-musks-spacex-performing-10-for-1-stock-split.html KEY POINTS ·
Elon Musk’s
SpaceX is splitting the value of its common stock 10-for-1, CNBC has learned. With SpaceX valued at $560 a share during its most recent sale,
the split reduces SpaceX’s common stock to $56 a share, according to a
company-wide email obtained by CNBC. A stock split is cosmetic and does not fundamentally change
anything about the company. Elon Musk’s SpaceX is splitting the value of its common stock
10-for-1, CNBC has learned, with the company’s valuation having soared to
more than $100 billion. The split means that for each share of SpaceX stock owned as
of Thursday, a holder now has 10 shares after the conversion. With SpaceX
valued at $560 a share during its most recent sale, the split reduces
SpaceX’s common stock to $56 a share, according to a company-wide email
obtained by CNBC. “The split has no impact on the overall valuation of the
company or on the overall value of your SpaceX holdings,”
the email said. SpaceX did not immediately respond to CNBC’s request for
comment. As the email to employees emphasizes, a stock split is
cosmetic and does not fundamentally change anything about the company.
Companies occasionally perform stock splits, such as high-growth tech
companies such as Apple or Google-parent Alphabet, and the move is typically
seen as a way to make the shares more accessible or manageable. This is the first time SpaceX has performed a stock split,
according to multiple people familiar with the private company. The company’s valuation has soared in the last few years as
SpaceX has raised billions to fund work on two capital-intensive projects:
the next generation rocket Starship and its global satellite internet network
Starlink. What is SpaceX
stock? SpaceX is not a publicly traded company. That means you cannot
buy SpaceX stock in the public market. Unless you are extremely wealthy or
have a large stake in a company that has a stake in SpaceX, it’s unlikely you
will ever be able to own anything resembling SpaceX shares, for now. SpaceX still does of course have stakeholders. Founder Elon
Musk, who also founded famed electric vehicle manufacturer Tesla, funded the
company initially with funds from his sale of popular online payments
platform PayPal. Other equity firms, like Founders Fund and Valor Equity
Partners, also have significant stake in SpaceX. How to buy
SpaceX stock As mentioned, the only people buying SpaceX stock aren’t
individuals — they’re large corporations and equity firms. For instance,
Google and Fidelity together invested around a billion dollars in 2015 for a
10% stake in the company. How much does
SpaceX’s stock cost? SpaceX’s
shares are valued at $56 per share. SpaceX is not a publicly traded company; therefore, publicly
traded SpaceX stock (which doesn’t exist) has no price. The only way to know how much SpaceX shares could be worth
would be to look at the company’s last evaluation. In October of 2021, it was
reported that a private shareholder sold shares for a price of $560 per
share. That puts the worth of SpaceX at $100 billion, the second highest
valued private company in the world. However, SpaceX went through a 10-1 stock split in February of
2022 meaning that for every one share a holder owned, they now own 10. This
also reduces the price of the share, meaning the current price of a single
share of SpaceX is now $56. A stock split doesn’t change anything about the
company except for the number of shares. SpaceX stock
symbol SpaceX is not a publicly traded company; therefore, publicly
traded SpaceX stock (which doesn’t exist) has no stock ticker symbol. If it
did have one, SPCX would probably be a good fit. When will
SpaceX go public? Elon Musk has stated that SpaceX will not go public any time
soon. Musk has stated that short-term demands of shareholders could ruin the
company’s chance of colonizing Mars, the long term goal of SpaceX. Once that
goal is achieved, Musk might rethink keeping SpaceX private. https://spaceexplored.com/guides/spacex-stock/ |
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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
%:3.74% As of 2/26/2022 As of today, Hertz Global
Holdings Inc's weighted average cost of capital is 3.74%. Hertz
Global Holdings Inc's ROIC % is 7.26% (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 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. 5.
Common
stock currently sells =
$45.00 /
share; and earn $2.75 /share this year, payout
ratio is 70%, and its constant growth rate = 6.00%.
New stock can
be sold at the current price, a flotation cost =8%. How much would the cost
of new stock beyond
the cost of retained earnings? Answer: Expected
EPS1 $2.75 Payout
ratio 70% Current
stk price $45.00 g 6.00% F 8.00% D1 $1.925 rs
= D1/P0 + g 10.28% re
= D1/(P0 × (1 − F)) + g 10.65% Difference = re – rs 0.37% 6. (1) The firm's noncallable bonds mature in
20 years, an 8.00% annual coupon, a market price of $1,050.00. (2) tax rate = 40%.
(3) The risk-free rate=4.50%,
the market risk premium =
5.50%, stock’s
beta =1.20. (4) capital
structure consists of 35% debt and
65% common equity.
What is its WACC? Answer: Coupon
rate 8.00% Maturity 20 Bond
price $1,050.00 Par
value $1,000 Tax
rate 40% rRF 4.50% RPM 5.50% b 1.20 Weight
debt 35% Weight
equity 65% Bond
yield 7.51% A-T
cost of debt 4.51% Cost
of equity, rs = rRF + b(RPM) 11.10% WACC = wd(rd)(1 – T) + wc(rs)
= 8.79% WACC Case study (due with 2nd mid term exam) FYI: WACC calculator https://fairness-finance.com/fairness-finance/finance/calculator/wacc.dhtml |
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FYI https://valueinvesting.io/WMT/valuation/wacc WMT WACC - Weighted Average Cost of Capital
WMT WACC calculation
AMZN WACC
- Weighted Average Cost of Capital
WACC AMZN WACC calculation
https://valueinvesting.io/AMZN/valuation/wacc TSLA WACC
- Weighted Average Cost of Capital
WACC TSLA WACC calculation
https://valueinvesting.io/TSLA/valuation/wacc 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 second midterm exam) 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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Second Midterm Exam |
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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)
http://www.jufinance.com/10k/bs http://www.jufinance.com/10k/is http://www.jufinance.com/10k/cf Note:
All companies, foreign and domestic, are required to file registration
statements, periodic reports, and other forms electronically through
EDGAR. ************
What is Free Cash Flow ************** What is free cash flow (video) What
is free cash flow (FCF)? Why is it important? • FCF is
the amount of cash available from operations for distribution to all
investors (including stockholders and debtholders)
after making the necessary investments to support operations. • A
company’s value depends on the amount of FCF it can
generate. What
are the five uses of FCF? 1.
Pay interest on debt. 2.
Pay back principal on debt. 3.
Pay dividends. 4.
Buy back stock. 5.
Buy nonoperating assets (e.g., marketable
securities, investments in other companies, etc.)
What
are operating current assets? • Operating
current assets are the CA needed to support operations. • Op CA
include: cash, inventory, receivables. • Op CA
exclude: short-term investments, because these are not a part of operations. What
are operating current liabilities? • Operating
current liabilities are the CL resulting as a normal part of operations. • Op CL
include: accounts payable and accruals. • Op
CL exclude: notes payable, because this is a
source of financing, not a part of operations.
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. https://www.sec.gov/edgar/searchedgar/companysearch.html In class exercise Firm AAA has EBIT (operating income) of $3
million, depreciation of $1 million. Firm AAA’s
expenditures on fixed assets = $1 million. Its net operating working capital
= $0.6 million. Calculate for free cash flow. Imagine that the tax
rate =40%. FCF = EBIT(1
– T) + Deprec. – (Capex + NOWC) answer: EBIT $3 Tax
rate 40% Depreciation $1 Capex + NOWC $1.60 So, FCF
= $1.2 Case study of
chapter 3 – First case study · Excel
File here (due with the final exam,) ‘ |
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FYI: Market Value Added (MVA) By
JAMES CHEN Updated May 26, 2021, Reviewed by DAVID KINDNESS, Fact checked by
HANS DANIEL JASPERSON What Is
Market Value Added? Market value added (MVA) is a calculation
that shows the difference between the market value of a company and the
capital contributed by all investors, both bondholders and shareholders. In other words, it is the market value of debt and equity minus all
capital claims held against the company. It is calculated as: MVA = V
- K where
MVA is the market value added of the firm, V is the market value of the firm,
including the value of the firm's equity and debt (its enterprise value), and
K is the total amount of capital invested in the firm.
MVA is
closely related to the concept of economic value added (EVA), representing
the net present value (NPV) of a series of EVA values. KEY
TAKEAWAYS ·
MVAs
are representations of value created by the actions and investments of a
company's management. ·
A
high MVA is evidence that the value of management's actions and investments is
greater than the value of the capital contributed by shareholders, whereas a
low MVA means just the opposite. ·
MVAs
should not be considered a reliable indication of management performance
during strong bull markets when stock prices rise in general. Understanding
Market Value Added (MVA) When investors want to look under the hood to
see how a company performs for its shareholders, they first look at MVA. A company’s MVA is an indication of its capacity to increase
shareholder value over time. A high
MVA is evidence of effective management and strong operational capabilities.
A low MVA can mean the value of management’s actions and investments is less
than the value of the capital contributed by shareholders. A negative MVA
means the management's actions and investments have diminished and reversed
the value of capital contributed by shareholders. MVA
Reflects Commitment to Shareholder Value Companies
with a high MVA are attractive to investors not only because of the greater
likelihood they will produce positive returns but also because it is a good
indication they have strong leadership and sound governance. MVA can be
interpreted as the amount of wealth that management has created for investors
over and above their investment in the company. Companies
that are able to sustain or increase MVA over time typically attract more
investment, which continues to enhance MVA. The MVA may actually understate the performance of a company because
it does not account for cash payouts, such as dividends and stock buybacks,
made to shareholders. MVA may not be a reliable indicator of management
performance during strong bull markets when stock prices rise in general. Examples
of MVA Companies
with high MVA can be found across the investment spectrum. Alphabet
Inc., (GOOGL) the parent of Google, is among the most valuable companies in
the world with high growth potential. Its stock returned 1,293% in its first
10 years of operation. While much of its MVA in the early years can be
attributed to market exuberance over its shares, the company has managed to
more than double it from 2015 to 2019. Alphabet’s MVA has grown from $354.25
billion in 2015 to $606.20 billion in December 2017 to $809.01 billion in
December 2019 to $1.19 trillion in 2020. On the
other end of the spectrum is one of the most established companies in the
S&P 500 index, the Coca-Cola Company (KO). Coca-Cola is one of Warren
Buffett’s favorite stock holdings because its management is so effective at
increasing shareholder value. At the end of the year 2019, the company's MVA
was $219.66 billion, up from $158.52 billion in 2017 and $150.41 billion in
2015, and that does not include the roughly $6 billion annually in dividend
payments to shareholders. As of 2019, Coca-Cola has increased its dividends
each year for the last five years by an average of 5.3% per year. FYI: Economic Value Added (EVA) By
JAMES CHEN Updated March 22, 2022, Reviewed by JANET BERRY-JOHNSON, Fact
checked by KIRSTEN ROHRS SCHMITT https://www.investopedia.com/terms/e/eva.asp What Is
Economic Value Added (EVA)? Economic value added (EVA) is a measure of a
company's financial performance based on the residual wealth calculated by
deducting its cost of capital from its operating profit, adjusted for taxes
on a cash basis. EVA can also be referred to as economic
profit, as it attempts to capture the true economic profit of a company. This
measure was devised by management consulting firm Stern Value Management,
originally incorporated as Stern Stewart & Co. KEY
TAKEAWAYS ·
Economic
value added (EVA), also known as economic profit, aims to calculate the true
economic profit of a company. ·
EVA
is used to measure the value a company generates from funds invested in it. ·
However,
EVA relies heavily on invested capital and is best used for asset-rich
companies, where companies with intangible assets, such as technology
businesses, may not be good candidates. Understanding
Economic Value Added (EVA) EVA is
the incremental difference in the rate of return (RoR) over a company's cost
of capital. Essentially, it is used to measure the value a company generates
from funds invested in it. If a
company's EVA is negative, it means the company is not generating value from
the funds invested into the business. Conversely, a positive EVA shows a
company is producing value from the funds invested in it. The formula for calculating EVA is: EVA = NOPAT - (Invested Capital * WACC) Where: NOPAT = Net operating profit after taxes Invested capital = Debt + capital leases +
shareholders' equity WACC = Weighted average cost of capital2 Special
Considerations The
equation for EVA shows that there are three key components to a company's
EVA—NOPAT, the amount of capital invested, and the WACC. NOPAT can be
calculated manually but is normally listed in a public company's financials. Capital
invested is the amount of money used to fund a company or a specific project.
WACC is the average rate of return a company expects to pay its investors;
the weights are derived as a fraction of each financial source in a company's
capital structure. WACC can also be calculated but is normally provided. The
equation used for invested capital in EVA is usually total assets minus current
liabilities—two figures easily found on a firm's balance sheet. In this case,
the modified formula for EVA is NOPAT - (total assets - current liabilities)
* WACC. As
noted by Stern Value Management, in 1983 the management team developed EVA,
"a new model for maximizing the value created that can also be used to
provide incentives at all levels of the firm." The goal of EVA is to
quantify the cost of investing capital into a certain project or firm and
then assess whether it generates enough cash to be considered a good
investment. A positive EVA shows a project is generating returns in excess of
the required minimum return. Advantages
and Disadvantages of EVA EVA
assesses the performance of a company and its management through the idea
that a business is only profitable when it creates wealth and returns for
shareholders, thus requiring performance above a company's cost of capital. EVA as
a performance indicator is very useful. The calculation shows how and where a
company created wealth, through the inclusion of balance sheet items. This
forces managers to be aware of assets and expenses when making managerial
decisions. However,
the EVA calculation relies heavily on the amount of invested capital and is
best used for asset-rich companies that are stable or mature. Companies with
intangible assets, such as technology businesses, may not be good candidates
for an EVA evaluation.
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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) Critical thinking
challenge (due with final): · Recalculate 100
times of the NPV based on the Monte Carlo simulation method by randomly
changing the tax rate and the WACC · Report
statistical results: Mean, Standard Deviation, Min, Max of the NPV. · Report the
Histogram of the NPV, or the probability distribution of the NPV. Monte Carlo
Simulation Demonstration (FYI) Using Microsoft
Excel to generate random normal numbers (FYI)
Introduction to
Monte Carlo Simulation in Excel 2016 (FYI)
Terminal Year Cash
Flows Recovery of net
working capital
-------
In class exercise: 1. What is the project's Year 1 cash
flow? Sales revenues $22,250 Depreciation $8,000 Other operating costs $12,000 Tax rate 35.0% Answer:
Sales revenues $22,250 − Operating costs (excl. deprec.) 12,000 − Depreciation 8,000 Operating income (EBIT) $ 2,250 −
Taxes Rate = 35% 788 After-tax EBIT $ 1,463 +
Depreciation 8,000 Cash
flow, Year 1 $ 9,463 2. The required equipment has a
3-year tax life, and it will be depreciated by the straight-line method over
3 years. What is the project's Year 1
cash flow? Equipment cost (depreciable basis) $65,000 Straight-line depreciation rate 33.333% Sales revenues, each year $60,000 Operating costs (excl. deprec.) $25,000 Tax rate 35.0% Answer: Equipment life, years 3 Equipment cost $65,000 Depreciation: rate = 33.333% $21,667 Sales revenues $60,000 − Basis x rate =
depreciation 21,667 − Operating costs (excl. deprec.)
25,000 Operating income (EBIT) $13,333 − Taxes Rate
= 35.0% 4,667 After-tax EBIT $ 8,667 +
Depreciation 21,667 Cash
flow, Year 1 $30,333 3. The equipment that would be used
has a 3-year tax life, and the allowed depreciation rates for such property
are 33%, 45%, 15%, and 7% for Years 1 through 4. Revenues and other operating costs are
expected to be constant over the project's 10-year expected life. What is the Year 1 cash flow? Equipment cost (depreciable basis) $65,000 Sales revenues, each year $60,000 Operating costs (excl. deprec.) $25,000 Tax rate 35.0% Answer: Equipment cost $65,000 Depreciation rate 33.0% Sales revenues $60,000 − Operating costs (excl. deprec.) 25,000 − Depreciation 21,450 Operating income (EBIT) $13,550 −
Taxes Rate = 35% 4,743 After-tax EBIT $ 8,808 +
Depreciation 21,450 Cash
flow, Year 1 $30,258 4. The equipment that would be used
has a 3-year tax life, would be depreciated by the straight-line method over
its 3-year life, and would have a zero salvage value. No new working capital would be
required. Revenues and other operating
costs are expected to be constant over the project's 3-year life. What is the project's NPV? Risk-adjusted WACC 10.0% Net investment cost (depreciable
basis) $65,000 Straight-line deprec. rate 33.3333% Sales revenues, each year $65,500 Operating costs (excl. deprec.),
each year $25,000 Tax rate 35.0% Answer: WACC 10.0% Years 0 1 2 3 Investment cost -$65,000 Sales revenues $65,500 $65,500 $65,500 − Operating costs (excl. deprec.) 25,000 25,000 25,000 − Depreciation rate = 33.333% 21,667 21,667 21,667 Operating income (EBIT) $18,833 $18,833 $18,833 −
Taxes Rate = 35% 6,592 6,592 6,592 After-tax EBIT $12,242 $12,242 $12,242 +
Depreciation 21,667
21,667 21,667 Cash flow -$65,000 $33,908 $33,908 $33,908 NPV $19,325 5. The equipment originally cost
$22,500, of which 75% has been depreciated.
The firm can sell the used equipment today for $6,000, and its tax
rate is 40%. What is the equipment’s
after-tax salvage value for use in a capital budgeting analysis? Note that if the equipment's final market
value is less than its book value, the firm will receive a tax credit as a
result of the sale. Answer: % depreciated on equip. 75% Tax rate 40% Equipment cost $22,500 − Accumulated deprec. 16,875 Current book value of equipment $ 5,625 Market value of equipment 6,000 Gain (or loss): Market value − Book value $
375 Taxes paid on gain (−) or
credited (+) on loss -150 AT
salvage value = market value +/− taxes $
5,850 |
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The
West has hit Russia with tough sanctions. They could be tougher still. Are
economic sanctions against Russia the answer? (FYI) March
11, 2022 by
Cheryl Walker | walkercv@wfu.edu |
336.758.6073 https://news.wfu.edu/2022/03/11/are-economic-sanctions-against-russia-the-answer/ From a
ban on Russian oil imports to McDonald’s closure of restaurants, economic
sanctions have been an important part of the U.S. response to Russia’s
invasion of Ukraine. Benjamin Coates, associate professor of history, is
currently conducting research for a book that will examine the U.S. and
economic sanctions since WWI. Coates is a historian of U.S. foreign
relations, whose first book examined the relationship between international
law and empire. In the following Q&A, he explains how sanctions have been
used in the past, how they are being used against Russia and the impact they
are likely to have. How has
the U.S. used economic sanctions in the past? The United
States has relied on sanctions more than any other country in the world since
World War II. These have ranged from cutoffs of foreign aid or arms sales (or
threats thereof) to full-scale embargoes. In recent years the country has
turned to sanctions even more frequently. Under the Obama administration
about 500 people or organizations were added to sanctions lists every year;
during the Trump presidency this number nearly doubled. Reliance on sanctions
reflects in part the centrality of the dollar to global trade and finance,
which allows the U.S. to block transactions around the world. But it also
reflects a certain mindset that sanctions are easy to impose and relatively
cost-free from the perspective of the United States. The rise of “targeted
sanctions” in the 1990s also gave the impression that it was possible to use
sanctions in a way that hurt only the “bad guys” while causing minimal
collateral damage. What is
different now? What’s
dramatic about the current sanctions is just how far-reaching they are and
how quickly they’ve been imposed. Never before—outside of the World Wars—has
a country with an economy the size of Russia’s been subject to this level of
economic coercion. And not only has the U.S. acted, but the EU, Japan, the
UK, and even Switzerland have jumped on board. How are
sanctions affecting average Russian citizens? Others? Financial
observers are predicting that the sanctions will cause a severe recession in
Russia, meaning that many Russians will lose their jobs. Because of the collapse
of the ruble and a rise in interest rates, they will find it harder to
purchase food and other necessities. These sanctions will impose collective
punishment. It’s also clear that these sanctions will be costly for the rest
of the world. We’ve seen oil and commodity prices jump, worsening previous
inflation. Wheat prices have skyrocketed. This looks like an economic war
that will affect people around the world. Is this
the first time private U.S. businesses like McDonald’s, Coca-Cola, VISA and
Netflix have taken this type of action? What about businesses based in other
countries? Private
companies nowadays have employees and sometimes entire departments whose job
it is to make sure that the company doesn’t violate U.S. sanctions. They know
that violations can result in fines from the U.S. government, sometimes in
the tens or hundreds of millions of dollars. This sometimes leads to what
scholars call “overcompliance” or “de-risking.” That means that when you have
a country that is subject to multiple sanctions, private companies may opt to
do more than what is strictly required by law, for fear of straying into
legal gray areas. The other issue here is reputation. The solidarity for
Ukraine in the U.S. and Western Europe has been so widespread (polls are
finding 70%+ of Americans support sanctions even if that means higher gas
prices) that companies fear boycotts and shareholder actions. Just recently
the Japanese company that sells Uniqlo clothing announced a withdrawal from
Russia after previously pledging to continue business there on the grounds
that clothing is a “necessity of life.” But criticism on social media and
from the Japanese government convinced them to change course. This kind of
pressure on companies isn’t new. In the 1970s and 1980s activists pressured
companies to stop doing business with apartheid South Africa, for example.
But the speed this time is completely unprecedented. Already over 300
companies have limited at least some of their business with Russia.
Previously it would take years or even decades of pressure to get those kinds
of numbers. Does
the combination of official government economic sanctions and U.S. businesses
increase the likelihood Russia will change course in Ukraine? While
the sanctions will have a devastating economic impact, their political impact
is less clear. The U.S. has had sanctions on Iran for 40 years and on Cuba
for 60. North Korea has been subject to sanctions since 1950! In none of
these cases has economic pressure led to a fundamental shift in government
(though Iran was persuaded in 2015 to pause work on nuclear weapons). Will
sanctions lead Russians to demand Putin’s overthrow, or at least an end to
the war? It’s possible, but most Russian experts seem doubtful. What
effect is the withdrawal of U.S. businesses from Russia having on the Russian
economy? The
cooperation of private business increases the economic pressure on Russia.
Initially the U.S. and Europe intentionally exempted Russian energy sales
(primarily oil and natural gas) from sanctions. But Russian oil companies
found that few Western companies were willing to buy their product anyway.
Russia is also responding by threatening foreign businesses. The government
has issued a decree allowing Russian companies to ignore patents from “unfriendly”
countries and has tried to stop foreigners from withdrawing investments. It
may wind up seizing foreign property. What this all means is that even if
sanctions are lifted at some point, it will require significant time and
effort to restore economic connections. What
are your thoughts on social media platforms suspending Russian users? This
highlights the double-edged nature of sanctions. In punishing Russia for its
actions it helps the Russian government enhance its control over civil
society. In effect Putin’s government and Western media companies have
cooperated to shut down the free internet. This has long been an issue for
sanctions: if you cut off a country from outside sources (of information,
capital, trade, etc.) that can make it easier for the government to
concentrate its power. Is
there a danger of escalation? This is
the first time we’ve seen this level of sanctions on a country with nuclear
weapons. President Biden has drawn a clear line: the U.S. will not use
military force, even as it ramps up sanctions and military aid to Ukraine.
But it’s not clear that Russia sees things this way. Putin describes
sanctions as “economic war” and has made veiled nuclear threats. I don’t
think either side wants a full-out war, thankfully, but the threat of
escalation is real, especially if Russia were to respond to economic coercion
with cyberwarfare. As the history of the Cold War shows us, in times of
heightened fear and tension, the potential for catastrophe looms. The Cuban
Missile Crisis is Exhibit A. We are far from that at the moment but even a
minuscule chance of a horrific outcome is worth worrying about. I hope that
some kind of diplomatic settlement can be reached to stop the violence in
Ukraine and lift sanctions. |
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Chapter 19 Derivatives Chapter 19 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)
|
|
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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Chapter 15 Distributions to Shareholders Theory one: Indifference
theory Do Dividends
even matter? - Dividend Irrelevance theory (video)
The Irrelevance
of Dividends (FYI, video)
n
Assuming: –
No transactions costs to buy
and sell securities –
No flotation costs on new
issues –
No taxes –
Perfect information –
Dividend policy does not
affect ke n
Dividend policy is
irrelevant. If dividends are too high, investors may use some of the funds to
buy more of the firm’s stock. If dividends are too low, investors may sell
off some of the stock to generate additional funds. Theory two: bird in hand
theory – High dividend can increase firm value Warren
Buffett and the first investment primer: a bird in the hand equals two in the
bush (Aesop) (video)
Dividends
are less risky. Therefore, high dividend payout ratios will lower ke
(reducing the cost of capital), and increase stock price Theory three: Tax effect
theory – Low dividend can increase firm value Dividend
Clienteles | Business Finance (FINC101)
1)
Dividends received are taxable in the
current period. Taxes on capital gains, however, are deferred into the future
when the stock is actually sold. 2)
The maximum tax rate on capital gains is
usually lower than the tax rate on ordinary income. Therefore, low dividend
payout ratios will lower ke (reducing the cost of capital), raise
g, and increase stock price. Which theory is most
correct? – again, results are mixed. 1)
Some research suggests that high payout
companies have high required return on stock, supporting the tax effect
hypothesis. 2)
But other research using an international
sample shows that in countries with poor investor protection (where agency
costs are most severe), high payout companies are valued more highly than low
payout companies. Stock
Repurchase: Buying
own stock back from stockholders. Reasons
for repurchases: ·
As an alternative to distributing cash as
dividends. ·
To dispose of one-time cash from an asset
sale. ·
To make a large capital structure change. ·
May be viewed as a negative signal (firm
has poor investment opportunities). ·
IRS could impose penalties if repurchases
were primarily to avoid taxes on dividends. ·
Selling stockholders may not be well
informed, hence be treated unfairly. ·
Firm may have to bid up price to complete
purchase, thus paying too much for its own stock. Stock Split: Firm
increases the number of shares outstanding, say 2:1. Sends shareholders more shares. Reasons
for stock split: ·
There’s a widespread belief that the
optimal price range for stocks is $20 to $80. ·
Stock splits can be used to keep the price
in the optimal range. ·
Stock splits generally occur when
management is confident, so are interpreted as positive signals. |
|
Why Stock Buybacks Are Dangerous for the
Economy (FYI) by
William Lazonick, Mustafa Erdem Sakinç, and Matt Hopkins, January 07, 2020 https://hbr.org/2020/01/why-stock-buybacks-are-dangerous-for-the-economy Even as
the United States continues to experience its longest economic expansion
since World War II, concern is growing that soaring corporate debt will make
the economy susceptible to a contraction that could get out of control. The
root cause of this concern is the trillions of dollars that major U.S.
corporations have spent on open-market repurchases — aka “stock buybacks” —
since the financial crisis a decade ago. In 2018 alone, with corporate
profits bolstered by the Tax Cuts and Jobs Act of 2017, companies in the
S&P 500 Index did a combined $806 billion in buybacks, about $200 billion
more than the previous record set in 2007. The $370 billion in repurchases
which these companies did in the first half of 2019 is on pace for total
annual buybacks that are second only to 2018. When companies do these
buybacks, they deprive themselves of the liquidity that might help them cope
when sales and profits decline in an economic downturn. Making
matters worse, the proportion of buybacks funded by corporate bonds reached
as high as 30% in both 2016 and 2017, according to JPMorgan Chase. The
International Monetary Fund’s Global Financial Stability Report, issued in
October, highlights “debt-funded payouts” as a form of financial risk-taking
by U.S. companies that “can considerably weaken a firm’s credit quality.” It can
make sense for a company to leverage retained earnings with debt to finance
investment in productive capabilities that may eventually yield product
revenues and corporate profits. Taking on debt to finance buybacks, however,
is bad management, given that no revenue-generating investments are made that
can allow the company to pay off the debt. In addition to plant and equipment,
a company needs to invest in expanding the knowledge and skills of its
employees, and it needs to reward them for their contributions to the
company’s productivity. These investments in the company’s knowledge base
fuel innovations in products and processes that enable it to gain and sustain
an advantage over other firms in its industry. The
investment in the knowledge base that makes a company competitive goes far
beyond R&D expenditures. In fact, in 2018, only 43% of companies in the
S&P 500 Index recorded any R&D expenses, with just 38 companies
accounting for 75% of the R&D spending of all 500 companies. Whether or
not a firm spends on R&D, all companies have to invest broadly and deeply
in the productive capabilities of their employees in order to remain
competitive in global markets. Stock
buybacks made as open-market repurchases make no contribution to the
productive capabilities of the firm. Indeed, these distributions to
shareholders, which generally come on top of dividends, disrupt the growth dynamic
that links the productivity and pay of the labor force. The results are
increased income inequity, employment instability, and anemic productivity. Buybacks’
drain on corporate treasuries has been massive. The 465 companies in the
S&P 500 Index in January 2019 that were publicly listed between 2009 and
2018 spent, over that decade, $4.3 trillion on buybacks, equal to 52% of net
income, and another $3.3 trillion on dividends, an additional 39% of net
income. In 2018 alone, even with after-tax profits at record levels because
of the Republican tax cuts, buybacks by S&P 500 companies reached an
astounding 68% of net income, with dividends absorbing another 41%. Why
have U.S. companies done these massive buybacks? With the majority of their
compensation coming from stock options and stock awards, senior corporate
executives have used open-market repurchases to manipulate their companies’
stock prices to their own benefit and that of others who are in the business
of timing the buying and selling of publicly listed shares. Buybacks enrich
these opportunistic share sellers — investment bankers and hedge-fund
managers as well as senior corporate executives — at the expense of
employees, as well as continuing shareholders. In
contrast to buybacks, dividends provide a yield to all shareholders for, as
the name says, holding shares. Excessive dividend payouts, however, can
undercut investment in productive capabilities in the same way that buybacks
can. Those intent on holding a company’s shares should therefore want it to
restrict dividend payments to amounts that do not impair reinvestment in the
capabilities necessary to sustain the corporation as a going concern. With
the company plowing back profits into well-managed productive investments,
its shareholders should be able to reap capital gains if and when they decide
to sell their shares. Stock
buybacks done as open-market repurchases emerged as a major use of corporate
funds in the mid-1980s after the Securities and Exchange Commission adopted Rule
10b-18, which gives corporate executives a safe harbor against stock-price
manipulation charges that otherwise might have applied. As a mode of
distributing corporate cash to shareholders, buybacks surpassed dividends in
1997, helping to elevate stock prices in the internet boom. Since then,
buybacks, which are much more volatile than dividends, have dominated
distributions to shareholders when the stock market is booming, as companies
have repurchased stock at high prices in a competition to boost their share
prices even more. As shown in the exhibit “Buying When Prices Are High,”
major companies have continued to do buybacks in boom periods when stock
prices have been high, rendering these businesses more financially fragile in
subsequent downturns when abundant profits disappear. JPMorgan
Chase has constructed a time series for 1997 through 2018 that estimates the
percentage of buybacks by S&P 500 companies that have been debt-financed,
increasing the financial fragility of companies. In general, the percentage
of buybacks that have been funded by borrowed money has been far higher in
stock-market booms than in busts, as companies have competed with one another
to boost their stock prices. In
2018, however, as stock buybacks by companies in the S&P 500 Index spiked
to more than $800 billion for the year, the proportion that were financed by
debt plunged to about 14% in the last quarter. Why was there a sharp decline
in 2018, when the dollar volume of buybacks far surpassed the previous peak
years of 2007, 2014, and 2015? The
answer is clear: Corporate tax breaks contained in the Tax Cuts and Jobs Act
of 2017 provided the corporate cash for the vastly increased level of
buybacks in 2018. First, there was a permanent cut from 35% to 21% in the tax
rate on corporate profits earned in the United States. Second, going forward,
the 2017 law permanently freed foreign profits of U.S.-based corporations
from U.S. taxation (Under the Act, the U.S. Treasury has been reclaiming some
tax revenue lost because of a tax concession dating back to 1960 that had
enabled U.S.-based corporations to defer payment of U.S. taxes on their
foreign profits until repatriating them). In 2018
compared with 2017, corporate tax revenues declined to $205 billion from $297
billion, hypothetically increasing the financial capacity of U.S.-based
corporations to do as much as $92 billion more in buybacks in 2018 without
taking on debt. Given that from 2017 to 2018 stock buybacks by S&P 500
companies increased by $287 billion (from $519 billion to $806 billion), the
reality is that, through the corporate tax cuts, the federal government
essentially funded $92 billion in buybacks by issuing debt and printing money
to replace the lost corporate tax revenues. Since
the total federal government deficit increased by $114 billion (from $665
billion in 2017 to $779 billion in 2018), we can (again hypothetically) think
of $92 billion of this additional government debt as taxpaying households’
gift to business corporations to enable them to do even more buybacks
debt-free, shifting the debt burden of stock buybacks from corporations to
taxpayers. If, as a “transfer payment,” we add $92 billion to the $150
billion in debt that, according to the JPMorgan data, S&P 500 companies
used to fund buybacks in 2018, the percentage of their 2018 buybacks that
were debt-financed rises to 30%, greater than the proportion of 29% for 2017.
But because of corporate tax cuts, in 2018 taxpaying households were burdened
with about 38% of the combined government and business debt that enabled
corporations to do buybacks. Whether
it is corporate debt or government debt that funds additional buybacks, it is
the underlying problem of the corporate obsession with stock-price
performance that makes U.S. households more vulnerable to the boom-and-bust
economy. Debt-financed buybacks reinforce financial fragility. But it is
stock buybacks, however funded, that undermine the quest for equitable and
stable economic growth. Buybacks done as open-market repurchases should be
banned. |
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Chapter 21 Mergers and Divestitures Mergers rules of SEC
Mergers are business combination
transactions involving the combination of two or more companies into a single
entity. Most state laws require that
mergers be approved by at least a majority of a company's shareholders if the
merger will have a significant impact on either the acquiring or target
company. If the company you've
invested in is involved in a merger and is subject to the SEC disclosure
rules, you will receive information about the merger in the form of either
a proxy statement on Schedule 14A or
an information statement on Schedule
14C. The proxy or information statement will describe the terms of
the merger, including what you will receive if the merger proceeds. If you believe the amount you will
receive is not fair, check the statement for information on appraisal or
dissenter's rights under state law. You must follow the procedures precisely
or your rights may be lost. You can obtain a copy of a
company's proxy or information statement by using the SEC's EDGAR
database. Summary
of key M&A documents for finding deal terms of public targets (www.wsp.com)
Whole foods form 8k filed with SEC on
8/23/2017 “As a result of the Merger, each share of common stock……was
converted into the right to receive $42.00 in cash, without interest (the
“Merger Consideration”).” Whole Foods DEFA 14A 8k form with SEC 6/14/2017 Whole foods DEFA 14A 8k form with SEC 6/16/2017 Whole foods DEFA 14A 8k form with SEC 6/16/2017 Whole foods is providing materials for the upcoming shareholder
voting. Whole foods DEFA 14A 8k with SEC 7/21/2017 Has law suit documents Whole foods DEFA 14A 8k with SEC 7/21/2017 Notifying shareholders for upcoming special shareholder meeting ********* Amazon SEC filing ********* Amazon Form 8k with SEC on 6/15/2017 Financing of the Merger The Company expects to
finance the Merger with debt financing …… Amazon Whole Foods Merger Agreement on
6/15/2017 For the term project, if you work on this M&A case, you
should be able to find most of the information in this agreement. Amazon 8k form Completion of acquisition or
disposition of assets 8/28/2018 ********** Miscellaneous ********** 7 potential bidders, a call to Amazon, and an
ultimatum: How the Whole Foods deal went down (from business
insider.com) ********** SDC Amazon Whole Foods Deal Record
(For this class only)***** Tear Sheet (SDC) (on blackboard)
Why does
Amazon's Bezos want Whole Foods? (video)
Amazon-Whole
Foods Merger: What You Need To Know | TODAY (video)
Mergers and
Acquisitions Explained: A Crash Course on M&A (youtube, FYI)
Twitter's board
has 'no choice' but to reject Elon Musk's offer: Jim Cramer (youtube)
Distraction Or
Hostile Takeover? Analysts Weigh In On Elon Musk’s Offer To Buy Twitter
(youtube)
For discussion: · Why
does Amazon want to buy Whole Foods? · Did
Whole Foods want to be acquired? What can Whole Foods do to defend itself? (poison
pill, white knight, classified board, golden parachute, etc.) · What
can Amazon do to persuade Whole Foods shareholders to sell their stocks? · Why
does Elon Musk want to acquire Twitter? · Did
Twitter want to be acquired? What can Twitter do to defend itself? (poison
pill, white knight, classified board, golden parachute, etc.) · Why
cannot Elon Musk create another version of Twitter by himself? · Why
cannot Face book merge with Twitter? For
your knowledge: · In
reality, dividends are
more predictable than earnings . · You own
around 100 shares of the stock of AAA, which is currently being sold for
around $120 per share. A 2-for-1 stock split is about to be declared by the
company. After the split has taken place, which of the following describes
your probable position? You
own 200 shares of AAA’s stock. Meanwhile, the AAA stock price will be near
$60 per share. · Alice
Gordan and Alex Roy believe that when the dividend payout ratio is lowered, the
required return on equity tends to increase. On which of the following
assumptions is their argument based? dividends are viewed as less risky than future capital
gains. · A
strict residual dividend policy is followed by your firm. Everything remains
constant, which of the factors mentioned below are most probably going to
result in an increase in the dividend per share of a firm? when a company’s profit (net
income) rises · What
should a firm pay in case it strictly follows a residual dividend policy, and
in case its optimal capital budget needs the utilization of all of the
earnings for a particular year ( in addition to the new debt as per the
optimal debt/total assets ratio)? when the company paid no
dividends at all · Other
things remain constant, which of the actions mentioned below are going to
allow a company to raise additional equity capital? when a company announces a new stock dividend
reinvestment plan. ·
Horizontal
merger would be an example of The Home Depot and Lowe’s getting merged. ·
What is referred to as the savings that a big firm can benefit
from the production of goods in high volume which a small company can not do?
economies of scale ·
When the merger of two companies in a similar industry takes
place in order to develop products that are needed at various stages of the
production cycle, it is referred to as: integration vertically ·
tax loss benefits is not considered to be the
justification for the benefits of diversification from mergers. ·
A rights offering that provides the existing target
shareholders with the rights to purchase shares in the acquirer of the target
at an extremely discounted price after particular conditions are met is
referred to as a: poison
pill (Twitter POISON Pill
Explained by a Lawyer (youtube)) ·
A scenario where each and every director gets a three-year
term to provide their services and the terms are arranged in a staggered
manner so that just one-third of the directors are eligible for the election
every year is referred to as a: classified board ·
In a situation where it becomes inevitable that a hostile
takeover may take place, and a target company may at times search for another
friendlier company in order to acquire it, is referred to as a: white knight Can Twitter
find a white knight to fend off Elon Musk? (youtube)
·
When a firm is being taken over and the senior managers of
that firm are let go, a very lucrative severance package is offered to those
senior managers. It is referred to as a:
golden parachute |
|
Summary of Financial Data Primary Sources
Primary SEC Filings in M&A
Transactions—U.S. Issuers
------------------------------------------------------------------------------------------------------------------- Useful Mergers and Acquisitions Web Sites · Federal Trade Commission:
Bureau of Competition. The FTC's antitrust arm seeks to prevent
business practices that restrain competition -- including monopolistic
practices, attempts to monopolize, conspiracies in restraint of trade, and
anticompetitive mergers and acquisitions. · Statistics on Mergers
& Acquisitions (M&A). Courtesy of the Institute of Mergers,
Acquisitions and Alliances. · U.S. Department of
Justice: Antitrust Division. Provides access to electronic
documents related to the enforcement of antitrust laws, including policies,
guidelines, case filings, speeches, testimony, and press releases. · Overseas Private Investors
Corporation (OPIC). OPIC is an independent U.S. Government agency
that assists U.S. companies in some 140 emerging economies. · A Plain English Guide to Antitrust Laws.
Full text of Promoting Competition, Protecting Consumers booklet
from the U.S. Federal Trade Commission (FTC). Visit the FTC for
mergers and acquisitions guidelines, business guidance, and more. |
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4/26 – Final exam, Exit Exam
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Warmest congratulations on your graduation!
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