����FIN 435 Class Web Page, Spring '17

Instructor: Maggie Foley

Jacksonville University

Weekly SCHEDULE, LINKS, FILES and Questions

Week

Coverage, HW, Supplements

{C}-        {C}Required

WSJ Papers for Discussionin following week

Videos (optional)

Week 1

Marketwatch Game

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

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

Your career choices with a finance degree (Career Expo 3/16 in campus)

Mutual Fund, Retail Banking, Investment Banking, Venture Capital, Hedge Fund, Private Banking�

Chapter 3  Financial Statement Analysis

Chapter 3 Case study (first case study, due on 4/5)

Q1: Why are financial statements important?

Q2: What are the three major financial statements?

Q3: Free cash flow: concept and equation. What is FCF?

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Capital expenditure = increases in NFA + depreciation

Or, capital expenditure = increases in GFA

All companies, foreign and domestic, are required to file registration statements, periodic reports, and other forms electronically through EDGAR.

EDGAR online

Steps:

{C}1.      {C}Go to EDGAR online

{C}2.      {C}Search AAPL

{C}3.      {C}Search financial statement of AAPL in 2016, 2015, 2014, and 2013.

Chapter 4 Ratio Analysis

Chapter 4 case study (second case study, due on 4/5)

HW of chapters 3, 4 (due on 4/5)

1. Firm A's sales last year = \$280,000, net income = \$23,000.  What was its profit margin? (8.21%)

2. Firm A�s total assets = \$415,000 and its net income = \$32,750.  What was its return on total assets (ROA)?(7.89%)

3. Firm A�s total common equity = \$405,000 and its net income = \$70,000.  What was its ROE? (17.28%)

4. Firm A�s stock price at the end of last year = \$23.50 and its earnings per share for the year = \$1.30.  What was its P/E ratio? (18.08)

5. Meyer Inc's assets are \$625,000, and its total debt outstanding is \$185,000.  The new CFO wants to establish a debt/assets ratio of 55%.  The size of the firm does not change.  How much debt must the company add or subtract to achieve the target debt ratio? (\$158,750)

6. Chang Corp. has \$375,000 of assets, and it uses only common equity capital (zero debt).  Its sales for the last year were \$595,000, and its net income was \$25,000.  Stockholders recently voted in a new management team that has promised to lower costs and get the return on equity up to 15.0%.  What profit margin would the firm need in order to achieve the 15% ROE, holding everything else constant? (9.45%)

7. A firm has \$300 in inventory, \$600 in fixed assets, \$200 in accounts receivable, \$100 in accounts payable, and \$50 in cash. What is the amount of the current assets? (\$550)

8. Art's Boutique has sales of \$640,000 and costs of \$480,000. Interest expense is \$40,000 and depreciation is \$60,000. The tax rate is 34%. What is the net income? ( \$39,600)

9.Use the following information to prepare the cash flow statement in 2008 of Nabors, Inc.

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 Cash Flow Statement Partial Solution Cash at the beginning of the year 310 Cash from operation net income Xxx plus depreciation Xxx � -/+ AR� Xxx � -/+ Inventory Xxx �+/- AP Xxx net change in cash from operation 1075 Cash from investment �-/+ (NFA+depreciation) Xxx net change in cash from investment -1080 Cash from finaning �+/- (long term debt+notes payable) Xxx �+/- common stock Xxx �- dividend Xxx net change in cash from investment 100 Total net change of cash 95 Cash at the end of the year 405

10. Read the following article. Summarize what is going on under each situation. Where are the auditors? Are they completely ineffective? Are they on the side with the employers? What is your view?

���� sec_logitech.pdf (FYI)���� sec_ener1.pdf (FYI)

SEC Announces Financial Fraud Cases

FOR IMMEDIATE RELEASE
2016-74

Washington D.C., April 19, 2016 �

The Securities and Exchange Commission today announced a pair of financial fraud cases against companies and then-executives accused of various accounting failures that left investors without accurate depictions of company finances.

In one case, technology manufacturer Logitech International agreed to pay a \$7.5 million penalty for fraudulently inflating its fiscal year 2011 financial results to meet earnings guidance and committing other accounting-related violations during a five-year period.  Logitech�s then-controller Michael Doktorczyk and then-director of accounting Sherralyn Bolles agreed to pay penalties of \$50,000 and \$25,000, respectively, for violations related to Logitech�s warranty accrual accounting and failure to amortize intangibles from an earlier acquisition.  The SEC filed a complaint in federal court yesterday against Logitech�s then-chief financial officer Erik Bardman and then-acting controller Jennifer Wolf alleging that they deliberately minimized the write-down of millions of dollars of excess component parts for a product for which Logitech had excess inventory in FY11.  For Logitech�s financial statements, the two executives falsely assumed the company would build all of the components into finished products despite their knowledge of contrary facts and events.

In the other case, three then-executives at battery manufacturer Ener1 agreed to pay penalties for the company�s materially overstated revenues and assets for year-end 2010 and overstated assets in the first quarter of 2011.  The financial misstatements stemmed from management�s failure to impair investments and receivables related to an electric car manufacturer that was one of its largest customers.  Former CEO and chairman of the board Charles L. Gassenheimer, former chief financial officer Jeffrey A. Seidel, and former chief accounting officer Robert R. Kamischke agreed to pay penalties of \$100,000, \$50,000, and \$30,000, respectively.

�We are intensely focused on whether companies and their officers evaluate judgmental accounting issues in good faith and based on GAAP,� said Andrew Ceresney, Director of the SEC�s Division of Enforcement.  �In these two cases, we allege deficiencies in Ener1�s failure to properly impair assets on its balance sheet and Logitech�s failure to write down the value of its inventory to avoid the financial consequences of disappointing sales.�

In the Ener1 case, the SEC also found that Robert D. Hesselgesser, the engagement partner for PricewaterhouseCoopers LLP�s audit of Ener1�s 2010 financial statements, violated PCAOB and professional auditing standards when he failed to perform sufficient procedures to support his audit conclusions that Ener1 management had appropriately accounted for its assets and revenues.  Hesselgesser agreed to be suspended from appearing and practicing before the SEC as an accountant, which includes not participating in the financial reporting or audits of public companies.  The SEC�s order permits Hesselgesser to apply for reinstatement after two years.

�Auditors play a critical role regarding the accuracy of financial statements relied upon by investors, and they must be held accountable when they fail to do everything required under professional auditing standards,� said Michael Maloney, Chief Accountant of the SEC�s Division of Enforcement.

In the Logitech case, former CEO Gerald Quindlen was not accused of any misconduct, but has returned \$194,487 in incentive-based compensation and stock sale profits received during the period of accounting violations, pursuant to Section 304(a) of the Sarbanes-Oxley Act.

The companies and executives who agreed to settlements neither admitted nor denied the charges.

The SEC�s investigation of Logitech was conducted by Paul Gunson and Matthew Finnegan, and supervised by Douglas McAllister.  The litigation is being led by Paul Kisslinger and Kevin Lombardi, and supervised by Bridget Fitzpatrick.

The SEC�s investigation of Ener1 was conducted by Carolyn Winters, Richard Haynes, and Deena Bernstein, and supervised by Douglas McAllister.

Financial Statement Templates

Useful website for stock picks

www.finviz.com (stock screener)

money.msn.com/investing

zacks.com

minyanville.com

moneychimp.com

nasdaq.com

marketwatch.com

superstockscreener.com

gurufocus.com

portfoliomoney.com

stockconsultant.com

moderngraham.com

stockpickr.com

stockta.com

thestreet.com

quotes.wsj.com

oldschoolvalue.com

fool.com

analystratings.com

barchart.com

stock2own.com

theonlineinvestor.com

seekingalpha.com

# How Did Enron Make Their Money, Hide Their Finances, Fail and Get Caught? Financial Reporting (2004)

## The Billion Dollar Secret

### The Zacks Rank Guide to Trading Success

Week 2,3

Chapter 6 Interest rate

third case study, due on 4/5)

Market data website:

http://finra-markets.morningstar.com/BondCenter/Default.jsp (FINRA bond market data)

Market watch on Wall Street Journal has daily yield curve and interest rate information.

Formula

r���������� = r* + IP + DRP + LP + MRP

����������� r���������� = required return on a debt security

����������� r*��������� = real risk-free rate of interest

����������� DRP���� = default risk premium

����������� MRP���� = maturity risk premium

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MRPt = 0.1% (t � 1)

DRPt+ LPt =Corporate spread * (1.02)(t−1)

Summary of Yield Curve Shapes and Explanations

Normal Yield Curve
When bond investors expect the economy to hum along at normal rates of growth without significant changes in inflation rates or available capital, the yield curve slopes gently upward. In the absence of economic disruptions, investors who risk their money for longer periods expect to get a bigger reward � in the form of higher interest � than those who risk their money for shorter time periods. Thus, as maturities lengthen, interest rates get progressively higher and the curve goes up.

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Steep Curve � Economy is improving
Typically the yield on 30-year Treasury bonds is three percentage points above the yield on three-month Treasury bills. When it gets wider than that � and the slope of the yield curve increases sharply � long-term bond holders are sending a message that they think the economy will improve quickly in the future.

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Inverted Curve � Recession is coming
At first glance an inverted yield curve seems like a paradox. Why would long-term investors settle for lower yields while short-term investors take so much less risk? The answer is that long-term investors will settle for lower yields now if they think rates � and the economy � are going even lower in the future. They're betting that this is their last chance to lock in rates before the bottom falls out.

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Flat or Humped Curve

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.

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Homework of chapter 6 (Due on 4/5)

HW1  The following yields on U.S. Treasury securities were taken from a financial publication:

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1. Plot a yield curve based on these data.
2. Based on this yield curve, if you needed to borrow money for longer than 1 year, would it make sense for you to borrow short term and renew the loan or borrow long term? Explain.
3. Calculate the 2 years interest rate 1 year from now, using the pure expectations theory.
4. Calculate the 5 years interest rate 5 year from now, using the pure expectations theory.

HW2 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:

• Maturity risk premium = 1.8%
• Default risk premium = 2.15%

On the basis of these data, what is the real risk-free rate of return? (answer: 2.25%)

HW3 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: 5%, 6.33%)

HW4 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%)

HW5 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%)

HW6 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%)

HW7

Fed just raised fed fund rate. Read the following four papers and write an article regarding your perception of its impact in the market(less than five pages, double space, font size 12)

Fed raise interest rate paper 1����� ��������paper 2���� ���������������paper 3���� ����������paper 4

Fed Raised interest rate (video)

What is interest rates

# Gerald Celente: Low Interest Rates are Building the Biggest Bubble in Modern History - 9/21/14

How interest rates are set

What happens if Fed raise interest rates

Week 4

Mid Term (take home due on 4/5 for chapters 3, 4, and 6)

Chapter 7

Case study of chapter 7 (Due on 4/5)

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.

3.      Bond Online

Simplified Balance Sheet of WalMart

 In Millions of USD As of 2017-01-31 Total Assets 198,825.00 Total Current Liabilities 66,928.00 Long Term Debt 42,018.00 Total Liabilities 121,027.00 Total Equity 77,798.00 Total Liabilities & Shareholders' Equity 198,825.00

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?

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FINR-A Bond market information

WAL-MART STORES INC(Prospect)

Coupon Rate

3.300

%

Maturity Date

04/22/2024

 Symbol WMT4117477 CUSIP 931142DP5 Next Call Date 01/22/2024 Callable Yes Last Trade Price \$102.48 Last Trade Yield 2.899% Last Trade Date 03/14/2017 US Treasury Yield �

Credit and Rating Elements

 Moody's Rating Aa2 (10/14/2015) Standard & Poor's Rating AA (04/16/2014) Fitch Rating AA (09/16/2016) TRACE Grade Investment Grade Default � Bankruptcy N Insurance � Mortgage Insurer � Pre-Refunded/Escrowed � Additional Description Senior Unsecured Note

Classification Elements

 Bond Type US Corporate Debentures Debt Type � Industry Group Industrial Industry Sub Group Retail Sub-Product Asset CORP Sub-Product Asset Type Corporate Bond State � Use of Proceeds � Security Code �

Special Characteristics

 Medium Term Note N

Issue Elements

 *dollar amount in thousands Offering Date 04/15/2014 Dated Date 04/22/2014 First Coupon Date 10/22/2014 Original Offering* \$1,000,000.00 Amount Outstanding* \$1,500,000.00 Series � Issue Description � Project Name � Payment Frequency Semi-Annual Day Count 30/360 Form Book Entry Depository/Registration DTC, Clearstream, Euroclear Security Level Senior Collateral Pledge � Capital Purpose �

Put & Redemption Provisions

Call Date

01/22/2024

Call Price

\$100.00

Call Frequency

Continuously

Put Date

Put Price

Trading record of the above bond on 3/29 and 3/28

 Time Settlement 3/29/2017 14:02:14 4/3/2017 T 8000 103.789 2.687 3/29/2017 12:50:46 4/3/2017 T 5MM+ 104.01 2.652 3/29/2017 12:50:15 4/3/2017 T 5MM+ 104.042 2.647 3/29/2017 11:41:41 4/3/2017 T 5MM+ 104.086 2.64 3/29/2017 10:16:33 4/3/2017 Correction 3000 103.695 2.728 3/29/2017 10:16:33 4/3/2017 Cancel 3000 103.533 2.728 3/29/2017 10:16:33 4/3/2017 Cancel 3000 103.533 2.728 3/29/2017 10:16:33 4/3/2017 Correction 3000 103.695 2.728 3/28/2017 16:20:53 3/31/2017 T 475000 103.768 2.691 3/28/2017 16:20:41 3/31/2017 T 475000 103.71 2.7 3/28/2017 13:26:10 3/31/2017 T 50000 103.918 2.667 3/28/2017 13:26:10 3/31/2017 T 50000 103.905 2.669 3/28/2017 12:46:15 3/31/2017 T 139000 103.716 2.699 3/28/2017 11:55:12 3/31/2017 T 10000 103.925 2.666 3/28/2017 11:54:45 3/31/2017 T 10000 103.925 2.666 3/28/2017 10:17:12 3/31/2017 T 15000 103.792 2.687

For class discussion:

{C}                     {C}Fed has hiked interest rates. So, shall you invest in short term bond or long term bond?

{C}                     {C}Which of the three WMT bonds are the most attractive one to you? Why?

{C}                     {C}Referring to the price chart of the above bond, the price was reaching peak in the middle of 2015. Why? The price was really low in the middle of 2014. Why? Interest rate is not the reason.

HOMEWORK (Due on 4/5)

{C}1.                  {C}AAA firm� bonds will mature in eight years, and coupon is \$65. YTM is 8.2%. Bond�s market value? (\$903.04)

{C}2.                  {C}AAA firm�s bonds� market value is \$1,120, with 15 years maturity and coupon of \$85. What is YTM?(7.17%)

3.�������� AAA firm� bonds market value is \$1,050, with six years to maturity and coupon of \$75. Current yield?�� (7.14%)

4. ������� AAA firm�s semiannual bond has 12 years maturity and coupon rate of 8.75% semiannually. The firm also sells annual bonds with all the same condition except the coupon is paid annually (means ytm is the same). What is the price of this annual coupon bond?(hint: the two bonds should offer the same annual effective rate, not semi-rate * 2) (986.25)

5.�������� 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%)

6.�������� 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%)

7.�������� 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)

8.������� 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)

9.������� 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%)

10.������ 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 n*o 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%)

11.������ 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)

12. Read the attached prospects and answer the following questions: �We are offering \$500,000,000 of our 1.000% notes due 2017 (symbol WMT4117476), \$1,000,000,000 of our 3.300% notes due 2024 (symbol WMT4117477) and \$1,000,000,000 of our 4.300% notes due 2044 (symbol WMT4117478)

1) The money raised would be used for what purpose?

2) Which of the three WMT bonds are the most attractive one to you? Why?

Bond Pricing Formula (FYI)

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Bond Pricing Excel Formula

To calculate bond price  in EXCEL (annual coupon bond):

Price=abs(pv(yield to maturity, years left to maturity, coupon rate*1000, 1000)

To calculate yield to maturity (annual coupon bond)::

Yield to maturity = rate(years left to maturity, coupon rate *1000, -price, 1000)

To calculate bond price (semi-annual coupon bond):

Price=abs(pv(yield to maturity/2, years left to maturity*2, coupon rate*1000/2, 1000)

To calculate yield to maturity (semi-annual coupon bond):

Yield to maturity = rate(years left to maturity*2, coupon rate *1000/2, -price, 1000)*2

### Redemption Features (FYI)

While the maturity date indicates how long a bond will be outstanding, many bonds are structured in such a way so that an issuer or investor can substantially change that maturity date.

#### Call Provision

Bonds may have a redemption or call provision that allows or requires the issuer to redeem the bonds at a specified price and date before maturity. For example, bonds are often called when interest rates have dropped significantly from the time the bond was issued. Before you buy a bond, always ask if there is a call provision and, if there is, be sure to consider the yield to call as well as the yield to maturity . Since a call provision offers protection to the issuer, callable bonds usually offer a higher annual return than comparable non-callable bonds to compensate the investor for the risk that the investor might have to reinvest the proceeds of a called bond at a lower interest rate.

#### Put Provision

A bond may have a put provision, which gives an investor the option to sell the bond to an issuer at a specified price and date prior to maturity. Typically, investors exercise a put provision when they need cash or when interest rates have risen so that they may then reinvest the proceeds at a higher interest rate. Since a put provision offers protection to the investor, bonds with such features usually offer a lower annual return than comparable bonds without a put to compensate the issuer.

#### Conversion

Some corporate bonds, known as convertible bonds, contain an option to convert the bond into common stock instead of receiving a cash payment. Convertible bonds contain provisions on how and when the option to convert can be exercised. Convertibles offer a lower coupon rate because they have the stability of a bond while offering the potential upside of a stock.

Treasury Bond Auction Website

What is duration? (not required but useful)

Duration is defined as the weighted average of the present value of the cash flows and is used as a measure of a bond price's response to changes in yield.

If duration = 10 years, then for 1% increase in interest rate, the bond price will drop by 10 times of 1%, which is 10%.

You can calculate duration in excel.

Syntax

DURATION(settlement, maturity, coupon, yld, frequency, [basis])

How to calculate bond prices using exact

date? (not required but useful)

Use price function in Excel. Returns the price

per \$100 face value of a security that pays periodic interest.

Syntax

PRICE(settlement, maturity, rate, yld, redemption, frequency, [basis])

Calculate bond yield using exact date?(not required but useful)

Use YIELD to calculate bond yield.

Syntax

YIELD(settlement,maturity,rate,pr,

redemption, frequency, basis)

Excel yield function video

Risk of Bonds

Bond risk (video)

Bond risk � credit risk (video)

How to invest in bond market when Fed is hiking interest rates? (Videos)

Week 5

Chapter 8 Risk and Return

Chapter 8 case study (option 1, due before final)

Summary of the steps in the case study:

1st, calculate expected return based on probabilities and corresponding returns

2nd, calculate standard deviation based  on probabilities and corresponding returns

3rd,  calculate expected return and standard deviation based on probabilities historical returns

4th, Use corr function to calculate correlation based on two stocks� historical returns.

5th, Understand the concept of correlation and can pick stocks based on correlations

6th,understand what is beta and can calculate beta using slope function

7th, can use CAMP to calculate stock returns.

Option 2: Risk and Return, and Portfolio (due before final)

Instructions and requirements

{C}         {C}Pick three stocks and find their stock prices by the end of each month in the past five years on finance.yahoo.com.

{C}         {C}Calculate monthly stock return of each stock

{C}         {C}Calculate the mean and the standard deviation of each stock.

{C}         {C}Calculate correlations and generate correlation matrix. Discuss your results regarding the degree of correlation of your stocks.

{C}         {C}Assume that your investment funds are evenly distributed among the three stocks, calculate the portfolio�s return and standard deviation (risk) and compare the results with those of each stock in your portfolio. Discuss your findings.

{C}         {C}Go back to finance.yahoo.com and download sp500 index price of each month in the past five years and calculate its return (ticker: ^GSPC)

{C}         {C}Use slope function in excel to calculate beta of each stock. Discuss your findings. Compare the beta that you find with that reported on google/finance. Should match.

Chapter 9 Stock Return Evaluation

Summary of risk factors that are important to the stock valuation (based on class discussion)

{C}         {C}Free cash flow

{C}         {C}EBIDTA

{C}         {C}Yield curve

{C}         {C}Inflation

{C}         {C}Exchange rate

{C}         {C}Firm size

{C}         {C}Market to book ratio

{C}         {C}Tax rate

{C}         {C}Momentum

{C}         {C}PE

{C}         {C}Earning

{C}         {C}Merger and Acquisition

{C}         {C}IPO

{C}         {C}Debt

{C}         {C}Dividend

{C}         {C}Share split

{C}         {C}Short interest ratio

{C}         {C}Technical analysis ratios

{C}         {C}New product and new market

{C}         {C}World events

{C}         {C}Weather

{C}         {C}����

We can create a model to predict stock returns based on the above risk factors:

Stock return = function (Free cash flow, EBIDT,��)

Homework (Due before final)

Read 2017 US Equity Outlook: Democracy in America and the Triumph of Hope over Fear (in blackboard under course documents /introduction). On page 10, the authors say that we recommend three strategies for US equity investors. What are the three strategies?

See the following for the summary of the paper above.

Summary of Goldman Sachs 2017 Market Outlook

2017 US Equity Outlook: Democracy in America and the Triumph of Hope over Fear

November 28, 2016

� US equity investors have focused �more on hope than fear� since Donald Trump�s election. Ironically, many commentators believe his campaign rhetoric focused �more on fear than hope.� In 2017, we expect the stock market will be animated by competing views of whether economic policies and actions of President Trump and a Republican Congress instill hope or fear.

� �Hope� will dominate through 1Q 2017 as S&P 500 climbs by 9% to 2400. The inauguration occurs on January 20 and our Washington economist expects much legislation will be proposed during the first 100 days. The prospect of lower corporate taxes, repatriation of overseas cash, reduced regulations, and fiscal stimulus has already led investors to expect positive EPS revisions. Instead of our baseline adjusted EPS growth of 5% to \$123, growth could accelerate to 11% and reach \$130, which would support a P/E multiple above 18x. Top �Hope� investment recommendations: (1) Cyclicals vs. Defensives; (2) Stocks with high US versus foreign sales exposure; and (3) High tax rate companies.

� �Fear� is likely to pervade during 2H and S&P 500 will end 2017 at 2300, roughly 5% above the current level. Our economists expect inflation will reach the Fed�s 2% target, labor costs will be accelerating at an even faster pace, and policy rates will be 100 bp higher than today. Rising inflation and bond yields typically lead to a falling P/E multiple. Congressional deficit hawks may constrain Mr. Trump�s tax reform plans and the EPS boost investors expect may not materialize. Potential tariffs and uncertainty around other policy positions may raise the equity risk premium and lead to lower stock valuations in 2H. The median stock trades at the 98th percentile of historical valuation based on an array of metrics. Top �Fear� investment recommendations: (1) Low vs. High labor cost companies; and (2) Strong vs. Weak Balance Sheet stocks.

� Money flow represents a potential upside to our baseline forecast. Equity mutual fund and ETF inflows may benefit as investors lose money owning bonds. After years of active management underperformance and outflows, higher return dispersion will increase the alpha opportunity for investors skilled enough to capture it. Economic policy uncertainty and the later stages of the economic cycle are typically associated with higher stock return dispersion.

DEMOCRACY IN AMERICA AND THE TRIUMPH OF HOPE OVER FEAR

More than 180 years after it was first published, Alexis de Tocqueville�s Democracy in America remains the most insightful analysis of US society and its political economy. Although written in 1835, his description of the presidential elections is timeless: �For a long while before the appointed time has come, the election becomes the important and, so to speak, the all-engrossing topic of discussion. Factional ardor is redoubled, and all the artificial passions which the imagination can create in a happy and peaceful land are agitated and brought to light. . . . As the election draws near, the activity of intrigue and the agitation of the populace increase; the citizens are divided into hostile camps, each of which assumes the name of its favorite candidate; the whole nation glows with feverish excitement; the election is the daily theme of the press, the subject of private conversation, the end of every thought and every action, the sole interest of the present. It is true that as soon as the choice is determined, this ardor is dispelled, calm returns, and the river, which had nearly broken its banks, sinks to its usual level; but who can refrain from astonishment that such a storm should have arisen.� (Alexis de Tocqueville, Democracy in America, originally published 1835).

The words above perfectly characterize the nature of the 2016 election and the unexpected victory of Donald Trump. Another observation of de Tocqueville has particular relevance to our 2017 US equity outlook: �One of the principal vices of the elective system is that it always introduces a certain degree of instability into the internal and external policy of the estate.�

Policy uncertainty introduces a degree of instability to our 2017 forecast that has been absent in recent years. Of course, last year any reference to �policy uncertainty� would have related to the Fed�s own projections that it would raise the funds rate four times during 2016, although as of this writing it has not tightened even one time (but a hike is widely expected on December 14).

Uncertainty always exists when forecasting, but our projections for next year have more elements of instability than usual. Tax reform is widely anticipated but details of any corporate tax cuts are unknown. Policies on the repatriation of foreign earnings are unknown. Specifics regarding any aspect of fiscal stimulus are unknown. President-elect Trump has promised to reduce regulations, but specific policies have not yet been identified.

We expect no policy details will be available until March 2017 at the earliest. Our Washington, DC-based economist Alec Phillips anticipates draft budget resolutions from the House and Senate Budget Committees will be released towards the end of 1Q. These resolutions will show the top-line revenue, spending, and deficit projections for the next 10 years and include reconciliation instructions for the tax-writing and other committees relating to tax reform, infrastructure, and other fiscal issues. (see US Daily: A Fiscal Boost in 2017: How Much, How Fast?, November 17, 2016)

In March or April, our economist expects President Trump will submit a FY 2018 spending bill with detail on tax reform and health care proposals. Between April and July the actual budget resolutions will be debated on the floor of the House and Senate, the tax-writing committees will begin work on detailed legislation, and both chambers will consider the actual tax reform legislation.

In September, the final House/Senate conference report will be enacted before the October 1 start of FY 2018. Note that many of the details of tax reform are likely to change until final agreement is reached. Put simply, enormous tax and fiscal policy uncertainty will exist for almost all of 2017.

Trade is another area of great policy uncertainty. Reflecting on the Great Convention of 1831 relating to the tariff, de Tocqueville wrote: �The question of a tariff or free trade has much agitated the minds of Americans. The tariff was not only the subject of debate as a matter of opinion, but it affected some great material interests of the states.� The issues de Tocqueville identified nearly 200 years ago remain contemporary. The revenue impact on individual companies from potential tariffs, trade barriers, or a border-adjusted tax system will remain unknown until details are released by the new administration.

We end our political discussion on a hopeful note after cautioning investors about the unusual uncertainty surrounding our 2017 forecast. As de Tocqueville observed: �The President is chosen for four years, and he may be re-elected, so that the chances of a future administration may inspire him with hopeful undertakings for the public good and give him the means of carrying them into execution.�

In some ways, the market response to the election of Donald Trump parallels the market�s heightened expectations following the December 2012 election of Shinzo Abe as the Prime Minister of Japan. After years of economic stagnation, Japan finally elected a politician committed to reflating the economy. Investors cheered and the TOPIX rallied by 6% during the ten days between the election and when he took office, and then surged by more than 50% within five months. We expect S&P 500 will rally during the next four months by a relatively modest 9%.

OUR 2017 US EQUITY FORECAST ASSUMES THE FOLLOWING:

1. Earnings. S&P 500 operating EPS will grow by 10% to \$116 in 2017 and adjusted EPS will increase by 5% to \$123.Investors are excited about a prospective cut in corporate taxes that could boost adjusted EPS to perhaps \$130, representing growth of 11%. However, our economists are skeptical that all the anticipated tax cuts will take place given the federal budget deficit constraints. Some tax reform will take place and upside exists to our baseline EPS forecast but it will be less than many investors now expect.

2. Inflation and interest rates. In terms of inflation, core PCE will reach the Fed�s 2% objective by the end of next year. The Fed will hike interest rates next month and three additional times in 2017. Ten-year US Treasury yields will rise to 2.75%.

3. Valuation. S&P 500 currently trades at 19x our forward top-down operating EPS estimate, 18x our forward top-down adjusted EPS and 17x our upside adjusted EPS scenario. The market trades at 17x forward consensus bottom-up adjusted EPS. US equities are highly valued relative to history on most metrics and versus inflation and interest rates. We forecast static valuation during the next 12 months.

4. Path and target. We expect the S&P 500 index will rise to 2400 (+9%) by the end of 1Q as investors embrace the possibility that lower taxes will lead to positive EPS revisions. But less-than-expected tax cuts and higher inflation and interest rates will limit both upward EPS revisions and any P/E multiple expansion. S&P 500 will end next year at 2300, reflecting a price gain of 5% and a total return of 7% including dividends.

5. Buybacks and dividends. Buybacks will rise by 30% as companies repatriate cash held overseas. Dividends will rise by 6% in 2017, above the 4% growth rate currently implied by the dividend swap market.

6. �Hope� vs. �Fear� strategies: �Hope� will dominate during the first part of 2017 as Cyclicals beat Defensives. Firms with high domestic sales will outperform along with companies with high tax rates. �Fear� will dominate later in the year when investors focus on rising inflation and interest rates. Low labor cost and strong balance sheet firms will outperform.

This outlook was authored by GS Global Investment Research team.

Stock screening tools

{C}         {C}Reuters stock screener to help select stocks

{C}         {C}FINVIZ.com

{C}         {C}WSJ stock screen

{C}         {C}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

 RECOMMENDATIONS CURRENT 1 MONTH AGO 2 MONTHS AGO 3 MONTHS AGO Strong Buy 26 26 25 24 Moderate Buy 4 4 4 4 Hold 8 8 8 9 Moderate Sell 0 0 0 0 Strong Sell 0 0 0 0 Mean Rec. 1.51 1.51 1.53 1.58

Summary of stock screening rules from class discussion

PEG<1

PE<15  (? FB�s PE>100?)

Growth rate<20

ROE>10%

Zacks average =1 (from Ranking stocks using PEG ratio)

current price>5

How to pick stocks

Capital Asset Pricing Model (CAPM)Explained

Ranking stocks using PEG ratio

# ��The Importance of Diversification

Understanding Diversification in Stock Trading to Avoid Losses

# How to Build a Portfolio | by Wall Street Survivor

Useful website (recommended by David and Phil. Thanks, David and Phil)

money.msn.com/investing

zacks.com

minyanville.com

moneychimp.com

nasdaq.com

marketwatch.com

superstockscreener.com

gurufocus.com

portfoliomoney.com

stockconsultant.com

moderngraham.com

stockpickr.com

stockta.com

thestreet.com

quotes.wsj.com

oldschoolvalue.com

fool.com

analystratings.com

barchart.com

stock2own.com

theonlineinvestor.com

seekingalpha.com

Week 6

Chapter 10 WACC

ppt

Chapter 10 Review

Discount rate to figure out the value of projects is called WACC (weighted average cost of capital)

WACC = weight of debt * cost of debt *(1-tax rate) + weight of equity *( cost of equity)

Cost of debt = rate(nper, coupon, price � flotation costs, 1000)

Cost of Equity = D1/(Po � Flotation Cost)+ g���

D1: Next period dividend; Po: Current stock price; g: dividend growth rate

Discussion:

{C}         {C}Cheaper to raise capital from debt market. Why? Why not 100% financing via borrowing?

{C}         {C}Why tax rate cannot reduce firms� cost of equity?

{C}         {C}Hertz�s WACC = 7.9%. Too low or too high? How to get this WACC?

 Issuer Name Symbol Callable Sub-Product Type Coupon Maturity Moody S&P Price Yield HERTZ CORP Yes Corporate Bond 6.75 4/15/2019 B2 B 98.542 7.551 HERTZ CORP Yes Corporate Bond 7.375 1/15/2021 B2 B 95.386 8.843 HERTZ CORP Yes Corporate Bond 5.875 10/15/2020 B2 B 91.563 8.728 HERTZ CORP Yes Corporate Bond 6.25 10/15/2022 B2 B 89.719 8.64 HERTZ CORP � Yes Corporate Bond 7 1/15/2028 B3 99.637 7.047 HERTZ CORP Corporate Bond 4.25 4/1/2018 101.44 HERTZ CORP Corporate Bond 10/15/2024 85.625 HERTZ CORP Corporate Bond 7.5 10/15/2018 98.5 HERTZ CORP Corporate Bond 4/15/2019 99 Corporate Bond

In Class Exercise

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 =

HOMEWORK of Chapter 10 (due before final)

1. 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 (5.48%)

2.�� 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%)

3. 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.

4. As learned from our classmates in class, calculate WACC of Hertz (7.99%).

Chapter 11: Capital Budgeting

ppt

Case study questions (as home work) (due before final)

Npv, irr, mirr, payback, template (my contribution, simple excel command)

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.

{C}{C}{C}

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.

MIRR Excel syntax

Syntax

MIRR(values, finance_rate, reinvest_rate)

Values: required. An array of a reference to cells that contain numbers.

These numbers represent a series of payments (negative numbers) and income (positive values) occurring at regular period.

Finance�_rate: Required. The interest rate you pay on the money used in the cash flow.

Reinvest_rate: Required. The interest rate you receive on the cash flows as you reinvest them

Weighted Average Cost of Capital (WACC) Calculator (FYI)

# �Simple Rules� for Running a Business (fyi)

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, tooanalyzing 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 algorithmsone 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 resourceseither people or money or attentioncan benefit from simple rules.

WSJ: Can you give an example of how that simplification works in a company?

Sull: Theres 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 didnt 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 projectsthat 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 Frontierstuff 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 factorsis 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, youll 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. Theyre easy to remember, they dont confuse or stress you, they save time.

They should be tailored to your specific goals, so you choose the rules based on what exactly youre 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: Lets 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 insteadhe decided what the most important goals were. You cant achieve everything at once. In their case, their priorities were removing bottlenecks on growing revenues and minimizing upfront expenditure. So when allocating money, they had a bias for projects that both addressed the bottleneck problem and, for example, used existing tracks and trains.

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 thats where the money will stretch farther.

# Weighted Average Cost of Capital (WACC) in 3 Easy Steps: How to Calculate WACC

How to Calculate the Weighted Average Cost of Capital (WACC) Using Real Data

# Using Excel for Net Present Values, IRR's and MIRR's

Week 7

Chapter 12: Cash flow estimation

ppt

case study questions (last case study required) (due before final)

Chapter 18 Derivatives

Chapter 18 PPT

Chapter 18 Case Study - call and put option, hard but very interesting,

(optional, for 10 extra points added to the final exam, due before 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

4th, can calculate call option price using black-scholes model

Review of the Final Exam

Final Study Guide (Final on 4/26/2017)

Exit exam (40 questions all from the pool)

###### Multiple Choice:� Conceptual (15*2=30)

{C}1.      {C}Choose least risky stock, based on beta and standard deviation (you should compare based on beta, since everybody holds diversified portfolio)

{C}2.      {C}Given stock returns and market returns, guess for beta (of course, you can calculate beta using slope function in excel, but it is closed book section, so just guess)

{C}3.      {C}Can investor eliminate all risk? What type of risk can be diversified away? So this is a diversification problem

{C}4.      {C}The effect of adding one randomly chosen stock, from the perspective of risk management?

{C}5.      {C}Portfolio of two stocks: Given correlation coefficient of the two stocks, how can risk change accordingly?

{C}6.      {C}WACC component questions (three components)

{C}7.      {C}IRR conceptual question (remember, IRR is the breakeven rate)

{C}8.      {C}Multi-IRR problem

{C}9.      {C}Compare IRR, MIRR and NPV

1. Hard one � Two projects� NPV profiles and CF projections

{C}11.  {C}Chapter 12�s conceptual question.

����������� Which of the following factors should be included in the cash flows used to estimate a project�s NPV?

1. Derivative examples (just names)

{C}13.  {C}The factors for stock option value

{C}14.  {C}Concept of call and put option

1. Out of money and in the money concept

Calculation Questions (25 questions, chapter 11 and 12, 18 open book open notes, 2.8 points each.

{C}1.      Calculate NPV

{C}2.      Calculate payback

{C}3.      Calculate IRR

{C}4.      Calculate MIRR

{C}5.      Calculate crossover rate

{C}6.      Calculate MIRR

{C}7.      Calculate MIRR, and IRR

8-10 Other npv, irr, etc calculations

11-20 like case study of chapter 12 but questions might be harder.

Just calculate initial outlay, each year�s cash flow, final year�s cash flow.

Project NPV.

{C}21.  {C}Call option�s exercise value calculation using exercise value=max(market price � strike price, 0)

{C}22.  {C}Calculation option premium using option premium = option price � exercise value of the option

{C}23.  {C}Exercise value of put option. Use max(strike-current price, 0) to get it.

{C}24.  {C}Use Option premium = Option value − Exercise value to get option premium

{C}25.    {C}Use black-scholes model to calculate call option price, similar to case study question

{C}{C}{C}

Black-Scholes model (reference only)

{C}{C}{C}

# Gambling on Derivatives, Hedging Risk or Courting Disaster?

Week 8

Final (in class) and Exit Exam (4/26m at 6pm)

Exit exam corrections for Q1-Q75 (See Corrections in red. Thanks, Angela. )

Exit exam for Q76-Q100 (See corrections in red. Thanks, Maria)