FIN 435 Class Web Page, Spring '19

Business Finance Online, an interactive learning tool for the Corporate Finance Student https://www.zenwealth.com/BusinessFinanceOnline/index.htm (could be very helpful) =IF(OR( SUM(C4:C54)<>0,), IRR(C4:C54),"")

Weekly SCHEDULE, LINKS, FILES and Questions

Week

Coverage, HW, Supplements

-        Required

Equations

Videos (optional)

Week 0

Market Watch Game

Use the information and directions below to join the game.

http://www.marketwatch.com/game/jufin435-19spring

2.     Password for this private game: havefun.

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!

Week 0

Week 1

# 6 Signs a Business Has Bad Management | Phil Town (video)

For class discussion: What are the 6 signs? Which one is the hardest one to catch? Which one is the most important one to investors?

Chapter 3  Financial Statement Analysis

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

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

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

EDGAR online

Steps:

1.      Go to EDGAR online

2.      Search AAPL

3.      Search financial statement of AAPL in 2018, 2017, 2016, and 2015.

Chapter 4 Ratio Analysis

Chapter 4 case study - second case study, with mid-term exam

HW of chapters 3, 4 (due by 3/31)

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.  Calculate FCF.

 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.

First week’s class videos

(plus balance sheet, income statement)

https://www.jufinance.com/ratio

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

ROE = (net income / sales) * (sales / assets) * (assets / shareholders' equity)

This equation for ROE breaks it into three widely used and studied components:

ROE = (net profit margin) * (asset turnover) * (equity multiplier)

# FYI: Amazon.com Inc. (AMZN)https://www.stock-analysis-on.net/NASDAQ/Company/Amazoncom-Inc/DCF/Present-Value-of-FCFF

## Value Stock Criteria List:

### VALUE CRITERIA #1:

Look for a quality rating that is average or better. You don’t need to find the best quality companiesaverage or better is fine. Benjamin Graham recommended using Standard & Poors rating system and required companies to have an S&P Earnings and Dividend Rating of B or better. The S&P rating system ranges from D to A+. Stick to stocks with ratings of B+ or better, just to be on the safe side.

### VALUE CRITERIA #2:

Graham advised buying companies with Total Debt to Current Asset ratios of less than 1.10. In value investing it is important at all times to invest in companies with a low debt load. Total Debt to Current Asset ratios can be found in data supplied by Standard & Poors, Value Line, and many other services.

### VALUE CRITERIA #3:

Check the Current Ratio (current assets divided by current liabilities) to find companies with ratios over 1.50. This is a common ratio provided by many investment services.

### VALUE CRITERIA #4:

Criteria four is simple: Find companies with positive earnings per share growth during the past five years with no earnings deficits. Earnings need to be higher in the most recent year than five years ago. Avoiding companies with earnings deficits during the past five years will help you stay clear of high-risk companies.

### VALUE CRITERIA #5:

Invest in companies with price to earnings per share (P/E) ratios of 9.0 or less. Look for companies that are selling at bargain prices. Finding companies with low P/Es usually eliminates high growth companies, which should be evaluated using growth investing techniques.

### VALUE CRITERIA #6:

Find companies with price to book value (P/BV) ratios less than 1.20. P/E ratios, mentioned in rule 5, can sometimes be misleading. P/BV ratios are calculated by dividing the current price by the most recent book value per share for a company. Book value provides a good indication of the underlying value of a company. Investing in stocks selling near or below their book value makes sense.

### VALUE CRITERIA #7:

Invest in companies that are currently paying dividends. Investing in undervalued companies requires waiting for other investors to discover the bargains you have already found. Sometimes your wait period will be long and tedious, but if the company pays a decent dividend, you can sit back and collect dividends while you wait patiently for your stock to go from undervalued to overvalued.

One last thought. We like to find out why a stock is selling at a bargain price. Is the company competing in an industry that is dying? Is the company suffering from a setback caused by an unforeseen problem? The most important question, though, is whether the company’s  problem is short-term or long-term and whether management is aware of the problem and taking action to correct it. You can put your business acumen to work to determine if management has an adequate plan to solve the company’s current problems.

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

Week 2

Week 3

Chapter 6 Interest rate

third case study, due by 3/31)

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.

# The yield curve (Video, Khan academy)

Treasury Yields

 NAME COUPON PRICE YIELD 1 MONTH 1 YEAR TIME (EDT) GB3:GOV 3 Month 0.00 2.40 2.44% +3 +69 2:53 PM GB6:GOV 6 Month 0.00 2.44 2.51% +1 +55 2:53 PM GB12:GOV 12 Month 0.00 2.42 2.49% -4 +43 2:53 PM GT2:GOV 2 Year 2.50 100.07 2.46% -3 +15 2:54 PM GT5:GOV 5 Year 2.38 99.79 2.42% -4 -24 2:53 PM GT10:GOV 10 Year 2.63 100.14 2.61% -3 -25 2:54 PM GT30:GOV 30 Year 3.00 99.53 3.02% +5 -6 2:54 PM

**** exercise: Please draw the yield curve based on the above information *****

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

 Date 1 Mo 2 Mo 3 Mo 6 Mo 1 Yr 2 Yr 3 Yr 5 Yr 7 Yr 10 Yr 20 Yr 30 Yr 03/01/19 2.44 2.46 2.44 2.52 2.55 2.55 2.54 2.56 2.67 2.76 2.97 3.13 03/04/19 2.45 2.46 2.46 2.54 2.54 2.55 2.52 2.53 2.63 2.72 2.93 3.09 03/05/19 2.44 2.45 2.46 2.53 2.54 2.55 2.52 2.53 2.63 2.72 2.93 3.08 03/06/19 2.43 2.44 2.47 2.53 2.54 2.52 2.49 2.49 2.59 2.69 2.90 3.06 03/07/19 2.45 2.46 2.45 2.52 2.52 2.47 2.44 2.44 2.54 2.64 2.86 3.03 03/08/19 2.45 2.46 2.46 2.52 2.53 2.45 2.43 2.42 2.51 2.62 2.83 3.00 03/11/19 2.44 2.45 2.46 2.54 2.53 2.47 2.45 2.44 2.53 2.64 2.86 3.03 03/12/19 2.44 2.46 2.46 2.53 2.52 2.45 2.41 2.41 2.50 2.61 2.82 3.00 03/13/19 2.43 2.44 2.45 2.53 2.53 2.45 2.41 2.42 2.51 2.61 2.82 3.02 03/14/19 2.48 2.46 2.45 2.52 2.52 2.46 2.42 2.43 2.53 2.63 2.86 3.04 03/15/19 2.46 2.46 2.45 2.52 2.52 2.43 2.39 2.40 2.49 2.59 2.83 3.02 03/18/19 2.47 2.46 2.44 2.51 2.52 2.45 2.41 2.42 2.51 2.60 2.83 3.01

Monday Mar 18, 2019

For daily yield curve, please visit http://finra-markets.morningstar.com/BondCenter/Default.jsp

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

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.

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.

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.

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.

Homework of chapter 6 (Due by 3/31)

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

 Date 1 Mo 2 Mo 3 Mo 6 Mo 1 Yr 2 Yr 3 Yr 5 Yr 7 Yr 10 Yr 20 Yr 30 Yr Dec 3rd, 2018 2.3 2.35 2.38 2.56 2.72 2.83 2.84 2.83 2.9 2.98 3.15 3.27

1. Plot a yield curve based on these data. Is the yield inverted?
2. Calculate the 2 years interest rate 1 year from now, using the pure expectations theory.
3. 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: 6%, 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

Based on the class discussion, the videos watched and the papers that we read in the class, what is your opinion on the inverted yield curve?

This week’s class videos

# Why Investors Are Obsessed With the Inverted Yield Curve (video)

***For class discussion: Do you think it is a big deal that the yield curve gets flattened?***

# What a Flat Yield Curve Really Means (video)

The U.S. Yield Curve Just Inverted. That’s Huge.

The move ushers in fresh questions about the Fed and the economy.

By

Brian Chappatta, Bloomberg

December 3, 2018, 12:27 PM EST

(

 Date 1 Mo 2 Mo 3 Mo 6 Mo 1 Yr 2 Yr 3 Yr 5 Yr 7 Yr 10 Yr 20 Yr 30 Yr Dec 3rd, 2018 2.3 2.35 2.38 2.56 2.72 2.83 2.84 2.83 2.9 2.98 3.15 3.27

The U.S. Treasury yield curve just inverted for the first time in more than a decade.

It’s a moment that the world’s biggest bond market has been thinking about for the past 12 months. I wrote around this time last year that Wall Street had come down with a case of flattening fever, with six of the 11 analysts I surveyed saying that the curve from two to 10 years would invert at least briefly by the end of 2019. That’s not exactly what happened Monday, though that spread did reach the lowest since 2007. Rather, the difference between three- and five-year Treasury yields dropped below zero, marking the first portion of the curve to invert in this cycle.

The First Inversion

After years of flattening, the yield difference between some Treasury notes falls below zero

Source: Bloomberg

The move didn’t come out of nowhere. In fact, I wrote a week ago that the spread between short-term Treasury notes was racing toward inversion, and Bloomberg News’s Katherine Greifeld and Emily Barrett noted the failed break below zero on Friday. Still, I wasn’t necessarily expecting this day to come so soon. Rate strategists have long said that being close doesn’t cut it when talking about an inverted yield curve and the well-known economic implications that come with it, namely that the spread between short- and long-term Treasury yields has dropped below zero ahead of each of the past seven recessions.

It’s important to keep in mind the timeline between inversion and economic slowdowns — it’s not instantaneous. The  yield curve from three to five years dipped below zero during the last cycle for the first time in August 2005, some 28 months before the recession began. That this is the first portion to flip isn’t too surprising, considering how much scrutiny bond traders place on the Federal Reserve’s outlook for rate increases. All it means is that the central bank will probably leave interest rates steady, or even cut a bit, in 2022 or 2023. I’d argue that’s not just possible, but probable, given that we’re already in one of the longest economic expansions in U.S. history.

The more interesting question might be why this part of the yield curve won the race to inversion, rather than the spread between seven- and 10-year Treasuries, which looked destined to fall below zero earlier this year. One reason could be that the Fed’s balance-sheet reduction is putting more pressure on 10-year notes than shorter-dated maturities, which wasn’t the case during past periods of inversion. Indeed, policy makers have shown no signs of easing up on this stealth tightening.

On top of that, the Treasury Department is selling increasing amounts of debt, which disproportionately affects the longest-dated obligations because buyers have to consider the duration risk they’re absorbing. Remember the curve from five to 30 years, which fell below 20 basis points in July? That spread is about 46 basis points now, driven by stubbornly higher long-bond yields.

Given the recent pivot from the most important Fed leaders — Jerome Powell, Richard Clarida and John Williams — this flirtation with inversion among two-, three- and five-year Treasury notes probably isn’t going away. The bond market is fast approaching the point where traders have to ask themselves whether a rate hike now increases the chance of a cut in a few years. Other questions include “What is neutral?” and “Can the Fed engineer a soft landing?” To say nothing about whether the assumed relationship between the labor market and inflation expectations is still intact.

Those are big questions without easy answers, and the first inversion of the U.S. yield curve offers only one clue. The Fed wants to be more data dependent going forward. Odds are the market will do the same.

A Recession Is Coming, And Maybe a Bear Market, Too

History shows that equities normally drop about 21 percent when the economy contracts.

By

A. Gary Shilling, Bloomberg

March 18, 2019, 6:00 AM EDT

I first suggested the U.S. economy was headed toward a recession more than a year ago, and now others are forecasting the same. I give a business downturn starting this year a two-thirds probability.

The recessionary indicators are numerous. Tighter monetary policy by the Federal Reserve that the central bank now worries it may have overdone. The near-inversion in the Treasury yield curve. The swoon in stocks at the end of last year. Weaker housing activity. Soft consumer spending. The tiny 20,000 increase in February payrolls, compared to the 223,000 monthly average gain last year. Then there are the effects of the deteriorating European economies and decelerating growth in China as well as President Donald Trump’s ongoing trade war with that country.

There is, of course, a small chance of a soft landing such as in the mid-1990s. At that time, the Fed ended its interest-rate hiking cycle and cut the federal funds rate with no ensuing recession. By my count, the other 12 times the central bank restricted credit in the post-World War II era, a recession resulted.

It’s also possible that the current economic softening is temporary, but a revival would bring more Fed restraint. Policy makers want higher rates in order to have significant room to cut in the next recession, and the current 2.25 percent to 2.50 percent range doesn’t give them much leeway. The Fed also dislikes investors’ zeal for riskier assets, from hedge funds to private equity and leveraged loans, to say nothing of that rankest of rank speculations, Bitcoin. With a resumption in economic growth, a tight credit-induced recession would be postponed until 2020.

“Recession” conjures up specters of 2007-2009, the most severe business downturn since the 1930s in which the S&P 500 Index plunged 57 percent from its peak to its trough. The Fed raised its target rate from 1 percent in June 2004 to 5.25 percent in June 2006, but the main event was the financial crisis spawned by the collapse in the vastly-inflated subprime mortgage market.

Similarly, the central bank increased its policy rate from 4.75 percent in June 1999 to 6.5 percent in May 2000.  Still, the mild 2001 recession that followed was principally driven by the collapse in the late 1990s dot-com bubble that pushed the tech-laden Nasdaq Composite Index down by a whopping 78 percent.

The 1973-1975 recession, the second deepest since the 1930s, resulted from the collapse in the early 1970s inflation hedge buying of excess inventories. That deflated the S&P 500 by 48.2 percent. The federal funds rate hike from 9 percent in February 1974 to 13 percent in July of that year was a minor contributor.

The remaining eight post-World War II recessions were not the result of major financial or economic excesses, but just the normal late economic cycle business and investor overconfidence. The average drop in the S&P 500 was 21.2 percent.

At present, I don’t see any major economic or financial bubbles that are just begging to be pricked. The only possibilities are excess debt among U.S. nonfinancial corporations and the heavy borrowing in dollars by emerging-market economies in the face of a rising greenback. Housing never fully recovered from the subprime mortgage debacle. The financial sector is still deleveraging in the wake of the financial crisis. Consumer debt remains substantial but well off its 2008 peak in relation to household income.

Consequently, the recession I foresee will probably be accompanied by about an average drop in stock prices. The S&P 500 fell 19.6 percent from Oct. 3 to Dec. 24, but the recovery since has almost eliminated that loss. A normal recession-related decline of 21.2 percent – meeting the definition of a bear market – from that Oct. 3 top would take it to 2,305, down about 18 percent from Friday’s close, but not much below the Christmas Eve low of 2,351.

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 exam)

Chapter 7

Case study of chapter 7 (Due with final)

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 2019-01-31 Total Assets 219,295,000 Total Current Liabilities 77,477,000 Long Term Debt 43,520,000 Total Liabilities 139,661,000 Total Equity 72,496,000 Total Liabilities & Shareholders' Equity 219,295,000

For discussion:

·         What is this “long term debt”?

·         Who is the lender of this “long term debt”?

So this long term debt is called bond in the financial market. Where can you find the pricing information and other specifications of the bond issued by WMT?

How Bonds Work (video)

FINRA – Bond market information

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

# WAL-MART STORES INC

http://finra-markets.morningstar.com/BondCenter/BondDetail.jsp?ticker=C104227&symbol=WMT.GP

7.550

%

02/15/2030

WMT.GP

931142BF9

\$138.45

3.318%

03/18/2019

## Credit and Rating Elements

 Moody's® Rating Aa2 (10/14/2015) Standard & Poor's Rating AA (02/10/2000) TRACE Grade Investment Grade Default — Bankruptcy N Insurance — Mortgage Insurer — Pre-Refunded/Escrowed — Additional Description Senior Unsecured Note

## Classification Elements

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

Special Characteristics

 Medium Term Note N

## Issue Elements

 *dollar amount in thousands Offering Date 02/09/2000 Dated Date 02/15/2000 First Coupon Date 08/15/2000 Original Offering* \$1,000,000.00 Amount Outstanding* \$1,000,000.00 Series — Issue Description — Project Name — Payment Frequency Semi-Annual Day Count 30/360 Form Book Entry Depository/Registration Depository Trust Company Security Level Senior Collateral Pledge — Capital Purpose —

## Bond Elements

 *dollar amount in thousands Original Maturity Size* 1,000,000.00 Amount Outstanding Size* 1,000,000.00 Yield at Offering 7.56% Price at Offering \$99.84 Coupon Type Fixed Escrow Type

For class discussion:

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

Study guide

1.      Find bond sponsored by WMT

just go to www.finra.orgè Investor center è market data è bond è corporate bond

Corporate Bond

 Issuer Name Callable Coupon Maturity Moody S&P Fitch Price Yield WMT No 7.55 2/15/2030 Aa2 AA AA 138.45 3.318 WMT yes 6.75 4/2/2043 Aa2 AA AA 110.45 4.065

(see below for details)

# WALMART INC

4.750

%

10/02/2043

WMT4055720

931142DK6

04/02/2043

Yes

\$110.45

4.065%

03/14/2019

### US Treasury Yield

 Prospectus

For class discussion:

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

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

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

HOMEWORK (Due with final)

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

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

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%)

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%)

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)

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)

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%)

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%)

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)

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

1) What is the purpose for the money raised?

2) Which of the two outstanding WMT bonds are more attractive one to you? Why?

3) Who are the underwriters for the WMT bonds?

Class videos

Bond Pricing Formula (FYI)

Bond Pricing Excel Formula

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

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

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

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

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

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

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

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

### Redemption Features (FYI)

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

#### Call Provision

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

#### Put Provision

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

#### Conversion

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

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 with 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 with final)

Instructions and requirements

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

·         Calculate monthly stock return of each stock

·         Calculate the mean and the standard deviation of each stock.

·         Calculate correlations and generate correlation matrix. Discuss your results regarding the degree of correlation of your stocks.

·         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.

·         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)

·         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.

Equations

1.     Expected return and standard deviation

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

where

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

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

where

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

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

2.     Two stock portfolio equations:

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

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

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

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

Chapter 9 Stock Return Evaluation

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

·         Free cash flow

·         EBIDTA

·         Yield curve

·         Inflation

·         Exchange rate

·         Firm size

·         Market to book ratio

·         Tax rate

·         Momentum

·         PE

·         Earning

·         Merger and Acquisition

·         IPO

·         Debt

·         Dividend

·         Share split

·         Short interest ratio

·         Technical analysis ratios

·         New product and new market

·         World events

·         Weather

·         …………

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

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

Homework (Due with final)

Read Beating the Historical Odds: Recession Risk in 2019 and Beyond

1.      How does GS evaluate the likelihood of an recession occurring in 2019?

2.      What are GS’s forecasts of the US economy in the short run?

Class videos (Sorry for not turning on the microphone. The videos have no sound. My apologies)

Beating the Historical Odds: Recession Risk in 2019 and Beyond

We have long highlighted the risks that have historically been associated with large overshoots of full employment. We have noted that the Fed has never engineered a soft landing from beyond full employment, that few other advanced economy central banks have either, and that countries that have achieved very long expansions often used countercyclical policy to prevent a large overshoot in the first place. In practice it hasnt been easy to nudge up the unemployment rate just so. While we take this lesson seriously, we think it is being applied too mechanically by market participants today. The key difference with the past is that the Phillips curve is flatter and better anchored on the Feds target today. As a result, where labor market overshoots once led to high and accelerating inflation and consequently had to be unwound urgently with a forceful policy response, today an overshoot will more likely mean inflation persistently but only moderately above target. The Fed could probably live with this for a while, permitting it to tighten gradually and unwind the overshoot slowly. This gives the Fed a good chance of beating the historical odds. How worried should we be about recession risk today? The history of US recessions points to two classic causes of US recessions, overheating and financial imbalances. While overheating risks could emerge down the road, they look quite limited for now: core inflation is at 2%, trend unit labor cost growth is at 2%, and both household inflation expectations and market-implied inflation compensation are below average (Exhibit 9).

(Please refer to https://www.goldmansachs.com/insights/pages/outlook-2019/us-outlook/report.pdf for a better quality graph)

We also see little risk from financial imbalances at the moment. At a high level, the private sector financial balancea very good predictor of recession risklooks quite healthy (Exhibit 10). Digging deeper, our financial excess monitor looks for elevated valuations and stretched risk appetite across major asset classes, and for financial imbalances and vulnerabilities in the household, business, banking, and government sectors. Overall, the message is mostly reassuring. On the valuations side, while commercial real estate prices look somewhat frothy, lending terms and standards have tightened in recent years. On the sectoral imbalances side, fiscal sustainability remains a long-run concern, but we see this less as a recession trigger than as something that could prolong a downturn if policymakers perceive a lack fiscal space to respond. These two classic recession risks are complementaryoverheating and the associated risk of a more abrupt shift in monetary policy is more threatening when financial imbalances are elevated and less threatening when they are limited. With neither risk looking worrisome at the moment, we do not think it makes sense to characterize the economy as late cycle at this point.

The most obvious recession risk beyond 2019 is a mundane and technical one. With a low potential growth rate and a possible need to operate the economy a touch below potential to gradually unwind the overshootwe forecast 1.5% growth in 2020 and 2021the likelihood that normal fluctuations will tip growth negative is mechanically somewhat higher. We would interpret this as simply highlighting the arbitrariness of defining recessions as negative growth, rather than as a material rise in the unemployment rate. Of course, even a less severe recession could see a large sell-off in risk assets. Accounting for these and other considerations, our recession risk model indicates that recession risk is still quite low (Exhibit 11). The expansion is therefore on course to become the longest in US history next year, and even in subsequent years recession is not our base case.

(Please refer to https://www.goldmansachs.com/insights/pages/outlook-2019/us-outlook/report.pdf for a better quality graph)

### ·         What Is the Capital Asset Pricing Model?

The Capital Asset Pricing Model (CAPM) describes the relationship between systematic risk and expected return for assets, particularly stocks. CAPM is widely used throughout finance for pricing risky securities and generating expected returns for assets given the risk of those assets and cost of capital.

Ri = Rf + βi  *( Rm - Rf) ------ CAPM model

Ri = Expected return of investment

Rf = Risk-free rate

βi = Beta of the investment

Rm = Expected return of market

(Rm - Rf) = Market risk premium

Investors expect to be compensated for risk and the time value of money. The risk-free rate in the CAPM formula accounts for the time value of money. The other components of the CAPM formula account for the investor taking on additional risk.

The beta of a potential investment is a measure of how much risk the investment will add to a portfolio that looks like the market. If a stock is riskier than the market, it will have a beta greater than one. If a stock has a beta of less than one, the formula assumes it will reduce the risk of a portfolio.

A stocks 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 stocks 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.

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.

Week 6

Chapter 10 WACC

ppt

One option (if beta is given)

Another option (if dividend is given):