FIN435 Class Web Page, Spring '20

Jacksonville University

Instructor: Maggie Foley

Exit Exam Questions (will be posted in week 10 on blackboard)

Weekly SCHEDULE, LINKS, FILES and Questions

Week

Coverage, HW, Supplements

-        Required

Videos (optional)

Week

1

Marketwatch Stock Trading Game (Pass code: havefun)

Use the information and directions below to join the game.

https://www.marketwatch.com/game/jufin435-20s

2.     Password for this private game: havefun.

6.   Game will be over on 4/17/2019

Chapter 3 Financial Statement

# 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

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

Case study of chapter 3:

·        Excel File here  (due with the first mid term exam)

·        Video available  on blackboard collaborate

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

## Present Value of Free Cash Flow to the Firm (FCFF)

In discounted cash flow (DCF) valuation techniques the value of the stock is estimated based upon present value of some measure of cash flow. Free cash flow to the firm (FCFF) is generally described as cash flows after direct costs and before any payments to capital suppliers.

### Intrinsic Stock Value (Valuation Summary)

Amazon.com Inc., free cash flow to the firm (FCFF) forecast

 Year Value FCFFt or Terminal value (TVt) Calculation Present value at 16.17% 01 FCFF0 (4,286) 1 FCFF1 – = (4,286) × (1 + 0.00%) – 2 FCFF2 – = – × (1 + 0.00%) – 3 FCFF3 – = – × (1 + 0.00%) – 4 FCFF4 – = – × (1 + 0.00%) – 5 FCFF5 – = – × (1 + 0.00%) – 5 Terminal value (TV5) – = – × (1 + 0.00%) ÷ (16.17% – 0.00%) – Intrinsic value of Amazon.com's capital – Less: Debt (fair value) 45,696 Intrinsic value of Amazon.com's common stock – Intrinsic value of Amazon.com's common stock (per share) $– Current share price$1,642.81

1

### Weighted Average Cost of Capital (WACC)

Amazon.com Inc., cost of capital

 Value1 Weight Required rate of return2 Calculation Equity (fair value) 803,283 0.95 16.97% Debt (fair value) 45,696 0.05 2.10% = 2.99% × (1 – 29.84%)

1 USD $in millions Equity (fair value) = No. shares of common stock outstanding × Current share price 488,968,628 ×$1,642.81 = $803,282,551,764.68 Debt (fair value). See Details » 2 Required rate of return on equity is estimated by using CAPM. See Details » Required rate of return on debt. See Details » Required rate of return on debt is after tax. Estimated (average) effective income tax rate = (20.20% + 36.61% + 60.59% + 0.00% + 31.80%) ÷ 5 = 29.84% WACC = 16.17% ### FCFF Growth Rate (g) #### FCFF growth rate (g) implied by PRAT model Amazon.com Inc., PRAT model  Average Dec 31, 2017 Dec 31, 2016 Dec 31, 2015 Dec 31, 2014 Dec 31, 2013 Selected Financial Data (USD$ in millions) Interest expense 848 484 459 210 141 Net income (loss) 3,033 2,371 596 (241) 274 Effective income tax rate (EITR)1 20.20% 36.61% 60.59% 0.00% 31.80% Interest expense, after tax2 677 307 181 210 96 Interest expense (after tax) and dividends 677 307 181 210 96 EBIT(1 – EITR)3 3,710 2,678 777 (31) 370 Current portion of long-term debt 100 1,056 238 1,520 753 Current portion of capital lease obligation 5,839 3,997 3,027 2,013 955 Current portion of finance lease obligations 282 144 99 67 28 Long-term debt, excluding current portion 24,743 7,694 8,235 8,265 3,191 Long-term capital lease obligations, excluding current portion 8,438 5,080 4,212 3,026 1,435 Long-term finance lease obligations, excluding current portion 4,745 2,439 1,736 1,198 555 Total stockholders' equity 27,709 19,285 13,384 10,741 9,746 Total capital 71,856 39,695 30,931 26,830 16,663 Ratios Retention rate (RR)4 0.82 0.89 0.77 – 0.74 Return on invested capital (ROIC)5 5.16% 6.75% 2.51% -0.12% 2.22% Averages RR 0.80 ROIC 3.31% Growth rate of FCFF (g)6 0.00%

2017 Calculations

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

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

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

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

6 g = RR × ROIC
0.80 × 3.31% = 0.00%

#### FCFF growth rate (g) forecast

Amazon.com Inc., H-model

 Year Value gt 1 g1 0.00% 2 g2 0.00% 3 g3 0.00% 4 g4 0.00% 5 and thereafter g5 0.00%

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

Calculations

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

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

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

Chapter 4 Ratio Analysis

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

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

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

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

Chapter 4 case study (updated, due with first mid term)

·        PPT affiliated with this case study FYI

·        Video is available on blackboard collaborate

Ratio Analysis  template

## 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 companys  problem is short-term or long-term and whether management is aware of the problem and taking action to correct it. You can put your business acumen to work to determine if management has an adequate plan to solve the companys current problems.

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

Chapter 6 Interest rate

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 (EST) GB3:GOV 3 Month 0.00 1.53 1.56% +0 -87 7:02 PM GB6:GOV 6 Month 0.00 1.53 1.56% +1 -94 7:02 PM GB12:GOV 12 Month 0.00 1.49 1.53% +2 -102 7:02 PM GT2:GOV 2 Year 1.63 100.13 1.56% -5 -98 7:02 PM GT5:GOV 5 Year 1.75 100.70 1.60% -5 -93 7:02 PM GT10:GOV 10 Year 1.75 99.69 1.79% -4 -93 7:02 PM GT30:GOV 30 Year 2.38 102.98 2.24% -2 -84 7:02 PM

In Class Exercise:

·         Please draw the yield curve based on the above information;

·         What can be predicted from the current yield curve?

For Daily Treasury rates such as the following, please visit https://www.treasury.gov/resource-center/data-chart-center/interest-rates/pages/textview.aspx?data=yield

 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 01/02/20 1.53 1.55 1.54 1.57 1.56 1.58 1.59 1.67 1.79 1.88 2.19 2.33 01/03/20 1.52 1.55 1.52 1.55 1.55 1.53 1.54 1.59 1.71 1.80 2.11 2.26 01/06/20 1.54 1.54 1.56 1.56 1.54 1.54 1.56 1.61 1.72 1.81 2.13 2.28 01/07/20 1.52 1.53 1.54 1.56 1.53 1.54 1.55 1.62 1.74 1.83 2.16 2.31 01/08/20 1.50 1.53 1.54 1.56 1.55 1.58 1.61 1.67 1.78 1.87 2.21 2.35 01/09/20 1.53 1.55 1.54 1.56 1.54 1.58 1.59 1.65 1.77 1.85 2.17 2.38 01/10/20 1.52 1.55 1.54 1.55 1.53 1.56 1.59 1.63 1.74 1.83 2.14 2.28 01/13/20 1.54 1.56 1.57 1.57 1.53 1.58 1.60 1.65 1.76 1.85 2.16 2.30 01/14/20 1.53 1.56 1.57 1.57 1.53 1.58 1.59 1.63 1.74 1.82 2.12 2.27 01/15/20 1.53 1.56 1.57 1.58 1.54 1.56 1.56 1.60 1.71 1.79 2.09 2.23 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 01/02/20 1.53 1.55 1.54 1.57 1.56 1.58 1.59 1.67 1.79 1.88 2.19 2.33

For class discussion: Why do interest rates change daily? Who determines interest rate?

interest rates are determined by the Federal Open Market Committee (FOMC), which consists of seven governors of the Federal Reserve Board and five Federal Reserve Bank presidents. The FOMC meets eight times a year to determine the near-term direction of monetary policy and interest rates.”

# Who Determines Interest Rates?

By NICK K. LIOUDIS  Updated Aug 15, 2019

Interest rates are the cost of borrowing money. They represent what creditors earn for lending you money. These rates are constantly changing, and differ based on the lender, as well as your creditworthiness. Interest rates not only keep the economy functioning, but they also keep people borrowing, spending, and lending. But most of us don't really stop to think about how they are implemented or who determines them. This article summarizes the three main forces that control and determine interest rates.

KEY TAKEAWAYS

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

## Short-Term Interest Rates: Central Banks

In countries using a centralized banking model, short-term interest rates are determined by central banks. A government's economic observers create a policy that helps ensure stable prices and liquidity. This policy is routinely checked so the supply of money within the economy is neither too large, which causes prices to increase, nor too small, which can lead to a drop in prices.

In the U.S., interest rates are determined by the Federal Open Market Committee (FOMC), which consists of seven governors of the Federal Reserve Board and five Federal Reserve Bank presidents. The FOMC meets eight times a year to determine the near-term direction of monetary policy and interest rates. The actions of central banks like the Fed affect short-term and variable interest rates.

If the monetary policymakers wish to decrease the money supply, they will raise the interest rate, making it more attractive to deposit funds and reduce borrowing from the central bank. Conversely, if the central bank wishes to increase the money supply, they will decrease the interest rate, which makes it more attractive to borrow and spend money.

The Fed funds rate affects the prime ratethe rate banks charge their best customers, many of whom have the highest credit rating possible. It's also the rate banks charge each other for overnight loans.

The U.S. prime rate remained at 3.25% between Dec. 16, 2008 and Dec. 17, 2015, when it was raised to 3.5%.

## Long-Term Interest Rates: Demand for Treasury Notes

Many of these rates are independent of the Fed funds rate, and, instead, follow 10- or 30-year Treasury note yields. These yields depend on demand after the U.S. Treasury Department auctions them off on the market. Lower demand tends to result in high interest rates. But when there is a high demand for these notes, it can push rates down lower.

If you have a long-term fixed-rate mortgage, car loan, student loan, or any similar non-revolving consumer credit product, this is where it falls. Some credit card annual percentage rates are also affected by these notes.

These rates are generally lower than most revolving credit products but are higher than the prime rate.

Many savings account rates are also determined by long-term Treasury notes.

## Other Rates: Retail Banks

Retail banks are also partly responsible for controlling interest rates. Loans and mortgages they offer may have rates that change based on several factors including their needs, the market, and the individual consumer.

For example, someone with a lower credit score may be at a higher risk of default, so they pay a higher interest rate. The same applies to credit cards. Banks will offer different rates to different customers, and will also increase the rate if there is a missed payment, bounced payment, or for other services like balance transfers and foreign exchange.

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

# Introduction to the yield curve (khan academy)

Chapter six case study

www.jufinance.com/video/fin435_c6_case_p2.mp4

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

# ByJEAN FOLGERUpdated Dec 6, 2019

Inflation and interest rates are often linked and frequently referenced in macroeconomics. Inflation refers to the rate at which prices for goods and services rise. In the United States, the interest rate, or the amount charged by a lender to a borrower, is based on the federal funds rate that is determined by the Federal Reserve (sometimes called "the Fed").

By setting the target for the federal funds rate, the Fed has at its disposal a powerful tool that it uses to influence the rate of inflation. This tool enables the Fed to expand or contract the money supply as needed to achieve target employment rates, stable prices, and stable economic growth.

KEY TAKEAWAYS

• There is an inverse correlation between interest rates and the rate of inflation.
• In the U.S, the Federal Reserve is responsible for implementing the country's monetary policy, including setting the federal funds rate which influences the interest rates banks charge borrowers.
• In general, when interest rates are low, the economy grows and inflation increases.
• Conversely, when interest rates are high, the economy slows and inflation decreases.

## The Inverse Correlation Between Interest Rates and Inflation

Under a system of fractional reserve banking, interest rates and inflation tend to be inversely correlated. This relationship forms one of the central tenets of contemporary monetary policy: Central banks manipulate short-term interest rates to affect the rate of inflation in the economy.

The below chart demonstrates the inverse correlation between interest rates and inflation. In the chart, CPI refers to the Consumer Price Index, a measurement that tracks changes in prices. Changes in the CPI are used to identify periods of inflation and deflation.

In general, as interest rates are reduced, more people are able to borrow more money. The result is that consumers have more money to spend, causing the economy to grow and inflation to increase.

The opposite holds true for rising interest rates. As interest rates are increased, consumers tend to save as returns from savings are higher. With less disposable income being spent as a result of the increase in the interest rate, the economy slows and inflation decreases.

To better understand how the relationship between inflation and interest rates works, it's important to understand the banking system, the quantity theory of money, and the role interest rates play.

Fractional Reserve Banking

2.268%

01/27/2020

## Credit and Rating Elements

 Moody's® Rating Aa2 (5/9//2018) Standard & Poor's Rating AA (02/10/2000) TRACE Grade Investment Grade Default — Bankruptcy N Insurance — Mortgage Insurer — Pre-Refunded/Escrowed — Additional Description Senior Unsecured Note

## Classification Elements

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

Special Characteristics

 Medium Term Note N

## Issue Elements

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

## Bond Elements

4.065%

03/14/2019

### US Treasury Yield

For class discussion:

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

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

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

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

·      Video on blackboard

·      Also at www.jufinance.com/video/fin435_c7_case.mp4

In class exercises

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

2.                  AAA firm’s bonds’ market value is $1,120, with 15 years maturity and coupon of$85. What is YTM?  (7.17%,  rate(15, 85, -1120, 1000))

3.         Sadik Inc.'s bonds currently sell for $1,180 and have a par value of$1,000.  They pay a $105 annual coupon and have a 15-year maturity, but they can be called in 5 years at$1,100.  What is their yield to call (YTC)? (7.74%, rate(15, 105, -1180, 1100))

4.         Malko Enterprises’ bonds currently sell for $1,050. They have a 6-year maturity, an annual coupon of$75, and a par value of $1,000. What is their current yield? (7.14%, 75/1050) 5. Assume that you are considering the purchase of a 20-year, noncallable bond with an annual coupon rate of 9.5%. The bond has a face value of$1,000, and it makes semiannual interest payments.  If you require an 8.4% nominal yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond? ($1,105.69, abs(pv(8.4%/2, 20*2, 9.%*1000/2, 1000)) ) 6. Grossnickle Corporation issued 20-year, non-callable, 7.5% annual coupon bonds at their par value of$1,000 one year ago.  Today, the market interest rate on these bonds is 5.5%.  What is the current price of the bonds, given that they now have 19 years to maturity? ($1,232.15, abs(pv(5.5%, 19, 75, 1000))) 7. McCue Inc.'s bonds currently sell for$1,250. They pay a $90 annual coupon, have a 25-year maturity, and a$1,000 par value, but they can be called in 5 years at $1,050. Assume that no costs other than the call premium would be incurred to call and refund the bonds, and also assume that the yield curve is horizontal, with rates expected to remain at current levels on into the future. What is the difference between this bond's YTM and its YTC? (Subtract the YTC from the YTM; it is possible to get a negative answer.) (2.62%, YTM = rate(25, 90, -1250, 1000), YTC = rate(5, 90, -1250, 1050)) 8. Taussig Corp.'s bonds currently sell for$1,150.  They have a 6.35% annual coupon rate and a 20-year maturity, but they can be called in 5 years at $1,067.50. Assume that no costs other than the call premium would be incurred to call and refund the bonds, and also assume that the yield curve is horizontal, with rates expected to remain at current levels on into the future. Under these conditions, what rate of return should an investor expect to earn if he or she purchases these bonds? (4.2%, rate(5, 63.5, -1150, 1067.5)) 9. A 25-year,$1,000 par value bond has an 8.5% annual payment coupon.  The bond currently sells for $925. If the yield to maturity remains at its current rate, what will the price be 5 years from now? ($930.11, rate(25, 85, -925, 1000), abs(pv( rate(25, 85, -925, 1000), 20, 85, 1000))

10. Read the attached prospects and answer the following questions: “We are offering $500,000,000 of our 1.000% notes due 2017 (symbol WMT4117476),$1,000,000,000 of our 3.300% notes due 2024 (symbol  WMT4117477) and $1,000,000,000 of our 4.300% notes due 2044 (symbol WMT4117478) 1) What is the purpose for the money raised? 2) Which of the two outstanding WMT bonds are more attractive one to you? Why? 3) Who are the underwriters for the WMT bonds? 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. Mid Term exam (chapters 3, 4, 6, 7) on 2/11 and 2/13 Study Guide ###### First Mid Term Exam – Problems Solving Study Guide ###### Multiple Choice: Problems (25*2=50) [i]. Calculate for FCF, given EBIT, depreciation, FA, NOWC, tax rate. [ii]. Calculate for NI, given sales, costs, tax rate, interest. 3. Calculate NOWC, given balance sheet. 4. Calculate for debt, given TA, debt ratio. 5. Calculate for times-interest-earned (TIE), given sales, costs. 6. Calculate for BEP, given TA, EBIT. 7. Calculate PE ratio, given price and EPS. 8. Calculate for PM, given ROE, TA, sales. 9. Calculate for ROE, given assets, sales, NI, debt ratio. 10. Calculate for real risk free rate of return, given T-bill rate, inflation premium. 11. Calculate for T-bill rate, given real risk free rate of return, inflation premium. 12. Calculate for T-notse rate, given real risk free rate of return, inflation premium, maturity risk premium. 13. Calculate for corporate bond rate, given real risk free rate of return, inflation premium, maturity risk premium, default premium and liquidity premium. 14. Calculate for liquidity premium, given corporate bond rate, real risk free rate of return, inflation premium, maturity risk premium, default premium. 15. Calculate for inflation premium, given corporate bond rate, real risk free rate of return, maturity risk premium, default premium, liquidity premium,. 16. Calculate for maturity premium, given corporate bond rate, real risk free rate of return, inflation premium, default premium, liquidity premium. 17. Expectation theory calculation question. 18. Expectation theory calculation question. 19. Calculate for bond price, given all required information. 20. Calculate for YTM, given all required information. 20. Calculate for YTC, given all required information. 21. Calculate for current yield. 22. Calculate for YTC. 23. Calculate for coupon rate, given all required information. 24. Bond pricing 25. Given Debt ratio, ROA, ROE, TE, TA calculate NI. ###### First Mid Term Exam Conceptual Section ###### Multiple Choice (25*2=50) 1. balance sheet structure question True / false 2. What is RE, NI? Where can find them? True / false 3. Balance sheet and income statement basic question. True / false 4. What is EBIT? What is operating income? What is EBITDA? What is gross income? What is NI? True / false 5. What is EBIT? What is operating income? What is EBITDA? What is gross income? What is NI? True / false 6. balance sheet structure question True / false 7. balance sheet structure question True / false 8. What is yield curve? True / false 9. A downward sloping yield --- True / false 10. An upward-sloping yield curve -- True / false 11. Compare interest rates among T bonds, T bill, T notes, and corporate bonds. True / false 12. Break down interest rates. True / false 13. Break down interest rates. True / false 14. Break down interest rates. True / false 15. Callable bond. True / false 16. Bond sensitivity to interest rate changes. True / false 17. The price risk of bonds with different maturities. True / false 18. Bond basic question. True / false 19-20. What is callable bond? Difference between callable and noncallable bond? 21. What is the capital gain yield of a bond? 22-23. What is the differences between current yield and ytm? 24-25. What type of bond is more sensitive to interest rate change? Chapter 8 Risk and Return Videos --- available on blackboard collaborate Ultra under Recording And also available below 2. class video excel solver part 2 (solver, for 5 extra points) Excel File here (with solver solution) 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. http://www.zenwealth.com/businessfinanceonline/RR/MeasuresOfRisk.html 2. Two stock portfolio equations: 3. W1 and W2 are the percentage of each stock in the portfolio. • 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 In Class Exercise 1. An investor currently holds the following portfolio: He invested 30% of the fund in Apple with Beta equal 1.1. He also invested 40% in GE with Beta equal 1.6. The rest of his fund goes to Ford, with Beta equal 2.2. Use the above information to answer the following questions. 1) The beta for the portfolio is? (1.63) 2) The three month Treasury bill rate (this is risk free rate) is 2%. S&P500 index return is 10% (this is market return). Now calculate the portfolio’s return. 15.04% Refer to the following graph. The three month Treasury bill rate (this is risk free rate) is 2%. S&P500 index return is 10% (this is market return). 2. What is the value of A? 2% 3. What is the value of B? 10% 4. How much is the slope of the above security market line? 8% 5. Your uncle bought Apple in January, year 2000 for$30. The current price of Apple is $480 per share. Assume there are no dividend ever paid. Calculate your uncle’s holding period return. 15 times 6. Your current portfolio’s BETA is about 1.2. Your total investment is worth around$200,000. You uncle just gave you $100,000 to invest for him. With this$100,000 extra funds in hand, you plan to invest the whole $100,000 in additional stocks to increase your whole portfolio’s BETA to 1.5 (Your portfolio now worth$200,000 plus \$100,000). What is the average BETA of the new stocks to achieve your goal? (hint: write down the equation of the portfolio’s Beta first) 2.10

7.

Years                  Market r                Stock A                 Stock B

1                               3%                      16%                         5%

2                             -5%                      20%                         5%

3                               1%                      18%                         5%

4                           -10%                      25%                         5%

5                               6%                      14%                         5%

·         Calculate the average returns of the market r and stock A and stock B. (Answer: -1%, 18.6%, 5%)

·         Calculate the standard deviations of the market, stock A, & stock B (Answer: 6.44%, 4.21%;  0 )

·         Calculate the correlation of stock market r and stock a. (Answer: -0.98)

·         Assume you invest 50% in stock A and 50% in stock B. Calculate the average return and the standard deviation of the portfolio. (Answer: 11.8%; 2.11%)

Calculate beta of stock A and beta of stock B, respectively (Answer: -0.64, 0)

Beating the Historical Odds: Recession Risk in 2019 and Beyond

We have long highlighted the risks that have historically been associated with large overshoots of full employment. We have noted that the Fed has never engineered a soft landing from beyond full employment, that few other advanced economy central banks have either, and that countries that have achieved very long expansions often used countercyclical policy to prevent a large overshoot in the first place. In practice it hasn’t been easy to nudge up the unemployment rate just so. While we take this lesson seriously, we think it is being applied too mechanically by market participants today. The key difference with the past is that the Phillips curve is flatter and better anchored on the Fed’s target today. As a result, where labor market overshoots once led to high and accelerating inflation and consequently had to be unwound urgently with a forceful policy response, today an overshoot will more likely mean inflation persistently but only moderately above target. The Fed could probably live with this for a while, permitting it to tighten gradually and unwind the overshoot slowly. This gives the Fed a good chance of beating the historical odds. How worried should we be about recession risk today? The history of US recessions points to two classic causes of US recessions, overheating and financial imbalances. While overheating risks could emerge down the road, they look quite limited for now: core inflation is at 2%, trend unit labor cost growth is at 2%, and both household inflation expectations and market-implied inflation compensation are below average (Exhibit 9).

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

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