Finance 316 Terms and concepts

HW #5

1. If a firm that operates in a single business has positive net leverage in its capital structure (more debt than cash), the required return on its equity will be higher than the appropriate discount rate for the firm's typical projects. 2. A firm generated $400 million in free cash flow this year. $60 million was used for interest and coupon payments, $200 million was invested in new projects, and the rest was paid out as dividends (all at the end of the year). The firm has 225 million shares outstanding. The stock price at the end of the year is $30.87. What is the dividend yield? 3. A firm has a $400 million market capitalization and $250 million in debt. It also has $100 million in cash and short-term investments on the balance sheet. The yield to maturity on its debt is 4%, the corporate tax rate is 35%, and the required return on its equity is 14%. What is this firm's WACC? 4. A firm's required return on equity is 20%, its pre-tax cost of debt is 7%, and its tax rate is 25%. What percent of its capital structure is equity and net debt if WACC is 10%? 5. By purchasing a public firm's stock in the secondary market, an investor is providing cash directly to the firm. 6. Because of increased awareness of healthy eating, McDonalds' hamburger restaurants have struggled. To counter this trend, McDonalds decides to open a chain of McFit fitness clubs. McDonalds' equity beta is 0.80, and it has zero net debt. Its market capitalization is $100 billion. The risk premium for the S&P 500 is 5.0%. The risk-free rate is 3.0%. What is the required return for the McFit project? 7. You estimate Orbit Inc. has free cash flows of $72 million arriving in 1 year, $80 million in 2 years, and $85 million in 3 years. After year 3, the long term growth rate of FCF will be 2% (thus year 4 FCF is $86.7 million). Orbit has $125 million in net debt and a WACC of 14%. What is your estimate of the Enterprise Value of Orbit? 8. After studying Lemons Inc. for 3 weeks, you calculate its enterprise value to be $500 million. Lemons has $42 million in cash, $190 million in total debt, and 7.7 million shares outstanding. What is your estimate for the stock price? 9. A real estate development firm is looking to invest in a new apartment complex (similar to its other projects) that requires an initial investment of $10M today. This project will yield free cash flows of $1M each year for the next 15 years (from t=1 to t=15). The firm is financed half with equity and half with bonds (assume no cash). The firm's equity beta is 1.5, yield to maturity on its bonds is 6.0%, and tax rate is 20%. If the expected return on the S&P500 Index is expected to be 7.0% each year and the relevant risk-free rate is 2.0%, what is the NPV of this project (in millions)?

Balance sheet

"What do i own, what do i owe; how much am i worth?" a snapshot as of a particular date. includes: Cash and cash-like Inventory AR other current assets LT Assets AP other current Liabilities short term debt long term debt Shareholder's equity

Annual Percentage Yield (APY)

- How much actual interest is paid/earned in a year. -This is the r we've been using - includes compounding so it will look like a bigger annual number

Annual Percentage Rate (APR)

- How much interest earned in a year ignoring compounding. -will always be less than or equal to APY * to find the actual r, (APR/compounding)

Market (Systematic) Risk

- Risks common to the entire market (everyone zigs at same time) - Generates positive correlation between firms - cannot be diversified away - No hiding from these risks

Idiosyncratic (Firm specific, DIVERSIFIABLE) risk

- Risks specific to a particular firm or industry - Zero correlation between one firm's idiosyncratic and another's - CAN be diversified away by investing in a wide variety of assets Examples: - Successful drug trials - Investigation into fraud - New product bombs with public - CEO dies -as portfolio grows this risk washes out

Bonds and interest:

- bonds are risky because their prices change when interest rates change. - when interest rates go up, bond prices go down (and vice versa). - all else equal, longer the maturity, the more affected by interest rate changes - all else equal, bonds with lower coupons are more affected by interest rate changes

R

- compensation for time + - Compensation for risk = σ (total risk) which is composed of market risk

Finance

- only cares about when cash enters or leaves your pocket -Finance needs to account for all relevant assets and liabilities, including intangible or those not purchased, such as: Brand power, patents, potential legal liabilties, etc

Inflation

- when prices go up. - because of inflation, a dollar tomorrow typically does not buy as much as a dollar today

Market Efficiency

-Competition among investors eliminates opportunities to "beat" the market; no positive NPV stocks to buy - Doesn't mean every stock is selling for the correct price - the PV of its expected FCF, rather, given avalibale info, even if they arent, you dont know which are too high or too low - THIS IS A HYPOTHESIS

Accounting, accural

-recognizes economic events regardless of whether money actually changed hands -tries to match revenues and costs -accounting statements only include assets and liabilities that can be measured with receipts

HW #1

1. A savings account pays you 1.5% interest every year, compounded annually. How long will it take for a deposit today of $1,000 to grow to $5,000? 2. What is the value in year 2 (FV2) of a perpetuity that pays $400 every year if the first payment arrives 4 years from today and annual r = 1.5% forever? 3. Three years ago, you deposited $500 into a bank account which paid 1.0% interest each year, compounded annually. You made no withdrawals. Starting today, this account will pay 1.8% annual interest. You deposit another $1,000 today into this account. Assuming you still make no withdrawals, how much will be in this account two years from today? 4. What is the value 4 years from today of a $500 cash payment you will receive 10 years from today? The interest rate is 4% each year. 5. You made a deposit into a bank account 12 years ago. Today, you see that your money has tripled. What average annual interest rate did you receive? 6. You have $50,000 in student loans. You set up a plan to repay this debt with monthly payments over the next 15 years (so 180 total payments). Your first payment will be in one month, and you believe with raises at work that each payment can be 0.2% higher than the previous one (so, for example, if your first payment is $100, your second month payment would be $100.20). If your monthly interest rate on this loan is 0.5%, what will your first payment in one month be? 7. You owe someone $2,000 today. You are indifferent between repaying this debt today or repaying how much 4 years from now? The relevant interest rate is 6%. 8. You are offered $150 in exactly one year. Each year thereafter forever, you (or your estate) will receive an amount 2% higher than the previous year (so you will receive $153 in exactly two years, for example). From a purely present value perspective, would you prefer this infinite stream of payments or $10,000 cash today? Assume the interest rate is always 4%. 9. A rich uncle has left you an annuity that will make twenty equal annual payments of $10,000. The first payment arrives in five years, and the last (20th) arrives in exactly 24 years. If annual r is 4.0%, what is the present value of this gift? 10. When a firm borrows money from a bank to grow its business, it is ultimately using money that belongs to households.

the 4 financial statements required by the SEC:

1. Balance sheet 2. income statement 3. statement of cash flows 4. statement of stockholders equity

NPV steps:

1. Estimate expected incremental cash flows 2. Estimate correct discount rate for those cash flows, "r" becomes required return or cost of capital. 3. add up all PV of all cash flows to get NPV.

HW #3

1. There is a goose that lays golden eggs, one each year, arriving at the end of the year. Each egg weighs one pound. The price of gold is currently $1,247 per ounce (16 ounces in a pound), and this is your best guess for the price going forward. You expect the goose to live 10 years (thus laying 10 eggs). The discount rate is 8%. How much is this goose worth today? Assume the goose provides no additional value (e.g., companionship, food) and that expenses are negligible 2. One year ago, you paid $27,400 for an empty plot of land. Today, you are considering developing it into a parking lot. It will cost you $50,000 today to turn this land into a parking lot. As a parking lot, you anticipate that it will generate $10,000 in revenue each year forever, starting one year from today. The required return for this project is 14% annually. Assume that you have no other ideas for what to do with this land; if you don't build the parking lot, it will not be used for anything else. Also assume you will never sell this land. From a financial perspective, is turning this land into a parking lot today a good idea? 3. A project requires an initial investment of $25,000 and generates positive future cash flows. The appropriate discount rate is 19%. This project has an NPV of -$700 (negative NPV). The project's IRR is 4. Your firm is presented with an opportunity to purchase a ski lodge today for $2.4 million. In one year, the lodge will generate cash of $200,000 if it was a good snow season and $120,000 if it was a bad snow season. These amounts will both grow by 2% each year (so in year 2, if snow is good, you receive $204,000; bad, $122,400). Each year, the chance of good snow is 60%. Your firm would run this lodge forever. The required rate of return is 10%. What is the NPV of purchasing the ski lodge? 5. When will the NPV rule provide better guidance regarding project selection than the IRR rule? a) When a project has net expenditures (outflows) that occur after positive cash inflows. b) When deciding between mutually exclusive projects with different initial investment amounts, where neither choice will preclude any other investments. c) When a project has two possible IRRs. 6. You can invest $1,000 today to receive an expected $2,000 in five years. What is the IRR of this investment if the appropriate discount rate is 16%? 7. A candy business generates $200,000 in cash flow each year, in perpetuity. Assume each year's entire cash flow arrives at the end of the year. It is considering adding a second assembly line. Doing so will increase total annual cash flow to $350,000 each year. The expansion project will cost $2 million, paid today, and be finished in time to fully impact this year's cash flow. The required return is 8%. What is the NPV of this expansion project (in thousands)? 8. What is EBITDA margin? 9. What is the market-to-book ratio of a firm with a stock price of $25.00, 80 million shares outstanding, and shareholder's equity of $670 million?

HW #6

1. You are using multiples analysis to value a company. All the following about picking comparable firms are generally true except: Comps have similar beta Comps have similar stock prices Comps in same industry Comps have same long-term growth prospects 2. Netflix, an online video streaming service, has 125 million subscribers. It has 429 million shares outstanding, 8.3 billion in debt, 1.3 billion in cash, and a stock price of $286. Hulu, a similar company, has 20 million subscribers. How much do you think Hulu's business operations are worth (in billions)? 3. High _______ in a stock portfolio tends to hurt performance because of trading fees. 4. T/F Reading the Wall Street Journal Online this morning, you learn that GreenCo, a publicly traded green energy company, has made a surprise announcement that they have perfected a new technology to make cheap, efficient solar panels. This will dramatically increase their future free cash flows. If the market is efficient, you should buy shares of GreenCo to profit from the stock price going up on this news. 5. Apple makes a surprise announcement today that they are switching their iPhone glass supplier from sapphire screens to Gorilla Glass, made by Corning, for the next five years. This will result in an additional $450 million in free cash flow for Corning, starting in one year, and growing at 5% per year thereafter through year 5. Corning has 951 million shares outstanding, 100 million net debt, and a WACC of 8.0%. Which of these is the most likely Corning stock price reaction when Apple made this announcement? 6. You have found three comparable firms for your firm of interest, Firm A, and have calculated these multiples: EV/EBITDA EV/Sales Comp X 9.6 1.5 Comp Y 10.2 0.8 Comp Z 15.1 1.9 If Firm A has sales of $233 million, EBITDA of $24 million, cash of $7 million, debt of $55 million, and 8 million shares outstanding, which of these is the most reasonable estimate of A's stock price using multiples analysis? 7. Which of these would lead you to prefer using Discounted Free Cash Flow analysis instead of Multiples to value firm X in industry Y? You have very little time to arrive at a valuation You believe the other public traded firms in industry Y are overvalued You don;t know much about industry Y There are many public firms similar to firm X 8. At the beginning of the year, you invest $10,000 in an S&P 500 index fund. This fund charges an annual fee of 0.1% of your end-of-year assets at the end of the year. Your friend invests $10,000 in an actively managed fund that charges 1.4% of end-of-year assets at the end of the year. Before fees are taken into account, the index fund is up 9.0% at the end of the year while the actively managed fund is up 9.5%. After fees, how does your performance compare to your friend's? 9. Lucasfilm Ltd. owns the intellectual property rights to Star Wars. Lucasfilm, on its own, has the ability to create one film every three years (you may model this as 1/3 of a film each year). Disney acquired Lucasfilm in 2012. Under Disney ownership, one Star Wars film will be created every year. Assume the following: each Star Wars film generates $500 million in nominal free cash flow; the first film to be released after the 2012 acquisition arrives one year later in 2013 (full for Disney, 1/3 of one for Lucasfilm standalone); under either owner, films will continue to be made forever; Lucasfilm activities will not impact any other lines of Disney business; the WACC for movie studios is 14%. At the time of purchase, what is the value of the potential synergies generated by Disney's acquisition of Lucasfilm?

HW #4

1. You own a portfolio of two assets: $10,000 of McDonald's stock and $4,000 of Microsoft corporate bonds. The correlation between these two investments is 0.25. The standard deviations of returns for McDonald's stock and the Microsoft bond are 19% and 8%, respectively. What is the standard deviation of your portfolio? 2. A real estate investment has a beta with respect to the S&P 500 of 0.77. The relevant risk free rate is 2.73%, and the market risk premium is expected to be 6.0%. What is this real estate's required return for a diversified investor? 3. What do we mean when we say "the market risk premium?" 4. With the information below on monthly returns for a stock and the S&P 500 market index, what would you estimate the stock's CAPM beta to be? Month 1: Stock -0.1%, Market -3.5% Month 2: Stock -4.0%, Market -4.0% Month 3: Stock +1.9%, Market +2.0% Month 4: Stock +5.4%, Market +10.8% 5. A stock has a correlation with the S&P 500 of 0.72. The standard deviation of the stock's returns is 23%. The standard deviation of the S&P 500 is 16%. The market is expected to return 7.0% over the next year, and one-year treasury bills are yielding 0.8%. What return does a diversified investor require to invest in this stock? 6. JPMorgan Chase stock has a standard deviation of 22% and a beta of 1.4. Goldman Sachs stock has standard deviation 31% and beta of 1.2. Which of these statements is true? 7. Which of these risks will a diversified investor likely need to worry about? a. A computer hack erases all electronic financial records of everyone in the country. b. A firm's key advertising executives quit to start their own company. c. A highly contagious virus emerges that turns humans into zombies. 8. Your portfolio comprises four investments, with an equal dollar value invested in each. The four investments are 1) the S&P 500 market portfolio, 2) shares of Facebook stock, 3) shares of Netflix stock, and 4) cash in a bank savings account which pays 1.5% interest each year. The CAPM betas for Facebook and Netflix are 0.70 and 1.18, respectively. What is the beta of your entire portfolio? 9. T/F: In the U.S., stocks have always outperformed Treasury Bonds over periods of 5 years or more, but in some single years, Treasury Bonds have beaten stocks. 10. A diversified investor thinking of adding a little bit of a new investment to her portfolio needs to worry about that investment's ______ risk.

HW #2

1. Your bank account compounds interest weekly. The annual percentage yield (APY) is 2.40%. What is the weekly interest rate? 2. A 12-year maturity bond has a yield to maturity of 4.8%. Its face value is $1,000, it makes quarterly payments (four times per year), and its coupon rate is 6.0%. What is this bond's current price? The first coupon arrives in 3 months. 3. Suppose interest rates suddenly rise. Which of these bonds should see the least dramatic change in price? 4. T/F: An increase in nominal interest rates combined with a drop in inflation results in an increase in consumer purchasing power. 5. The government issues a 1-year maturity zero-coupon bond. The face value is $10,000. You can buy it today for $9,709. What is its yield to maturity? 6. You have a $13,000 car loan at an APR of 9.0%, compounded monthly. Your goal is to eliminate this debt in four years. What equal payment must you make each month, starting one month from today, to reach your goal? 7. In 1980, a subway ride in New York City was 60 cents. If subway fares had kept pace with overall inflation, how much would it cost to ride the subway in 2017? The Consumer Price Index (CPI) was 86.3 in 1980 and 242.9 in 2017. 8. Kraft Heinz wants to issue $1 million face value, 10-year maturity bonds with a 5% coupon, paid annually. Similar bonds issued by the U.S. government have a yield to maturity of 2.75%. Kraft Heinz's credit spread is 3.44%. How much will these Kraft Heinz bonds sell for? 9. Last year, your savings account paid you 0.015% interest every day, including weekends and holidays. What was your APY?

Enterprise Value

= Market value of equity + Debt - cash

Market capitalization

= Share price * number of shares

Net working Capital

= current assets - current liabilities =( Inv. + AR) - AP Change in NWC: = NWC this year - NWC last year = (Inv.t - Invt-1) + (ARt - ARt-1) - (APt - APt-1)

Payment for Order Flow (Order routing)

A payment for order flow is the compensation and benefit a brokerage receives by directing orders to different parties to be executed. The brokerage firm receives a small payment, usually a penny per share, as compensation for directing the order to the different parties.

Acquisition

Acquiring firm swallows target; target firm disappears and acquiring firm survives

Payback rule

Advantage: -easy to understand -ok for small, relatively insignificant decisions Shortcomings: -ignores cash flows after payback period - doesnt consider TVM - totally arbitrary

Passive funds/Index funds/ Exchange Traded Funds (ETFs)

Buy and hold a proportional share of everything in a category; match the S&P 500, or a particular industry's stocks, or eve commodities Little to no effort required to run these. Hence, charges roughly .25% of assets per year

Russell 2000

By size, the #1000-3000 largest stocks. also called an index for "small market cap" stocks.

Leverage

Debt magnifies equity risk relative to firm risk.

Lecture 10, WACC, Weighted Average Cost of Capital

Equity risk premium today is 5% - Hence, β for a firm's equity will be higher than for a firm's projects (like the house) if the company has any debt. Leverage: debt magnifies equity risk relative to firm risk FCF that firm generates are split between debtholders and equityholders: -Debt gets paid first so is less risky -Equity gets leftover so it is more risky different riskiness means different required returns: - Equity holders require cost of Equity (the r found using CAPM/firm's stock beta) -Debt holders require cost of debt WACC mistakes: -CANT/DON'T apply firm's WACC to a project unlike what the firm typically does -For firms in multiple, diverse, businesses: applying the same WACC to everything is INCORRECT

Takeover types

Horizontal - two companies in same industry Vertical - Target's industry buys from or sells to acquirer's industry Conglomerate/Diversifying - acquirer and target in different industries Private equity/Leveraged buyout (LBO) - acquirer is a financial (not operating) firm. Use borrowed money; goal is to sell for more than price paid in a few years

Risk premium

How much more return is the market expected to give you above the risk free rate Beta times the risk premium is like saying, "the more market risk asset has, the more return we need"

Bond pricing

If price > face, it trades at premium "premium bond" If price < face, trades at a discount "Discount bond" "zero coupon bonds" if price = face, it trades at par

Mergers a good thing?

Judging by stock market reaction, it appears on average they create value, with most of the benefit going to target shareholders. Mergers don't NEED to happen though for positive things to happen- just the threat of mergers can keep companies on their toes.

LECTURE 12, MULTIPLES

Multiples: - are much broader than a method to value stock - Find something similar to your target ( select comparable assets/firms with similar risk, growth, and cash flow characteristics

Multiples Method

Pros: - reflects the current market, 1000s of participants. "What are people paying for comparable assets right now?" - Easy - Don't need to try and explicit project the future or a WACC - Easy to explain to non-finance person Cons: - good comps hard to find - difficult to know whether the target asset value should be more/less/equal to the mean of comp set - can be tweaked - can't detect when "market value" is wrong

DCF Model

Pros: - the process of doing a DCF helps you learn how the business operates (e.g. Do they have fat/thin, stable/volatile operating margins? Is the business capital intensive?) - Very amenable to sensitivity analysis, which uncovers the important value drivers. - Less affected by the current "mood of the market" i.e., panic or euphoria. - The projections can accommodate superior information. - DCF is fundamental value; PV of the cash flows received as an owner is a powerful idea Cons: - can be tweeked to say just about anything forced to predict the future which is imossible and uncomfortable

Why do takeovers happen?

Reasons: Synergy - combined entity produces more FCF than when separate Non-synergistic reasons: 1. Economies of scale - the savings large companies enjoy from producing at high volume that are unavailable to small companies. (this means more buying power when buying in bulk, better capacity utilization, combining marketing and distribution) 2. Access to new markets, distribution - access to new geography and new delivery channel. 3. Vertical integration - joining of firms making goods at different stages of the production cycle, or between firms that are customer and supplier ( benefit is coordination across production cycle, less "holdup" by suppliers or customers) 4. Expertise 5. Financial synergy - Excess cashand tax benefits 6. Reducing/removing competition - fewer competitors could mean increased profits. Anti trust laws try to prevent this 7. Undervaluation - company you are trying to buy has cheap price tag relative to the cash flows it generates 8. Bad management - CEO doesn't know what he's doing and takes negative NPV projects as well as mergers being a disciplining device (acquirer buys lots of your shares, now as owner, votes to change board of directers, gets new board to fire CEO, easier if firm is publicly traded 9. Acquirer agency problems - Conflict arising when people (agents) entrusted to look after the interest of others (principals) use their authority or power for their own benefit.

Disposition Effect

Refers to a tendency to hold on to stocks that have lost value and sell stocks that have risen in value. Why? - perhaps people don;t like to lose, "I'll sell my loser when it bounces back so i can break even" - Reluctance to admit mistake by taking a loss, - By selling winners, you can "lock in" a win

Income statement

Revenues and expenses over a period of time EBIT= earnings before interest and taxes EBITDA= EBIT + Depreciation & Amortization

What we see when a firm gets acquired

Stock price of targets jumps UP on average 15% the day takeover is announced. Stock price of the acuiring firm, on average, is pretty flat

LECTURE 11, STOCK VALUATION

Stock: - A share of common stock, or equity, is an OWNERSHIP CLAIM on the firm - the price of a share of stock is how much you have to pay for that ownership claim As a stockholder, you get: - vote for board members - might matter for large shareholdersget rest of FCF if not paid out to debt holders or invested In general for dividends and investing FCF: -Young, growing firms pay less/zero dividends to owners because they have plenty of investment ideas/opportunities for FCF. -Mature firms pay larger dividends- they are likely done with the heavy investment phase of their business and are reaping the rewards.

Overconfidence

Tendency of individual investors to trade too much based on the mistaken beleif that they can pick winners and losers better than investment professionals

Active Funds

The managers pick only those stocks they think will do better than others charge 1-2% of assets per year

"Return"

Total (Realized) returns (R), or the return that occurs over a particular time period. Your return is made up of two parts: -the change in price of the asset -any dividend (cash payment) the asset made to you.

Dow Jones Industrial Average (The Dow)

Value of a portfolio holding one share in each of 30 large industrial firms (First computed in 1896)

Standard & Poor's Composite Index (S&P 500)

Value of a portfolio holding shares in 500 firms. Holdings are proportional to each company's market capitalization.

Primary Market

When a firm sells new shares to investors (Initial or secondary offerings). This is the only time the firm actually gets $$

Secondary Market

When a firm's shares are traded between investors. When we buy/sell, we're doing it on secondary market. we're getting used shares. without secondary market, there would be no primary market

Comparing IRR and NPV

When choosing between mutually exclusive projects, IRR and NPV might disagree as well, because IRR does not account for scale NPV will always give you right answer IRR rule sometimes gives the wrong answer: -When net cash flows change sign more than once - when positive cash flows come before the negative cash flows - when comparing mutually exclusive projects that have different scale or size

Interest rates and companies:

When inflation is high, you want to spend now before prices go up, so you're not putting money in bank. For companies, -lower r makes it easier to borrow money and invest - government will keep r low when the economy is slumping to encourage investment - the gov't will raise r when economy is recovering or even overheating to prevent future inflation

Financial markets

Where buyers meet sellers, buy and sell when you want at cleary posted prices. Stocks and bonds traded here. The ability to trade these assets at known prices provides liquidity to the asset holders. The more easily an investment can be converted to cash at a competitive price, the more "Liquid it is", it encourages investment.

Relationship between coupon rate and TYM for a coupon bond:

YTM = coupon rate, bond's price will be same as par/face value YTM > coupon rate, bond price < Par value (discount bond) YTM < coupon rate, Bond price > par value (premium bond)

Free cash flow

for a project, incremental effect of a project on firms cash each year. for a firm, amount of cash it generates each year. For both, its the amount of cash available for all investors(Debtholders, equtyholders) after paying taxes and making necessary investments FCF is before any money has been given to investors, such as interest payments, dividents, etc. Formula: FCF = EBIT * (1 - Tax rate) + D&A - Cappex - Change in NWC + Salvage value or net proceeds from asset sales

Nominal interest rate (r) :

growth in actual $

Inflation rate ( i ):

growth in prices

Real Interest Rate (r*):

growth in purchasing power of your cash

Coupon amount

how many dollars is each coupon. (Coupon rate x Par value)/(# of coupon payments per year

Market to book ratio (Price to book ratio)

how much a company's assets minus liabilties are actually worth relative to their historical cost - higher values mean high growth potential or more value from hard to measure assets market val of equity is market cap = Market value of equity/BV of equity

Turnover

how much you trade, if portfolio stays the same, turnover is zero

Step 1 of NPV; Expected value, incremental

if cash flow is uncertain, to get expected value= probability of outcome 1 * outcome 1... etc incremental, the difference in cash flows if you do it minus if you dont do it. -do not include unrelated costs and benefits -do not include sunk costs - include opportunity costs

Bonds

is an IOU usually issued by the governments or corporations. - to buy a bond you pay its price today, it can change everyday - payments in regular intervals over lifespan then the big payment at the ends. - these are sold to get money right away for spending needs, buying one means you are loaning money.

Terminal Value

is the discounted value of FCFs from when we stop explicity projecting to infinity

Enterprise Value (EV)

is the market value of a firm's operating assets. (Op assets is just total assets minus cash) EV = MVE + Debt - Cash

Internal Rate of Return (IRR)

is the particular rate of return that makes NPV of an investment zero - is basically the average annual return of the investment, higher the better. - if IRR > discount/req. return, it is a good project If IRR < discount rate/req. return, it is a bad project

Time Value of Money (TVM)

key to valuation of projects and securities. it is a fundemnetal tool. A dollar otday is worth more than a dollar in the future.

"Beat" the market

refers to achieving a better risk adjusted return than the market return (S&P 500), in other words, getting positive NPV from picking stocks. Methods to beat the market: 1. Using past price patterns (technical analysis) 2. Using all public information including past prices 3. Using all public and private information

Credit risk

risk of default, not being paid for bond. Corporations with higher credit risk need to pay higher yields to attract buyers to their bonds. -credit spread is the difference between the yields of corporate bonds and Treasuries - higher the credit risk, higher the credit spread

Perpetuity

stream of equal cash flows made each period until the end of time.

Annuity

stream of equal cash flows made for a fixed number of periods

Behavioral Finance

study of phycological biases and their implications for investors

Yield to Maturity (YTM)

the r that set the PV of the promised bond payments equal to the price of the bond. - use YTM to get what r you should use to discount those cash flows to get the bonds price

Merger

when two firms form a new company.

LECTURE 9, RR

β (= Market risk) - tells us how much market risk an investment has - coefficient on S&P in the regression - How much, on average, GE moves per unit move in S&P - Slope of the line - β of market portfolio is 1 if β: = 1, implies a stock/asset has the SAME market risk as the market, when market goes up stock does up >1, implies asset has MORE market risk than the market <1, implies an asset has LESS market risk than the market Low p choice has the lower β and the lower return

LECTURE 8, Risk

σ is total risk of an asset We want to capture the "swinginess" of an asset's returns. - Standard Deviation (σ) is one way to capture the variability of returns. It measures how spread out the data points are around the mean. - 68% of the time returns end up within one σ from the mean - 95% of the time returns end up within two σ from the mean. Portfolio return is the weighted average of the two individual returns, BUT the portfolio σ is LESS than the weighted average σ Combined portfolio is LESS VOLATILE than the average riskiness of what you've combined - the more differently two things move, the more risk reduction benefit you get from combining them Correlation is a measure of the degree to which two things move together linearly. Ranges from -1 to +1. -1 means always move opposite linearly, 0 means uncorrelated which is no tendency to move together or opposite to each other. +1 means always move together linearly. - Lower the correlation between two assets, the lower the σ of a portfolio that combines them - More stocks in our portfolio, the σ seems to go lower and lower