Eindsamenvatting corporate finance and behaviour
Also learn the written formulas!!! (die en ook die van de formula sheet staan niet hier)
Present values
Adding fudge factors to discount rates undervalues long projects compared with
quick-payoff projects.
Coupon rates of bonds are annual
The time value of money concept is the fact that the same amount of money in the
future is less worthy than it is now.
Risk
Investing is about return vs risk. If on the y-axis is expected return and on the x-axis the beta,
there is a security line. If an asset lies above the line, it is too cheap, so demand will increase
and the asset will become on the line.
To determine the risk, you can calculate the beta, for which you have to look to the
covariance of the return between the two investments.
Variance of X = sum of (x - mean of x)^2 / n
So with x = (2, 4, 6, 8, 10), mean is 6, so variance = (2-6)^2 + (4-6)^2 + … / 5 = 8
Y = (12, 11, 8, 3, 1) so variance Y = 18.8
Covariance = sum of (x – mean of x) * (y – mean of y) / n
-4 * 5 + -2 * 4 + … / 5 = -12.
There are two types of risk:
Systematic risk affects a large number of assets and you cannot do anything about it
Unsystematic risk affects only a small number of assets and is only about one
company. You can get rid of unsystematic risk using diversification, in which you
spread the risk, so like an ice cream company investing in an umbrella company.
The higher the beta, the higher the systematic risk and risk premium and a higher beta
means that the stocks tend to move more than the market. Unsystematic and total risk is
calculated by the standard deviation. You also should choose projects with lower standard
deviation over projects with higher standard deviation, and even lower standard deviation is
better than a combination of the low and high standard deviation project.
Cost of capital, assets, equity, debt and the value of a firm
For cost of capital, market values are used.
When you start a new project with the same risk as the current projects together,
cost of capital stays the same. But if the new project has more or less risk, you need
to calculate the new cost of capital.
The asset beta is the weighted (based on market values) average of the debt beta
and the equity beta. The asset beta doesn’t change when you start using more or less
debt.
MM first proposition: the value of a firm is independent of their capital structure
When the D/E ratio increases, both the return on debt and the return on equity will
increase, and the return on assets stays the same.
Return on debt = YTM
, Debt creates leverage, because the more debt, the higher the returns to
shareholders in good times and the lower they are in bad times.
The financial goal of a corporation is to maximize firm’s value, which will maximize
the value for the shareholders.
The capital structure of a company doesn’t affect the value! Unless you are faced
with taxes.
The financial market and the market efficiency theory
In the financial market is much more competition than in the product market, so finding
positive-NPV finance strategies is harder than positive-NPV investment strategies. It’s more
difficult to sell your stocks for a too high price than your product. Financing decisions are
usually zero-NPV (= efficient market hypothesis), so you can ignore this calculation and just
look to the NPV of the investment (and not the NPV of bonds sold). NPV can be positive if,
for example, you get subsidized.
Investment decisions always involve financing decisions, as investments need to be financed.
Also if you already have the money to invest in something, it is a financing decision, as you
could also use the money for something else.
A market is efficient when:
According to Fama: prices reflect all available information. The price of a stock equals
the expected value of future dividends, discounted at a rate that reflects their risk.
According to Jensen: it’s impossible to make excess returns by trading on available
information
The difference is in the word ‘excess’ in the definition of Jensen, because in this definition
also taxes and transaction costs are taken in account.
Lessons of market efficiency:
Markets have no memory past gives no guarantee for the future
Trust market prices all information is incorporated in the prices
Read the entrails in financial statements there is info
Do it yourself alternative replication can be done both by companies as well as by
the individual investors who will not need others for this service
Seen one stock seen them all the demand for stock should be elastic and has a
realistic balance between risk and return
Efficiency levels:
Weak form efficiency prices are based on the past
Semis-strong form efficiency prices will react immediately to new public
information
Strong form efficiency prices will react immediately to new public and private
information
Financing decisions are more easily reversed than investment decisions
Markets never are efficient, they need to be inefficient to create incentives to trade
Also learn the written formulas!!! (die en ook die van de formula sheet staan niet hier)
Present values
Adding fudge factors to discount rates undervalues long projects compared with
quick-payoff projects.
Coupon rates of bonds are annual
The time value of money concept is the fact that the same amount of money in the
future is less worthy than it is now.
Risk
Investing is about return vs risk. If on the y-axis is expected return and on the x-axis the beta,
there is a security line. If an asset lies above the line, it is too cheap, so demand will increase
and the asset will become on the line.
To determine the risk, you can calculate the beta, for which you have to look to the
covariance of the return between the two investments.
Variance of X = sum of (x - mean of x)^2 / n
So with x = (2, 4, 6, 8, 10), mean is 6, so variance = (2-6)^2 + (4-6)^2 + … / 5 = 8
Y = (12, 11, 8, 3, 1) so variance Y = 18.8
Covariance = sum of (x – mean of x) * (y – mean of y) / n
-4 * 5 + -2 * 4 + … / 5 = -12.
There are two types of risk:
Systematic risk affects a large number of assets and you cannot do anything about it
Unsystematic risk affects only a small number of assets and is only about one
company. You can get rid of unsystematic risk using diversification, in which you
spread the risk, so like an ice cream company investing in an umbrella company.
The higher the beta, the higher the systematic risk and risk premium and a higher beta
means that the stocks tend to move more than the market. Unsystematic and total risk is
calculated by the standard deviation. You also should choose projects with lower standard
deviation over projects with higher standard deviation, and even lower standard deviation is
better than a combination of the low and high standard deviation project.
Cost of capital, assets, equity, debt and the value of a firm
For cost of capital, market values are used.
When you start a new project with the same risk as the current projects together,
cost of capital stays the same. But if the new project has more or less risk, you need
to calculate the new cost of capital.
The asset beta is the weighted (based on market values) average of the debt beta
and the equity beta. The asset beta doesn’t change when you start using more or less
debt.
MM first proposition: the value of a firm is independent of their capital structure
When the D/E ratio increases, both the return on debt and the return on equity will
increase, and the return on assets stays the same.
Return on debt = YTM
, Debt creates leverage, because the more debt, the higher the returns to
shareholders in good times and the lower they are in bad times.
The financial goal of a corporation is to maximize firm’s value, which will maximize
the value for the shareholders.
The capital structure of a company doesn’t affect the value! Unless you are faced
with taxes.
The financial market and the market efficiency theory
In the financial market is much more competition than in the product market, so finding
positive-NPV finance strategies is harder than positive-NPV investment strategies. It’s more
difficult to sell your stocks for a too high price than your product. Financing decisions are
usually zero-NPV (= efficient market hypothesis), so you can ignore this calculation and just
look to the NPV of the investment (and not the NPV of bonds sold). NPV can be positive if,
for example, you get subsidized.
Investment decisions always involve financing decisions, as investments need to be financed.
Also if you already have the money to invest in something, it is a financing decision, as you
could also use the money for something else.
A market is efficient when:
According to Fama: prices reflect all available information. The price of a stock equals
the expected value of future dividends, discounted at a rate that reflects their risk.
According to Jensen: it’s impossible to make excess returns by trading on available
information
The difference is in the word ‘excess’ in the definition of Jensen, because in this definition
also taxes and transaction costs are taken in account.
Lessons of market efficiency:
Markets have no memory past gives no guarantee for the future
Trust market prices all information is incorporated in the prices
Read the entrails in financial statements there is info
Do it yourself alternative replication can be done both by companies as well as by
the individual investors who will not need others for this service
Seen one stock seen them all the demand for stock should be elastic and has a
realistic balance between risk and return
Efficiency levels:
Weak form efficiency prices are based on the past
Semis-strong form efficiency prices will react immediately to new public
information
Strong form efficiency prices will react immediately to new public and private
information
Financing decisions are more easily reversed than investment decisions
Markets never are efficient, they need to be inefficient to create incentives to trade
