Finance & Corp Gov
,Exam Preparation
● Book concept checks
● Tutorials
● Learning outcomes
● MyLab Finance
● Slide exercices
● Slides – theory
● Theory remember
● Remaining exercices redo
● Past exam
● RWACC and APV model in exercices!!
● Ferrari and Magic Timber Case revise!!
● Formulas remember
,NOTES TO REMEMBER
Week 1. Introduction
- Hart and Zingales: from premise that there are activities where profit-making and
societal damage are inextricably connected (cannot use the donations model of Friedman
because in that case those are separated), maximising shareholder welfare should be the
objective because ethical considerations of investors are part of it ⇒ law and rules should
support this (market for corporate control, voting mechanisms and redefine fiduciary
duty), otherwise there is a risk of amoral drift
- Key functions of stock markets: provide liquidity, transport cash across time, risk transfer
and diversification, payment mechanism and provide information
Week 2. Valuation
- Amortisation loans: paying interest on the loan plus some part of the loan balance each
month, usually is the same amount until fully repaid with the final payment.
- APR and EAR:
- Annual percentage rate: indicates amount of simple interest earned in one year
without the effect of compounding
- Effective annual rate: indicates total amount of interest that will be earned at the end
of one year including the effect of compounding (interest over interest)
- Expectations short-term interest rates on yield curve: If investors expect interest rates to
rise in the future, they would not want to make long-term investments. Instead, they could do
better by investing on a short-term basis and then reinvesting after interest rates rose. Thus, if
interest rates are expected to rise, long-term interest rates will tend to be higher than short-
term rates to attract investors. Similarly, if interest rates are expected to fall in the future, then
borrowers would not wish to borrow at long-term rates that are equal to short-term rates. They
would do better by borrowing on a short-term basis, and then taking out a new loan after rates
fall. So, if interest rates are expected to fall, long-term rates will tend to be lower than short-
term rates to attract borrowers. These arguments imply that the shape of the yield curve will
be strongly influenced by interest rate expectations. A sharply increasing (steep) yield curve,
with long-term rates much higher than short-term rates, generally indicates that interest rates
are expected to rise in the future. A decreasing (inverted ) yield curve, with long-term rates
lower than short-term rates, generally signals an expected decline in future interest rates.
Because interest rates tend to drop in response to a slowdown in the economy, an inverted
yield curve is often interpreted as a negative forecast for economic growth.
- Bond’s coupon rate and duration, price’s sensitivity to interest rate: The sensitivity of a
bond’s price to changes in interest rates depends on the timing of its cash flows. Because it is
, discounted over a shorter period, the present value of a cash flow that will be received in the
near future is less dramatically affected by interest rates than a cash flow in the distant future.
Thus, shorter-maturity zero-coupon bonds are less sensitive to changes in interest rates than
are longer-term zero-coupon bonds. Similarly, bonds with higher coupon rates—because they
pay higher cash flows up front—are less sensitive to interest rate changes than otherwise
identical bonds with lower coupon rates. The sensitivity of a bond’s price to changes in
interest rates is measured by the bond’s duration.
- Opportunity cost of capital: bets available expected rate of return for an investment in the
market with similar risk and term to the cash flow being discounted → when risk free,
using government bonds or using CAPM model when risky
- Sovereign bonds: bonds issued by governments and reflecting investors’ expectations on
credit, inflation and default. Countries may repay their debt by printing additional currency,
which generally leads to a rise in inflation and a sharp currency devaluation. When “inflating
away” the debt is infeasible or politically unattractive, countries may choose to default on
their debt.
Week 3. Making Capital Investment Decisions
- Opportunity costs included: because a resource could provide value for the firm in another
opportunity or project. Opportunity cost of using a resource is the value it could have
provided in its best alternative use, and because the value is lost, we should include it as an
incremental cost of the project.
- Ways to assess capital budgeting forecast:
- Scenario analysis: changing multiple assumptions at the same time
- Sensitivity analysis: changing one parameter at the time
- Break-even analysis: level of input where NPV = 0 for each parameter
- Gervais: managers suffer from overconfidence leading to bad investment decisions. It is both
agency conflicts and behavioural biases that lead to that (excessive optimism and
overconfidence). This is because investment decisions are complex, not suited for learning,
there are self-attribution and self-selection biases.
Week 4. Equity Valuation
- Reasons for using equity: as last resort, to increase debt capacity and get external funding
- 4 Limitations of DDM: uncertainty with estimating dividend growth rate and future
dividends + small changes in growth rate can lead to large changes in estimated stock price +
does not include share repurchases and influence of borrowing + firms tend to smooth
dividends making them less informative about firm’s performance and less application to use
in valuations
,Exam Preparation
● Book concept checks
● Tutorials
● Learning outcomes
● MyLab Finance
● Slide exercices
● Slides – theory
● Theory remember
● Remaining exercices redo
● Past exam
● RWACC and APV model in exercices!!
● Ferrari and Magic Timber Case revise!!
● Formulas remember
,NOTES TO REMEMBER
Week 1. Introduction
- Hart and Zingales: from premise that there are activities where profit-making and
societal damage are inextricably connected (cannot use the donations model of Friedman
because in that case those are separated), maximising shareholder welfare should be the
objective because ethical considerations of investors are part of it ⇒ law and rules should
support this (market for corporate control, voting mechanisms and redefine fiduciary
duty), otherwise there is a risk of amoral drift
- Key functions of stock markets: provide liquidity, transport cash across time, risk transfer
and diversification, payment mechanism and provide information
Week 2. Valuation
- Amortisation loans: paying interest on the loan plus some part of the loan balance each
month, usually is the same amount until fully repaid with the final payment.
- APR and EAR:
- Annual percentage rate: indicates amount of simple interest earned in one year
without the effect of compounding
- Effective annual rate: indicates total amount of interest that will be earned at the end
of one year including the effect of compounding (interest over interest)
- Expectations short-term interest rates on yield curve: If investors expect interest rates to
rise in the future, they would not want to make long-term investments. Instead, they could do
better by investing on a short-term basis and then reinvesting after interest rates rose. Thus, if
interest rates are expected to rise, long-term interest rates will tend to be higher than short-
term rates to attract investors. Similarly, if interest rates are expected to fall in the future, then
borrowers would not wish to borrow at long-term rates that are equal to short-term rates. They
would do better by borrowing on a short-term basis, and then taking out a new loan after rates
fall. So, if interest rates are expected to fall, long-term rates will tend to be lower than short-
term rates to attract borrowers. These arguments imply that the shape of the yield curve will
be strongly influenced by interest rate expectations. A sharply increasing (steep) yield curve,
with long-term rates much higher than short-term rates, generally indicates that interest rates
are expected to rise in the future. A decreasing (inverted ) yield curve, with long-term rates
lower than short-term rates, generally signals an expected decline in future interest rates.
Because interest rates tend to drop in response to a slowdown in the economy, an inverted
yield curve is often interpreted as a negative forecast for economic growth.
- Bond’s coupon rate and duration, price’s sensitivity to interest rate: The sensitivity of a
bond’s price to changes in interest rates depends on the timing of its cash flows. Because it is
, discounted over a shorter period, the present value of a cash flow that will be received in the
near future is less dramatically affected by interest rates than a cash flow in the distant future.
Thus, shorter-maturity zero-coupon bonds are less sensitive to changes in interest rates than
are longer-term zero-coupon bonds. Similarly, bonds with higher coupon rates—because they
pay higher cash flows up front—are less sensitive to interest rate changes than otherwise
identical bonds with lower coupon rates. The sensitivity of a bond’s price to changes in
interest rates is measured by the bond’s duration.
- Opportunity cost of capital: bets available expected rate of return for an investment in the
market with similar risk and term to the cash flow being discounted → when risk free,
using government bonds or using CAPM model when risky
- Sovereign bonds: bonds issued by governments and reflecting investors’ expectations on
credit, inflation and default. Countries may repay their debt by printing additional currency,
which generally leads to a rise in inflation and a sharp currency devaluation. When “inflating
away” the debt is infeasible or politically unattractive, countries may choose to default on
their debt.
Week 3. Making Capital Investment Decisions
- Opportunity costs included: because a resource could provide value for the firm in another
opportunity or project. Opportunity cost of using a resource is the value it could have
provided in its best alternative use, and because the value is lost, we should include it as an
incremental cost of the project.
- Ways to assess capital budgeting forecast:
- Scenario analysis: changing multiple assumptions at the same time
- Sensitivity analysis: changing one parameter at the time
- Break-even analysis: level of input where NPV = 0 for each parameter
- Gervais: managers suffer from overconfidence leading to bad investment decisions. It is both
agency conflicts and behavioural biases that lead to that (excessive optimism and
overconfidence). This is because investment decisions are complex, not suited for learning,
there are self-attribution and self-selection biases.
Week 4. Equity Valuation
- Reasons for using equity: as last resort, to increase debt capacity and get external funding
- 4 Limitations of DDM: uncertainty with estimating dividend growth rate and future
dividends + small changes in growth rate can lead to large changes in estimated stock price +
does not include share repurchases and influence of borrowing + firms tend to smooth
dividends making them less informative about firm’s performance and less application to use
in valuations
