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FNCE+2P91-Corporate+Finance-Notes-Chapter+13.docx

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Department
Finance
Course
FNCE 2P91
Professor
Clarke Melville
Semester
Winter

Description
FNCE 2P91 - Section 05 Winter 2011 - Duration 03 29.03.11 FNCE 2P91: Corporate Finance-Notes-Chapter 13 Notes  Final class next week Final Exam  April 16 from 2:00pm – 5:00pm What is Ahead?  Lab 9 sue April 4  Chapter 13 th  Lab 10 Due April 11  Chapter 14  Quiz 4 Open from April 7 0- 9  Chapters 12 – 14 Tonight  Chapter 13 Last Class  Review Chapter 14 (WACC – Weighted Average for Cost of Capital)  Review for final o Review is comprehensive  Goes back to the first day of class  Higher weight on those chapters covered after the midterm www.brocku.ca/learningobjects/flash_content/LO/Portfolio.html  Link will also be posted on Sakai Question: Events There are three possible events on the horizon for next year: GM files for bankruptcy, the Government bails out GM, or GM sales rise. NEXT YEAR EXPECTED RETURN EVENT PROBABILITY MAGNA VW GM Files for Bankruptcy 30% -10% 15% Government Bails Out GM 40% 5% 0% GM Sales Rile 30% 15% -3% Part One: Expected Return: ( ) ( ) ( ) ( ) ( ) Part Two: Standard Deviation: √ ( ) ( ) ( ) FNCE 2P91 - Section 05 Winter 2011 - Duration 03 Part Three: What is the Chance that VW could generate a return next year greater than 10%? So 19.77% chance returns will be greater than 10% Part Four: What is the Covariance between Magna and VW? ( )( ) ( )( ) ( )( ) Part Five: Correlation Coefficient Part Six: Build a portfolio with 50% of funds in each stock i. Expected Return ( ) ( ) ( ) ii. Standard Deviation of Portfolio √ ( ) ( ) ( )( )( )( )( ) IS IT POSSIBLE TO ELIMINATE ALL RISK?  NO, while you can eliminate SOME of the risk through diversification. You can not eliminate all risk.  Some risk comes from just being a part of the overall market or “system“  Systematic risk affects a very large number of stock versus non-systematic risk which is unique to a few or one stock Systematic Non-Systematic  Natural Disaster  CEO scandal  Inflation  Union Strike  Economy  Policy Changes within the Company  Price of Oil  Death of a Key Member of the Corporation  Increase to Minim Wage FNCE 2P91 - Section 05 Winter 2011 - Duration 03 Total Risk Non-Systematic Risk You can diversify away Non Diversifiable Risk or Systematic Risk You can NOT diversify away Number of Stocks in a Portfolio MEASURE SYSTEMATIC RISK: BETA COEFFICIENT  How much systematic risk a particular asset as relative to the overall market or average asset  If you have a specific asset with as much risk as the overall market the  An asset with half of the systematic risk has a  Most stocks have a –  Beta measures the sensitivity of an asset’s return relative to the return of the market ( )( )( ) ( )( ) Example: If the BMO has a T of 0.12 and a correlation with the market of 0.71 and the overall market T = 0.09 BMO M ( )( ) Therefore, BMO holds as much as (a little bit less) systematic risk as the overall market. CAPITAL ASSET PRICING MODEL (CAPM)  How risk is priced into the market In a competitive and efficient market the expected risk premium (over a risk free rate) of an individual asset varies in direction proportion to the asset’s Beta FNCE 2P91 - Section 05 Winter 2011 - Duration 03 Returns SML (Security Market Line) Where: Return Required
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