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BU473 (10)
Lecture

BU473 Lecture Notes - Limited Liability, Risk Premium, Fot


Department
Business
Course Code
BU473
Professor
Ning Tang

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Goals of investment: Safety Income - Growth of capital
Expected return = anticipated return by some investors = risk-free rate (RF) +
expected risk premium
Investment process: decision to invest - choice of investment: risk averseness,
set up investment goals, risk-return analysis transaction monitor performance
Important considerations when investing: Nothing is certain Globalization -
Tech advances (Old Econ vs. New Econ) - institutional investors (vs ind investors) -
Market efficiency - Corporate Governance
Direct Investing: Non-marketable money mkt capital mkt derivatives mkt
Indirect Investing: Investment funds (open and closed end)
Def’n: Options limited liability….Futures unlimited liability
Def’n: Investment Taxation: Interest taxed as ordinary income… Dividends
gross up and then apply tax credit… Cap Gains only 50% is taxable, loss can be
carried backwards 3 years and forwards indefinitely
Def’n: Unit Inv. Trust: passive investment; unmanaged, designed to be bought
and held, goal is capital preservation...minimum operating costs… investment
funds can be unit, open-end, or closed-end
Def’n: Red Herring = preliminary prospectus Blue Skied = gain approval
Dividend Yield: income component of return Div/Price D1/P0
Payout Ratio: % of earnings paid in cash to stockholders Div/Earnings OR 1-b
P/E Ratio: earnings multiplier Price/EPS
Bond equivalent yield (BEY) --------------
Bank discount yield (BDY)(used in USA)
Effective annual yield:
Holding period return: HPR = (P1 P0 + C)/P0
Income tax Rates: <40k: 15%... 40-82k: 22%... 82-127k: 26%...>127k: 29%
Div Tax Credits: 44% gross up, 17.98% tax credit on grossedup… gross up, apply
federal tax, subtract federal tax credit, provincial tax is half of remaining fed tax,
Net Asset Value (NAV): values investment (mutual fund) company shares
Pricing for funds: Open-end = NAV, closed-end = Prem/Discount to NAV… if
NAV>mkt price, selling at discount
When fund has front-end load, price is NAV/(100%-sales charge), ie NAV is 10,
sales charge is 5%, price is 10/95%
Stock Indices: Price-Weighted = avg of stock prices… Mkt Value-Weighted = mkt
cap weighted avg of stock prices… Equally Weighted = avg of stock returns
Price-Weighted Index: inv equal # of sh in each firm; divisor adjusted sometimes
Market Value-Weighted: get RoR/HPR? sum up MV only
*doesn’t auto-adjust 4 splits
Equally Weighted: Arithmetic avg and Geometric avg…X = P1/P0…MUST -1 at
end of both eq’ns to find % RoR
Def’n: DRIP: can reinvest dividends to buy more shares at no add’l cost
Protection agencies: OSC, CIPF, IIROC
Stock purchases are cleared by CDS
Initial Margin: 30% CA, 50% USA…Maintenance: 30% both
Leverage is by 1/margin requirement
Margin Ex.: price of stock drops, but amount of loan stays constant, it’s your equity
that drops with the MV, which drops your margin…how far can price fall before
margin call?
Shortsell Ex.: the total collateral is the value of the stock owed + margin…when
stock price goes up, stock owed goes up meaning the net equity (your original
margin) goes down (margin = equity/stock owed) … margin call price
Valuation Approaches: Book, Acquisition
(liquidation and replacementTobin’s Q: when ratio is near 1, company is trading
close to replacement cost), Intrinsic (DDM, Earnings, FCF), Relative valuation
DDM: no-growth model: P = D0/k … constant growth: P = D1/(k g)
Estimate guse historicals OR g = ROE×b…keeping b constant, g = earnings
growth rateb = 1 D0/EPS0 ... to find PVGO find b g EPS1 k
Note: b = retention ratio/clawback ratio/plowback ratio
Est kuse CAPM:k = rf + beta(km rf)...not give? Mkt Risk Prm = 5.5%, Rf7.5%
g = expected cap gains yield k = div yield + cap gains yield
Geometric Annual growth rate (g)
Note: don’t use original Div,
use Current Div when calculating based on historicals
Transition Period DDM: find g (of EPS), EPS, Payout Ratio (of D), D, k, possibly
beta, and discount
EPS: IV = PV of constant earnings + PVGO PVcons.earn = EPS1/k PVGO
when g is constant … so P = EPS1/k + PVGO
Free Cash Flow Model:
FCFF = EBIT(1-t) + Depreciation Capex Change(NWC) OR
FCFF = NI + NCC Cap. Ex. Change(NWC) + I(1 t)
Vf = FCF/(WACC g) Value of Common Equity = Vf debt
IV of stock = Value of equity / # shares outstanding
FCFE = FCFF Interest Expense(1-t) + Increase in Net Debt OR
FCFE = NI + NCC Cap. Ex. Change(NWC) Net debt
Relative Valuation Approach: M/B = P0/BV0, BV is per share
P0 = sales per share * justified P/S ratio = sales0 * P/S
P/E Approach: Value of t he stock = next year’s earnings × justified P/E
Estimate justified P/E w/ industry avg, own hist, or regression…Estimate earnings
w/ hist EPS growth, stats Earnings Multiplier = E1 * P0/E1
Regression approach Other Approaches:
EVA = (ROC - WACC) x Capital OR EVA =NOPAT-(WACC*Capital)
MVA = Mkt valu of the firm Capital more fwd-looking than EVA
Valuation of Preferred Stocks: V = C/k, where C = coupon
ADRs =indirect way invest in foreign firm, GNMA=mortgage ass.
Total Asset TO=Sales/Total Assets ROE=TO*Prof Marg*Equity Multiplier
Profit Margin = Net Income/Sales Equity Multiplier = Total Assets/Total Equity
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