Download - Topic a (ch 1, week1)
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1.
Cores of Learning in This Chapter
The determinants of interest ratesTerm structurePure expectations hypothesis
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2.
Overview of Financial Management
Definition of finance
Financial management functions
Goals of the corporation
Financial markets
Interest rates and yield curves
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3.
Definition of finance
Finance is concerned with the process, institutions, markets, and instruments involved in the transfer of money among individuals and organizations.
Definition of finance
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4.
Relationships among investors, firms, and financial markets
FinancialInstitutions
FinancialMarkets
FirmsInvestors
Funds Funds
Funds Funds
Deposit certificates
Loan contracts
Securities Securities
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5.
Forecasting and planning
Investment and financing decisions
Coordination and control
Transactions in the financial markets
Managing risk
Financial management functions
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6.
The primary goal is shareholder wealth maximization, which translates to maximizing stock price.Should firms behave ethically? YES!Do firms have any responsibilities to
society at large? YES! Shareholders are also members of society.
Goals of the Corporation
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7.
Is maximizing stock price good for society, employees, and customers?
Actions maximizing stock price also benefit society: managers that maximize stock price improve
the quality of lives of their owners, a lot of whom are ordinary citizens
stock price maximization requires efficient, low-cost operations that produce high quality products that benefit consumers
Companies that successfully increase stock price also grow and add more employees, thus benefiting employees
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8.
Amount of cash flows expected by shareholders
Timing of the cash flow stream
Risk of the cash flows
Figure 1-1 (slide 12).
Factors that AffectCompany Value (Stock Price)
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9.
Factors that Affect the Amountof Cash Flows
Sales Revenues (investment decisions)
Increase unit sales单位销售额 by providing what customers want
Develop new products for higher prices
Operating costs and taxes
Reduce operating costs by supply chain management and employee training, etc.
Investments in operations
Reduce asset requirements: e.g. JIT
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10.
Factors that Affect the Riskof Cash Flows (WACC)
Financing decisions: wd, wce
Capital structureSpecific type of financing
Interest rate: rRF
Firm risk: betaBusiness characteristics
Market risk: rM - rRF
Stock market investors’ overall attitude toward risk
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11.
Value of OperationsThe Influence of Timing onCompany Value
)WACC1(
FCF....
)WACC1(
FCF
)WACC1(
FCFValue
22
11
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12.
Value of OperationsDeterminants of A Firm’s Value
Sales
Revenues
OperatingCosts and
Taxes
RequiredInvestments
in Operations
Financing
Decisions
Interest
Rates
Firm
Risk
Market
Risk
Free Cash Flows
(FCF)
Weighted AverageCost of Capital
(WACC)
Value of the Firm
)WACC1(
FCF....
)WACC1(
FCF
)WACC1(
FCFValue
22
11
Amount of cash flows Risk of cash flows
Timing of cash flows
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13.
The Financial Environment
Financial marketsDeterminants of interest ratesYield curves 产出曲线
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14.
Define these markets
A market is a method of exchanging one asset (usually cash) for another asset.
Markets for physical assets Markets for financial assets Money versus capital markets Primary versus secondary markets Spot versus futures markets
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15.
What do we call the price, or cost, of debt capital?
The interest rate
What do we call the price, or cost, of equity capital?
Required Dividend Capital return yield gain= + .
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16.
What four factors affect the costof money?
Production opportunities (r*)Time preferences for consumption
(r*)Risk (DRP, LP, MRP)Expected inflation (IP)
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17.
Real versus Nominal Rates
r = Any nominal rate.
= Real risk-free rate. T-bond rate if no inflation; 1% to 4% (0.67% for an inflation-indexed treasury bond of 4-year maturity in Apr. 2003)= Rate on Treasury securities= r* + IP.
r *
rRF
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18.
r = r* + IP + DRP + LP + MRP.
Here:
r = Required rate of return on a debt security.
r* = Real risk-free rate.
IP = Inflation premium.
DRP = Default risk premium (0.6-3.5%).
LP = Liquidity premium (2-5%).
MRP = Maturity risk premium (1-3%).
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19.
Premiums Added to r* for Different Types of Debt
ST Treasury: only IP for ST inflationLT Treasury: IP for LT inflation, MRPST corporate: ST IP, DRP, LPLT corporate: LT IP, DRP, LP, MRP
(Besides MRP, DRP and LP are also larger for long-term bond. • There is a higher default risk in a longer maturity.• Due to low DRP and MRP of short-term bond, a buyer can buy it without doing much credit checking. higher liquidity)
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20.
What is the “term structure of interest rates”? What is a “yield curve”?
Term structure: the relationship between interest rates (or yields) and maturities.
A graph of the term structure is called the yield curve.
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21.
Data for yield curve construction
Inflation rate – 5% next year, 6% the following year, and 8% thereafter.
Maturity risk premium – 0 for securities that mature within 1 year, 0.1% for 2-year security, MRP increase by 0.1% point per year thereafter up to year 20, after which it is stable.
Real risk-free rate is 3%.
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22.
Yield Curve Construction
Step 1: Find the average expected inflation rate over years 1 to n:
n
INFLt
t = 1
nIPn = .
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23.
IP1 = 5%/1.0 = 5.00%.
IP10 = [5 + 6 + 8(8)]/10 = 7.5%.
IP20 = [5 + 6 + 8(18)]/20 = 7.75%.
Must earn these IPs to break even versus inflation; that is, these IPs would permit you to earn r* (before taxes).
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24.
Step 2: Find MRP based on this equation:
MRPt = 0.1%(t - 1).
MRP1 = 0.1% x 0 = 0.0%.
MRP10 = 0.1% x 9 = 0.9%.
MRP20 = 0.1% x 19 = 1.9%.
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25.
Step 3: Add the IPs and MRPs to r*:
rRFt = r* + IPt + MRPt .
rRF = Quoted market interestrate on treasury securities.
If r* = 3%:
rRF1 = 3% + 5% + 0.0% = 8.0%.rRF10 = 3% + 7.5% + 0.9% = 11.4%.rRF20 = 3% + 7.75% + 1.9% = 12.65%.
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26.
Hypothetical Treasury Yield Curve
0
5
10
15
1 10 20
Years to Maturity
InterestRate (%) 1 yr 8.0%
10 yr 11.4%20 yr 12.65%
Real risk-free rate
Inflation premium
Maturity risk premium
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27.
What factors can explain the shape of this yield curve?
This constructed yield curve is upward sloping.
This is due to increasing expected inflation and an increasing maturity risk premium.
A yield curve can be downward sloping if the expected inflation is lower in the long-term than in the short-term. (decreasing IP, increasing MRP)
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28.
What kind of relationship exists between the Treasury yield curve and the yield curves for corporate issues?
Corporate yield curves are higher than that of the Treasury bond. However, corporate yield curves are not necessarily parallel to the Treasury curve (The spread widens in maturity since DRP and LP are larger in longer maturity only for corporate bonds).
The spread between a corporate yield curve and the Treasury curve widens as the corporate bond rating decreases (DRP, LP).
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29.
Hypothetical Treasury and Corporate Yield Curves
0
5
10
15
0 1 5 10 15 20
Years tomaturity
Interest Rate (%)
5.2%5.9%
6.0%Treasuryyield curve
BB-Rated
AAA-Rated
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30.
The Pure Expectations Hypothesis (PEH)
As large bond traders buy and sell long-term bonds as frequently as short-term bonds to pick up short-term profit, they are not exposed to MRP. Thus MRP = 0. (for long-term bonds, they are exposed to more LP, exposed to the same DRP compared to short-term bonds)
Shape of the yield curve depends on the investors’ expectations about future interest rates. Interest rate is an average of current and expected future short-term interest rates.
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1r i
n
1i
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