financial theories

7/30/2019 Financial Theories

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By: Najam Us Sahar


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Type of Decisions Investment Decisions

Risk management

Financing

Compensation Plans

Dividend Payments

Mergers, Partnerships and acquisitions


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Finance is to Business and economics, whatengineering is to Basic Sciences


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Assumption of Perfect Capital

Markets Large number of fully informed buyers and sellers, no

one to influence market prices

The absence of Market friction like fees, taxes,information acquisition or any other transaction cost.

Homogeneous expectation.

Perfectly competitive product and factor markets

always in equilibrium. Costless and instantaneous market access or all

potential buyers and sellers


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Thy are able to derive fundamental results in such anidealized environment

Large number of modern finance theories aredeveloped in US and Great Britain

Financial Practitioners use these theories to firstanalyze and then design the practical means to

address real business challenges Does it makes sense?


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Saving and Investment In perfect

Capital markets


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Fisher: 1930

Total investment and total saving, with and withoutCapital markets

Fisher Separation theorem

DCF: Discounted Cash Flows


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Portfolio Theory


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Harry Markowitz: 1952

Dont put all your eggs in one Basket.

Adding assets, decreases risk and increases returnprobability

CoVarience


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Capital Structure theory


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Capital Structure theory Modigliani and Miller(1958)

Capital Structure Irrelevance

Cash flows concern


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Dividend Policy


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Miller and Modigliani(1961)

Irrelevance

Investment policy fixed, paying dividend is to make upby selling new equity.


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Asset Pricing Models CAPM : 1964 Sharpe, 1965 Linter, 1966 Mossin

First time to quantify the risk and how it is priced

Greater the systematic risk. Higher rate of return,

CML

Ross (1976) APT, Factor loading


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Efficient Capital Market Theory Fama (1970)

Three formsWeak form?

Strong Form?

Semi Strong Form?


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Option Pricing Theory Black and Scholes (1973)

Opening of CBOE

In the money, Out of Money Risk of adverse price and hedging


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Signaling Theory(1970s)Asymmetry of Information.

Signaling Costly

Cant be mimicked.


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The modern theory of Corporate

Control 1980s Mergers and Aquisitions


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Market Micro-Structure Theory Since 1985

Internal structure of different

Relative merits of different microstructure.Determinants of bid-ask spread in different markets

How private info is incorporated into securities prices.

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Assignment Research Areas???

Relation to Practical world???/


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THanks

financial theories

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