Corporate Finance Equations Sheet

Topics: Modern portfolio theory, Capital asset pricing model, Financial markets Pages: 7 (1185 words) Published: April 12, 2013
Assignment 1
NPV: = -PF + FV /(1+r)
PV = FV/(1+r) or
PV = C1/1-r + C2/(1-r)2 + .. + CT/(1-r)T
Rate of return: R=(Vf-Vi)/Vf
Rate r compounded m times a year:
FV = C(1+r/m)mt
10% semiannually = 10.25% annually, Hence 10.25 is said to be the Effective Annual Yield (EAY) 1+EAY = (1+r/m)mt
Assignment 2
The value of D received each year, forever: PV = D/r
The value of D received each year for T years:
PV = (D/r)*[1 – 1/(1+r)T]
Growing Perpetuity
PV = D/(R-g)
R: the cost of capital, interest rate
Growing Annuity
PV = (D/(r-g))*[1 – (1+g)T/(1+r)T]
Dividend & Stock Price
Rate of Return of Stock
r = (D1 + P1)/P0 - 1
Given annual growth rate g1, g2, then g3 remained constant forever: Di = Di-1*(1+r)
P2 = D3 /(R-g)
P0 = D1 /(1+r)+ (D2+P2)/(1+r)2
Variation: quarterly basis
Di = Di-1*(1+r)4
P2 = D3 /(R-g/4)
Variation2: Change of Growth
Find the R before Change:
P0 = D1 /(R+g)
Use it to find future P
P1 = D2 /(R+gnew)
Repayment = total bond*(face value + last payment price)
Efficient Market
-Stock prices fully reflect available information
-Competition among investors eliminates abnormal profit
Foundation of ME
Rationality: adjust their estimate of stock prices in a rational way Independent deviation from rationality: # optimist = perssimistic Arbitrage: 0 investment, no risk, but + reward
Different Type of Efficiency
Weak: Prices reflects all information in past prices and vol. Semi-Strong: Prices reflect all publicly available information: historical price, published acc statement, info on annuals report Strong : reflect all information, public and private(e.g insiders), it implies that anything pertinent to the stock and known to at least one investor is already incorporated in the price. What neglects?

1.Investors can throw darts.
2.Prices are random and uncaused.
Expected Return
E(r total) = Wb E(rb) + Wa E (ra)
Var(A, B) = Wa2(Var(A)) + Wb2(Var(B)) + 2(Wa)(Wb)(Cov(A, B)) Or
Var(A, B) = Wa2(Var(A)) + Wb2(Var(B)) + 2(Wa)(Wb)(Corr(A, B))ab

Covariance & Correlation
Stock A| Return(%)| Prop|
Good| RA Good| P Good|
Medium| RA Medium| P Medium|
Bad| RA Bad| P Bad|
Stock B| Return(%)| Prop|
Good| RB Good| P Good|
Medium| RB Medium| P Medium|
Bad| RB Bad| P Bad|

Expected Return of Stock A =
P Good* RA Good +
P Medium*RA Medium +
P Medium*RA Medium = E(A)
Standard Deviation of Stock A =
(P Good*( RA Good- E(A))2 +
P Medium *( RA Medium - E(A))2 +
P Bad *( RA Bad - E(A))2 )1/2 = A

Cov( A, B) =
P1(RA – E(A)) (RB – E(B))Good +
P2(RA – E(A)) (RD – E(B))Medium +
P3(RA – E(A)) (RD – E(B))Bad

A,B = Cov( A, B) / AB

Total Risk = Systematic risk + unsystematic risk
Systematic: non-divertible market risk, affect a large number of assets Unsystematic: affect a single asset, can be eliminated by combining

PortfolioOptimal Decision Rule
1. Use estimation of return, var, and convar to determine point M and CML (without personal) 2. Investors to decided how he will combine pt M with the riskless asset.

Step 1: Tangency = M
Step 2: Rational investors will passively hold an index fund Step 3: Al efficient portfolios have same price of risk: CML slope

Capital Market Line
x = standard deviation
y = Expected return

beta (measure of a stock’s systematic risk only => cov(Ri, Rm) / var (Rm)

which is unitless!
< 1 = the asset has less systematic risk than the overall market

E[Rportfolio] = wE[RA] + (1-w) E[RB]
portfolio = w A + (1-w)B

Capital Asset Pricing Model
Assume no monopoly trading power
No tax, transaction cost, regulations
Investors tradeoff against stand_dev
All investor analyze the securities the same way

E[Ri] = RF + i *(E[RB] – RF)

Security Market Line (SML)
x = 
y = Expected return

- traces the efficient set of...
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