Intermediate Financial Management

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BA – 316

Project
Part 1
Identify a company
Look at financial statements (from previous years, at least one year)
Conduct ratio analysis. Use Dupont equation from results.. Make a financial statement
Organize and Analyze Statements
Make recommendations – how will you improve the forecast
Strengths, weaknesses, etc.

Part 2
Forecasting – Statistical Analysis
Standard Goal of 10%
Determine location of new funds (borrowing, issuance of stocks, capital)

½ page to 1 page proposal before starting project

Chapter 2
Homework – (5 , 9) & Mini Case (a – i), (#12 for 08/31)

**Mini Case (j – m) for 09/12

Correlation Coefficient -> Degree of variability

Possibilities of economy on investments
ProbabilityRate of Return A
Pessimistic.2513%
Likely.5015%
Optimistic.2517%

Realized Rate of Return & Correlation Coefficient

***Calculate Correlation of Coefficient for these stocks
Stocks X, Y, and Z
Year 1Year 2Year 3Year 4Year 5Avgσ
X8%10%12%14%16%12%3.16
Y16%14%12%10%8%12%3.16
Z8%10%12%14%16%12%3.16

Correlation – A statistical measure of the relationship between the rates of return of two assets

Correlation Coefficient – A statistical measure of the degree of the relationship between the rates of return of two assets. Positively Correlated – Describes two rates of return that move in the same direction Negatively Correlated- Describes two rates of return that move in opposite directions

ρ= t=1n(ri,t-ri,avg)(rj,t - rj,avg)t=1nri,t-ri,avg2t=1nrj,t - rj,avg2

Yearr ̅xryrz

18%16%8%Rxy=
2101410
3121212Rxz=
4141014
516816

Diversifiable Risk
Company-specific risk
Unsystematic risk

S&P, NASDAQ, Dow Jones

Non-Diversifiable Risk
Market Risk
Systematic Risk

The risk of a portfolio depends on the correlation coefficient of returns on the assets within the portfolio.
1. If rate of return of two assets are perfectly positively correlated, R = 1
2. If rate of return of two assets are perfectly negatively correlated, R = -1
3. If rate of return of two assets are independent, -1 < R < 1

Beta Coefficient – b
Measure of the risk that one asset can contribute to a portfolio
ry = a + b(rM)

When beta is positive, it means that the stock moves with the market
And vice-versa if beta is negative

Beta measures the non-diversifiable risk of an asset.

Find Correlation Coefficient (as a portfolio)
Calculate beta - Use S&P
What should be the risk of the portfolio?
**Pick a pair
Exxon & BP
Walmart & Kroger
Verizon & AT&T
Toyota & Ford

CAPM – Capital Asset Pricing Model
A model that describes the relationship between the required rate of return and the non-diversifiable risk of a portfolio

rMrxryrz
55102.5
1010205
1515307.5
20204010
25255012.5
30306015
r17.517.5358.75
b1120.50
ρ111

bx= ∆rx∆rmρxm

= σxσmρxm

SML Equation - ri = rrf + (rm - rrf)bi

IF rm = 9%
RRF = 3%

bA = 0.5
bB= 1
bC= 2

Slope of SML line provides the riskiness of the market, aka market risk premium.

Chapter 3 – page 76 Optimal Portfolio
Homework (#7)
Covariance

COVAB = i=1nrAi- rArBi- rBPi

ProbabilityAsset AAsset BAsset CAsset DAsset E

.158%4%12%2%4%
.20861046
.3088878
.2081061210
.1581241612

r ̂88888
σ02.522.524.662.52

COV

COVxy= σx σy(ρ xy)

Solve COVBD, COVBE, COVCD

Calculate risk without beta
σp= wx2σx2+(1-w)y2σy2+2w(1-w)ρxyσxσy

Two key factors for investing
How much is the rate of return
What is the risk involved

If COV is large & positive
Portfolio standard deviation will be between the two stand-alone deviations

If COV is large...
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