The process in which money is transferred among businesses, government and households

Is to increase the value of their stock -

Stock reflects the value of its future financial profits -

The purpose of any firm

Career plans-

Investing activity -

It is important in personal life beyond activities as an investor -

Why should it be relevant to me as a student?

Finance:

$

Life time

Spending

Borrowingincome

Using Saving

saving

Commercial□

Investment□

Banks-

Mutual funds□

Insurance Companies-

Lender savers

Borrowers and spenders

Coordination □

Financial Markets-

Financial intermediaries: Financial System

Federal Reserve○

Financial Managers•Financial Markets •Investors • All interact with one another

Obtaining funds (financing)Investing Funds (investing)

Higher cash inflows1)Money received sooner2)Lower the risk of shareholders 3)

Three ways to increase the price per share:□

Pshare * Nshares

Maximize the value of the firm

Private planes, expensive offices, fancy cars□

Things that management provides for itself from the firms resources for the financial teams benefit that doesn’t benefit the firm directly itself

Benefits the managers but not the stock itself

"Agency Costs"-

Being a good citizen by firms giving money to a service

It is the firms responsibility to enhance its value in order to benefit the community for the firms service

"Social Responsibilities"-

Financial Management

Government decisions effect the populations outcome.Thus an informed population can benefit the community as a whole

An informed decision is better than not. Financial success is at stake if one does not understand finance

FinanceTuesday, September 07, 20102:01 PM

Finance Page 1

An informed decision is better than not. Financial success is at stake if one does not understand finance

They don’t have to be as creative. They just have to accomplish the mission by managing the given budget Mission first funding comes after

There is no real limit to what you can do □

There is little incentive to grow □

Inefficient operation □

Issues involved in this-

Nonprofit- fund the operations of the institution given the goals of the institution

For Profits- maximize the value of the firm

Financial Managers:

Firm organization:

[Prez]CEO

VPHR

VPManuf

VP Fin

VpMktg

VPInfor

Treas (Fin Mgt) Controller (accounting)

Financial Managers effect the left side of the balance sheet [The Assets] •

Accounting Formula:A= L + OEOE= A-L

Required Return

Rf 0

R.R

Risk

You have to offer a higher consumption that what one could consume now Time Preference

Borrow money•Debt finance1)

Retained Earnings •

Common stocks

Preferred stocks

Selling equity securities (ownership shares) •

Equity Finance 2)

Two sources:Funding:

Financial managers optimize the sources of funding

Individuals1)Institutions 2)

Types:

Include principal and interestLoans:

Issued at discountResalableMature

Debt securities :

No maturity date, resalable Return either dividends paid to holders and increase in price is a return

Equity Securities

Investors

Finance Page 2

No maturity date, resalable Return either dividends paid to holders and increase in price is a return

Risk on debt securities is a risk of default Equity-the risk is the market price going down. Low dividends or no dividends at all

All securities are risky

Risk-averse

Gamblers Risk-lovers

Investors are risk averse- higher risk higher returns

Financial managers help real assetsFinancial markets assist thee flows of money

Investors decisions increase the value of the firm

Ps

Q 0

Ds

Ss

Q0 Q1

Ps0

Ps1

Ds

You buy a bond at $1000 at %5= $1050 in one year1)With repect to money present values exceed future values PV<FVi.

Time Value of Money 1)

Risk takers must be compensated (or they wont take the risk) 2)Risk can be reduced by diversification p.7 3)

Six Basic principals of Finance

Return

0 Risk

Rf

.5(0)+.5(2400)=$1200

Outcomes

Combined investment

Possible returns

Combined Returns

1 1000 0+0 0

2 1000 0+1,200 1200

3 1000 1200+0 1200

4 1000 1200+1200 2400

Diversification is less risky when the probabilities are different

Markets bring information together and consequently set the prices that represent the best information

i.

The good info about a stock will spread through the market and the price per share will go up until return is brought down again

ii.

Expected earning per share (EPS) is $5 & Current Price = $50

Expected EPS is now $6Expected return is $6/$50=$0.12 %12

Current Expected Return $5/$50=$0.1 %10

Expected Return is $6/$60=$0.1 %10

ABC Corp.

Financial markets are efficient in pricing 4)

Managers objectives can be different from the owners5)Reputation Matters 6)

Business ethics are higher than political ethics because of the market. Politicians also have a check on them you can remove them from office

Business ethics vs political ethics:

Finance Page 3

from office

Investor trading Shareholder activismTakeover (buy all the shares to put yourself in charge) [Calr Ichan]

How do you influence the financial managers so that what they do is beneficial to the firm:

They are in-between savers and investors Channel savings into loans or investments

Sept. 7 2010- $13,461,672,342,582.93 National Debt

II Q 2010- $14.7 trillion GDP:

The Fed:

Financial Intermediaries

Depository institutions Commercial banks

Mutual fundsPension fundsSaveing and loans

Financial Institutions

The banking system began in 1790 in the united states

They were going out of the US because there was a trade deficit more goods were coming in than going out of the US 2.5 million people in the colonies3 million in england 12 million dollars in circulation in US

Payment was supplemented by bartering, tobacco, corn etc. = $5 per person

Before this most money that circulated was gold and silver from europe

1618 the Virginia specified an official price for tobacco

Parliament in England didn’t like this so in 1690 England set up the bill act that prevented paper money from being printed

1690 Massachusetts started printing bills of credit

1779 congress had issued 1 million continental bills

Bank of north america issued bank notes, and issued creditNew york and boston soon built banks also which was the start of the bank industry

1781 they chartered the bank of north America

The money supply will only expand as the country expands

Commercial loan theory of credit- banks should never make anything but short term liquid loans bc they are short term gains

It had a 20 year charter

Payed off the debts gained over the revolution-

Made loans◊

Issued currancy◊

Collected costums◊

Established the bank of US which acted as the fiscal bank for the government -

He did two important things to get the government to a stable start

This resulted in a ton of different bank notes 1810 90 banks charted by states

250 banks and paper currency was being issued like crazy There were so many different kinds of currancy

1816

Hamilton started it

20 year charterThe 2nd bank tried to discipline the banks by issuing gold & silver for their notes This lead to panic of 1819 -> many banks failed

2nd charter of the US bank

1823 - Nicholas Biddle was appointed president of the second bank of the US

The first bank of US was a federal bank which acted as a fiscal agent of the US

Before 1790:

Finance Page 4

He regulated the bank system As the gold and silver increased by banks the number of notes increased

1823 - Nicholas Biddle was appointed president of the second bank of the US

Jackson told the treasury to distribute the surplus to the state banks in proportion to the senators in congress

1833 Jackson stopped the 2nd bank by refusing deposits to the bank

Some states refused banks to open-

Others let anyone open a bank -

States changes their banking systems -

1846 congress passed the independent treasury act

It required all banks to maintain a certain percentage of reserves -

The national banking act superseded anything at that time -

Ney York the banking act that the legislation passed worked so well that the national banking system was modeled after it

Banking before 1863 was a large mixture of differently run operations

The idea of having a nationally charted bank was for the bank to sell federal securities to raise money for the government

State banks saw the demand deposite system to work to avoid government charges and this started the creation of money and checking accounts

It was severe short term panic, A bank in New york going bankrupt would then bankrupt the smaller state bank invested in them so the panics caused people to pull money out

The panic of 1907

The compromise was the federal reserve act- a decentralized central bank which set up 12 districts

1912 the establishment of a central bank that would regulate all banks

They buy debt, issue loans etcDepository

Demand deposits: payable on demand Time Deposits: they remain their, so savings accounts etc

CD- certificate of deposit

Term loans: loan for specific period of time Lines of credit: there is a specific amount of money available if company wants to draw on it

Banks who make loans often give

Commercial Banks

Store of Value, you accumulate value in the form of exchange and you hang onto it through time to support later spending

-

Standard of value, it’s a measuring stick of the value of things and their prices-

Standard of differed payments -

Money: anything that performs a medium of exchange

Federal Reserve knows the amount of money in the system

Into the second quarter= 1718.4 billionM1

8,610.9 billion M2=M1+

p.19 ^^

How banks create money:

www.Stlouisfed.org

5.9% is the current saving rate which is the highest in a few decades people are conserned for the future.

p.69: Table 3.2

How banks create money:

Finance Page 5

Finance Page 6

Money supply doesn’t really go up and down, the rate of increase rises and falls

Federal insurance policies National banks are regulated by the comptroller of the currency State banks are regulated by the state banking boardFederal Reserve

Commercial banks are regulated by:

Established in 1913 as a lender of last resort

Any bank that is apart of the system has an account at then Fed, which is used to settle inner bank debts Banks can pull money from the fed when needed, especially during Christmas time

The Fed is a Banker's Bank

-Ben bernanke monatary economist

Each regional bank has a board of directors and each board has 9 people, 3 people elected by banks, 3 elected by the public, 3 elected by board of governors, pres of the board is elected by the board

Board of governors itself has 7 memebers, they are appointed by the prez with the consent of congress, each has 14 year term. Cannot be removed unless impeached or found guilty of a high crime

12 regional banks

Federal Reserve System:

Finance Page 7

a high crime

Making changes in the money supply and interest rates that are favorable to the economy

They try to carry out monetary policy

Government checking account 1)Banker's bank 2)Supervise and regulate local banks 3)

Manage Money supply and interest rates -

^Money supply leads to pushes down the interest rates which leads toincreased interest rates which increases employment which leads to causes malinvestment and a recession vMoney supply leads interest rates to go up which leads to lower interest rates which leads to decrease in employment

Conducts monetary policy4)

Fed Reserve 3 responsibilities:

3%-12% -

Reserve requirement1)

Rate the fed charges member banks to borrow from it -

Federal funds rate: rate banks charge each other for overnight loans •

Discount rate 2)

*Open Market Operations 3)

Tools:

Bond Prices and Interest rates move inversely

Fractional Reserve System:

Term structure on interest rates

Ms-> I-rates-> I L

Ms->^irates->VIVL

Commercial BanksMutual Funds

Brokerage Investment companies Investment Banks

Securities Firms

Insurance companies Pension funds Depository institutions

Money Supply x Velocity Money= Ro x PLMonetarists:

MV=P*Q

Relationship between Money supply and Economic activity:

∆Ms ->∆ i-rates -> ∆expenditures -> ∆GDPKeynsians:

Lm1i

Ioi1

0 y

lm

∆Ms -> ∆i-rates (nominal) -> ∆structure of expenditures -> malinvestment -> BustAustrians:

Manipulators

Of the economy

If you try to mess around and fix it you just prolong the issue You can't do anything, you just have to wait and it will fix itself eventually

International Finance

P$ [E] S$ PE

SE

1.43.699

S$

.777

Finance Page 8

P$ [E]

0 Q$

S$ PE

D$

0 QE

DE

SE

1.43.699

S$

DE

.777

1.287

It was a responsibility of these to promote economic growth and full employment, price stability, and net exports= 0

Established the council of economic advisors

The employment act of 1946

Food

0 Housing

P.P Curve

^ resources, improve technology, improve economic order (division of labor, improve knowledge of cause and effect), Mkt economy vs. Planned economy > Economic growth

GDP= C + I + G + (X-M)

GDP= PCE + GPDI + GE + NE Physical policy= manipulation of government spending and taxes Congress and President both engage in physical policy

Police and the courtGovernment has a couple of responsibility: according to Smith

>this leads to a departure from smiths ideaBismarck brought the idea of the state being the molder of society

G=T balanced budget G>T deficit and Borrow G<T surplus and redeem

p.63 2nd Q 2010GDP= 13,191.5PCE= 10,325.5GDPI= 1,838.7 GE= 2,991NE= -536

200814,441?2,1362,883-696

Published the first intro econ textbookMankiw:

10%9876543

2007 2008 2009 2010

Stimulus Plan

W/o Plan

Actual

Foreign sources

Most failed and were a financial failure

Projects □

Government:

China

Brittain (cattle investment in tx)

Industries □

International organization (world bank etc)

Government to government lending

3 sources for development in poor countries□

Foreign Sources

Sources of savings

Government and private

Finance Page 9

International organization (world bank etc)Government to government lending

Non profit organization lending

Lending to repressive regimes don’t really work □

Governments using their lending to achieve undermining goals □

Historically we don’t have good results □

Government to Government

Most successful in history □

Globalization, capital transfers □

Private sources

Personal = positive Business= deficit

incomes 1)

Price levels -

incomes-

Expectations ***2)

Business Cycle and Demographics 3)Life stages 4)

What affect saving?

Savings:Table 3.2 p. 69

tradesi.Establish Prices1)

Dealers in financial markets (middle man)i.Provide Liquidity 2)

High volume of trade i.Rules ii.Standardized contracts iii.

Minimize transactions costs3)

Financial Markets:

Primary Markets •

Market for used assets □

1366 seats (the right to trade) □

New york stock exchange

Organized markets for securities

Nasdaq - Amex□

OTC (over the counter market)

Secondary Markets•

Financial Markets

Dealers p ask p1 ^ po v Bid

Mortgage Speculation on interest rate movementsForeign exchange rates speculations

Derivatives •0 Q

s

d

shortage

surplus

Leon Walra

Approximating the right price

If there Is a surplus you drop the prices, if there is a deficit you raise the prices

Investors change their behavior so prices fluctuate

Trade over many means of communicationBanks use them to park funds until they find something to do with the money Borrowing people use money markets to make short term gains

Bills= < 1 yearNotes= between 1 and 10 yearsBonds = 10+

US treasury- sells: B-N-B

13 26 360

91 days 182 days

10K 15k 50k, 100k ,1million

No interest Only way to gain is to get the right price initially

Treasury bills

buy price= risk free rate of return

Yield= Sell price - buy price

Money Markets:

Actual return=10,000 -9,8001) 9,800 = 9,800 .0204=2.4%9900-98002) 9800 = .0102=1.02%

Ex.

Finance Page 10

9800 = .0102=1.02%9900-9800 3653) 9800 x 180 = .0207 or 2.07%10,000-9900 3654)9,900 x 180 =.0205 or 2.05%

Federal Funds MarketRepurchase AgreementsNegotiable Certificates of deposit Commercial paper Banker's Acceptances

Federal -

State -

Local/municipal-

Corp bonds-

Corp stock-

Mortgages -

Treasury 10-30 years□

Yield= sell price - buy price

Treasury notes 1-10 years □

Tax exempt from state and local taxes

buy price + sum of 6 mo coupon payments

Agency bonds □

General obligation bonds

Revenue bonds

$5,000 minimum

Tax exempt from all levels

Municipal bonds □

$1,000

10-30 years in maturity

Debenture- you get no return

Mortgage

Corporate bond □

Voting rights◊

Everyone gets paid before you get paid ◊

Common

Guaranteed they will be paid a dividend ◊

No voting rights ◊

Preferred

Stocks □

Bonds-

Government bonds and notesCapital Markets

Rf= r = RR= 1P

r=nominal

RR=r- lPRR= real rate + inflation rate

r=RR+IPRf-P=r

Any interest rate on a security is on the markets belief on what needs to be included r=RR+IP+DRP+MRP+LP

Risk free: treasury bill, note, bond rate

They come from a market for loan able funds Where do interest rates come from?

Interest Rate

SLF

DLF

r

LS=D

ro* r1

Saving more brings the interest rates downi.Savers change their practices1-

Open marketsi.Discount rateii.Legal reserve rateiii.

The Feds to what they do2-

How do you change the rate of loanable funds?

S'LF

S -> I

Supply and demand of loan-able funds:

Finance Page 11

SLF

DLF

W/P

LS=I*

Io*

S'LF

I1

Supply: Demand:

SLF

DLF

r

LS=I

ro*

Demand in business is driven by optimism or pessimism

•

Optimism, pessimism○

Government ○

House holds• SLF

DLF

r

S=I

ro*

If prices are higher then the supply will shift to the left, and the demand will also increase When people think inflation rates are going to be higher. Supply and demand goes up.

The fed supports the treasury buy supporting the treasuries borrowing to hold down interest rates The treasury borrowing drives monetary policyThey stopped this

Expected effects of fed supporting treasury borrowing

Jun 30 2010: fed owns 40% private investors 60% Foreign banks/investors 30%

p.91 text Who owns our national debt?

How an interest rate spreads out through time

Investors can think rates are going to be higheri)Reflects investors expectations of future interest rates, and inflationa)

The yield curve 1)Expectations theory1-

3 theories :

Term Structure of Interest Rates

Short term funds Long term funds

SLF

DLF

r

LFL*

ro

0

ro1

SL

DL

W/P

LL*

W/p*

r

LF0

r=RR+IP

IP=inflation premium

Finance Page 12

Anticipation of interest rates being lowerii)

Short term funds Long term funds

SLFr

LFL*

ro

0

DLF

SLFr

LFL*

ro

0

DLF

r

LF0

r1

r1

The risk on short term is lower than long term securitiesa.The yeild curve tends to slope up b.

Liquidity Preference Theory2)

The interest rates are set separately between the short term and long term i.The short term and long term markets are differenta.

Market segmentation theory3)

(Irving Fisher)

>i=r+∏^eN=r+INF+r(INF)

Fisher Equation N=nominal interest rater= real interest rateINF= inflation

Business risk (cash-flow) -

Financial risk (debt load)-

Default risk:The longer you have a security the more the price is effected by interest rates

-

Maturity Risk:

Investment Grade BBB Baa

BB Ba

Finance Page 13

Investment Grade

Junk Bond

Return %

Finance Page 14

Risk 0

Prime Com PaperU.S. TreasInvestment grade nots

Investment Grade bonds

Medium Grade Bonds

Prefferred Stock

Speculative Common Stocks

Increase investment and promote economic growthBonds become more attractive than stocksPush people to save more and consume less

Increases in interest rates:

One demand and supply curve Two parts- true false, multiple choice

And divisions

Institutions

Markets

Six principles

Know finance•

Mager componenets of financial system•

History in the US

1st and 2nd banks

Fiat

M1

Money•

Simple form of quantity theory of money (mv=PQ) ->increase in money supply increases price levels and visaversa

•

Savings

Fractional reserve □

Banks creation of money

Legal reserves

Discount rate

Open market operations

3 tools□

Monetary policy

Depository instituition•

Open market committee •Money multiplier p.52•Employment act of 1946•GDP from expenditure point of view•Balanced budget•Surplus•

Business and gov are the biggest borrowers

Where national debt comes from •

Major factors that effect saving •Real assets vs --- assets•

Bonds

Stocks

Securities•

Money securities <1

Capital securities> 1 year

Money market vs capital market •

Premiums

Terms of market of nominal rate of interest = sum of inflation rate•

Treasury bills= short run

Treasury bonds= 10 yrs or more

Treasury securities (hand out) •

Test Prep:

Finance Page 15

Financial institutionsFinancial instruments

Time Value of Money

Timing of money going in and out of the hands of the public or the firms hand

Calculating future value- calculate the end value of the cash flow

-10,000 3,000 5,000 3000 2000

0. 1 2 3 4 5

Present Value

Future Value

Discounting

Compounding

These values are calculated by financial tables and/or calculators

Compounded by being added to the principle being madeInterest is paid on principle

Saving money and you want to know how much you saved after 4 yearsYou had $1000 @ 10% a year

Year 1: 1000+ 1000(.10)= $1100Year 2: [1000+ 1000(.10)]* .10=110/1210Year 3: {[1000+1000(.10)].10}.10= 121/1331Year 4: [{[1000+1000(.10)].10}.10].10= 133.10/ $1464.10

MO=0.00Dec=4Periods per year: 2nd-> p/y = 1.00001000-> present value-> 10%

Calc:

FV=$1000(1+.10)^4=$1000(1.46)=$1460

FVn=Pvo(1+r)^n

FV13= 100,000 (1.05)^13 = $188,600

General formula:

EX.

2010 M1 MZM M2

1 3.83 -4.24 .01

2 1.75 -4.61 1.95

The fed is not increasing th money supply right now

FVn=PVo(1+r)^n

Ex. 188,564.91=1000,000(1.05)^13

Future values: found by compounding Time Value of Money

Semiannual:

FVn=PV(1+[r/m])^(nm)

100,000 semiannually at 4%

Period Principal FVIF FV

6mo 100,000 1.02 102,000

12mo 102,000 1.02 104,040

18mo 104,040 1.02 106,120.80

108,160- annual108,285.70- quarterly108,314.30-monthly108,325.38-weekly108,328.23-daily108,328.71-continuous

Finance Page 16

24mo 106120.80 1.02 108,243.22 108,328.71-continuous

e^x f(n)=[1+(1/n)]^n = 2.71828=e f(1)=(1+1/1)^1=2F(2)=(1+1/2)^2=2.25f(3)=(1+1/3)^3= 2.37f(4)=(1+1/4)^4=2.44

Compounding continuously:

If a dollar can be shown to be "e" dollars continuously compounded at %100 given an interest rate of I then: e^x= e^i*n

Principal I Years Asset value and the end of the period

$1 100% 1 e

$1 100% n e^n

$PV 100% n PV(e^n)

$PV I n PV(e^i*n) or PV(e^x)

PV(e^i*n)

Ex. n=2, r=4% =.04

FV=100,000(1.0833)= 108,330 So, e^i*n=e^.04*2 = e^.08 = 2.7183^.08=1.0833

FVn(cont. compounding)= PV(e^i*n)

E.A.R

E.A.R=(1+r/m)^m-1

The frequency of compounding -

Effective annual rate of interest:

If FVn=Pvo(1+r)^n

=100,000/(1.05)^5= 100,000/1.276281562=$78,352.62 Then, Pvo=FVn/(1+r)^n

Inflation in mind:FV1=PV1(1+.03)^1= 40,000(1.03)=$41,200Retiring:FV35= 40,000(1+.025)^35 = 40,000(2.3732)= $94,928.21

Accumulating a future Balance/Amount

Streem of equal value payments over a specified time period.

You receive payments after the end of the first year-

PMT{(1+r)^n-1/r)}

Fvoa=PMT1+PMT2 (1+r) + PMT3(1+r)^2+… PMTn(1+r)^n-1)-

Ordinary1-

Higher future values-

Annuity due2-

2 kinds:

Annuities

Ex.FV4= $10,000(1.05)^4= 10,000(1.216)= $12,160.00FV3=$10,000(1.05)^3=10,000(1.158)= $11,580.00FV2= $10,000(1.05)^2=10,000(1.102)= $11,020.00FV1=10,000(1.05)^0= 10,000(1)= $10,000 5.526 55,260.00

Its in the table in the book

Need to save $100,000How much money do you need to deposit at 5%

FVAn=PMT(FVIFAi,n)

Suppose you want to save money for a business and you need $50,000 to open a franchise, and another $50,000 to open up the stand.

Finance Page 17

FVAn=PMT(FVIFAi,n)Then PMT= FVAn/FVIFAi,n = 100,000/5.526=18,096.2722 $18,096.72

5.526(1.05)=5.802FVIFAi,n (1+r)

So, Fva.d.=$10,000(5.802)= $58,020

Future Value of Annuity Due

Present value of a future value is the amount of money one would have to invest in in order to grow to the future amount

Present values:

i=8%PV+FV(8%)=$1,000PV(1+8%)= $1000PV(1.08)=$1000PV= 1000/1.08 = 1/1.08(1,000)= (.9259)1000=$925.90

PV+ i-rates move inverse to one another

i=6%

PV+PV(%6)+[PV+PV(6%)] 6%=6% $1000PV + PV(.06)+[PV+PV(.06)].06=$1000PV(1+0.6)+[PV(1+.06)].06=$1000Pv(1.06)+[PV(1.06)].06=1000PV(1.06)[1+.06]=1000PV(1.06)(1.06)=1000PV(1.06^2)=1000

When you were receiving 6% on your money and you wanted to know how much you need to have to receive 100000 at the end of the year $890

PV + irates move inverse to one another1)PV + time move inverse to one another 2)

Pvo=FVn/(1+r)^n= 1/(1+r)^n FVn

FVn=(1+r)^nPVo

Problem 1 p.137Problems at the end of ch. 5: 2,4,6,8,19(a,e) p. 132

PV5=$10,000 (1/1.05^5)=$10,000 (.784)=$7,840 PV4=$10,000 (1/1.05^4)=$10,000(823)= $8,230PV3=$10,000 (1/1.05^3)=$10,000(.864)=$8,640PV2=$10,000 (1/1.05^2)=$10,000(.907)=$9,070PV1=$10,000 (1/1.05^1)=$10,000(.952)=$9520 $43,300 PVAs=$10,000(4.33)=$43,300

Present Value of ordinary annuity

PVIFAr ∞= 1/r = 1/.05 = 20.0 PVA5 ∞= (20)$10,000= $200,000

Value of a Perpetuity

Discount each of the lumps in the stream of unequal payments

=147,580

Year FV PVIF PV

1 50,000 .909 45,450

2 60,000 .826 49,560

3 70,000 .751 52,570

Present value of a mixed stream of payments

P.V. Calculator45,454.5549,586.7852,592.04=147,633.37

Calc instructions:CFOEnterV50,000 enter vv60,000 enter vv70,000 enter Npv 10 enterV cpt #147,633.36

Calculate the stream of payments over the term of the loan

If PVAn =PMT (PVIFAr,n)Then PMT= PVAn/ PVIFAr,n

Loan Amortization

Finance Page 18

If PVAn =PMT (PVIFAr,n)Then PMT= PVAn/ PVIFAr,n

=100,000/4.329= 23,100.02

End of Year Beginning Principal Payment Interest Principal End principal

1 100,000 23,097.48 5,000 18,097.48 81,902.52

2 81,902.52 23,097.48 4,095.13 19,002.35 62,900.17

3 62,900.17 23,097.48 3,145.01 19,952.47 42,947.70

4 42,947.70 23,097.48 2,147.39 20,950.19 21,997.61

5 21,997.61 23,097.48 1,099.88 21,997.60 .01

Year PMT

2009 25,000

2008 23,000

2007 21,000

2006 19,000

2005 18,000

Growth Rates

18,000/25,000=0.72 ~9%

Borrow $20,000 after 4 years pay 3,500 per year for ten years. What is your interest rate?

PVAn=PMT(PVIFAi,n)

-take this number and look at ten years and look for a number closest to this number and fid out what percent =11.7255

PVIFAi,n= PVAn/PMT= 20,000/3500=5.7143

Calculate growth rate for a stream of payments from an initial amount

IRR CPT

2nd clwrk -

2nd reset enter -

CF0= .00-

75,000 enter-

V -

CO1- 35,000 enter vv-

Co2- 30,000 enter vv-

5,000 enter vv-

0 enter -

=10.0416 -

Annual interest rate

p.33 problem 19 part e

Everything is easy accept for unequal payment…. -

PV/ FV

Rate of ReturnAny time one makes an investment they do so after analyzing possible returns and losses. •

Rt=Ct+(PE-PE-1) Pt-1

Bought a cab 20,00090,000 milesNow its worth 8,000

2nd year it generated a net income of 45,000

45,000+(8,000-20,000) = 33,000 = 1.65 or 16.5% 20,000 20,000

Rt= n/t=1Е Rt/n= 16.5% + 150% + 200% + 175%/ 4 = 690/4 = 172.5%

Risk is that the rate of return may be different than you epected Risk and return:

Gypsy Cab

Finance Page 19

Risk is that the rate of return may be different than you epected

G²=nЕt=1 (Rt-R)²/ n-1

=1,325

Year Return R Re-R (deviation) (RE-R)²

1 165 172.5 -7.5 56.25

2 150 172.5 -22.5 506.25

3 200 172.5 27.5 756.25

4 175 172.5 2.5 6.25

Variance

G²=1,325/3= 441.67G=√G² = √441.67= 21.02

Ways to measure risk:

1 standard deviations: 68% of obs2 s.d.:98.5%3 s.d.: 100%

151.48 172.5 193.53

172.5-21.02=151.48 172.5+21.02=193.52 172.5-2(21.02)=130.46172.5+2(21.02)=214.54

C.V.= G/R = 21.02/172.5=0.1219

The smaller the coefficient of variation the tighter the distribution

Coefficient of Variation=

Risk that a firm cannot cover operating cost -

Business risk a.

Firm cannot meet its financial obligations -

Financail Risk b.

Firm Specific Risk 1)

Interest rate risk a.

An investment becomes less liquid -

Liquidity Risk b.

Something will happen in the market that will effect everyone-

Market Riskc.

Investor Specific Risk2)

Event Riska.Exchange rate risk b.Purchasing power risk c.Tax Risk d.

Firm and Investor Risk3)

3 areas-Sources of Risk:

Boom: R1=20% ; p=.1Normal: R2=10% ; p=.2

Three possible scenerios -

Recession : R3=2% ; p=.7

Estimate alternate returns•Assign probabilities•Plug into E (R )= nЕi-1 pi Ri = (.1)(20)+(.2)(10)+(.7)(2)= 5.4 •

Risk assessment for the future:

Estimate returns in every scenerio- recession, boom, same or differentFuture•

Measuring Risk

Relationship Between Risk & Return

Finance Page 20

Estimate returns in every scenerio- recession, boom, same or different□

Future•

Set up a range of possible returns (to measure the risk)Sensitivity Analysis

Car wash-

Mexican restaurant -

Two investments: $100 thousand each

Measure the most optimistic and pessimistic •Which will return 10% annually?

Prob..7.6.5.4.2.10 5 10 15 20

Prob..7.6.5.4.2.10 8 10 12

Wash Restaurant

Return Return

Car wash Restaurant

Initial I $100,000 100,000

Annual R Prob

Pessimistic 5% 8% .2

Most likely 10% 10% .6

Optimistic 15% 12% .2

Range 10% 4%

Wtd value Wtd value

1% 1.6%

6 6

3 2.4

E( R)=10 10

I Ri E ( R) Ri- E( R)

1 5 10 -5

2 10 10 0

3 15 10 5

Car Wash:

10

[Ri-E( R)]2 Pi [Ri-E( R)]2* Pi

25 .2 5

0 .6 0

25 .2 5

√10=3.162 =G10+ =G

R=nEi=1/nE( R)=nEi=1 piRi

G2=nEi=1Pi[Ri-E( R)]2

Gi= √G2

Using Standard Deviation

1.6√1.6=1.265=G

I Ri E ( R) Ri- E( R) [Ri-E( R)]2 Pi [Ri-E( R)]2* Pi

1 8 10 -2 4 .2 .8

2 10 10 0 0 .6 0

3 12 10 2 4 .2 .8

Restaurant:W-CV=3.1623/10= .3162R- CV= 1.265/10=.1265

Confidence intervals

Given any risk you maximize return-

What return do I want -- minimize your risk -

Efficient Portfolio:

Limits risk-

Pick assets from different markets -

Diversification:

Total Risk= Diversification + Non diversifiable

Portfolio Risk

Unsystematic risk(firm specific, industry specific) Market risk (systematic risk)

E(Rp)= W1E(R1)+W2E(R2)+…+WnE(Rn) % of the portfolio Expected return investment

Valuing Stocks:

1000*.085=85.0

Finance Page 21

Po=Do(1+g) = D1

g<rs rs-g rs-g = 1.00(1+.0574) = 1.0574

=$46.79 .08-.0574 .0226

Rs-g= D1/Po

And r=D1/Po+g = 1.0574/46.79 + .0574=.0799=%8

g=Po*r-Do

Po+Do

Po=D1/r-g If Po=D1/r-g, then r-g=D1/Po

And -g=D1/Po-rOr g=r-D1/Po =.08-1.0574/46.79=.0574

p.214Growth rate changes the value of the stock can still be calculated

If Po= Do(1+g) = D1

r-g r-g

r=Rf+[В(Rm-Rf)]

Capital Asset pricing model:

B tells how risky the firm is

What do you do to value a stock that doesn’t pay dividends? Or a company with an erratic dividend history?

PE

Cerro gate: Price earnings ratio

P/E*E=P

P/E=25.04EPS=$24.62

Google:

P= 25.04*24.62=616.48

If price of stock is less then it is undervalued If price of stock is more then it is overvalued

Chapter 5,6,7,8 [9&10-> reading assignment]

Ch6. 1,2,5,7Ch7. 4,5,12Ch8. 7,9,11,13

Test Prep:

American- start low and go up at the highest bid Dutch- start high and sell parts

Dutch vs. American Auction:

They suck at everything Security exchange commission:

Ch10: Investment applications

Minimize it by diversification Unsystematic risk- asset or company specific

Going international is one way to minimize the risk Systematic risk-effected by whatever happens in the market

Securities are subject to two types of risk

Attempt to measure how the systematic risk in a particular security or asset β=slope

Capitol Asset Pricing Model

Finance Page 22

Attempt to measure how the systematic risk in a particular security or asset β=slopeCapitol asset pricing

β=1

Market return (%)

Asset Return

Your companies volatility of returns is more volatile than the market Your companies volatility of returns is less volatile than the market

Month Y: Return on J X:return of Market

1 -10 -5

2 -5 -2.5

3 5 2.5

4 -2 -1

5 10 5

6 12 6

7 0 0

Calculator: 2nd- data2nd clrworkKey in X value Enter vKey in Y value Enter vKey in next x enter vKey in next y enter v…Enter last (don’t press v)2nd Stat2nd clr work

b=2

J is twice as volatile as the market

Bp=(w1*b1)+(w2*b2)+…+(wn*bn)Portfolio Beta

Assumes that you have a market of many small investors with no restrictions on investors and all investors are rational

The efficient marketCapitol asset pricing model:

Ri= Rf+bi(Rm-Rf)

Ri= 2.7%+ 1.13(8.41-2.7) =2.7+1.13(5.71)= 2.7+6.4523 =9.2

Expect a return of 9.2%

Google:

Rf- if the risk free rate goes up then your expectations on the investment you need is expected to go up tooβi- if a companies beta goes up then expectation goes up too. B shows the systematic risk of the system Rm& Rf- the greater the distance between the market rate and risk free rate the better

Required Return20

15

10

50

β0 .5 1.0 1.5 2.0 2.5 3.0

2.7

SML (security market line)

Market risk premium

Balance sheet, income statements Operating plans are made to support the mission

Grows to the point where it cannot grow anymore Proprietors (72%)- owned by a person, account for (5% total sales)

Business organizations:

Ch.11

Finance Page 23

Grows to the point where it cannot grow anymore Partnerships- the more people you have the more difficult it is to make decisions, this leads to limited partnerships where you have people with more say than others Corporations -(20% of all firms) (85% sales)- infinite in lifespan with limited liability.

Board of directors- manage the CPO- who manages everyone else

Treasurer-

Generally accepted accounting practices (GAAP)

Controller -

CFO

Defined by the financial accounting standards board (FASB)

Finance manager- cash flow (development/decision driven) Accountants-balance sheet

Annual reports: Balance sheet, cash flow statement, income statement

Stock holders

Firms are structured:

Once a yearTwice a year

Calculating the value of bonds

Yield to Maturity of a bond

If Pb= nεt=1 Cn/(1+rb)n + par/(1+rb)n

Then solve for rb

C=$70Par=$1000$1,206.42n=282.47%

=%5(1+.0247)2-1=.05

The higher the coupon rate, the higher the market value of the bond, given the market rate .

1)

The more frequent the coupon payment the higher the bond price (because the cash flows are received sooner)

2)

The higher the market i-rate, the lower the price of the bond and the higher the YTM

3)

More risky bonds have higher coupons + higher required yields or sell at lower prices

4)

Summary on bonds:

The I'=(1+.06)1/2-1=.0296Pb=$1,101.82 vs. 1,206.42YTM=(1+.0296)2-1= .0601

Assume mkt rate is 6%

Equity is permanent, you can buy a stock and own it until the company doesn’t exist any more

Debt interest is tax deductibleThe most you can lose is the vale of the stock

The par value of common stock is relatively meaningless, its only there for accounting purposes

Preemptive right to purchase stock at lower than the market price

The epensive stock is split so that iit is more affordableSo each stock owner gets another stock thus making a lot on money

Stock split:

Held by the company itselfTreasury stock:

-some shares of stock get the option of super voting-stock without a vote

Consist of cash, additional stock, or commodities Dividends are discretionary

There are differences between one preferred stock to another

The investment bank can also say they will may their best effort and give the company a portion of what they sell

Investment Banks may engage in underwriting, to guarantee the corp. that is selling debt the corp. will receive a certain amount of proceeds for the sold debt

Securities and Exchange registration 20 days before approval -

The company can issue a prospectus telling corps what they plan to do S.E.C Registration•

# of ways companies can go public:

Equity Capitol

Finance Page 24

The company can issue a prospectus telling corps what they plan to do -

"red herring" selling to potential buyers before the 20 days

S.E.C Registration•

Flotation costUnder writing cost- spread of what they buy and sell it forLegal cost

Costs:

They can have an auction instead of going through the SEC •

-find a lender or group of leaders to buy it offPrivate placement•

Ex.$1.25/.08=$15.62

Po=Do/rs

1.25/15.63=0.08 =8%Rs=Do/Po

Preferred Stock:

D1=D0(1+g)Po=D1/(1+rs) + P1/(1+rs)

Ex.P0=1.25/1.08+20/1.08= $19.68

One-Period Valuation1.

Po= Do(1+g)/(1+rs) + D1(1+g)/(1+rs)2+…+D∞ /(1+rs)∞ or Po=∞εt-1Dt/(1+rs)t

∆Po=D1/rs= $2.00/.08=$25.0 Ex.

D1=.60Po=.6/.02= $30Rs=D1/Po is "Dividend Yield"

Dow Chemical

No-Growtha.

Po= Do(1+g)/(1+rs) + D1(1+g)/(1+rs)2+…+D∞ /(1+rs)∞or Po=∞εt-1Dt/(1+rs)t

Po= Do(1+g)/(rs-g) and g<rs

-> as a future amount approaches zero we can collapse it to:

Ex.

2009:1.002008:.952007:.902006:.852005:.80

Dividend history:

1.00(1+0.0574)/.08-.0574= $46.79

Constant Growth Model (Myron Gordon growth model)b.

General Model2.

Common Stock:

Variable growth modelRead it

p.214-215

Write out the procedures for the different calculations

Test-Next Thursday the 18th

Finance Page 25

Companies are forced to use various depreciation by government that has nothing to do with old equipment. p.325-26

Life of asset -

Rate at which it will depreciate -

The full cost of the item is depreciated

What you can depreciate is what can be subtracted from your income before being taxed

Depreciation is for the purpose of saving money

Evaluating and selecting long term investment projects Capitol Budgeting

Finance Page 26

Evaluating and selecting long term investment projects Projects that will last greater than 1 year

Proposal 1)Reviewed and analyzed 2)Decision 3)Implementation4)Follow up5)

Independent projects

Mutually exclusive

Steps:

Accept or rejectRank process to do the projhects in a certain order

Decision making

Conventional- outflows followed by inflowsNon-conventional: outflows and inflows period after period

Cash flow scenarios:

Goal of firm is to maximize the wealth of the owners/ the value of the firm

Payback period •Net present value method•Profitability index (NPV)•Internal rate of return •Modified IRR •

Capital Budgeting Techniques: analyze- capitol budget techniques:

Interpret results

In evaluating- identify all cash flows

Different techniques:

Once you have estimate of inflowsCalculate amount of time it will take the firm to cover initial investmentMax acceptable limit for payback

Payback period-

year Saving

0 -256,800

1 77,000

2 93000

3 80000

4 76000

5 75000

Expected cash flow=

Simple:

Computer system replacement^^^

year Saving

0 -250000

1 70000

2 85000

3 95000

4 110000

5 100000

System analysis

77000+93000=170000+80000=250000256800-250000=6800 76000/12=6333.3333 Jan

Which one should we do?

70,000+85000=155000+95000=250,000

Net Present Value Approach:

Expected cash flow=

year Saving

0 -256,800

1 77,000

2 93000

Present value of cash inflows-initial investment=NPV

NPV=E1n CFE/(1+rs)t - CF

Assume: rs=.10

Finance Page 27

3 80000

4 76000

5 75000

Computer system replacement^^^

System analysis VVV

year Saving

0 -250000

1 70000

2 85000

3 95000

4 110000

5 100000

See Sheet: calculate NPVWhatever has the highest value is the most valuable

Discount Rates(X)% Computer system Systems Analysis D.f

0 144,200 210,000 65800

5 91,283.95 144,678.63 53,394.6

10 48,642 92,482.81 43840.81

15 13,820.68 50,216.35 36,395.67

20 -14,961.65 15,573.56 30.535.21

25 -39,014.40 -13,136 -25,876.40

250

200

150

100

50

0 5 10 15 20 25 30 %

1000's

Computer System

Systems analysis

Using NPV:

PI=PV(cash inflows)/ PV(cash outflows)OrPV(cash inflows)/ initial investment

Profitability Index

Accept the project if the PI>1

Computer system PI=305,442/256,800=1.19System Analysis PI=342,453/250,000=1.37

IRR

IRR=Ent=1 CFt/(1+IRR)t= CF0

Computer systemExpected cash flow=

year Saving

0 -256,800

1 77,000

2 93000

3 80000

4 76000

5 75000

System analysis VVV

year Saving

0 -250000

1 70000

2 85000

3 95000

256,800NPV=0

IRR=17.2860%

250,000

IRR=22.5986%

Finance Page 28

3 95000

4 110000

5 100000

250,000NPV=0

When all the cash flows are not all inModified IRR

0 1 2 3 4

-10,000 5000 -2000 5000 5000

8% PV outflows 10,000 1,714.68 $11,714.68

FV Inflows6,298.565,400.005,000.0016,698.56

n=4

Payback period1)Net present Value2)Profitability index3)Internal rate of return 4)Modified IRR5)

Capital Budgeting Techniques

0 1 2 3 4 5

Investment $ $ $ $ $

PV

PI=pv/investment

Finance Page 29