Chapter 13 Market Value Current market value of assets minus current market value of liabilities Liquidation Value Net amount realized from sale of assets and paying off all debt Firm becomes a takeover target if market value stock falls below this amount so liquidation value may serve as floor to value Tobin s Q Market Value Replacement Cost should tend toward 1 over time D1 dividend 1 P1 price 1 P0 begin price Expected HPR E r E D1 E P1 P0 P0 Assuming a 1 year holding period If stock is priced correctly then CAPM should equal Expected HPR Intrinsic Value the economic value of the company assuing the actual payoffs are known V0 E D1 E P1 1 k Where k CAPM 1 k k market capitalization Trading Signals If V0 P0 Buy If V0 P0 Sell short If V0 P0 Keep fairly priced No Growth Model V0 D K Constant growth model V0 D0 x 1 g k g V1 Do 1 g 2 k g Why do you have to pay more for the constant growth stock A Must pay for expected growth g ROE x b b plowback ratio 1 dividend payout rate Present Value of Growth Opportunities PVGO D0 x 1 g k g E1 K T Multi Stage Growth Model 1 g1 t 1 k t D0 t 1 DT 1 g2 k g2 1 k T Period of growth at t 1 P E Ratios are a function of two factors Required Rates of Return k inverse relationship Expected Growth in Dividends direct relationship Higher more growth P E No Growth 1 K with growth 1 b K g V0 P E x E1 P P R P Portfolio alpha A verage excess return Portfolio beta the on portfolio M Average the on market R excess return Measure of abnormal return Must establish statistical significance via regression Possible conceptual problem Greater abnormal return may be due to greater risk Unless you can hedge out the risk with short sales one should rank portfolio performance by the adjusted alpha which is Ap Bp Multi index model SMB small big HML high low Index Return Benchmark R r r SMBt during Month Weight HML SMB Major performance determinants 1 45 0 3 Broad asset allocation among types of securities 0 6 5 81 Industry weighting in equity portfolio 0 48 0 1 Security choice Timing of purchases and sales 5 34 Component Bonds Shearson Lehman Index Equity S P500 Index Cash Money Market Bogey Performance and Extra Return R P HMLt Mt Pt P 1 37 3 97 Return of the Managed Portfolio Return of the Bogey Portfolio Extra Return of the Managed Portfolio Chapter 15 What is a listed call option A contract giving the holder the right to buy 100 shares of stock at a preset price called the exercise or strike price Contracts may be sold prior to maturity What is a listed Put option A contract giving the holder the right to sell 100 shares of stock at a preset price Option Characteristics If a call option holder wishes to purchase the stock he or she will exercise the option The option holder must pay the exercise price to the option writer Exercise prices are adjusted for stock splits and stock dividends but not cash dividends The cost of an option is called the premium and it is a small percentage of the cost of the underlying asset The option buyer pays the cost the option writer receives the cost at the time of sale of the option The underlying company is not involved in the option market Options are a zero sum game American Options the option can be exercised at any date after purchase European Options the option can only be exercised immediately before expiration Buy a call option Bullish HV unlim gain Write call option Bearish LV unlim loss Buy put option Bearish HV max gain of shares x exercise price option cost Write put option Bullish LV potential loss limited gain price received for put Loss BE x of shares Long or Bull Straddle Long or bull straddle buy a put and a call with the same T immediately before the options expiration and X exercise price Max gain unlimited max loss premium paid For bear or short straddle sell both put and call and just flip the graph upside down max gain premium received max loss unlimited Price to cash flow P Cash Flow instead of P E less subject to accounting manipulation Free Cash Flow for the Firm FCFF EBIT 1 T Dep CapEx Increase in NWC P T Firm Value 1T FCFF WACC 1t T g FCFF t WACC t P T WACC T 1 1 Equity Value Firm Value Market Value of Debt FCFE FCFF interest expense 1 Tc Increase in Net Debt P T FCFE 1T g k E E quity Value T 1t FCFE t k1 E t P T k1 E T Chapter 18 Risk Adjusted Performance Single index model R e R P P Mt Pt pt E R E R P Mt P P CAPM E r Rf B E rm Rf Use To measure abnormal performance must measure normal performance Jensen s Alpha Measure P R R MP P Long bull strap buy 2calls and 1put more bullish than straddle Long bull strip buy 2puts and 1call more bearish than straddle Warnings about options Options may have to move 10 15 or more in a short time period before an investor recovers the price commission Options are by definition short term instruments an investor can ride out bad times in spot markets but not in options the limited loss feature makes options appear safer than they are You have to compare equal investments in stocks and options to really see the higher risk of the option position Options are traded in a highly competitive market What s wrong with selling options Covered calls writing calls against stock you own potential gain is limited bullish The investor never gets the occasional large stock price run up and suffers most of the loss of a big price drop Eliminates any positive skewness of stock returns Wind up with portfolio of poorer performers Naked calls writing calls when you do not own the stock potential loss unlimited Maximum gain is limited to call premium but unlimited loss poor strategy in volatile markets protective put a long put added to a long stock Chapter 17 Forward an agreement calling for a future delivery of an asset at an agreed upon price Futures similar to forward but has standardized terms and is traded on an exchange Key difference in futures Futures have secondary trading liquidity Marked to market Standardized contract terms such as delivery dates price units contract size Clearinghouse guarantees performance eliminates counter party default risk Long position Agrees to purchase the underlying asset at the stated futures price at contract maturity Short position Agrees to deliver the underlying asset at the stated futures price at contract maturity potential loss unlimited Profits on long and short positions at maturity Long Futures price at maturity minus original futures price A gain …