Chapter 12x - U of L Class Index
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Transcript Chapter 12x - U of L Class Index
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ROSENGARTEN CORPORATION
Pro forma balance sheet after 25% sales increase
($)
(Δ,$)
($)
Assets
Current assets
Cash
A/R
Inventory
Total
Liabilities and Owner's Equity
$200
$40
550
750
$1,500
110
150
$300
Fixed assets
Net plant and
equipment
Total assets
(Δ,$)
$2,250
$450
$3,750
$750
Current liabilites
A/P
$375
$75
Notes payable
Total
100
$475
0
$75
Long-term debt
Owner's equity
$800
$0
$800
1,100
$1,910
$0
110
$110
$3,185
$185
Common stock
Retained earnings
Total
Total liabilities and
shareholder's equity
External financing
needed
$565
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EFN and Capacity Usage
Suppose Rosengarten is operating at 80%
capacity:
1. sales at full capacity 1000/.8=1250
2. What is the capital intensity ratio at full
capacity? 3300/1250 =2.64
3. What is EFN? 300
Conclusion: excess capacity reduces the
need for external financing and capital
intensity ratio
http://www.potashcorp.com/stakeholder_communications/2010/09/07/774/
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Chapter 12
SOME LESSONS FROM
CAPITAL MARKET
HISTORY
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Chapter Overview
Return of an investment: arithmetic and
geometric
The variability of returns
Efficiency of capital markets
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Return from a Security (1)
Dollar return vs. percentage return
Two sources of return
◦ dividend income
◦ capital gain (loss)
realized or unrealized
Div Pt 1 Pt
Ri
Pt
Pt
Dividend Payout
Capital Gain
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Mean
Assume the distribution is normal
Mean return - the most likely return
A measure of centrality
Best estimator of future expected returns
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The First Lesson
The difference between T-bills and other
investment classes can be interpreted as a
measure of the excess return on the risky asset
Risk premium = the excess return
required from an investment in a risky
asset over a risk-free investment
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Arithmetic vs. Geometric
Averages (1)
Geometric return = the average
compound return earned per year over
multiyear period
Geometric average return =
T (1 R1 ) * (1 R2 ) *... * (1 RT ) 1
Arithmetic average return = the return
earned in an average (typical) year over a
multiyear period
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Arithmetic vs. Geometric
Averages (2)
The geometric average tells what an investor
has earned per year on average, compounded
annually.
The geometric average is smaller than the
arithmetic (exception: 0 variability in returns)
Geom. average ≈ arithmetic average – Var/2
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Which Average to Use?
Geometric mean is appropriate for making
investment statements about past performance
and for estimating returns over more than 1
period
Arithmetic mean is appropriate for making
investment statements in a forward-looking
context and for estimating average return over
1 period horizon
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The Variability of Returns
Variance = the average squared deviation
between the actual return and the
average return
(R R )
Var ( R)
2
i
T 1
Standard deviation = the positive square
root of the variance
Var
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Standard Deviation
Measure of dispersion of the returns’
distribution
Used as a measure of risk
Can be more easily interpreted than the
variance because the standard deviation is
expressed in the same units as
observations
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The Normal Distribution (1)
A symmetric, bell-shaped frequency
distribution
Can be completely described by the mean
and standard deviation
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The Normal Distribution (2)
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Z-score
For any normal random variable:
X
Z
Z – z-score
X – normal random variable
- mean
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Yet Another Measure of Risk
VaR = statistical measure of maximum
loss used by banks and other financial
institutions to manage risk exposures
•
How much can a bank lose during one
year?
•
Usually reported at 5% or 1% level
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The Second Lesson
The greater the potential reward the
greater the risk
Which types of securities have higher
potential reward?
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Capital Market Efficiency
Efficient capital market - market in
which security prices reflect available
information
Efficient market hypothesis - the
hypothesis that actual capital markets are
efficient
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What assumptions imply efficient
capital market?
1.
Large number of profit-maximizing
participants analyze and value securities
2.
New information about the securities
come in random fashion
3.
Profit-maximizing investors adjust
security price rapidly to reflect the
effect of new information
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Forms of Market Efficiency
Weak form – the current price of a
stock reflects its own past prices
Semistrong form – all public
information is reflected in stock price
Strong form – all information (private
and public) is reflected in stock prices
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Weak Form Efficiency
Current stock price reflects all security market
information
You should gain little from the use of any trading
rule that decides whether to buy/sell security
based on the passed security market data
Major markets (TSX, NYSE, NASDAQ) are at
least weak form efficient
January
effect
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Semistrong Form Efficiency
Mutual fund managers have no special ability to
beat the market
Event studies (IPO, stock splits) support the
semistrong hypothesis
Quarterly
earnings surprise – test results
indicate abnormal returns during 13-26 weeks
following the announcement of large
unanticipated earnings change (earnings
surprise) in a company
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Strong Form Efficiency
No group of investors has access to private
information that will allow them to consistently
experience above average profits
Evidence
shows that corporate insiders and
stock exchange specialists are able to derive
above-average profits
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