Chapters 13-15 Flashcards
when are independant share valuations required
if the company is unquoted
if stock market does not value shares correctly
if there is a takeover bid and the value of the company will change
what is a market capitalisation
total value of all shares in the company
what is the maximum way of business valuation
cash flows or earnings for controlling interests
what is the maximum way of business valuation
value dividends under existing management
what is the minimum way of business valuation
value assets using net book value
how to calculate net assets
NCA+ CA - all liabilities
disadvantages of the asset based approach
ignores intangible assets and future profits
how do you use P/E ratio
P/E ratio x earnings of target
disadvantages of P/E Ratio
difficult to estimate P/E ratio
earnings of target company may need to be adjusted
P/E ratios may be distorted by swings in the stock market
what is the dividend valuation method
value of a share is calculated as present value of future dividends that are being generated by current mngmnt team
disadvantages of DVM
difficult to estimate future dividend growth
inaccurate to assume growth will be constant
creates zero values for zero dividend companies
what valuation can be used for securities other than shares
discounted cash flow techniques
what is the efficient market hypothesis
rationale for explaining how share prices react to new info about a company
what is allocative efficiency
ability of a financial market to direct funds to those borrowers who can use them most profitaby
what is operational efficiency
ability of a financial market to operate with minimal transaction costs
what is information processing efficiency
market price for securities reflects all relevant and available information relating to securities
what does a weak form of efficiency mean
stock market is not efficient at responding to events that should affect share prices
what does a semi strong form of efficiency mean
share prices reflect historical info and also reflect all publicly available info
what does a strong form of efficiency mean
share prices affect all information
what does behavioural finance mean
an alternative view, to explain market implications of the psychological factors behind investors decisions
what does herding mean
tendency for investors to follow trends which can lead to stock market bubbles
what is loss aversion
when investors place undue emphasis on avoiding short term losses even if long term performance looks strong
what is transaction risk
risk that a transaction is recorded at one rate and settled at a different rate because of forex
who loses put if the dollar is strong
exporters
who loses out if the dollar is weak
importers
what is a spot rate
exchange rate currently offered on a currency for immediate delivery
what currency do export sales result in
revenue in a foreign currency, so they will want to sell foreign currency and buy dollars
what happens if the cost is in a foreign company
they will need to sell dollars to buy foreign currency
who gets the lower rate of the spread
importer who is selling dollars
who gets higher rate of the spread
exporter who is buying dollars
what is a forward contract
a contract with a bank agreeing a exchange rate on a specific day
what is matching in the sense of managing risk
where possible creating costs in the same foreign currency
what is leading in the sense of managing risk
taking steps to encourage early payment by customers assuming the dollar is strengthening
what is invoice in domestic currency in the sense of managing risk
passes exchange rate risk to customers
adv’s of forward contracts
simple
zero up front costs
available for all currencies
disadv’s of forward contracts
its a fixed date
can be an unattractive rate
how can you eliminate exchange rate risk for an export
borrowing in foreign currency today
convert into dollars at todays spot rate
use foreign revenue to repay foreign currency loan
steps to create a money market hedge for an export
identify loan repayment required in the future (this matches revenue)
caculate amount that needs to be borrowed with interest
convert this to home currency at spot rate
place this on deposit using interest rate recieved on money
steps to create a money market hedge for an import
identify cash required to pay foreign invoice
calculate the amount that needs to be invested today in foreign currency
convert this using spot rate to domestic amount, this is the amount of dollars that need to be borrowed today
include cost of borrowing with foreign amount, compare to a forward rate
what are currency futures
a contract to purchase or sell a standard quantity of a currency by an agreed future date at a specified exchange rate
difference in currency futures and forward contracts
currency futures expire, and up until that expiry date can be used at any time
a futures contract is set up to compensate for a profit or loss on an exchange rate
advs of currency futures
more flexible
risk is lower
disadv’s of a currency future
only in available in large standard contract sizes and limited currencies
what is currency options
a right of an option holder to buy ( call ) or sell (put) a quantity of one currency in exchange for another, at a specific exchange rate on or before a future expiry date
is a currency option a contract
no, they dont have to do it
what must you do if you obtain a currency option
pay a premium up front
what is a swap
a formal agreement whereby two organisations contractually agree to exchange payments on different terms, ie in different currencies
what will happen if a country has relatively high levels of inflation
it will experience a fall in the value of its currency
how to calculate expected spot rate with inflation
SO x (1+hc)/(1+hb)
where s0 is the current spot rate
hc is inflation in foreign currency
hb is base country inflation
what is the interest rate parity theory
in the short run, banks use interest rates to calculate forward exchange rates
formula to calculate forward rates
so x (1+ic)/(1+ib)
where so is current spot rate
b is base country
c is foreign country
what is translation risk
the risk that the domestic currency value of a foreign currencys assets falls, or the value of foreign currency liabilities rises
what is economic risk
due to long term movements in the exchange rate that damage the value of a company because the NPV of the businesses cash flows is diminished by expected exchange rate trends
2 things companies can face interest risk on
borrowings
investments
what kind of interest rate risk is on investments
lower rates will reduce the return on cash investments
2 basic ways you can manage risk
smoothing
matching
what does smoothing mean
prudent mix of floating or fixed finance
what does matching mean
creating assets that are based on the same interest rates as there liabilties
what does FRA mean
forward rate agreements
a contract with the bank on a specific amount of money to be borrowed at an agreed interest rate
adv’s of FRA
simple
zero up front costs
fixes interest rate
disadv’s of FRA
fixed date
unattractive date
what is interest rate futures
a contract to receive or pay interest on a notional standard quantity of money at an agreed future date at a specified interest rate
what is a contract to buy in terms of interest rate futures
a contract to receive interest at a fixed rate
what is a contract to sell in terms of interest rate futures
a contract to pay interest at a fixed rate
what is an interest rate swap
an agreement whereby the parties to the agreement exchange interest rate commitments
