Efficient Markets, PV, NPV Flashcards
weak market efficiency
prices reflect the information
contained in the record of past prices.
semistrong market efficiency
prices reflect not just past prices but all other
public information, for example, from the Internet or the financial press.
strong-market efficiency
prices reflect all the information that can be acquired by painstaking analysis of the company and the economy.
Alpha
states how much on average the stock price changed when the market index was
unchanged
Beta
tells us how much extra the stock price moved for each 1% change in
the market index
arbitrage
investment strategy that guarantees superior returns without any risk
How to sell a stock short
To sell a stock short, you borrow shares from another investor’s portfolio, sell them, and
then wait hopefully until the price falls and you can buy the stock back for less than you
sold it for. If you’re wrong and the stock price increases, then sooner or later you will be
forced to repurchase the stock at a higher price (therefore at a loss) to return the borrowed
shares to the lender. But if you’re right and the price does fall, you repurchase, pocket the
difference between the sale and repurchase prices, and return the borrowed shares
Equity financing
giving out stocks
Debt financing
lenders giving money in hopes of interest
Sarbanes Oxley Act
requires that corp place more independent directors on the board
net present value
PV - intital investment
amortizating loan
part of payment goes to interest and rest goes to reduce the loan
Conditions for market efficiency (4) from lecture notes
1) there should be a large number of profit maximization participants
2) widely publicly and cheaply available information to all investors
3) new info should be rapidly flowing
4) transactions cost must be low
Goal of financial manager
To maximize market value of corporation by maxing stock price
Market information
Everyone has access to w/o doing any math
Example prices
Non market information (4)
Macro economics aggregates, dividends/ earning announcement
Political news
Stock splits
Insider information
Mergers and acquisitions
Types of capital budgeting decisions
Accept reject decisions
Capital rational decisions
Mutually exclusive decisions
Payback
Number of periods it takes to recover/recoup the initial investment
Issues w/ payback
TVM IS IGNORED
required payback is iffy
Don’t take into consideration years after payback
Type 1 error
Accept a project that should have been rejected
Type 2 error
Reject a project you should have acccepted
Multiply IRR
when there is more than one sign change
put CF in calc as normal. 1 i RCL g R/S
200 i RCL g R/S
setbacks of IRR
NPV and irr assume that cash benefits are re-invested at the prevailing market rate. BUT irr is re-invested at projects rate which is bigger than market rate.
Projects have different scale
Projects have different lives
Modifiy IRR
1) find NPV of + numbers with neg numbers as 0. Find FV of NPV as PV
2) find NPV of - numbers with pos numbers as 0. Find NPV as PV
3) Compute i with FV and PV found
EAA
Find NPV. Make it -PV and compute for PMT which is EAA
Working Capital Mistake
1) Forget about it entirely
2) forget that it changes
3) forget to recover it at the end of project
