finance and risk Flashcards
stock market-liquidity
ability to sell asset for close to the price you can currently buy it for
stock market- primary vs secondary market
primary: issue shares and sell to investors
secondary: shares trade between investors
bid ask spread
sell share at bid price and buy share at ask price: the difference is the transaction cost (for the market maker)
market vs book value
market to book ratio:
- market value of equity / book value of equity
- low: payout dividend but low growth
- high: not much dividend but high g
enterprise value:
-market value of equity + debt-cash
profitability ratios (ohne gross profit)
operating margin
=operating income:sales
-how much you earn before interest and tax from each euro of sales
net profit margin=net income:sales
cash ratio
liquidity ratio
cash:current liabilities
interest coverage ratio
ebit/interest expense
net debt
total debt-excess cash
valuation principle
value of benefits>value of costs
evaluated using market price
time value of money
difference in money today and money in the future
-caused by inflation or deflation
net present value
difference between PV of cash inflows and cash outflows
npv decision rule (always choose the one with the higher npv)
arbitrage
take advantage of price difference arising from buying and selling equivalent goods in different markets
arbitrage opportunity: any situation where it is possible to make profit without risk (not in competitive market)
three rules of time travel
rule 1: only possible to compare and combine values at the same point in time
rule 2: moving cashflows forward in time with the interest rate factor
rule 3: moving cf backwards in time
perpetuities vs annuities
perpetuity:
- regular interval and lasts forever
- cash flow at end of period
annuity:
-regulae interval witz fixed end
internal rate of return
interest rate that sets the net present value of ghe cash flow to zero
-break even point for investments
EAR and APR
effective annual rate
-total amount of interest that will be earned at the end of the year
annual percentage rate
- simple interest earned in one year or period
- without effect of compounding
yield curve
term structure: relationship between investment term and interest rate
yield curve: graph of a term structure
- normal: the longer you invest the higher return
- flat: no difference in long lr shortterm
- inverted: higher rate for shorter period (forerunner for recession)
what are bonds
liabilities (sources of debt financing)
„Bonds are investment securities where an investor lends money to a company or a government for a set period of time, in exchange for regular interest payments. Once the bond reaches maturity, the bond issuer returns the investor’s money.“
coupon bonds
coupond bond:
-pay face value ar maturity and regular coupon interest payments
YTM:
-single discount rate that equates pv of bonds remaining cashflow to its current price
zero coupon bonds
zero coupon:
- always sell at discount
- do not make coupon (interest rate) payments
YTM (yield to maturity): discount rate that sets the PV equal to the current market price
-=risk free interest rate
dynamic behaviour of bond prices
discount: price less than face value
par: equal
premium: price higher than face value
interest and bond prices
high interest rate low prices
internal rate of return
- take the investment where the IRR exceed the cost of captial
- problem with multiple or no IRR
payback rule
reject project if the pay back period (amount of time it takes to pay back initial investment) is more than a pre specified length of time
mutually exclusive products
rather select the projext with the higher NPV as the IRR can be mistaken because of differences in time scaling and risk
incremental IRR
IRR of the additional cashflow that results from replacing one project with the other
-tells us discount rate at which it makes sense to switch from one project to the other
profatibility index
identify optimal combination of projects and resources
capital budgeting
captial budget: list of investments company plans to do
incremental earnings: amount by which the company’s earnings are expected to change as a result of an investment decision
analyzing a project
break even: level of input that causes NPV to equal zero
sensitivity: how npv varies with change in one od assumptions
scenario: change of simultaneously changing multiple assumptions
how to increase dividend
increase net income
increase dividend payout rate
decrease shares outstanding
total payout model
values all of the companys equity
- repurchase shares with excess cash
- less money to pay dividends
- decrease in shares outstanding
- increase in earnings per share and dividend per share
discounted free cashflow modell
is a valuation method used to estimate the value of an investment based on its expected future cash flows
common and independent risk
common:
- due to market wide news
- market risk
independent:
- company specific news
- firm specific risk
capital asset pricing model
- investors can buy and sell all securities at competitive market prices and can borrow and lend at risk free interest rate
- investors hold efficient portfolios of traded securities that yield max expected return for a given level of volatility
- investors have homogeneous expectations regarding volatilities correlations and expected returns
risk- 4 Ts
tolerate risk
treat risk
transfer risk
terminate activity that generates risks
basel 3/4
equtiy ratio
-banks need to have higher capital ratio
liquidity buffer (30 days)
abs and mbs
asset based and mortgage based
collateralized debt obligation
summarize mbs and sell of as different tranches (waterfall principle)
subprime crisis
- refinance mortgages with existing once
- give them out to customers they did not know
- customers did not pay, bank got houses
- prices dropped after banks tried to sell them again
lehman
- credit flow stopped because all banks had liqudity problems
- moved to market risk after credit risk
consequences:
- interest rate cuts (make money cheaper)
- emergency funds
- basel 3
types of risks
market risk
- exchange rate, prices, insurance, liquidity
- to minimize transfer but not everything!
credit risk:
- loans (not paid back)
- minimize: insurance, collateral
operational risk
- human error
- fraud
- minimze: insurance, train employees
insurance
pay more than fair value
- because insurance needs liquidity buffer to cover expenses
- moral hassard: people handle things less carefull when have insurance
- biased information: you know more than insurance
efficient portfolio
firm specific risk diversified out and only market risk
beta
your stocks behaviour in relation to market
-market moves up 1% yours does beta percent
beta of one: stock moves like market
(everything oil related, very big companies)
high beta: luxury goods
low beta: people use it no matter what happens (walmart, mc donalds)
yield
compare different maturities with the same risk
- price goes up yield goes down
- negative yield: return of bond negative e.g. with negative interest rates and high prices)
types:
-steep: expect high interest rates because of inflation
-inverse: low interest rate and deflation
-helpful because people wont buy
bonds but invest in something else
and loans are cheap to get so it is easy
it invest
QE
quantitative easing
-CB buys longterm bonds, prices for them increase, yield decreases, inverse yield curve
