possible theory questions for final Flashcards
Preferential subscription rights: justification & economic valuation
- when a company decides to increase its share capital by issuing new shares or bonds convertible into shares; old shareholders have preference in the subscription
- 2 options:
1) exercise the right
2) sell the right
- in case of capital increases, charged to reserves, known as right of free assignment, shares are assigned without explicit instructions or any disbursement by the shareholder
valuation:
MARKET VALUE = SHARES OUTST. x SHARE PRICEa + NEW SHARES ISSUED x SHARE PRICEb
EX-RIGHTS PRICE = MARKET VALUE / (SHARES OUTST. + NEW SHARES)
VALUE OF A RIGHT = PRICE SHARES OUTSTANDING - EX-RIGHTS PRICE
Do you think an analyst can, based on technical analysis, beat the market if the weak hypothesis of efficiency is fulfilled?
WEAK:
- security prices reflect all information found in past prices
- if this holds, the technical analysis has no value
- since stock prices only respond to new information, which by definition arrives randomly, stock prices are said to follow a random walk
TECHNICAL ANALYSIS:
- use of past price movements to predict future fluctuations
In the weak form, fundamental analysis and non-public information can be used to excess returns.
Can the shares of 2 companies in the same sector have a very different beta?
Different firms in the same industry do have very different betas. A few reasons are as follows:
- Firms have different capital structures and different capital structures may have different betas.
- A firm’s profitability will greatly influence its beta.
- A firm’s infrastructure and manpower capacity impact the firm’s beta.
- A firm’s future planning and implementation impact the firm’s beta.
- Therefore, each firm has its uniqueness and differences, so the firms in the same industry may have very different betas.
Most analysts agree that betas are generally stable for firms in the same industry.
Changes in beta in same industry:
- changes in PRODUCT LINE
- changes in TECHNOLOGY
- DEREGULATION
- changes in FINANCIAL LEVERAGE
Highly cyclical stocks have higher betas.
* Empirical evidence suggests that retailers and automotive firms fluctuate with the business cycle
* Transportation firms and utilities are less dependent upon the business cycle
* Note that cyclicality is not the same as variability—stocks with high standard deviations need not have high betas
* Movie studios have revenues that are variable, depending upon whether they produce “hits” or “flops,” but their revenues may not be especially dependent upon the business cycle
What are the factors that influence the value of an option and how do they affect the premium of a call option?
the buyer of an option pays a premium to the seller of the derivative, in exchange for the payment, the buyer is given the option
stock option -> right to buy/sell a security at a set price within a set period of time, type of derivative
call option -> right to buy
put option -> right to sell
FACTORS:
- underlying price
- exercise price
- time to expiry
- risk-free rate
- volatility
- interim cash flows and costs
1) Premiums are determined by the interactions between buyers & sellers on the trading floor at the exchange. The 2 specific aspects of an option contract are the underlying futures contract and the strike price.
2) total cost of an option is the option premium multiplied by the size of the futures contract
3) before expiration, the option premium will consist of its intrinsic value plus its time value
4) an option at expiration will be equal to its intrinsic value because there is no remaining time value. if an option has no intrinsic value at expiration, it will expire worthless
5) the time value of an option’s premium is primarily determined by:
- relationship between underlying future price and the option strike price
- length of time remaining until separation
- volatility of underlying futures price
- interest rate
Determine the different sources of long-term financing of the firm and explain them.
FIRMS have DIFFERENT SOURCES OF CASH:
- INTERNALLY GENERATED FUNDS: defined as depreciation + earnings that are not paid out as dividends (retained earnings)
- EXTERNALLY GENERATED FUNDS:
1) Shares (paid after debtholders)
- Treasury stock: stock that has been repurchased by the company and is held in its treasury
- Outstanding shares: shares that have been issued by the company and are held by investors:
2) Debts (they are deductible from taxable income; government provides a tax subsidy on the use of debt)
- Bond: doesn’t have voting rights but it tends to have some covenants
- Bank loans: they are above bonds in seniority
- Line of credit
- Accounts payable
Efficient capital markets (Efficient Market Hypothesis)
An efficient capital market is one in which stock prices fully reflect available information.
This means that only new information will change the price of the stock (random walk). => There is no way to identify a more accurate fair value since all information used to calculate it is available to the public.
The EMH has implications for investors & firms:
* Since information is reflected in security prices quickly, knowing information when it is released does an investor little good (fundamental analysis is pointless). Technical analysis is equally useless since the past cannot be used to predict the randomness of the future.
FOUNDATIONS OF MARKET EFFICIENCY
* investor rationality
* independence of events
* arbitrage
types of market efficiency:
* WEAK form: security prices reflect all historical information (technical analysis doesn’t work; but fundamental analysis does)
* SEMISTRONG form: security prices reflect all publicly available information (neither fundamental nor technical analysis can be used)
* STRONG form: security prices reflect all information-public & private
Types of loans
- american
- french
- zero coupon
market portfolio
portfolio of all assets in the economy;
a broad stock market index is used to represent the market
Using an Industry beta
- It is frequently argued that one can better estimate a firm’s beta by involving the whole industry
- If you believe that the operations of the firm are similar to the operations of the rest of the industry, you should use the industry beta
- If you believe that the operations of the firm are fundamentally different from the operations of the rest of the industry, you should use the firm’s beta
- Do not forget about adjustments for financial
leverage
Determinants of beta
Business risk
* Cyclicality of revenues
* Operating leverage
Financial risk
* Financial leverage
Operating leverage VS Financial leverage
Operating leverage: sensitivity to the firm’s fixed costs of production
Financial leverage: sensitivity to the firm’s fixed costs of financing
Merger VS Consolidation
Merger
- One firm is acquired by another
- Acquiring firm retains name and acquired firm ceases to exist
- Advantage – legally simple
- Disadvantage – must be approved by stockholders of both firms
Consolidation
- Entirely new firm is created from combination of existing firms
