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					       Chapter 4 --Value-driven
       Management -- Arbitrage
 Explain how arbitrage works to ensure that the prices of
  financial claims are equal to the present value of the
  expected future cash flows.
 You have two investments of equal risk below:
 Investment A -- price $120 with a $10 return forever.
 Investment B -- price $80 with a $10 return forever.
 What should happen in the market?


 Answer  -- equal financial claims of equal risk sell for
  equal prices in the market.
         Arbitrage
 Explain how arbitrage works to ensure that the prices of
  financial claims are equal to the present value of the
  expected future cash flows.

 Two  investments of equal risk below:
 Investment A -- price $100 with a $12 return forever.
 Investment B -- price $100 with a $8 return forever.


 What   should happen in the market?
 Answer -- financial claims of equal risk sell for equal rates
  of return in the market.
      Price Terminology
 What    is the difference between bid prices, the
    highest bid price, asked prices, the lowest asked
    price and market price?

   What role does the existence of different
    information sets play in determining the different
    prices above?
    Information Sets
 Who   probably has the better information set
  pertaining to the future cash flows of Microsoft?
    Bill Gates -- the Chairman of the Board and
     Chief Executive of Microsoft
    A typical stockholder of Microsoft
 When we refer to the intrinsic value of Microsoft,
  to whose intrinsic value are we referring?
 What happens when the intrinsic value is different
  than the market price of the stock?
        Information Sets – Financing Decisions &
        Capital Investment
 When   the information set of management does not match
  the information set of the stockholders, two situations may
  exist that have an impact on the financing decision.
 Managers may be more optimistic than the market about
  the future cash flows of the company:
    What influence does this have on the financing of new
     investment opportunities?
 The market may be more optimistic than management
  about the future cash flows of the company:
    What influence does this have on the financing of new
     investment opportunities?
    Bonds
 Bonds  are one claim on the value of a firm
 Know how to find the present value of a
  bond
 Know how to use the IRR function on the
  calculator to find the market return or yield
  to maturity
 Know how to use the IRR function on the
  calculator to find the yield to call
   Bond Terminology
 Bond yield terminology
   Yield to maturity
   Yield to call
   Current yield
   Coupon rate
    Preferred Stock

 Preferred   stock is another claim on the value of a
  firm
 The value of preferred stock can be found using
  the perpetual no-growth model in chapter 3
 Value today = Expected dividend / required rate of
  return for preferred shareholders
 Market typically tells you the price and the
  dividend in know – work backwards to get the
  required return
    Common Stock
 Common stock is another claim on the value of a
  firm:
 A short-cut method to value common stock is to
  use the constant dividend growth model
 Value today = Expected dividend /(required return
  for common shareholders - growth)
 Weaknesses of the model:
    constant growth
    companies that do not pay dividends
       Asset View: Variables That Drive Stock
       Value

 Looking   at value from the asset side instead of the
  financing side, the firm value is driven by:
 Existing projects -- dividends or cash flows from existing
  projects
 NPV of new investment opportunities expected to be taken
  in the future -- with perfect information
 Competitive advantage --> Economic Profit --> taken to
  present leads to net present value --> which measures the
  increase in value of the stock (with perfect information)
    Other Events

 Factors that do not influence value -- smoke and
  mirrors
      Stock splits

      Stock dividends

 Factors that influence value
    Earnings
    Investment announcements

				
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posted:6/25/2011
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