CH 13

Expected HPR = E(r) = E(D1) + [E(P1) P0]/P0 Expected Dividend Yield [E(D1)/P0] + Expected Price Appreciation [E(P 1) P0]/P0
Market Capitalization Rate or Required Rate of Return = k = rf + [E(rm rf+)] Underpriced stock = k<E(r)
Intrinsic Value = V0 = [E(Dn) + E(Pn)]/(1+k) Underpriced stock = V0>P0
Dividend Discount Model = V0 = D1/(1+k).. + Dn/(1+k)n
Gordon or Constant-Growth DDM = V0 = D0(1+g)n/(k-g) = Dn/(k-g). If g = 0 dividend stream would be a perpetuity, P 0 = D1/(k-g)
Implies that stock value will be greater with: 1. Larger E(Dn); 2. Lower k; 3. Higher g
In case of a constant expected growth of dividends, capital gains = g. For V 0 = P0, E(r) = D1/P0 + (P1 P0)/P0 = D1/P0 + g
P1=V1=(D2+P2)/(1+k)
Dividend payout ratio = dividends/earnings. Plowback or earnings retention ratio (b) = retained earnings/earnings
Although dividends initially fall under the earnings reinvestment policy, subsequent growth in assets of the firm because of the
reinvested profits will generate growth in future dividends, which will be reflected in todays share price
g = Reinvested earnings/Book value = Reinvested earnings/total earnings x Total earnings/Book value = b x ROE
Increase in stock price due to a reinvestment plan reflects that the planned investments have a E(r)>k
Present value of growth opportunities (PVGO) = increased value in firm in terms of NPV of planned investments
Price = non-growth value per share + PVGO = E1/k + PVGO
ROE>k=Positive NPV ROE=k=Zero NPV ROE<k=Negative NPV
Growth per se is not what investors desire. It enhances value only if ROE>k
2-stage DDM =
Multi-stage DDM =
P/E = (1-b)/(k-g)=Price/EPS = P0/E1 = 1/k [(1+PVGO)/(E1/K)] = (1-b)/k (ROE x b)
PEG ration=(P/E)/g
Free Cash Flow to the Firm: FCFF=EBIT(1-t)+Depreciation-Capital Expense-Increase in NWC
Free Cash Flow to Equity: FCFE=FCFF-Interest expense(1-t)+Increase in net Debt.
Market Value of Equity=FCFE/k-g

CH.5
Arithmetic Average = (R1 + R2 + Rn)/n Ignores compounding doesnt represent an equivalent single R for the whole period
Geometric Average value (Time-weighted) (RG) = [(1+ R1) + (1+R2) + (1+Rn)]1/n -1 single period rate compounding the same
IRR (Dollar-weighted) Net inflows = negative; Net outflows = positive accounts for different amounts under management
Month 1 2 3
Assets managed, started at the $10,000,000 $13,200,000 $19,256,000
month
HPR % 2 8 (4)
Total assets before net inflows $10,200,000 $14,256,000 $18,485,760
Net inflows $3,000,000 $5,000,000 $0
Assets managed, end of the $13,200,000 $19,256,000 $18,485,760
month

CFo C01 F01 C02 F02 C03 F03

-10,000,000 -3,000,000 1 -5,000,000 1 18,485,760 1
CPT:IRR=1.1703654%
APR = [(1+EAR)1/n -1] x n EAR = (1 + APR/n)n -1
Compounded continuously: APR = ln(1+EAR) EAR = eAPR -1
Nominal Interest = R = (1+r)(1+i) -1
Real interest: r=(R-i)(1+i)
Scenario Analysis: Setting up a probability distribution of different HPRs based on different economic situations to quantify risk
Expected Return/Avg.HPR/Mean of HPR distribution/mean return = p(s)r(s) = Sum of HPR x its probability
Variance = Var(r) = p(s)[r(s) E(r)]2 Standard Deviation = [Var(r)]1/2 = %
A B C D E F
Scenario Probability HPR (%) B*C (%) Deviation from Variance
mean return
1 0.05 (37) (1.85) -37-10=-47 110.45
2 0.25 (11) (2.75) -11-10=-21 110.25
3 0.4 14 5.60 14-10=4 6.4
4 0.3 30 9 30-10=20 120
Total Mean: 10.0 347.1
Normal Distribution: mode = mean = median.
68.26% of observations within +/- 1
95.44% of observations within +/- 2
0.26 % of observations outside with +/- 3
2 assets with normally distributed returns = normally distributed
Normal distribution is completely described by its mean and
is an appropriate measure of risk for a normally distributed portfolio. No other statistic can improve the risk assessment
Standard Deviation Score/Standardized return/Standard normal variable = sr i = [ri E(ri)]/i ri = E(ri) + sri x i
Enables us to measure distance from the mean in units of
VaR = measure of the downside risk. The worst loss suffered with a given probability = E(r) + (-1.64485)
Risk Aversion: A=(E(rp)-rf)/2p (A plausible estimates for the value of A lie in the range of 1.5 4)
Sharpe ratio: S=Portfolio risk premium/SD of the portfolio excess return=(E(r p)-rf)/p (The greater the S gives a more efficient
portfolio). A risk-free assets would have zero of SD and risk premium
E(rc)=y(E(rp)-rf)+rf
c=yp
Slope of the Capital Allocation Line = Sharpe ratio
Preferred Capital allocation: y=(E(rp)-rf)/A2p

CH 10
Current yield = Annual Coupon / Bond Price
Invoice price of a bond = Flat price + Accrued interest
Accrued interest=(Annual Coupon payment/2)*(Days since last coupon payment/Days separating coupon payments)
Nominal Return = (Interest+Price Appriciation)/Initial Price (Same calculation as HPR)
Real Return=((1+ Nominal Return)/(1+Inflation)) - 1
Remember that the convention is to use semi-annual periods: Price of a Zero-Coupon Bond = Face Value / (1+ Semiannual YTM)T
Price of coupon bond=Coupon*(1/r)*(1-(1/(1+r)T))+Par Value *1/(1+r)T
Realized compound return: V0(1+r)2=V2 V0=Face Value V2=Bond price in second yr
If YTM then HPR
Forward rate of interest=1+fn=(1+yn)n/=(1+yn-1)n-1
Forward rate of interest: fn=E(rn)+Liquidity premium

Effective Annual Interest=(1+(i/n))n -1

Taxable Income=Interest income + Capital Gain