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Principles of Corperate Finance VALUE (Ch.3 Valueing Bonds (Extra info…
Principles of Corperate Finance VALUE
Goals and Governance of a Firm Ch 1
1.Corperate Investment and Financing Decisions
Need real assets (capital)
financial assets and securities (bank loan and bonds)
investment decisions often reffered to as capital budgeting or captial expenditure
Todays captial investment create future returns
small investments can cumulate into one massive investment
firms can raise equity in two ways
issueing new shares
reinvesting cashflow
"value comes from the asset side of the balance sheet"
A corperation - is a legal entity owned by its share holders
Special role for the board of directors
Corperations are owned by there shareholders - limited liability - can only be hit by the amount they put in
need for seperation of ownership - managers may abuse they power and act in thier own intrest
2.The Role of the Finacial Manager + Opportunity cost of capaital
(CFO) Chief finacial officer - financial policy and finacial planning
Treasurer and a controller - Short term cash management
Financial manager stands between the firm and outside investors
Opportunity cost of capital depends on the risk of the proposed investment project.
also cost of capital is generally not the intrest rate that the company pays on loan from the bank - its the expected return that investors can hope to achieve with the same level of risk
valueing the opportunity cost is one of the hardest decisions of a finacial manager
4.Agency Problem and Corperate Governance
The owner can only control managers throught the board of directors
Creates an angency problem when conflicts arise
When managers do not aim to maximize the firms value
shareholders incur costs to monitor the managers and constrain their actions.
agency problems can lead to outrageous behaviour - CEO of Tyco spent 2mil on his Wifes birthday
agency problem are mitigated by effective corperate governance
Compensation plans - Spurred by big cash payouts - e.g larry ellison of oracle got 70 mil - big personal stake
Legal and Regualtory requirements - Managers have a legal duty to act responsibly and in the intrests of investors.
Board of directors - passive stooges - Mum wrote the book on non excutive direcotrs, there role and their importance. hedge funds are now important aswell in influenceing the descions
Monitiring - security analysts look at all firms and label the issue on investors
Takeovers - failing business are targets for taking over - Raiders are private investment funds that reform poorly organised businesses
they buy out and reform businesses
Shareholder pressure - take over of the board of directors by powerful shareholders - if enough group together, they can perform the wlal street walk where they bail out and stock price tumbles
3.Goals of the Corperation
Share holders want managers to maximise value - smart managers make desicions to increase the current value of a companies shares and the wealth of its stock holders
risky projects are ok, provided that expected profits are more than enough to offset the risks
The Fundamental Result
Share Holders want three things
To be rich
to transform wealth into consumption
Manage risk of said consumption
Stock holders do not always need a managers help - if they have access tot he markets
How can the finacial managers help the firm's stockholders. there is only one way; by increasing their wealth. - I.e increasing market value of the firms and the current price of its shares
Profitable firms are those with satisfied customers and Loyal employees
Its essentail to maintain a very good reputation
The Ponzi scheme of Bernard Madoff
Jpaan priotritizes stakeholders
Ch.2 How to Calculate Present Values
1.Future Values and Present Values
Money can be invested to earn intrest - money has a time value
Bond and stock markets are where safe and risky cashflows are traded and valued
That is why we look to rates of return - prevailing financial markets to determine how much to discount time and risk
by calculating the present value of an asset, we are estimating how much people will pay for it if they have the alternative of investing in capital markets
Compound intrest in so very valauble
it is a constant process - the easiest way to do it is to annalyse a time frame
Net Present Value is Important
Accepting projects that are worth more than they cost
they need to seek projects with positive net present values
To find the net present value you calculate the prensent value
discount future cashflows by the r rate, usually the( discount rate, hurdle rate or opportunity cost of capital
Net present value is present value plus any immediate cash flow
Net present value (NPV) = C0 + PV
C here is 0 because it is an intial investment - a cash outflow
The Discount rate is r because rate is determined by rates of prevailing capital i.e if the cash flow is completely safe than then the discount rate on safe securities such as Government debt
2 more items...
Above is the Rates
Where:
FV = the future value of money
PV = the present value
i = the interest rate or other return that can be earned on the money
t = the number of years to take into consideration
time is the link between future and present value
1 more item...
n = the number of compounding periods of interest per year
Using the formula above, let’s look at an example where you have $5,000 and can expect to earn 5% interest on that sum each year for the next two years. Assuming the interest is only compounded annually, the future value of your $5,000 today can be calculated as follows:
FV = $5,000 x (1 + (5% / 1) ^ (1 x 2) = $5,512.50
There is a shortcut - How the value of an investmnent that can makes a level stream of cash flow forever (perpetuity)
One that produces a level stream ofr a limted period ( an annuity)
Valueing investments that are producing growing cash flows
2.looking for shortcuts - Growing Perpetuities and Annuities
3.More Shortcuts
Return = cash flow % present Value (r=C%PV)
4.How Interest is Paid and Quoted
Ch.3 Valueing Bonds
1.Using the Present Value Formula to Value Bonds
if you own a bond you are entitled to a fixed set of cash payoffs - every year until the bond matures you gain intrest repayments - at full maturity you get the face value back - this is the bond "principal" ( as in its principal/main value)
PV (bond) = PV (annuity of coupon payments) - PV (final payment of principle)
=Coupons X 4 year annuity factor) = (final payment x discount factor)
8.50 [1/.03 - 1/.03(1.03)4
e, the only general procedure for calculating the yield to maturity is trail and error. you guess at an interest rate and calculate the present value of a bond's payments
The U,S treasury raises money by regular auctions of new bond issues. Some of these issues do not mature for 20/30 years
2.How Bonds Prices Vary With Intrest Rates
As intrest rates change, so do bond prices.
the higher the intrest rates, the higher the bond prices.
bond prices and intrest rates must move in opposit directions. -
bond investors pray that intrest rates will fall. so that the value of their securities goes up.
bonds are more effected by changing intrest rates than short term bonds fluxuations
Strips are Zero coupon bonds
Investors calculate a bonds average maturity by it duration. They keep track of said duration becuase it measures the exposure of the bonds price to fluctuation in intrest rates
duration is the weighted average of the times when the bond's cash payments are recived.
3.The Term Structure of Intrest Rates
4.Explaining said structure of Intrest Rates
Expectation theory - basically group thingk for investments
The problem of Risk - expection does not account for it - good business men are fantastic at evaluating risk
Inflation and term struckture
confidence on future inflation is key
2009 example - was government borrowing going to prompt rapid inflation
was there going to be a period of prolonged deflation,
inflation is an importatn source of risk for long term investors, borrowers must offer some extra incentive.
A single yeild discount rate to calculate the value of each period's cashflow.- For many purposes using a single discount rate is a perfectly acceptable aproximation, but there are also occasions when you need to recognize that short term. intrest rates are differentfrom long term intrest rates.
the relationship between long and short term intrest rates is called the term structure of intrest rates.
5.Real and Nominal Rates of Interest
6.Corperate Bonds and the Risk of Default
Bonds are issued all over the world
corperations that get into finnancial distress may also be forced ot default on there bonds. Thus payments promised to corperate bondholders represent a best case sencario
the firms willl never pay more than the promised cashflow.
Any bonds over BAA are considwered to be investment grade bonds.
if an investment grade bond goes under - creates shock waves, - World com sold 11.8 billion of bonds in 2001 - next year it went bankrupt - bondholders lost 80%
the yeild for general motors in december 2008 was 50% - Amazing returns, however every one knew a reccession was about to happen, so it was unlikely that someone would get there money back.
Types of corperate bond
Floating rate bonds - they make coupon payments that are tied to some measure of current market rates. The rates might be reset once a year to the current short-term treasury rate plus a spread of 2%
Convertible bonds, if you buy convertible bonds, you can choose later to exchangeit for a specified number of shares of common stock. For example, a convertible bond that is issued at face value of 1,000 may be convertible into 50 shares of the firms stock.
they offer the opportunity to participate in any proce appreciation of the companies's stock convertibles can be issued at lower coupon rates than plain vanilla bonds.
Extra info
bonds are long term loans
Local authorities use bonds not just companies
risk of deffaulting on bond repayments
Investors expect higher rates of return from cost of capital for aa business - the project taht companies undertake are risky, not like bonds
bond traders make massive trades on minor price adjustments
Corperate bonds are not that liquid
Ch.4 The Value of Common Stocks
1.How Common Stocks are Traded
How Common Stocks are Valued
Estimating the Cost of Equity Capital
4.The Link between Stock Price and Earning per Share
5.Valueing a Business by Discounted Cash Flow
Ch.5 Net Present Value and Other Investment Critieria
1.Review of the Basics
2.Payback
Internal (Discounted-Cash-Flow) Rate of Return
4.Choosing Capital investment when Resources are limited
Ch 6 Making Investments Decisions with the Net Present Value Rule.
1.Applying the Net Present Value Rule
2.Example of the Rule - Case Study IM&C's Fertilizer Project
3.Investment Timeing
4.Equivalent Annual Cash Flows
