Cheat sheet mid PDF

Preview

Summary

cheat sheet...

Description

Chapter 1 – Overview of Financial Management

ownership management Unlimited Life

Investment Vehicle Model – Investors provide financing to the firm in exchange for financial securities (bonds and shares), and firm invests these funds in assets. The income generated by the firm is distributed to the investors.

&

ownership management

Ease of raising capital Ease of transferring ownership Balance Sheet Model (Accounting Model) – Investment decisions are The Primary Goal of Financial Management – represented by LHS/Assets and Financing decisions are represented by shareholder wealth (maximize stock price). RHS/Liabilities & Equity on the balance sheet. 1. Maximize the value of the firm Total Value of Assets = Total Firm Value to Investors 3 Primary Decision Areas of Corporate Finance Capital Budgeting What long term investments (fixed assets) should the firm engage in? Decision How can the firm raise money for the Capital Structure required investments? CL, LT Debt and Decision Shareholders’ Equity. How much ST cash flow does a Working Capital company need to pay its bills (manage Management liquidity)? NWC = CA-CL Typical Organisation Chart

Roles and Responsibilities of Financial Managers Controller Treasurer Supervising accounting personnel Raising capital, managing cash and capital expenditures Preparation of financial and Supervises relationships with managerial accounting financial institutions, work with information and reports investors and potential investors Analyses accounting information Manages investments and establishes credit policies Planning and decision making Manages insurance coverage Advantages of Different Types of Business Advantages Disadvantages Business Easy to start, few Limited to life of regulations owner Single owner keeps all Unlimited liability Sole the profits Proprietorship Taxed once as Equity capital is personal income limited to personal wealth More capital available Unlimited liability (may be limited partnership) Taxed once as Dissolves when one Partnership personal Income partner wishes to sell/dies More Capital available Difficult to sell/transfer Corporation Limited Liability Double taxation (not for Singapore Separation of Separation of

   

2.

Maximize the wealth of its owners

3.

Maximize the price of its stock

values in the market

&

Enterprise Value = Market Value of Equity + Debt – Cash. It assesses the value of the underlying business assets unencumbered by debt and separate from any cash and marketable securities.

is to

maximize

4. Maximize its contribution to the economy Shareholder wealth is a cash-flow related concept, maximizing annual profits, market share, sales and minimizing costs may not max wealth. Concentrating on the long term. Ability to generate cash flows for stockholders determines stock prices Amount, timing, and riskiness of cash flows determine the intrinsic value of stocks.

Sources of Cash (bring in cash) Decreases in assets other than cash Increases in equity and liability

Uses of Cash (cash outflow) Increases in assets other than cash Decreases in equity and liabilities

Operating – net income and changes in most current accounts (AP, AR, Invent); Investment – changes in fixed assets; Financing – changes in notes payable, LT debt, equity accounts and dividends. ∆Cash = ∆Retained Earnings (Net Income) + ∆CL - ∆CA other than cash -∆Net fixed assets + ∆Long Term Debt + ∆Common Stock

∆Cash = Operating Activities: Net Income + depreciation + ∆noninterest bearing current liabilities - ∆current assets other than cash. Investment activities: - (∆net fixed assets + depreciation) Financing Intrinsic Value – estimate of stock’s true value with accurate risk & return Activities: +∆interest bearing current liabilities ∆long-term debt +∆common stock - dividends information Market Price – based on perceived information by the marginal investor Accounts Payables do not bear interest Reputation – compilation of impressions held by all of the entity’s stakeholders  Reputation management involves managing expectations and perceptions Agency Problem – Conflict of interest between principal and agent  Direct Agency Costs: expenditures benefit management, (monitoring) audit cost  Indirect Agency Costs: lost opportunities that would increase firm value  Shareholders and Managers  Shareholders and Creditors 1. Compensation plans tied to share value Ways to handle 2. Monitoring by creditors, analysts and investors the agency 3. Threat of being fired 4. Awareness of good Corporate Governance problem Financial Markets – markets where finances are traded. Act as intermediaries between savers and borrowers. Money Markets – debt securities of less than one year are traded: treasury securities, commercial paper, bills and inter-bank loans. Dealer Markets Capital Markets – equity & long-term debt claims are traded. Auction Markets Primary Market – funds raised go to company directly. Government and corporations initially issued securities. Public and private offerings. Secondary Market – funds raised do not go to company directly. Existing financial claims are traded. Dealer Market: OTC markets (NASDAQ) Auction markets: SGX, NYSE. Getting market value of securities is easier Chapter 2 – Financial Statement Analysis Balance Sheet – snapshot of a firm’s financial position at one point in time; Income Statement – firm’s revenues and expenses over a given period of Common-size Balance Sheet – as a percent of total assets; Commontime; Statement of RE – how much of the firm’s earnings were retained, size Income Statements – all line items as a percent of sales. rather than paid out as dividends; Statement of Cash Flows – activities on cash flows over a given period of time. Liquidity Ratios: measure ability to pay liabilities in the short run (ability to convert assets to cash quickly without a significant loss in value) Book Values (historical costs Market Values less accumulated depreciation)  Current Ratio: Current Assets/Current Liabilities Determined by GAAP Determined by current trading  Quick Ratio: Current Assets – Inventory / Current Liabilities

Lost Earnings: Interest Revenue earned on investing the money  Cash Ratio: Cash / Current Liabilities n  NWC to Total Assets Ratio: Net Working Capital / Total Assets Loss of Purchasing Power: Due to Inflation. Real value is less than 2  Interval Measure: Current Assets / Average daily operating costs - (how nominal value Avg t many days of operations can the current assets fund) t =1 Ordinary Annuity: Payments are made at the end of the period. Long Term Solvency Ratios (Financial Leverage): extent of relying on Annuity Due: Payments are made at the beginning of the period debt financing rather than equity. More debt means more likely to default Perpetuity: Infinite series of equal payments. PV = payment/interest rate. Growing Perpetuity: set of payments which grow at a constant rate each Coefficient of Variation  Total Debt Ratio: Total Debt / Total Assets CV  Debt Equity Ratio = Total Debt / Total Equity period and continue forever. PV = payment/(interest rate – growth rate)  Equity Multiplier Ratio = Total Assets / Total Equity = DE-ratio +1 t better measure of risk t  Long Term Debt Ratio = Long Term Debt/Long Term Debt + Total n Financial Markets allow companies, government and individuals to FV interest factor = Equity increase utility PV factor = t  Times Interest Earned Ratio = EBIT / Interest (given what I earn,  Savers can invest in fin assets & earn compensation for deferred how much can it cover my interests payable) consumption  Cash Coverage Ratio = EBIT + Depreciation / Interest Effective Annual Rate (EAR): the actual rate paid (or received) after  Borrowers have more access to capital to invest in productive assets Asset Management Ratios: measure how effectively assets are managed taking into consideration any compounding that may occur during the year.  Provide information about returns required for various levels of risk Annual Percentage Rate (APR): annual rate that is quoted by law. Period  Inventory Turnover: COGS/Inventory  Days Sales in Inventory: 365/Inventory Turnover = rate = APR / number of periods per year. 365XInventory/COGS (no. of days taken to sell that ‘set’ of inventory) Pure Discount Loans: Like zero-coupon bonds, pure discount bonds,  Receivables Turnover: Sales/Receivables principal (and all interest) paid at maturity, no periodic interest payment,  Days Sales Outstanding: AR/Avg Daily Sales = 365/Receivables issued at discount turnover (number of days after making sales before receiving cash) Interest Only Loans: Interest paid throughout loan period, principal at  Fixed Asset Turnover: Sales/Net Fixed Assets (for every $ of fixed maturity asset, how much sales can it generate) Loans with Fixed Principal Payments: Interest and fixed principal  Total Asset Turnover: Sales/Total Assets payments over life Profitability Ratios: measures how successful a business is in earning Amortized Loan: Equal payments cover interest expense and reduce returns on its investments. Combined effects of liquidity asset management principal Expected Portfolio Return: Weighted average of E(R) on individual

σ=

FV =PV (1+r ) =PV (1 (1+r )

and debts.  Profit Margin = Net Income/Sales  Basic Earning Power = EBIT/Total Assets  ROA = Net Income / Total Assets  ROE = Net Income (-preferred dividends) / Total Common Equity o ROA is lowered by debt – interest expense lowers net income which also lowers ROA o ROE increases with debt o ROE does not consider risk and amount of capital invested

PV =FV /(1+r ) 1 ( ) 1+i

)

n−1

CV =

Standard Deviaion σ = ^r Expected Return

stocks

Chapter 4 – Risk and Return I

n

Dividend Yield (%) = Dividend/Initial Share Price Capital Gain Yield (%) = Capital Gain/Initial Share Price Percentage return = dividend yield + capital gains yield Impact of Inflation:

1+Real Rateof Return=

√

∑ (r´ −r´

1+ nominal Rateof Return 1+ Inflation Rate

^r p=∑ wi ^r i

i=1 Expected Portfolio σ: Find σ, treating portfolio as 1 stock (or below). CVp same Portfolio Risk Premium based on market risk.

SD of a 2 stock portfolio: Market Value Ratios: relate firms stock price to earnings, cash flow & book 2 2 2 2 Expected Returns take into account uncertainties that are present in diff p  w1 1  (1 w1 )  2  2 w1 (1 w1 ) 12 1 2 values  P/E Ratio: Price/Earnings how much investors are willing to pay for $1scenarios. Correlation Coefficient/Covariance: -1.0 ≤ ρ ≤ 1.0 of earnings n i  M/B Ratio: Market Price per share/Book Value per share how much 1 2 n n investors are willing to pay for $1 of book value equity 12 2 i 1 ,i 1 2, i i=1 OR 1 2 i i Dupont Identity If ρ=-1.0, 2 stocks can form a riskless portfolio i=1 i=1 ROE = ROA X EM = PM X TA TO X EM = NI/SALES x SALES/TA x TA/TE If ρ=+1.0, there is no reduction of risk for the 2 stock portfolio Profit Margin: measure of firm’s operating efficiency – Risk is the uncertainty associated with future possible outcomes. Total Risk = Company-specific (Unsystematic Risk) + Market how well does it control Investment risk is the potential for investment return to fluctuate up and (Systematic) Risk costs Unsystematic Risk: caused by random events specific to firm. Can be down diversified n Total Asset Turnover: Systematic Risk: affects most if not all firms. Cannot be diversified away. 2 measure of firm’s asset use i i efficiency – how well does it β measures stock’s market/systematic risk, shows volatility relative to i=1 manage its assets. market, indicating how risky a stock is if held in a well-diversified portfolio. Standard deviation measures stand-alone risk of an investment Market β is 1. Equity Multiplier: Using Historical Data: R avg = Arithmetic mean (avg annual return) R t = measure of the firm’s realized ROR financial leverage.

r

^r =∑ r P

∑ ¿ /T ^r =¿

√∑

σ=

Chapter 3 – Time Value of Money

(r −^r ) P

Cov ( r ,r ) = ρ =∑ p (r − r´ )(r −´r ) σ σ

Coupon: A bond’s interest (payment)

M r i ,r ¿ ¿ Cov ¿ σi ρℑ=¿ β i= σM

Coupon Rate × Par Value Coupon=No .of Coupon Payments per year

Geometric mean: what you actually earn per year on average compounded annually. Also known as mean holding period return or average compound return earned per year over a multi-year period. Arithmetic mean: what you earned in a typical year. Chapter 5 – Risk and Return II Risk-Return Trade-off for a portfolio is measured by portfolio’s expected return and standard deviation (volatility of the portfolio) Diversification involves investing in different asset classes and sectors. It reduces variability of returns without equivalent reduction in expected returns. Well Diversified Portfolios have very little unsystematic risk. Risk = systematic risk Portfolio’s Beta, βp is the weighted average of the assets betas. Systematic Risk Principle: There is a reward for bearing risk but there is no reward for bearing risk unnecessarily. Expected return on a risky asset depends only on β. β>1 implies that the asset has more systematic risk than the overall market

Coupon Rate: Annual coupon divided by the par value of the bond (annual) Par: Face value of a bond (principal amount) that will be repaid at Capital Asset Pricing Model: equation describing SML. Appropriate return maturity. for risk Callability: the issuer can redeem the bond before it expires Seniority: Preference in position over other creditors. Subordinated debt is junior Debenture: Bond backed by issuer’s general credit/ability to repay and not assets Basis Points: measures of differences in yields. 1 basis point = 0.01% Convertibility: option of exchanging bond for stock Protective Covenant: part of indenture that limits certain actions a company may choose to take during the term of the bond. Sinking Fund Provision: pay off loan over its life like an amortized loan. Reduced risk to investor and shortens average maturity. Not good if rates decline after issuance. Capital Market Line: the tangential line joining the Risk Free Rate to the Bond Indenture: Bond contract specifying principal, coupon, maturity, amt efficient frontier of all possible portfolios in the market of bonds, backing assets/securities, sinking fund, call provisions & protective Security Market Line Capital Market Line covenants Graphical representation of Shows rate of return, which Coupon Rate/YTM on a bond depends on risk characteristics when market’s risk and return at a given depend on risk free rate and issued time levels of risk of a specific portfolio Unsecured Subordinate No Sinking Callable Highe d Fund r Beta x-axis Standard deviation x-axis Both nonefficient and efficient Only efficient portfolios Lower Secured Senior Sinking Fund Non callable portfolios Where market portfolios and risk free assets are determined by CML, security factors are determined by SML. CML is superior to SML in measuring Yield To Maturity – rate earned if bond is held to maturity. Rate at which cash flows are discounted to the present value. Interest rate required on a risk factors. bond in the market. When YTM > Coupon Rate , bond sells below par value - Discount Bond Interest Rate rises, YTM increase, Bond prices decrease When YTM < Coupon Rate, bond sells above par value - Premium Bond Interest rate falls, YTM decreases, Bond prices increase Holding a bond till maturity ensures repayment of principal as long as no default Buying or Selling bonds before maturity can result in gains or losses outside coupon Bonds of similar risk & maturity will be priced similarly regardless of coupon

Risk Premium = (RM – RF)β = Expected Return – Risk Free Rate Market Risk Premium = RM – RF (since market beta is always 1) also risk-reward ratio Security Market Line: Graphical representation of the CAPM, and market equilibrium  Assets below SML are overpriced and assets above SML are Chapter 6 – Bond Valuation underpriced Bonds are long term debt instruments sold to raise money . Bonds are fixedincome investments, and this regular income is what makes bonds less volatile than stocks. Bond owners are creditors of the company and not owners (unlike stockholders)

Price Vs YTM

Put bond – bondholder can force the company to buy the bond back prior to maturity Lower required return Premium Bonds: YTM < Current Yield < Coupon Rate Discount Bonds: YTM > Current Yield > Coupon Rate Par Value: YTM = Current Yield = Coupon Rate

Structure of Interest Rates: r/s of time to maturity and yields ceteris paribus Does not include effects of default risk, different coupons

Normal: LT yields are more than ST

Factors Affecting Default Risk & Bond Ratings Financial Performance Bond Contract Provisions Debt Ratio Secured/Unsecured Debt TIE Ratio Senior/Subordinated Debt Current Ratio Guarantee & sinking fund provision Debt maturity Effect of Time on Bond Prices Inverted: LT yields are less than ST Factors that affect Bond Yields: Fischer Effect: 1. Real Rate of Interest 1+Nominal Rate = (1+real rate) 2. Expected Future Inflation(1+inflation) 3. Interest Rate Risk Approximation: 4. Default Risk 5. Taxability Nominal Rate = Real Rate + 6. Liquidity Risk

Pure Discount Bonds: 0-coupon bonds, sold at discount (YTM comes from difference between PV and principal sum) cannot sell more than par value. T bills Floating Rate Bonds: coupon rate float depending on index such as inflation. Less price risk. Coupon floats and unlikely to differ from YTM. Collar controlling rate Disaster bonds: issued by property and casualty companies. Pay interest and principal as usual unless claims reach a certain threshold for a single disaster. At that point, bondholders may lose all remaining payments Higher required return. Income bonds – coupon payments depend on level of corporate income. If earnings are not enough to cover the interest payment, it is not owed. LECTURE 4: Risks & Returns I Higher required return. Convertible bonds – bonds can be converted into shares of common stock at the bondholders discretion Lower required return...