Finance

Created 7/1/1996
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Business Administration 130:

Summary

http://www.j-bradford-delong.net/Intro_Finance/BAonethirty23.html

Six Important Concepts in Finance:

• Net present value: if you could buy cash flows in the capital markets cheaper than you can generate them through your own operations and investments, you should do so. Net present value is a way of making sure that you engage in only those investments that cover their opportunity cost.
• The capital asset pricing model: beta; only undiversifiable risk is priced.
• Efficient capital markets--there are no money machines.
• Value additivity
• Capital structure and Modigliani Miller
• Options pricing theory--replicating portfolios

Eleven Things We Do Not Know About Finance:

• How do (should) companies decide what businesses they should be in?
• How can you plan to create the economic rents that generate positive NPVs?
• What truly determines project betas?
• Failures of the CAPM--risk and return.
• How important are the failures of efficient markets hypothesis?
• Is management an off-balance-sheet liability?
• Why so many new securities and new markets?
• Why pay dividends?
• How should a company manage risks?
• What is the value of liquidity?
• Why merger waves?

Summary of Course:

Discounted Cash Flow and Present Value

• Maximize present value
• Calculating present value
• Role of the capital market in making NPV a reasonable goal
• Moving wealth in time using an efficient capital market
• Valuing cash flows
• Using shortcuts--perpectuities and annuities; compounding intervals; compound interest
• Nominal and real interest rates
• Bonds as annuities plus a terminal payment
• Valuing stocks using the dividend-discount model
• The link between stock prices and earnings per share
• Present value of growth opportunities
• Why NPV is superior to IRR and payback
• Making investment decisions with NPV--machine problems; what to discount; deprecation, taxes, project analysis, project interactions.

Risk and the CAPM

• Measuring portfolio risk
• Calculating portfolio Risk
• Diversification and portfolio risk
• Capital Asset Pricing Model
• Beta
• Using betas

Interaction of Finance and Operations

• Sensitivity analysis
• Monte Carlos
• Decision trees
• NPVs and economic edges
• Project authorizations
• Biases in bureaucratic decision making
• Problems with accounting measures of profitability

Market Efficiency and Securities Issues

• Lessons of market efficiency
• Markets have no memory
• Trust market prices
• Read the entrails
• No financial illusions
• Do-it-yourself if possible
• High elasticity of demand for stocks
• Types of corporate securities
• Issuing corporate securities
• Why pay dividends?
• Why issue debt?
• How much should a firm borrow?
• What is the real cost of capital?

Options and Options Pricing

• Calls and puts
• What determines option value?
• Black-Scholes
• "Real" options
• Warrants and convertibles

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