Introduction: Bond → Coupon = Coupon rate × 𝑓𝑎𝑐𝑒 𝑣𝑎𝑙𝑢𝑒 | Coupon rate = “fair interest rate |Bonds: Supplies Capital,

Claim on Cash
Flow, Fixed (Contractual) Cash Flow, Senior Claim | Stock: Supplies capital, claim on cash flow, discretionary cashflow, residual claim, voting
rights | Financial Instruments: Stocks, Bonds, etc. Financial Assets (claims on Cash flows) IPO AKA seasoned Equity offering “SEO”
𝐶1 𝐶2
TVM: NPV (net present value) = 𝒑𝒓𝒐𝒋𝒆𝒄𝒕 𝒗𝒂𝒍𝒖𝒆 − 𝒑𝒓𝒐𝒋𝒆𝒄𝒕 𝒄𝒐𝒔𝒕 > 𝟎 | NPV of Future Cash Flow: 𝑁𝑃𝑉 = 𝐶0 + 1+𝑟 + (1+𝑟) 2…
KEY: n=times compounded, t=time(years), r=discount rate, c = cash flow/coupon, EAR=equivalent annual rate | T = maturity 𝑃𝑡 = 𝑡ℎ𝑒 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑡ℎ𝑒 𝑠𝑡𝑜𝑐𝑘 𝑎𝑡 𝑡 →𝐷𝑡 = 𝑡ℎ𝑒 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑎𝑖𝑑 𝑎𝑡 𝑡 → 𝐸 = 𝑡ℎ𝑒 𝑒𝑥𝑝𝑒𝑐𝑡𝑎𝑡𝑖𝑜𝑛 𝑎𝑡 𝑡𝑖𝑚𝑒 𝑡 → 𝑟 𝑖𝑠 𝑡ℎ𝑒 𝑟𝑖𝑠𝑘 𝑎𝑑𝑗𝑢𝑠𝑡𝑒𝑑 𝑟𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛
𝐶 𝐶
Present Value of a Perpetuity: 𝑃𝑉 = | PV of a Growth Perpetuity: 𝑃𝑉 = 𝑟−𝑔 (use if Cash Flows never changes → this also means that t is irrelevant in this
𝑟
𝑟
scenario) | EAR Formula: 𝐸𝐴𝑅 = (1 + 𝑛)𝑛 − 1 Use: to find either EAR or r | FV of P t years from now: 𝑭𝑽 = 𝑃 × (1 + 𝑟)𝑡 | Present Value of C received t
𝟏
𝐶 𝑐 1
years from now: 𝑃𝑉 = 1+𝑟 𝑡 | 𝐸𝑞𝑢𝑖𝑣𝑎𝑙𝑒𝑛𝑡 𝑅𝑒𝑡𝑢𝑟𝑛 = [(𝟏 + 𝒓)𝒏 − 𝟏 × 𝒏] (use new n) |PV or Current bond price given YTM to find: 𝑃𝑉 = 𝑟 [1 − (1+𝑟)𝑡 ] +
𝐹𝑎𝑐𝑒 𝑉𝑎𝑙𝑢𝑒 1 1 𝑐 𝑐 𝑐
(1+𝑟)𝑡
|PV of 1 cash flow × an annuity: 𝑃𝑉 = 𝐶 𝑟 [1 − (1+𝑟)𝑡 ] | PV of stream of cash flow → 𝑃𝑉 = (1+𝑟) + (1+𝑟)2 + 1+𝑟)3… | FV given r and t with initial
𝑟 𝑡(𝑛) 𝑀𝑎𝑟𝑘𝑒𝑡 𝐶𝑎𝑝 𝑐 1
investment: 𝐹𝑉 = 𝐶 × (1 + 𝑛) | Share price = 𝑆ℎ𝑎𝑟𝑒𝑠 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 | PV to find monthly lease payments (C) given final value 𝑃𝑉 = 𝑟 (1 − (1+𝑟)𝑡(𝑛)) use
𝒓 𝐶 𝑐 𝑐 1−(1+𝑟)−𝑡
Periodic (coupon) rate = 𝒏 | Company Total Value: NPV = 1+𝑟 + (1+𝑟)2 + (𝑟−𝑔) | PV Annuity (IRR version) = 𝐶 × [ ] | PV of payment over x years
𝑟
(1+𝑟)2
𝑖𝑛𝑖𝑡𝑖𝑎𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡
= | Fair market value or PV of a bond with an initial investment (face) and years with a coupon rate and a market rate → 𝑷𝑽 =
𝑐𝑜𝑢𝑝𝑜𝑛 𝑟𝑎𝑡𝑒 %
1−(1+𝑟)−𝑡 𝑓𝑎𝑐𝑒 𝑛𝑒𝑤
𝒑𝒎𝒕 × [ ] + (1+𝑟)𝑡 pmt is the annual coupon payment 𝒑𝒎𝒕 = 𝑐𝑜𝑢𝑝𝑜𝑛 𝑏𝑜𝑛𝑑 × 𝑓𝑎𝑐𝑒 𝑣𝑎𝑙𝑢𝑒 |Net Returns = − 1 |Annualized returns 𝑭𝑽 =
𝑟 𝑜𝑙𝑑
1
𝐶𝐹(1 + 𝑟)𝑡 → CF is initial cash flow or purchase price | 𝐼𝑅𝑅 > 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑟𝑎𝑡𝑒 = 𝑝𝑜𝑠𝑖𝑡𝑖𝑣𝑒 𝑁𝑃𝑉 → Negative is opposite | PV of 1-dollar next year is 𝑃𝑉 = (1+𝑟)
𝐹 1 𝐶
| PV of F expected to arrive t years from now 𝑃𝑉 = (1+𝑟)𝑡 | Discount factor = (1+𝑟)𝑡 |PV (C in t years) = (1+ 𝑟 )𝑛𝑡 Rate per month: 𝒓𝒑𝒆𝒓 𝒎𝒐𝒏𝒕𝒉 → (1 + 𝑟) = (1 +
𝑛)
𝐶 𝐶 𝐶
𝑟(𝑝𝑒𝑟 𝑚𝑜𝑛𝑡ℎ) )12 |IRR is the r that solves 0 = 𝐶0 + 1+𝑟
1 2
+ (1+𝑟) 𝑛
2 + ⋯ + (1+𝑟)𝑛 | Value of a bond is the present value of a fixed stream of coupons (C) at the
𝑐 𝑃 𝑐 𝑃
principal payment (P) 𝑉 = ∑𝑡𝑡=1 (1+𝑟)𝑡 + (1+𝑟)𝑇 | YTM = Yield to Maturity → the YTM of this bond is the “y” that solves: 𝑉 = ∑𝑇1 (1+𝑦)𝑡 + (1+𝑦)𝑇 | Value of Equity = Firm
Value – Debt Value | Total firm Value = Value of equity + Value of debt | FCF (Free Cash Flow) = revenue - expenses (excluding depreciation) – CapEx – Taxes | Firm Value =
𝐶
𝐸𝑞𝑢𝑖𝑡𝑦 𝑉𝑎𝑙𝑢𝑒 𝐶 𝐶 𝐶 ( 4)
1 2 3 𝑟−𝑔
PV(expected FCF) | Equity Value = Firm Value – Debt Value | Stock Price # 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 | Firm Value: 𝑽 = 1+𝑟 + (1+𝑟)2
+ (1+𝑟)3
+ (1+𝑟) 3
| NPV for a project: Cash Flow =
Revenue – COGS - CapEx – Tax |Take present value of cash flows for a DCF and find NPV | Taxable profit = Revenue – COGS – Depreciation |Tax = Taxable profit X Corporate Tax rate | Depreciation =
CapEx / years But if we are given Net Income and depreciation already calculated then we should just use: 𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 + 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 − 𝐶𝑎𝑝𝐸𝑥 = 𝐵𝑎𝑠𝑖𝑐 𝐶𝑎𝑠ℎ 𝑓𝑙𝑜𝑤𝑠 | then we discount
𝑃𝑎𝑦𝑜𝑓𝑓−𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡
Measuring Returns: One year investment: 𝑅𝑒𝑡𝑢𝑟𝑛 = | Multi Year investments: 𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 × (1 + 𝑟)𝑡 = 𝑃𝑎𝑦𝑜𝑢𝑡 → r is our
𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡
return |When the discount rate and the return are the same the NPV = 0 |When we are given 3 cash flows and want to find the return rate use below equation:
𝐶1 𝐶2
2 = 0 and solve for r through trial and error (r is IRR) |IRR is the rate that gives a present value of 0 when discount rate and IRR are equal → If
𝐶0 + 1+𝑟 + (1+𝑟)
there is a positive NPV for a project than the IRR is greater than the discount rate
Bonds: 2 types of bonds → Fixed VS Variable rates |Debt issued by the government is supposedly risk free (default risk) | Fixed income securities promise to
pay their holder fixed cashflows at pre-specified dates |Payments throughout a bond’s life are coupon payments |Coupon rate of a bond may be higher or lower
than the fair market rate and the price of a bond adjusts accordingly |If a bond gives no coupon payments during its life it is called a pure discount bond | A
security (bond) is callable if the issuer can buy it back at a pre-specified price before the maturity date |The value of the bond is the present value of the fixed
𝐶 𝑃
stream of coupons ( C ) and the principle repayment (P) : as follows → 𝑉𝑎𝑙𝑢𝑒 = ∑𝑇𝑡=1 (1+𝑟)𝑡 + (1+𝑟)𝑇 |Principle payment is a single cash flow (using capital T)
while C is an annuity (t = years) | YTM = Yield to Maturity of a bond →Coupon payment C, maturity T, and face value P, The market price of the bonds is V→
𝐶 𝑃
YTM is the Y that solves the following (same as IRR): 𝑉𝑎𝑙𝑢𝑒 = ∑𝑇1 (1+𝑦)𝑡 + (1+𝑦)𝑇 | Interest rates and bond prices have an inverse relationship | HPR: Holding
period return → Return based on how long the owner of the bond held the bond | HPR = YTM if the bond is held to maturity | The longer time till maturity, the
more sensitive the bond is |Variable rates:Coupon rates reset regularly and can be linked to: Inflation,LIBOR/CIDR+ Spread(interbank borrowing rates),
Treasury build yield|Bonds with credit risk: Corporate Bonds, Sovereign Bonds, Municipal Bonds|Credit Spreads Vary:Over time, by maturity, financial crisis
Equities (Stocks): Valuation methods 1)Free Cash Flow 2) Conceptual approach. Dividend Discount Model 3) Multiples/ Comparables |Firms raise capital
from equity holders (shareholders/Stock) and debtholders (bonds/banks) |After all firm expenses are paid and reinvestment is made (Capital Expenditures) the
remaining free cash flow is distributed to equity holders and debtholders. |Common stockholders (equity holders) are the owners of them firm |A share of
common stock gives the holder the claim to the cash flows and assets of a firm after all fixed obligation have been met – including principal and interest to
debtholders. Stockholders also have voting rights to appoint the firm’s board of directors and other matters. |Free Cash Flow = Revenue – expenses (excluding
depreciation) – CapEx – Taxes (Alternatively, start with income and add back depreciation) |Firm Value = PV of expected free cash flow |Equity Value = Firm
Value – Debt Value |Stock Price = Equity Value / # of shares outstanding |Suppose we can forecast FCF for the next few years (perhaps at a high growth rate)
𝐶
𝐶1 𝐶2 𝐶3 𝐶4 ( 4)
and assume that it will grow at a lower (sustainable) growth rate g forever. →𝐹𝑖𝑟𝑚 𝑉𝑎𝑙𝑢𝑒: 𝑉 = 1+𝑟 + (1+𝑟)
𝑟−𝑔
2 + (1+𝑟)3 + (1+𝑟)3 + (1+𝑟)3 |𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦: 𝐸 = 𝑉 − 𝐷 |𝑃 = 𝐸/𝑛

The price of the stock at time t is 𝑃𝑡 → Dividend paid at the time t is 𝐷𝑡 → E() is the expectation at time t → r is the risk adjusted required rate of return
𝐸(𝐷 ) 𝐸(𝑃 ) 𝐸(𝐷 ) 𝐸(𝑃 ) 𝐷
|What is the price of the stock at time 0? → 𝑃0 = 1+𝑟1 + 1+𝑟1 |Dividends Discount Method: 𝑃1 = 1+𝑟2 + 1+𝑟2 |𝑃0 = 𝑟1 → If dividends don’t grow then the return
1 𝐷 𝐷1
is equal to dividend yield | 𝑃0 = (𝑟−𝑔) equivalently: 𝑟 = + 𝑔 |Return = dividend yield + growth rate |Use of Dividend Growth Formula: If we know r, and we
𝑃0
(1+𝑔)×𝐷0 𝐷1
observe 𝑃0 we can assess investors’ expectations of g 𝑃0 = ∑∞
𝑡=1 𝑟−𝑔
→ if its next year we just do 𝑃0 = ∑∞
𝑡=1 𝑟−𝑔 |𝑬𝑷𝑺 = 𝒆𝒂𝒓𝒏𝒊𝒏𝒈𝒔 𝒑𝒆𝒓 𝒔𝒉𝒂𝒓𝒆 𝐷𝑡 =
𝐷 𝐸𝑃𝑆1
𝐸𝑃𝑆𝑡 × (1 − 𝑏)|𝑅𝑂𝐸 = 𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝐸𝑞𝑢𝑖𝑡𝑦 → 𝑔 = 𝑹𝑶𝑬 × 𝑏 (b is the percent of retained earnings) |𝑟 = 𝑃1 = 𝑃0
→ Comparing earnings/price ratios is equal to
0
comparing returns and assuming no growth |Growth only adds value if ROE > r |Good growth results from plowing money back into the firm while having a
𝐸𝑃𝑆
positive NPV | 𝑃0 = 𝑟 + 𝑃𝑉𝐺𝑂 → PVGO (Present value of growth opportunities) Dividend, growth rate (g), required return (r) to find value of current stock price: 𝑃0 = 𝑟−𝑔
𝐷 1

𝑪
(𝒓−𝒈 −𝒃𝒐𝒏𝒅𝒔)
Find fair value for a share of a firm given FCF projections forevermore (perpetuity), growth rate, discount rate, and bonds outstanding, shares outstanding → 𝑷𝟎 = 𝒔𝒉𝒂𝒓𝒆𝒔

Portfolios and Risk: With higher risk – there is lower value, but higher possible/expected return |Expected return can be seen as: Required return on an
investment, discount rate for valuation, cost of capital for firm |Lower risk but higher cost may have a lower expected return → Higher risk, lower cost, but
possibly a higher expected |Shareholders required rate of return on equity, 𝑟𝐸 which compensates for Time Value of Money (Riskless rate of return) (𝑟𝑓 ), and
Risk (the premium risk level) (risk premium) |Higher Standard Deviation = higher risk |Required rate of Return (discount rate) = 𝑟𝑓 + 𝑟𝑖𝑠𝑘 𝑝𝑟𝑒𝑚𝑖𝑢𝑚 |Possible
returns 0% or 20% in year 1 → we invest $100 and get $100 or $120 back(50%chance) → Expected return: 𝐸(𝑟) = 0.5(0%) + 0.5(20%) = 10% → Standard
deviation 10% |Diversification Example: We split our investment in two independent investments of $50, We pay $50 at T=0 and we get $50 or $60 return at T=1
(50% chance each), Total Payoff = $100(25%); $110(50%); $120(25%), Which equals → 𝐸(𝑟) = 0.25(0%) + 0.5(10%) + 0.25(20%) = 10% → S.D =
7.1% |Correlation: Statistical measure of (P): the co-movement of two random variables |Correlation is always between -1 and +1, > 0: tendency to move
together, = 0: uncorrelated, < 0: tendency to move opposite, = 1 (or -1): moving in lockstep |The lower the correlation between 2 stocks, the lower the risk of
holding both (Diversification) |Total Risk = Systematic + Unsystematic Risk |Unsystematic: Effects a particular company/ stock and can be reduced through
diversification. Ex: new competitor in market, workers go on strike |Systematic: Affects all companies and cannot be reduced through diversification. Ex: Inflation
rises, Global Political instability, Interest rates rise |Risky cash flows can earn higher returns on average
Risk can’t be viewed independently; it depends on what else is in the portfolio |Diversification reduces risk → more so when correlation is lower
Options: Call Option: a contract between two parties in which the buyer of the option pays a premium (price) for the right (but not the obligation) to purchase
an underlying asset (usually stock). This contract also specifies an exercise price (strike price) at which the asset can be purchased and a maturity (expiration)
date. The buyer can choose whether to exercise the right to purchase based on the market price of the asset. (If share price increases above the strike price they
should purchase the asset) (We anticipate share price will increase) Put Option: A put option is the right but not the obligation to sell an underlying asset (stock)
for a premium at a specified strike price and expiration date. (Less risky than short selling and cheaper) → We are bearish |Options or derivative securities
because they are derived from another financial asset |European options can only be exercised at the expiration date (never before) |Terms: Out of the money →
Net loss, In the money → Net profit, At the money → Share price doesn’t change and as a result we incur a net loss |Combinations/Straddle: Combinations are
a combination of margin plays, shorts and longs that can result in many risk/returns combinations Straddle: consist of one call option and one put option on the
same asset with the same exercise price and same maturity date |A straddle is a call on volatility | strangle is cheaper option |We have a current trading price, price
of a call option, strike price, time till maturity, share price at maturity. Value of CALL OPTION at maturity = Share price (mature) – Strike Price |We have a
current trading price, price of a put option, strike price, time till maturity, share price at maturity. Value of PUT OPTION at maturity = Strike Price - Share
price (mature) (If it’s less than 0 we put 0) | We have a current trading price, price we sold a put option, strike price, time till maturity, share price at maturity.
Time value (profit) at maturity = Sold price of Put – (Strike – share(mature))
Investment Funds: Stocks/Types of accounts: Cash Accounts: Can only hold long positions, payment is due by settlement date i.e. 2 days after |Margin
Accounts: Securities firm lends money to buy securities “on margin” |Margin is the amount of your own money you are required to “put up”, Margin loans are the
other half of the money that the bank will put up to purchase a security at a given time |Short selling: Selling shares that we don’t own hoping share prices drops
for when we have to return/ repurchase the shares |Investment Funds: Alternatives to direct ownership of individual securities → they are financial
intermediaries that own investments on behalf of a group of investors: Individuals can invest in the fund, Fund managers have legal authority to invest clients
assets, Investors hold “shares” of the fund, Fund is a separate legal entity |Types of funds: Open-ended Mutual Funds: # of shares can change, Exchange Traded
Funds: # of shares can change, lower MER costs, better liquidity, Close-ended Funds: Publicly traded investment companies with a fixed number of shares
(REITs) listed on a stock exchange, less liquidity, Hedge Funds | Benefits of funds Diversification, Liquidity (investors can buy and sell units of the fund
easily), Trading costs (lower trading costs with brokers due to large size of fund and large trades), Professional Management | NAV (Net Asset Value) =
𝑴𝒂𝒓𝒌𝒆𝒕 𝑽𝒂𝒍𝒖𝒆 𝒐𝒇 𝑨𝒔𝒔𝒆𝒕𝒔−𝑨𝒄𝒄𝒓𝒖𝒆𝒅 𝑳𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔
# 𝒐𝒇 𝒔𝒉𝒂𝒓𝒆𝒔 𝒐𝒖𝒕𝒔𝒕𝒂𝒏𝒅𝒊𝒏𝒈
|Calculated at the end of each business day to find the value of a “unit” of the fund, if the price of funds asset increases, the funds
NAV increases | MER (Management Expense Ratio), Approx. 40% of the MER fees are management fees, Admin expenses (legal and audit fees) approx. 20%,
Distribution costs and trailer fees (paid to brokers who sell the fund) approx. 40%, Loads are charges by some funds – they are fees paid to the broker (rare),
|Fund Styles: Actively Managed Funds: Stocks are selected that should outperform the market index |Index Funds: A type of mutual fund that passively
replicates a market index, Lower MER then actively managed |Canadian Mutual Funds: Can’t short, can’t borrow, Can’t hold more than 10% of any company,
can’t buy commodities, can’t exceed limits of illiquid securities Hedge Funds: Have the most flexibility, they are not open to the average investor, not highly
regulated high minimum investment(usually upwards of $1 million), little liquidity | Find Current NAV with past NAV, how much stocks increased, and MER
NAV (present) = 𝑵𝑨𝑽(𝑳𝒂𝒔𝒕 𝒚𝒆𝒂𝒓) × 𝒇𝒖𝒏𝒅 𝒊𝒏𝒄𝒓𝒆𝒂𝒔𝒆 × (𝟏 − 𝑴𝑬𝑹)
Banking: Commercial banks Lend money. Profit = the difference between lending rate and borrowing rate |Health of one bank effect the health of another
(systematic risk) |Assets: Cash, securities, Loans (mortgages), Other (buildings/land/Insurance) |Liabilities: Deposits, Subordinated Debt, Insurance related
liabilities |non-deposit liabilities: Interbank borrowing |Balance Sheet Summary: Banks generally should have 8% capital to support their risk-weighted assets
1
|Banks keep about 10% of deposits in the vault and lends out 90% |𝑀𝑜𝑛𝑒𝑦 𝑀𝑢𝑙𝑡𝑖𝑝𝑙𝑖𝑒𝑟 (𝑀𝑀) = % 𝑟𝑒𝑠𝑒𝑟𝑣𝑒𝑠 | 3 Risks that provide maturity transformation
(accepting short-term deposits and lending long-term):Liquidity Risk: Depositors want to withdraw their money, but the bank has no more cash or liquid assets
(Bank Run), Default Risk: Loan is not repaid to bank and as a result we have an asset loss, Interest Rate Risk: If interest rates increase banks will lose out if they
made long-term loans at fixed interest rates, Systemic risk is the possibility that an event at the company level could trigger severe instability or collapse an entire
industry or economy → effects regulators
Efficiency: Efficiency in Markets: Public information (even if not universally known) is impounded into securities prices very quickly (priced in) 𝑃𝑡 =
𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 expected future cash flows|𝑃𝑡 = 𝑃𝑉 𝑜𝑓 𝐸 (𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤𝑠 | 𝑎𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑖𝑛𝑓𝑜𝑟𝑚𝑎𝑡𝑖𝑜𝑛) We expect markets to be efficient: this is because buyers
and sellers put money on their beliefs. Mispriced securities are quickly corrected → Underpriced securities attract buyers and overpriced attracts sellers which
Makes it very hard to outperform the market. |Three Forms of Market Efficiency (hypothesis): weak (information in past prices – stock goes up 2 days in a row
then down), semi-strong (publicly available info), Strong (all possible available info) |Markets are Most Efficient With: Active Markets,High Volume ,Liquid
Markets, Easily Accessible Information, Transparent Information, many Analysts, Market inefficiencies disappear because people discover trends and buy in
(level of info seen in market hypothesis’)|Behavioral Finance: Disposition effect: investors are less willing to recognize losses then gains, Loss Aversion: Loss of
$1 is more harmful than the gain of $1 beneficial.
Notes From HW 2: Standard Deviation of a stocks return is a measure of its total risk| If a portfolio is comprised of multiple stocks from an index, the standard
deviation of the portfolios return is always lower than the average of the S.D’s of each stocks return |The correlation in returns between two stocks is
generally higher if they are competitors in the same industry| Stocks that have more risk should have a higher expected return return: primarily based on
systematic risk| When a portfolio is diversified, what type of risk is reduced: unsystematic risk| If a call option has six months till maturity and, in a crisis, the
volatility of the share increases and share price drops, we expect that: it is uncertain if the value of the call option increases or decreases| Close-ended mutual
funds (REITS) are most likely to own Illiquid Assets| Exchange Traded Funds (ETFs) are most likely to have lower MERs| Mortgages are Bank Assets. Banks
are a concern for regulators due to systemic risk| The likelihood of a bank run is reduced if the bank has sufficient capital, and the government offers deposit insurance.
−𝒕
Notes from practice test: Bond Price: 30 year life, 7% coupon, 1,000,000 face value, yield of 1.77% (i) → 𝑪𝒐𝒖𝒑𝒐𝒏 𝒑𝒂𝒚𝒎𝒆𝒏𝒕 × [𝟏−(𝟏+𝒊)𝒊
]+
𝑷𝒓𝒊𝒏𝒄𝒊𝒑𝒍𝒆 𝑷𝒂𝒚𝒎𝒆𝒏𝒕
(𝟏+𝒓) 𝒕
|Sensitivity Analysis:
Discount rate is always (𝟏+𝒓) | NPV for a project: Cash Flow = Revenue – COGS - CapEx – Tax |Take present value of cash flows for a DCF and find NPV | Taxable profit =
𝑪𝒂𝒔𝒉 𝑭𝒍𝒐𝒘

Revenue – COGS – Depreciation |Tax = Taxable profit X Corporate Tax rate | But if we are given Net Income and depreciation already calculated then we should just use:
𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 + 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 − 𝐶𝑎𝑝𝐸𝑥 = 𝐵𝑎𝑠𝑖𝑐 𝐶𝑎𝑠ℎ 𝑓𝑙𝑜𝑤𝑠 | Use of Dividend Growth Formula: If we know r, and we observe 𝑃0 we can assess investors’ expectations of g 𝑃0 =
(1+𝑔)×𝐷0
∑∞
𝑡=1 |𝐷0 𝑖𝑠 𝑎 # 𝑛𝑜𝑡 % | Call Option: we write call option for RBC with a strike price of $100, 1 year life, and a $3 premium. After 2 months the share price is
𝑟−𝑔
$83. Is the value of the option more or less than it was 2 months ago? Are we better or worse off? In what instance are we worse off →The time till maturity
decreases making the call option worth less. Since we wrote the option and received the premium along with the share price below the strike price we are currently
in the money (better off) → worse off: volatility increases which increases the value of the option | Put Option: If we buy a put for $5 but the share price is $98 and strike
price is $100 what is the intrinsic value and what is the time value → Intrinsic: $2 gain (strike price – share price) → Time value $3 (Option Price – intrinsic value)
Notes From homework
Dividend, growth rate (g), required return (r) to find value of current stock price *
𝐷1
→ 𝑃0 = 𝑟−𝑔 → D1 is dividend next year

Constant Growth → assuming constant growth forever given growth rate and dividend yield, we add them together to assume → so we add the
growth rate and dividend yield %’s *

Firm growth rate given ROE, retention of earnings %, and earnings this year →
𝑅𝑂𝐸 = 𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝐸𝑞𝑢𝑖𝑡𝑦 → 𝑔 = 𝑅𝑂𝐸 × 𝑏 (b is the percent of retained earnings) g=growth *

Given earnings per share and discount rate we must find share price (𝑷𝟎 )
𝐸𝑃𝑆
𝑟 = 𝑃 1 → Comparing earnings/price ratios is equal to comparing returns assuming no growth. *
0

Present Value of Bookfaces growth opportunities per share

𝐸𝑃𝑆
𝑃0 = + 𝑃𝑉𝐺𝑂 → (PVGO = Present value of growth opportunities) *
𝑟

Find fair value for a share of a firm given FCF projections forevermore (perpetuity), growth rate, discount rate, and bonds outstanding,
𝑪
(𝒓−𝒈−𝒃𝒐𝒏𝒅𝒔)
shares outstanding → 𝑷𝟎 = *
𝒔𝒉𝒂𝒓𝒆𝒔
Standard Deviation of a stocks return is a measure of its total risk. If a portfolio is comprised of multiple stocks from an index, the standard deviation of the
portfolios return is always lower than the average of the S.D’s of each stocks return. The correlation in returns between two stocks is generally higher if they
are competitors in the same industry. Stocks that have more risk should have a higher expected return return: primarily based on systematic risk. When a
portfolio is diversified, what type of risk is reduced → unsystematic risk. If a call option has six months till maturity and, in a crisis, the volatility of the share
increases and share price drops, we expect that: it is uncertain if the value of the call option increases or decreases. Close-ended mutual funds (REITS) are
most likely to own Illiquid Assets. Exchange Traded Funds (ETFs) are most likely to have lower MERs. Mortgages are Bank Assets. Banks are a concern for
regulators due to systemic risk. The likelihood of a bank run is reduced if the bank has sufficient capital, and the government offers deposit insurance.*

We have a current trading price, price of a call option, strike price, time till maturity, share price at maturity. Value of CALL OPTION at
maturity = Share price (mature) – Strike Price*

We have a current trading price, price of a put option, strike price, time till maturity, share price at maturity. Value of PUT OPTION at maturity
= Strike Price - Share price (mature) (If it’s less than 0 we put 0)*

We have a current trading price, price we sold a put option, strike price, time till maturity, share price at maturity. Time value (profit) at
maturity = Sold price of Put – (Strike – share(mature))*

Find Current NAV with past NAV, how much stocks increased, and MER *
NAV (present) = 𝑵𝑨𝑽(𝑳𝒂𝒔𝒕 𝒚𝒆𝒂𝒓) × 𝒇𝒖𝒏𝒅 𝒊𝒏𝒄𝒓𝒆𝒂𝒔𝒆 × (𝟏 − 𝑴𝑬𝑹)

Find Current NAV with value of current holdings, accrued liabilities, shares outstanding*
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑯𝒐𝒍𝒅𝒊𝒏𝒈𝒔−𝒍𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔
→ 𝑵𝑨𝑽 = 𝑺𝒉𝒂𝒓𝒆𝒔 𝑶𝒖𝒕𝒔𝒕𝒂𝒏𝒅𝒊𝒏𝒈

Notes from practice test

𝟏−(𝟏+𝒊)−𝒕 𝑷𝒓𝒊𝒏𝒄𝒊𝒑𝒍𝒆 𝑷𝒂𝒚𝒎𝒆𝒏𝒕
Bond Price: 30 year life, 7% coupon, 1,000,000 face value, yield of 1.77% (i) → 𝑪𝒐𝒖𝒑𝒐𝒏 𝒑𝒂𝒚𝒎𝒆𝒏𝒕 × [ 𝒊
]+ (𝟏+𝒓)𝒕
𝑪𝒂𝒔𝒉 𝑭𝒍𝒐𝒘
Sensitivity Analysis: Discount rate is always (𝟏+𝒓)
NPV for a project: Cash Flow = Revenue – COGS - CapEx – Tax |Take present value of cash flows for a DCF and find NPV | Taxable profit =
Revenue – COGS – Depreciation |Tax = Taxable profit X Corporate Tax rate | Depreciation = CapEx / years But if we are given Net Income
and depreciation already calculated then we should just use: 𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 + 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 − 𝐶𝑎𝑝𝐸𝑥 = 𝐵𝑎𝑠𝑖𝑐 𝐶𝑎𝑠ℎ 𝑓𝑙𝑜𝑤𝑠 | then we discount

(1+𝑔)×𝐷0
Use of Dividend Growth Formula: If we know r, and we observe 𝑃0 we can assess investors’ expectations of g 𝑃0 = ∑∞
𝑡=1 𝑟−𝑔
|𝐷0 𝑖𝑠 𝑎 # 𝑛𝑜𝑡 %
Profit Diagram of a put option with a strike price of $50 and a $5 premium
Call Option: we write call option for RBC with a strike price of $100, 1 year life, and a $3 premium. After 2 months the
share price is $83. Is the value of the option more or less than it was 2 months ago? Are we better or worse off? In what
instance are we worse off?

- The time till maturity decreases making the call option worth less. Since we wrote the option and received the
premium along with the share price below the strike price we are currently in the money (better off).
- Two cases where we are worse off: volatility increases which increases the value of the option, we would also be
worse off if the financing rate increased significantly

Put Option: If we buy a put for $5 but the share price is 98 and strike price is $100 what is the intrinsic value and what is
the time value
- Intrinsic: $2 gain (strike price – share price)
- Time value $3 (Option Price – intrinsic value)

Note: if a company has gone public in the past 2 years, if in its first 2 years if the stock price is lower than the IPO price
then we will have sellers into Christmas