Lecture_1_2010

Lecture_1_2010 - E4729 Foundations of Finance Lecture 1...

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E4729 Foundations of Finance Lecture 1 Introduction to Finance July 7, 2010 Leo M. Tilman L.M.Tilman & Co. & Columbia University
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2 E4729 Foundations of Finance 2007-2009 Financial Crisis & Static Business Models Greater Risk-Taking Margins Compress Risk Exposures Increase Compensation for Risk Declines Fees Compress Competitive, Macroeconomic, and Market Pressures
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3 E4729 Foundations of Finance Risk Aversion and Deleveraging Subprime Mortgages Illiquidity: Prices Decline On Thin Trading Margin Calls and Forced Liquidations Contagion: Other Assets Are Sold Across Markets Inability to Borrow: Haircuts Increase, Lenders Shrink Balance Sheets More Price Declines and Margin Calls Deleveraging: Capital, Market, Credit & Funding Risks Vicious Circle
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4 E4729 Foundations of Finance The Challenge Macroeconomic Forces Low Return Environment Bretton Woods II Imbalances US Housing & Deficits Monetary Policies Financial Instruments Derivatives CDOs ABCP & SIVs Subprime MBS Financial Institutions Investment Banks Commercial Banks Hedge Funds SWFs & Pension Plans Intellectual Paradigm Accounting Earnings Standard Disclosures Portfolio Theory Credit Ratings Equity Market Valuations Complexity + Deficient Lens = Value Destruction RISK
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5 E4729 Foundations of Finance Corporate Balance Sheets
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6 E4729 Foundations of Finance Capital Structure of Corporations Balance Sheet (“Statement of Financial Position”) snapshot of a company’s “financial position” at a point in time
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7 E4729 Foundations of Finance Balance Sheets of Corporations Current assets: cash, marketable securities, inventory, accounts receivable expected to be turned into cash in the near term, etc. Current liabilities: maturity less than 1 year Working capital: current assets-current liabilities Long-term assets Long-term liabilities Shareholder equity (net worth)
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8 E4729 Foundations of Finance Income Statements
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9 E4729 Foundations of Finance Income Statements Sales Expenses Operating expenses (costs of goods sold; selling as well as G&A expenses, depreciation and amortization). Non-operating (financing expenses and taxes) Sales -- Operating Expenses = Operating Income or EBIT -- Interest Expense = Pre-Tax Income (EBT) -- Taxes =Net Income (EAT)
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10 E4729 Foundations of Finance MV Asset Classes ($millions) Residential Mortgages 35,000 Government Bonds 7,000 LIBOR Floaters 20,000 Asset-Backed Securities 8,000 Commercial Mortgages 9,000 Corporate Bonds 20,000 Municipal Bonds 1,000 Total Assets 100,000 Certificates of Deposit 5,000 Retail Deposits 46,000 Wholesale Debt 37,000 Total Liabilities 88,000 Shareholder Equity 12,000 Total Balance Sheet 100,000 Liabilities Assets $% Total Asset Income 5,500 5.50% Total Liability Expense -2,314 -2.31% Net Interest Margin 3,186 3.19% Non-Interest Income 1,500 1.50% Non-Interest Expense -2,200 -2.20% Loan Loss Provision -165 -0.17% Income (Pre-tax) 2,321 2.32% Taxes 812 0.81% ROA 1,508 1.51% ROE 1,508 12.57% Accounting Earnings Focus on Accounting Earnings Current Year 1 Year 2 Year 3 Year 4 Net Interest Margin Recession (-100) 3.05 2.83 2.74 2.72 2.65 Base Case 3.19 3.14 3.10 3.11 Recovery (+100) 3.09 3.34 3.37 3.43 3.53 Expansion (+200) 3.03 3.47 3.57 3.70 3.90 Stress Test (+300) 2.95 3.58 3.77 3.97 4.26 Return on Assets 1.42 1.28 1.22 1.20 1.16 1.51 1.48 1.45 1.46 1.61 1.63 1.67 1.73 1.41 1.69 1.76 1.84 1.97 Stress Test (+300) 1.36
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Lecture_1_2010 - E4729 Foundations of Finance Lecture 1...

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