Market Efficiency Chapt. 14 in RWJ
The Random Walk Theory - Stock prices follow a random walk. That is, they change
randomly with no predictable patterns or trends (the same can be said of bond prices).
Each movement is entirely independent of past moveme
Class Notes Index
Chapter 4 - The Time Value of Money
Chapter 8 - Bonds
Chapter 9 - Stock
Chapter 5 - Capital Budgeting
Chapter 6 - Cash Flows
Chapter 10 - Risk and Return
Chapter 11 - Asset Pricing Part 1
Chapter 11 - Asset Pricing Part 2
Chapter 13 - Be
Beta and WACC Chapt. 13 in RWJ
T
NPV
t
0
Ct
(1 r ) t
Ct is not known for certain. It is a random variable. It has a probability distribution with a
mean and standard deviation.
Ct = E(Ct) = expected cash flow
r is the appropriate cost of capital. It shou
Asset Pricing Part 2 Chapt. 11 in RWJ
Mean/Variance Analysis Risk-averse investors like a high expected (mean) return and a
low standard deviation (variance). They like return and dislike risk.
So if we plot expected return on the vertical axis and standa
Asset Pricing Part 1 Chapt. 11 in RWJ
Here, we are dealing with probabilities of future returns not historical data, so we
will calculate Expected Return and Standard Deviation differently.
Expected Return - Probability weighted average of possible outcom
The Time Value of Money Chapter 4 in RWJ
The time value of money - The most basic concept in Finance.
Definitions:
Interest - Money paid for the use of your money. Expressed as a % or a decimal.
Future Value - Amount to which an investment will grow after
Stock Chapt. 9 in RWJ
Common Stock = Stock = Equity: Ownership shares in a corporation.
Preferred Stock: A hybrid between stock and a perpetual bond. Receives a fixed
dividend, but generally has no voting rights. Priced as you would price a perpetuity.
Di
Risk and Return Chapt. 10 in RWJ
Converting Total Return to Annualized Return
Returns are measured over a period of time usually over the course of a year, but if
some other period, they can be annualized.
This is very similar to calculating the EAR, whic
Capital Budgeting Chapter 5 in RWJ
Capital Budgeting the process of choosing the best investment projects.
Because other capital budgeting techniques are either rarely used in practice or are
inefficient, we will only concern ourselves with Net Present Va
Bonds Chapt. 8 in RWJ
Definitions:
Bond - An IOU. - A security that obligates the issuer to make specified payments to the
bondholder.
Maturity - Date when the bond principal is repaid.
Face Value - Payment at maturity
Coupon Rate - Annual interest paymen
Explanations of Quiz Solutions for Chapters 8-9
1. A price of 97 means that the bonds are selling for 97% of their face value. A coupon rate
of 8.6% means that each year, the issuer pays the bondholder 8.6% of the face value of
the bond. Since the Yield t
Explanations of Quiz Solutions for Chapters 10-11
1. Since these five years are only as sample of the entire population of returns, we can
never know the true means, variances, standard deviations, or covariances. We must
calculate estimates using the sam
Explanations of Quiz Solutions for Chapters 5-6
1. Since the price of the widgets will be increasing at 3% per year and 3% per year is also
the inflation rate, the price of widgets will be constant in real dollars (purchasing power).
This is also true for
Explanations of Quiz Solutions for Chapter 4
1. The amount of money you are borrowing is the present value of the mortgage. Since the
payments are being amortized over 30 years with monthly payments, this is an annuity
with a monthly interest rate and 360