Description:
Позже (в 2008) изданная под названием 'Corporate Finance: An Introduction', эта книга была доступна на авторском сайте для комментариев и предварительного знакомства с материалом (Preview).Про книгуA First Course in Finance является первым такого рода пособием, с простым и кратким подходом к изложению основ финансового курса в доступных терминах. В нем использованы простые числовые примеры для пояснения всех основных финансовых концепций (и формул).Текст может быть использован в качестве полного курса, или как дополнение к традиционным учебникам по финансам.Первые отзывы студентов были очень положительны в обоих случаях.Несмотря на то, что это пособие подходит для самообучения, первоначальная цель его разработки была дополнить обучение в классах начального высшего образования и аспирантуры. Автор рассчитывал втиснуть материал в размер "напряженного" семестра или более размеренных 2-х семестров. Содержание:I. Investments and ReturnsChapter 1: A Short Introduction1•1 The Goal of Finance: Relative Valuation1•2 How do CFOs do It?1•3 Learning How to Approach New Problems1•4 The Main Parts of This BookChapter 2: The Time Value of Money2•1 Basic Definitions2•1.A. Investments, Projects, and Firms2•1.B. Loans and Bonds2•1.C. U.S. Treasuries2•2 Returns, Net Returns, and Rates of Return2•3 The Time Value of Money2•3.A. The Future Value of Money2•3.B. Compounding2•3.C. Confusion: Interest Rates vs. Interest Quotes2•4 Capital Budgeting2•4.A. Discount Factor and Present Value (PV)2•4.B. Net Present Value (NPV)2•5 SummaryChapter 3: More Time Value of Money3•1 Separating Investment Decisions and Present Values From Other Considerations3•1.A. Does It Matter When You Need Cash?3•1.B. Corporate Valuation: Growth as Investment Criteria?3•1.C. The Value Today is just “All Inflows” or just “All Outflows”3•2 Perpetuities3•2.A. The Simple Perpetuity Formula3•2.B. The Growing Perpetuity Formula3•2.C. A Growing Perpetuity Application: Individual Stock Valuation with Gordon Growth Models3•3 The Annuity Formula3•3.A. An Annuity Application: Fixed-Rate Mortgage Payments3•3.B. An Annuity Example: A Level-Coupon Bond3•3.C. The Special Cash Flow Streams Summarized3•4 Summarya Advanced Appendix: Proofs of Perpetuity and Annuity FormulasChapter 4: Investment Horizon, The Yield Curve, and (Treasury) Bonds4•1 Time-Varying Rates of Return4•2 Annualized Rates of Return4•3 The Yield Curve4•3.A. An Example: The Yield Curve in May 20024•3.B. Compounding With The Yield Curve4•3.C. Yield Curve Shapes4•4 Present Values With Time-Varying Interest Rates4•4.A. Valuing A Coupon Bond With A Particular Yield Curve4•5 Why is the Yield Curve not Flat?4•5.A. The Effect of Interest Rate Changes on Short-Term and Long-Term Treasury Bond Values4•6 The Yield To Maturity (YTM)4•7 Optional Bond Topics4•7.A. Extracting Forward Interest Rates4•7.B. Shorting and Locking in Forward Interest Rates4•7.C. Bond Duration4•7.D. Continuous Compounding4•8 SummaryChapter 5: Uncertainty, Default, and Risk 835•1 An Introduction to Statistics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 845•1.A. Random Variables and Expected Values 845•1.B. Risk Neutrality (and Risk Aversion Preview) 875•2 Interest Rates and Credit Risk (Default Risk) . . . . . . . . . . . . . . . . . . . . . . . . . . . 885•2.A. Risk-Neutral Investors Demand Higher Promised Rates 885•2.B. A More Elaborate Example With Probability Ranges 895•2.C. Preview: Risk-Averse Investors Have Demanded Higher Expected Rates 915•3 Uncertainty in Capital Budgeting, Debt, and Equity . . . . . . . . . . . . . . . . . . . . . . . 935•3.A. Present Value With State-Contingent Payoff Tables 935•3.B. Splitting Project Payoffs into Debt and Equity 965•4 Robustness: How Bad are Your Mistakes? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1045•4.A. Short-Term Projects 1045•4.B. Long-Term Projects 1045•4.C. Two Wrongs Do Not Make One Right 1055•5 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106Chapter 6: Dealing With Imperfect Markets 1116•1 Causes and Consequences of Imperfect Markets . . . . . . . . . . . . . . . . . . . . . . . . . 1126•1.A. Perfect Market Assumptions 1126•1.B. Value in Imperfect Markets 1136•1.C. Perfect, Competitive, and Efficient Markets 1136•2 The Effect of Disagreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1176•2.A. Expected Return Differences vs. Promised Return Differences 1176•2.B. Corporate Finance vs. Entrepreneurial or Personal Finance? 1186•2.C. Covenants, Collateral, and Credit Rating Agencies 1196•3 Market Depth and Transaction Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1236•3.A. Typical Costs When Trading Real Goods—Houses 1236•3.B. Typical Costs When Trading Financial Goods—Stocks 1246•3.C. Transaction Costs in Returns and Net Present Values 1266•3.D. Liquidity 1276•4 An Introduction to The Tax Code . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1286•4.A. The Basics of (Federal) Income Taxes 1286•4.B. Before-Tax vs. After-Tax Expenses 1306•4.C. Average and Marginal Tax Rates 1316•4.D. Dividend and Capital Gains Taxes 1316•4.E. Other Taxes 1326•4.F. What You Need To Know About Tax Principles In Our Book 1336•5 Working With Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1346•5.A. Taxes in Rates of Returns 1346•5.B. Tax-Exempt Bonds and the Marginal Investor 1346•5.C. Taxes in NPV 1356•5.D. Tax Timing 1376•6 Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1386•6.A. Defining the Inflation Rate 1386•6.B. Real and Nominal Interest Rates 1396•6.C. Handling Inflation in Net Present Value 1416•6.D. Interest Rates and Inflation Expectations 1426•7 Multiple Effects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1446•7.A. How to Work Problems You Have Not Encountered 1446•7.B. Taxes on Nominal Returns? 1456•8 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 147Chapter 7: Capital Budgeting (NPV) Applications and Advice 1537•1 The Economics of Project Interactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1547•1.A. The Ultimate Project Selection Rule 1547•1.B. Project Pairs and Externalities 1557•1.C. One More Project: Marginal Rather Than Average Contribution 1577•2 Comparing Projects With Different Lives and Rental Equivalents . . . . . . . . . . . . . . . 1627•3 Expected, Typical, and Most Likely Scenarios . . . . . . . . . . . . . . . . . . . . . . . . . . . 1647•4 Future Contingencies and Real Options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1657•4.A. A Basic Introduction 1657•4.B. More Complex Option Valuation in a Risk-Neutral World 1667•4.C. Decision Trees: One Set of Parameters 1667•4.D. Decision Trees: One Set of Parameters 1717•4.E. Summary 1737•5 Mental Biases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1757•6 Incentive (Agency) Biases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1767•7 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 180Chapter 8: Other Important Capital Budgeting Topics 1838•1 Profitability Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1848•2 The Internal Rate of Return (IRR) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1858•2.A. Definition 1858•2.B. Problems with IRR 1878•3 So Many Returns: The Internal Rate of Return, the Cost of Capital, the Hurdle Rate, andthe Expected Rate of Return . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1888•4 Other Capital Budgeting Rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1898•4.A. The Problems of Payback 1898•4.B. More Rules 1908•5 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 191II. Corporate Financials 193Chapter 9: Understanding Financial Statements 1979•1 Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1989•1.A. The Contents of Financials 1999•1.B. PepsiCo’s 2001 Financials 2059•1.C. Why Finance and Accounting Think Differently 2069•2 The Bottom-Up Example — Long-Term Accruals (Depreciation) . . . . . . . . . . . . . . . 2089•2.A. Doing Accounting 2089•2.B. Doing Finance 2119•2.C. Translating Accounting into Finance 2129•3 The Hypothetical Bottom-Up Example — Short-Term Accruals . . . . . . . . . . . . . . . . 2159•3.A. Working Capital 2159•3.B. Earnings Management 2189•4 Completing the Picture: PepsiCo’s Financials . . . . . . . . . . . . . . . . . . . . . . . . . . . 2199•5 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 224A Appendix: Supplementary Financials — Coca Cola . . . . . . . . . . . . . . . . . . . . . . . 225a. Coca Cola’s Financials From EdgarScan 226b. Coca Cola’s Financials From Yahoo!Finance 227B Appendix: Abbreviated PepsiCo Income Statement and Cash Flow Statement . . . . . . . 228Chapter 10: Valuation From Comparables 23310•1 Comparables vs. NPV . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23410•2 The Price-Earnings (PE) Ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23510•2.A. Definition 23510•2.B. Why P/E Ratios differ 23610•2.C. P/E Ratio Application Example: Valuing Beverage Companies 24410•3 Problems With P/E Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24510•3.A. Selection of Comparison Firms 24610•3.B. (Non-) Aggregation of Comparables 24710•3.C. A Major Blunder: Never Average P/E ratios 24810•3.D. Computing Trailing Twelve Month (TTM) Figures 25010•3.E. Leverage Adjustments For P/E Ratios 25110•4 Other Financial Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25510•4.A. Value-Based Ratios 25510•4.B. Non-Value-Based Ratios Used in Corporate Analyses 25710•5 Closing Thoughts: Comparables or NPV? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26210•6 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 262A Advanced Appendix: A Formula For Unlevering P/E ratios . . . . . . . . . . . . . . . . . . . 263III. Risk and Investments 267Chapter 11: A First Look at Investments 27111•1 Stocks, Bonds, and Cash, 1970–2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27211•1.A. Graphical Representation of Historical Stock Market Returns 27211•1.B. Comparative Investment Performance 27611•1.C. Comovement, Beta, and Correlation 28011•2 Visible and General Historical Stock Regularities . . . . . . . . . . . . . . . . . . . . . . . . 28211•3 History or Opportunities? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28311•4 Eggs and Baskets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28411•4.A. The Overall Basket 28411•4.B. The Marginal Risk Contribution 28511•4.C. The Market Equilibrium 28511•5 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 286Chapter 12: Securities and Portfolios 28712•1 Some Background Information About Equities Market Microstructure . . . . . . . . . . . 28812•1.A. Brokers 28812•1.B. Exchanges and Non-Exchanges 28812•1.C. How Securities Appear and Disappear 28912•2 Equities Transaction Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29112•2.A. Going Long 29112•2.B. Going Short: The Academic Fiction 29112•2.C. Going Short: The Real World 29212•3 Portfolios and Indexes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29412•3.A. Portfolio Returns 29412•3.B. Funds and Net Holdings 29612•3.C. Some Common Indexes 29712•3.D. Equal-Weighted and Value-Weighted Portfolios 29812•3.E. Quo Vadis? Random Returns on Portfolios 30112•4 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 302Chapter 13: Statistics 30513•1 Historical and Future Rates of Return . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30613•2 The Data: Twelve Annual Rates of Returns . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30713•3 Univariate Statistics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30813•3.A. The Mean 30813•3.B. The Variance and Standard Deviation 30813•4 Bivariate Statistics: Covariation Measures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31113•4.A. Intuitive Covariation 31113•4.B. Covariation: Covariance, Correlation, and Beta 31213•4.C. Computing Covariation Statistics For The Annual Returns Data 32013•5 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32313•6 Advanced Appendix: More Statistical Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . 32413•6.A. Historical and Future Statistics 32413•6.B. Improving Future Estimates From Historical Estimates 32413•6.C. Other Measures of Spread 32613•6.D. Translating Mean and Variance Statistics Into Probabilities 32613•6.E. Correlation and Causation 327Chapter 14: Statistics of Portfolios 32914•1 Two Investment Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33114•1.A. Expected Rates of Returns 33114•1.B. Covariance 33214•1.C. Beta 33314•1.D. Variance 33414•2 Three and More Investment Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33614•2.A. Expected Returns, Covariance, Beta 33614•2.B. Variance 33814•2.C. Advanced Nerd Section: Variance with N Securities and Double Summations 34014•2.D. Another Variance Example: PepsiCo, CocaCola, and Cadbury 34214•3 Historical Statistics For Some Asset-Class Index Portfolios . . . . . . . . . . . . . . . . . . 34514•4 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 349A Appendix: More Historical Statistics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 351a. Country Fund Rates of Return 352b. Dow-Jones Constituents 353Chapter 15: The Principle of Diversification 35715•1 What Should You Care About? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35815•2 Diversification: The Informal Way . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35915•3 Diversification: The Formal Way . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36015•3.A. Uncorrelated Securities 36015•3.B. Correlated Securities 36315•3.C. Measures of Contribution Diversification: Covariance, Correlation, or Beta? 36315•4 Does Diversification Work in the Real World? . . . . . . . . . . . . . . . . . . . . . . . . . . 36815•4.A. Diversification Among The Dow-Jones 30 Stocks 36815•4.B. Mutual Funds 37015•4.C. Alternative Assets 37015•5 Diversification Over Time . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37215•6 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 376Chapter 16: The Efficient Frontier—Optimally Diversified Portfolios 38116•1 The Mean-Variance Efficient Frontier . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38216•1.A. The Mean-Variance Efficient Frontier With Two Risky Securities 38216•1.B. Different Covariance Scenarios 38516•1.C. The Mean-Variance Efficient Frontier With Many Risky Securities 38616•2 Real-World Mean-Variance Efficient Frontier Implementation Problems . . . . . . . . . . . 39216•3 Combinations of Portfolios on The Efficient Frontier . . . . . . . . . . . . . . . . . . . . . . 39416•4 The Mean-Variance Efficient Frontier With A Risk-Free Security . . . . . . . . . . . . . . . 39716•4.A. Risk-Reward Combinations of Any Portfolio Plus the Risk-Free Asset 39716•4.B. The Best Risk-Reward Combinations With A Risk-Free Asset 39916•4.C. The Formula to Determine the Tangency Portfolio 40016•4.D. Combining The Risk-Free Security And the Tangency Portfolio 40216•5 What does a Security need to offer to be in an Efficient Frontier Portfolio? . . . . . . . . 40316•5.A. What if the Risk-Reward Relationship is Non-Linear? 40316•5.B. What if the Risk-Reward Relationships is Linear? 40416•5.C. The Line Parameters 40616•6 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 409A Advanced Appendix: Excessive Proofs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 411a. The Optimal Portfolio Weights Formula 411b. The Combination of MVE Portfolios is MVE — With Risk-Free Security. 412c. The Combination of Mean-Variance Efficient Portfolios is Mean-Variance Efficient — Without Risk-Free Security. 413d. Proof of the Linear Beta vs. Expected Rate of Return Relationship for MVE Frontier Portfolios 413Chapter 17: The CAPM: A Cookbook Recipe Approach 42117•1 The Opportunity Cost of Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42217•2 The CAPM . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42317•2.A. The Premise and Formula 42317•2.B. The Security Ma
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A First Course in Finance PDF

846 Pages·2006·7.131 MB·English
by  Ivo Welch / Иво Вэлч
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Description:
Позже (в 2008) изданная под названием 'Corporate Finance: An Introduction', эта книга была доступна на авторском сайте для комментариев и предварительного знакомства с материалом (Preview).Про книгуA First Course in Finance является первым такого рода пособием, с простым и кратким подходом к изложению основ финансового курса в доступных терминах. В нем использованы простые числовые примеры для пояснения всех основных финансовых концепций (и формул).Текст может быть использован в качестве полного курса, или как дополнение к традиционным учебникам по финансам.Первые отзывы студентов были очень положительны в обоих случаях.Несмотря на то, что это пособие подходит для самообучения, первоначальная цель его разработки была дополнить обучение в классах начального высшего образования и аспирантуры. Автор рассчитывал втиснуть материал в размер "напряженного" семестра или более размеренных 2-х семестров. Содержание:I. Investments and ReturnsChapter 1: A Short Introduction1•1 The Goal of Finance: Relative Valuation1•2 How do CFOs do It?1•3 Learning How to Approach New Problems1•4 The Main Parts of This BookChapter 2: The Time Value of Money2•1 Basic Definitions2•1.A. Investments, Projects, and Firms2•1.B. Loans and Bonds2•1.C. U.S. Treasuries2•2 Returns, Net Returns, and Rates of Return2•3 The Time Value of Money2•3.A. The Future Value of Money2•3.B. Compounding2•3.C. Confusion: Interest Rates vs. Interest Quotes2•4 Capital Budgeting2•4.A. Discount Factor and Present Value (PV)2•4.B. Net Present Value (NPV)2•5 SummaryChapter 3: More Time Value of Money3•1 Separating Investment Decisions and Present Values From Other Considerations3•1.A. Does It Matter When You Need Cash?3•1.B. Corporate Valuation: Growth as Investment Criteria?3•1.C. The Value Today is just “All Inflows” or just “All Outflows”3•2 Perpetuities3•2.A. The Simple Perpetuity Formula3•2.B. The Growing Perpetuity Formula3•2.C. A Growing Perpetuity Application: Individual Stock Valuation with Gordon Growth Models3•3 The Annuity Formula3•3.A. An Annuity Application: Fixed-Rate Mortgage Payments3•3.B. An Annuity Example: A Level-Coupon Bond3•3.C. The Special Cash Flow Streams Summarized3•4 Summarya Advanced Appendix: Proofs of Perpetuity and Annuity FormulasChapter 4: Investment Horizon, The Yield Curve, and (Treasury) Bonds4•1 Time-Varying Rates of Return4•2 Annualized Rates of Return4•3 The Yield Curve4•3.A. An Example: The Yield Curve in May 20024•3.B. Compounding With The Yield Curve4•3.C. Yield Curve Shapes4•4 Present Values With Time-Varying Interest Rates4•4.A. Valuing A Coupon Bond With A Particular Yield Curve4•5 Why is the Yield Curve not Flat?4•5.A. The Effect of Interest Rate Changes on Short-Term and Long-Term Treasury Bond Values4•6 The Yield To Maturity (YTM)4•7 Optional Bond Topics4•7.A. Extracting Forward Interest Rates4•7.B. Shorting and Locking in Forward Interest Rates4•7.C. Bond Duration4•7.D. Continuous Compounding4•8 SummaryChapter 5: Uncertainty, Default, and Risk 835•1 An Introduction to Statistics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 845•1.A. Random Variables and Expected Values 845•1.B. Risk Neutrality (and Risk Aversion Preview) 875•2 Interest Rates and Credit Risk (Default Risk) . . . . . . . . . . . . . . . . . . . . . . . . . . . 885•2.A. Risk-Neutral Investors Demand Higher Promised Rates 885•2.B. A More Elaborate Example With Probability Ranges 895•2.C. Preview: Risk-Averse Investors Have Demanded Higher Expected Rates 915•3 Uncertainty in Capital Budgeting, Debt, and Equity . . . . . . . . . . . . . . . . . . . . . . . 935•3.A. Present Value With State-Contingent Payoff Tables 935•3.B. Splitting Project Payoffs into Debt and Equity 965•4 Robustness: How Bad are Your Mistakes? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1045•4.A. Short-Term Projects 1045•4.B. Long-Term Projects 1045•4.C. Two Wrongs Do Not Make One Right 1055•5 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106Chapter 6: Dealing With Imperfect Markets 1116•1 Causes and Consequences of Imperfect Markets . . . . . . . . . . . . . . . . . . . . . . . . . 1126•1.A. Perfect Market Assumptions 1126•1.B. Value in Imperfect Markets 1136•1.C. Perfect, Competitive, and Efficient Markets 1136•2 The Effect of Disagreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1176•2.A. Expected Return Differences vs. Promised Return Differences 1176•2.B. Corporate Finance vs. Entrepreneurial or Personal Finance? 1186•2.C. Covenants, Collateral, and Credit Rating Agencies 1196•3 Market Depth and Transaction Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1236•3.A. Typical Costs When Trading Real Goods—Houses 1236•3.B. Typical Costs When Trading Financial Goods—Stocks 1246•3.C. Transaction Costs in Returns and Net Present Values 1266•3.D. Liquidity 1276•4 An Introduction to The Tax Code . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1286•4.A. The Basics of (Federal) Income Taxes 1286•4.B. Before-Tax vs. After-Tax Expenses 1306•4.C. Average and Marginal Tax Rates 1316•4.D. Dividend and Capital Gains Taxes 1316•4.E. Other Taxes 1326•4.F. What You Need To Know About Tax Principles In Our Book 1336•5 Working With Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1346•5.A. Taxes in Rates of Returns 1346•5.B. Tax-Exempt Bonds and the Marginal Investor 1346•5.C. Taxes in NPV 1356•5.D. Tax Timing 1376•6 Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1386•6.A. Defining the Inflation Rate 1386•6.B. Real and Nominal Interest Rates 1396•6.C. Handling Inflation in Net Present Value 1416•6.D. Interest Rates and Inflation Expectations 1426•7 Multiple Effects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1446•7.A. How to Work Problems You Have Not Encountered 1446•7.B. Taxes on Nominal Returns? 1456•8 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 147Chapter 7: Capital Budgeting (NPV) Applications and Advice 1537•1 The Economics of Project Interactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1547•1.A. The Ultimate Project Selection Rule 1547•1.B. Project Pairs and Externalities 1557•1.C. One More Project: Marginal Rather Than Average Contribution 1577•2 Comparing Projects With Different Lives and Rental Equivalents . . . . . . . . . . . . . . . 1627•3 Expected, Typical, and Most Likely Scenarios . . . . . . . . . . . . . . . . . . . . . . . . . . . 1647•4 Future Contingencies and Real Options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1657•4.A. A Basic Introduction 1657•4.B. More Complex Option Valuation in a Risk-Neutral World 1667•4.C. Decision Trees: One Set of Parameters 1667•4.D. Decision Trees: One Set of Parameters 1717•4.E. Summary 1737•5 Mental Biases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1757•6 Incentive (Agency) Biases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1767•7 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 180Chapter 8: Other Important Capital Budgeting Topics 1838•1 Profitability Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1848•2 The Internal Rate of Return (IRR) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1858•2.A. Definition 1858•2.B. Problems with IRR 1878•3 So Many Returns: The Internal Rate of Return, the Cost of Capital, the Hurdle Rate, andthe Expected Rate of Return . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1888•4 Other Capital Budgeting Rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1898•4.A. The Problems of Payback 1898•4.B. More Rules 1908•5 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 191II. Corporate Financials 193Chapter 9: Understanding Financial Statements 1979•1 Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1989•1.A. The Contents of Financials 1999•1.B. PepsiCo’s 2001 Financials 2059•1.C. Why Finance and Accounting Think Differently 2069•2 The Bottom-Up Example — Long-Term Accruals (Depreciation) . . . . . . . . . . . . . . . 2089•2.A. Doing Accounting 2089•2.B. Doing Finance 2119•2.C. Translating Accounting into Finance 2129•3 The Hypothetical Bottom-Up Example — Short-Term Accruals . . . . . . . . . . . . . . . . 2159•3.A. Working Capital 2159•3.B. Earnings Management 2189•4 Completing the Picture: PepsiCo’s Financials . . . . . . . . . . . . . . . . . . . . . . . . . . . 2199•5 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 224A Appendix: Supplementary Financials — Coca Cola . . . . . . . . . . . . . . . . . . . . . . . 225a. Coca Cola’s Financials From EdgarScan 226b. Coca Cola’s Financials From Yahoo!Finance 227B Appendix: Abbreviated PepsiCo Income Statement and Cash Flow Statement . . . . . . . 228Chapter 10: Valuation From Comparables 23310•1 Comparables vs. NPV . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23410•2 The Price-Earnings (PE) Ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23510•2.A. Definition 23510•2.B. Why P/E Ratios differ 23610•2.C. P/E Ratio Application Example: Valuing Beverage Companies 24410•3 Problems With P/E Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24510•3.A. Selection of Comparison Firms 24610•3.B. (Non-) Aggregation of Comparables 24710•3.C. A Major Blunder: Never Average P/E ratios 24810•3.D. Computing Trailing Twelve Month (TTM) Figures 25010•3.E. Leverage Adjustments For P/E Ratios 25110•4 Other Financial Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25510•4.A. Value-Based Ratios 25510•4.B. Non-Value-Based Ratios Used in Corporate Analyses 25710•5 Closing Thoughts: Comparables or NPV? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26210•6 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 262A Advanced Appendix: A Formula For Unlevering P/E ratios . . . . . . . . . . . . . . . . . . . 263III. Risk and Investments 267Chapter 11: A First Look at Investments 27111•1 Stocks, Bonds, and Cash, 1970–2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27211•1.A. Graphical Representation of Historical Stock Market Returns 27211•1.B. Comparative Investment Performance 27611•1.C. Comovement, Beta, and Correlation 28011•2 Visible and General Historical Stock Regularities . . . . . . . . . . . . . . . . . . . . . . . . 28211•3 History or Opportunities? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28311•4 Eggs and Baskets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28411•4.A. The Overall Basket 28411•4.B. The Marginal Risk Contribution 28511•4.C. The Market Equilibrium 28511•5 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 286Chapter 12: Securities and Portfolios 28712•1 Some Background Information About Equities Market Microstructure . . . . . . . . . . . 28812•1.A. Brokers 28812•1.B. Exchanges and Non-Exchanges 28812•1.C. How Securities Appear and Disappear 28912•2 Equities Transaction Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29112•2.A. Going Long 29112•2.B. Going Short: The Academic Fiction 29112•2.C. Going Short: The Real World 29212•3 Portfolios and Indexes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29412•3.A. Portfolio Returns 29412•3.B. Funds and Net Holdings 29612•3.C. Some Common Indexes 29712•3.D. Equal-Weighted and Value-Weighted Portfolios 29812•3.E. Quo Vadis? Random Returns on Portfolios 30112•4 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 302Chapter 13: Statistics 30513•1 Historical and Future Rates of Return . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30613•2 The Data: Twelve Annual Rates of Returns . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30713•3 Univariate Statistics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30813•3.A. The Mean 30813•3.B. The Variance and Standard Deviation 30813•4 Bivariate Statistics: Covariation Measures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31113•4.A. Intuitive Covariation 31113•4.B. Covariation: Covariance, Correlation, and Beta 31213•4.C. Computing Covariation Statistics For The Annual Returns Data 32013•5 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32313•6 Advanced Appendix: More Statistical Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . 32413•6.A. Historical and Future Statistics 32413•6.B. Improving Future Estimates From Historical Estimates 32413•6.C. Other Measures of Spread 32613•6.D. Translating Mean and Variance Statistics Into Probabilities 32613•6.E. Correlation and Causation 327Chapter 14: Statistics of Portfolios 32914•1 Two Investment Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33114•1.A. Expected Rates of Returns 33114•1.B. Covariance 33214•1.C. Beta 33314•1.D. Variance 33414•2 Three and More Investment Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33614•2.A. Expected Returns, Covariance, Beta 33614•2.B. Variance 33814•2.C. Advanced Nerd Section: Variance with N Securities and Double Summations 34014•2.D. Another Variance Example: PepsiCo, CocaCola, and Cadbury 34214•3 Historical Statistics For Some Asset-Class Index Portfolios . . . . . . . . . . . . . . . . . . 34514•4 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 349A Appendix: More Historical Statistics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 351a. Country Fund Rates of Return 352b. Dow-Jones Constituents 353Chapter 15: The Principle of Diversification 35715•1 What Should You Care About? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35815•2 Diversification: The Informal Way . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35915•3 Diversification: The Formal Way . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36015•3.A. Uncorrelated Securities 36015•3.B. Correlated Securities 36315•3.C. Measures of Contribution Diversification: Covariance, Correlation, or Beta? 36315•4 Does Diversification Work in the Real World? . . . . . . . . . . . . . . . . . . . . . . . . . . 36815•4.A. Diversification Among The Dow-Jones 30 Stocks 36815•4.B. Mutual Funds 37015•4.C. Alternative Assets 37015•5 Diversification Over Time . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37215•6 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 376Chapter 16: The Efficient Frontier—Optimally Diversified Portfolios 38116•1 The Mean-Variance Efficient Frontier . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38216•1.A. The Mean-Variance Efficient Frontier With Two Risky Securities 38216•1.B. Different Covariance Scenarios 38516•1.C. The Mean-Variance Efficient Frontier With Many Risky Securities 38616•2 Real-World Mean-Variance Efficient Frontier Implementation Problems . . . . . . . . . . . 39216•3 Combinations of Portfolios on The Efficient Frontier . . . . . . . . . . . . . . . . . . . . . . 39416•4 The Mean-Variance Efficient Frontier With A Risk-Free Security . . . . . . . . . . . . . . . 39716•4.A. Risk-Reward Combinations of Any Portfolio Plus the Risk-Free Asset 39716•4.B. The Best Risk-Reward Combinations With A Risk-Free Asset 39916•4.C. The Formula to Determine the Tangency Portfolio 40016•4.D. Combining The Risk-Free Security And the Tangency Portfolio 40216•5 What does a Security need to offer to be in an Efficient Frontier Portfolio? . . . . . . . . 40316•5.A. What if the Risk-Reward Relationship is Non-Linear? 40316•5.B. What if the Risk-Reward Relationships is Linear? 40416•5.C. The Line Parameters 40616•6 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 409A Advanced Appendix: Excessive Proofs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 411a. The Optimal Portfolio Weights Formula 411b. The Combination of MVE Portfolios is MVE — With Risk-Free Security. 412c. The Combination of Mean-Variance Efficient Portfolios is Mean-Variance Efficient — Without Risk-Free Security. 413d. Proof of the Linear Beta vs. Expected Rate of Return Relationship for MVE Frontier Portfolios 413Chapter 17: The CAPM: A Cookbook Recipe Approach 42117•1 The Opportunity Cost of Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42217•2 The CAPM . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42317•2.A. The Premise and Formula 42317•2.B. The Security Ma
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