Free Essay

Submitted By datuberu

Words 1541

Pages 7

Words 1541

Pages 7

1. (a). A number of stylised features of financial data have been suggested at the start of Chapter 8 and in other places throughout the book:

- Frequency: Stock market prices are measured every time there is a trade or somebody posts a new quote, so often the frequency of the data is very high

- Non-stationarity: Financial data (asset prices) are covariance non-stationary; but if we assume that we are talking about returns from here on, then we can validly consider them to be stationary.

- Linear Independence: They typically have little evidence of linear (autoregressive) dependence, especially at low frequency.

- Non-normality: They are not normally distributed – they are fat-tailed.

- Volatility pooling and asymmetries in volatility: The returns exhibit volatility clustering and leverage effects.

Of these, we can allow for the non-stationarity within the linear (ARIMA) framework, and we can use whatever frequency of data we like to form the models, but we cannot hope to capture the other features using a linear model with Gaussian disturbances.

(b) GARCH models are designed to capture the volatility clustering effects in the returns (GARCH(1,1) can model the dependence in the squared returns, or squared residuals), and they can also capture some of the unconditional leptokurtosis, so that even if the residuals of a linear model of the form given by the first part of the equation in part (e), the [pic]’s, are leptokurtic, the standardised residuals from the GARCH estimation are likely to be less leptokurtic. Standard GARCH models cannot, however, account for leverage effects.

(c) This is essentially a “which disadvantages of ARCH are overcome by GARCH” question. The disadvantages of ARCH(q) are:

- How do we decide on q?

- The required value of q might be very large

- Non-negativity constraints might be violated.

When we estimate an ARCH model, we require (i >0 ( i=1,2,...,q (since variance cannot be negative)

GARCH(1,1) goes some way to get around these. The GARCH(1,1) model has only three parameters in the conditional variance equation, compared to q+1 for the ARCH(q) model, so it is more parsimonious. Since there are less parameters than a typical qth order ARCH model, it is less likely that the estimated values of one or more of these 3 parameters would be negative than all q+1 parameters. Also, the GARCH(1,1) model can usually still capture all of the significant dependence in the squared returns since it is possible to write the GARCH(1,1) model as an ARCH((), so lags of the squared residuals back into the infinite past help to explain the current value of the conditional variance, ht.

(d) There are a number that you could choose from, and the relevant ones that were discussed in Chapter 8, inlcuding EGARCH, GJR or GARCH-M.

The first two of these are designed to capture leverage effects. These are asymmetries in the response of volatility to positive or negative returns. The standard GARCH model cannot capture these, since we are squaring the lagged error term, and we are therefore losing its sign.

The conditional variance equations for the EGARCH and GJR models are respectively

[pic]

And

(t2 = (0 + (1[pic]+((t-12+(ut-12It-1

where It-1 = 1 if ut-1 ( 0 = 0 otherwise

For a leverage effect, we would see ( > 0 in both models.

The EGARCH model also has the added benefit that the model is expressed in terms of the log of ht, so that even if the parameters are negative, the conditional variance will always be positive. We do not therefore have to artificially impose non-negativity constraints.

One form of the GARCH-M model can be written

yt = ( +other terms + ((t-1+ ut , ut ( N(0,ht)

(t2 = (0 + (1[pic]+((t-12

so that the model allows the lagged value of the conditional variance to affect the return. In other words, our best current estimate of the total risk of the asset influences the return, so that we expect a positive coefficient for (. Note that some authors use ((t (i.e. a contemporaneous term).

(e). Since yt are returns, we would expect their mean value (which will be given by () to be positive and small. We are not told the frequency of the data, but suppose that we had a year of daily returns data, then ( would be the average daily percentage return over the year, which might be, say 0.05 (percent). We would expect the value of (0 again to be small, say 0.0001, or something of that order. The unconditional variance of the disturbances would be given by (0/(1-((1 +(2)). Typical values for (1 and (2 are 0.8 and 0.15 respectively. The important thing is that all three alphas must be positive, and the sum of (1 and (2 would be expected to be less than, but close to, unity, with (2 > (1.

(f) Since the model was estimated using maximum likelihood, it does not seem natural to test this restriction using the F-test via comparisons of residual sums of squares (and a t-test cannot be used since it is a test involving more than one coefficient). Thus we should use one of the approaches to hypothesis testing based on the principles of maximum likelihood (Wald, Lagrange Multiplier, Likelihood Ratio). The easiest one to use would be the likelihood ratio test, which would be computed as follows:

1. Estimate the unrestricted model and obtain the maximised value of the log-likelihood function.

2. Impose the restriction by rearranging the model, and estimate the restricted model, again obtaining the value of the likelihood at the new optimum. Note that this value of the LLF will be likely to be lower than the unconstrained maximum.

3. Then form the likelihood ratio test statistic given by

LR = -2(Lr - Lu) ( (2(m)

where Lr and Lu are the values of the LLF for the restricted and unrestricted models respectively, and m denotes the number of restrictions, which in this case is one.

4. If the value of the test statistic is greater than the critical value, reject the null hypothesis that the restrictions are valid.

(g) In fact, it is possible to produce volatility (conditional variance) forecasts in exactly the same way as forecasts are generated from an ARMA model by iterating through the equations with the conditional expectations operator.

We know all information including that available up to time T. The answer to this question will use the convention from the GARCH modelling literature to denote the conditional variance by ht rather than (t2. What we want to generate are forecasts of hT+1 ((T, hT+2 ((T, ..., hT+s ((T where (T denotes all information available up to and including observation T. Adding 1 then 2 then 3 to each of the time subscripts, we have the conditional variance equations for times T+1, T+2, and T+3: hT+1 = (0 + (1[pic] +( hT (1) hT+2 = (0 + (1[pic] +( hT+1 (2) hT+3 = (0 + (1[pic] +(hT+2 (3)

Let [pic] be the one step ahead forecast for h made at time T. This is easy to calculate since, at time T, we know the values of all the terms on the RHS. Given [pic], how do we calculate [pic], that is the 2-step ahead forecast for h made at time T?

From (2), we can write

[pic]= (0 + (1 ET([pic])+([pic] (4)

where ET([pic]) is the expectation, made at time T, of [pic], which is the squared disturbance term. The model assumes that the series (t has zero mean, so we can now write

Var(ut) = E[(ut -E(ut))2]= E[(ut)2].

The conditional variance of ut is ht, so

ht ( (t = E[(ut)2]

Turning this argument around, and applying it to the problem that we have,

ET[(uT+1)2] = hT+1

but we do not know hT+1 , so we replace it with [pic], so that (4) becomes

[pic]= (0 + (1[pic] +([pic] = (0 + ((1+()[pic]

What about the 3-step ahead forecast?

By similar arguments,

[pic]= ET((0 + (1[pic] +( hT+2) = (0 + ((1+() [pic] = (0 + ((1+()[ (0 + ((1+()[pic]]

And so on. This is the method we could use to forecast the conditional variance of yt. If yt were, say, daily returns on the FTSE, we could use these volatility forecasts as an input in the Black Scholes equation to help determine the appropriate price of FTSE index options.

(h) An s-step ahead forecast for the conditional variance could be written [pic] (x)

For the new value of (, the persistence of shocks to the conditional variance, given by ((1+() is 0.1251+ 0.98 = 1.1051, which is bigger than 1. It is obvious from equation (x), that any value for ((1+() bigger than one will lead the forecasts to explode. The forecasts will keep on increasing and will tend to infinity as the forecast horizon increases (i.e. as s increases). This is obviously an undesirable property of a forecasting model! This is called “non-stationarity in variance”.

For ((1+()…...

Premium Essay

...Solutions to Chapter 4 The Time Value of Money 1. a. b. c. d. $100/(1.08)10 = $46.32 $100/(1.08)20 = $21.45 $100/(1.04)10 = $67.56 $100/(1.04)20 = $45.64 $100 × (1.08)10 = $215.89 $100 × (1.08)20 = $466.10 $100 × (1.04)10 = $148.02 $100 × (1.04)20 = $219.11 2. a. b. c. d. 3. $100 × (1.04)113 = $8,409.45 $100 × (1.08)113 = $598,252.29 4. With simple interest, you earn 4% of $1,000 or $40 each year. There is no interest on interest. After 10 years, you earn total interest of $400, and your account accumulates to $1,400. With compound interest, your account grows to: $1,000 × (1.04)10 = $1480.24 Therefore $80.24 is interest on interest. PV = $700/(1.05)5 = $548.47 5. 4-1 6. Present Value a. $400 Years 11 Future Value $684 Interest Rate ⎡ 684 ⎤ ⎢ 400 ⎥ ⎣ ⎦ ⎡ 249 ⎤ ⎢ 183 ⎥ ⎦ ⎣ (1 / 11) − 1 = 5.00% (1 / 4 ) b. $183 4 $249 − 1 = 8.00% (1 / 7 ) c. $300 7 $300 ⎡ 300 ⎤ ⎢ 300 ⎥ ⎣ ⎦ − 1 = 0% To find the interest rate, we rearrange the basic future value equation as follows: ⎡ FV ⎤ FV = PV × (1 + r) ⇒ r = ⎢ ⎣ PV ⎥ ⎦ t (1 / t ) −1 7. You should compare the present values of the two annuities. a. ⎡ 1 ⎤ 1 − PV = $1,000 × ⎢ = $7,721.73 10 ⎥ ⎣ 0.05 0.05 × (1.05) ⎦ ⎡ 1 ⎤ 1 − PV = $800 × ⎢ = $8,303.73 15 ⎥ ⎣ 0.05 0.05 × (1.05) ⎦ b. ⎡ 1 ⎤ 1 − = $4,192.47 PV = $1,000 × ⎢ 10 ⎥ ⎣ 0.20 0.20 × (1.20) ⎦ ⎡ 1 ⎤ 1 − PV = $800 × ⎢ = $3,740.38 15 ⎥ ⎣ 0.20 0.20 × (1.20) ⎦ c. When the interest rate is low, as...

Words: 6215 - Pages: 25

Premium Essay

...Solutions for Chapter 8 Tools to Gather Audit Evidence Review Questions: 8-1. The three main tools the auditor might use in gathering and evaluating audit evidence are: • Audit sampling • Generalized Audit Software • Analytical procedures 8-2. Non-sampling risk is the risk that the auditor makes an improper assessment of inherent and/or control risk or did not apply audit procedures carefully. It can be minimized through: (1) Good hiring, training and supervision practices; and (2) Careful and knowledgeable review of audit documentation and audit procedures. Sampling risk is the risk that the misstatement projections based on the sample results lead to the wrong conclusion about the population because of a non-representative sample. Sampling risk can be reduced by increasing the sample size – to the extreme of auditing the entire population therefore eliminating sampling risk altogether. 8-3. Factors to consider when choosing between statistical and nonstatistical sampling include: • Need to quantify and control sampling risks. • Additional cost of designing, selecting, and evaluating a statistical sample. • Availability of computer software to assist in designing, selecting, and/or evaluating the sample. • Ability of the audit staff to properly implement statistical sampling. 8-4. a. Tolerable deviation rate depends on the significance of the control procedure being......

Words: 11678 - Pages: 47

Premium Essay

...iCHAPTER 1 TEACHING NOTES You have substantial latitude about what to emphasize in Chapter 1. I find it useful to talk about the economics of crime example (Example 1.1) and the wage example (Example 1.2) so that students see, at the outset, that econometrics is linked to economic reasoning, if not economic theory. I like to familiarize students with the important data structures that empirical economists use, focusing primarily on cross-sectional and time series data sets, as these are what I cover in a first-semester course. It is probably a good idea to mention the growing importance of data sets that have both a cross-sectional and time dimension. I spend almost an entire lecture talking about the problems inherent in drawing causal inferences in the social sciences. I do this mostly through the agricultural yield, return to education, and crime examples. These examples also contrast experimental and nonexperimental data. Students studying business and finance tend to find the term structure of interest rates example more relevant, although the issue there is testing the implication of a simple theory, as opposed to inferring causality. I have found that spending time talking about these examples, in place of a formal review of probability and statistics, is more successful (and more enjoyable for the students and me). 3 CHAPTER 2 TEACHING NOTES This is the chapter where I expect students to follow most, if not all, of the algebraic derivations. In class I like......

Words: 73034 - Pages: 293

Premium Essay

...Solutions Manual Fundamentals of Corporate Finance (Asia Global Edition) Ross, Westerfield, Jordan, Lim and Tan Updated April 2012 CHAPTER 1 INTRODUCTION TO CORPORATE FINANCE Answers to Concepts Review and Critical Thinking Questions 1. Capital budgeting (deciding whether to expand a manufacturing plant), capital structure (deciding whether to issue new equity and use the proceeds to retire outstanding debt), and working capital management (modifying the firm’s credit collection policy with its customers). Disadvantages: unlimited liability, limited life, difficulty in transferring ownership, hard to raise capital funds. Some advantages: simpler, less regulation, the owners are also the managers, sometimes personal tax rates are better than corporate tax rates. The primary disadvantage of the corporate form is the double taxation to shareholders of distributed earnings and dividends. Some advantages include: limited liability, ease of transferability, ability to raise capital, and unlimited life. The treasurer’s office and the controller’s office are the two primary organizational groups that report directly to the chief financial officer. The controller’s office handles cost and financial accounting, tax management, and management information systems, while the treasurer’s office is responsible for cash and credit management, capital budgeting, and financial planning. Therefore, the study of corporate finance is concentrated within the treasury group’s functions. To......

Words: 1113 - Pages: 5

Free Essay

...Task 1 Nowadays, adolescents rashly spend most of their money away without any financial planning. Over 90% of the adolescent’s parents are concerned about their children’s financial problems such as overspending and budget deficits.(1) According to the research of 00000, the adolescents’ knowledge of money management was decreased from 51% in 2007 to 35% in 2011.(8) I presume that budgeting can control income and expenses, therefore it would help the adolescents to achieve their financial goal. By having a good budget, adolescents can become aware of their financial situation and develop a spending plan to reach the financial goal in the future.(0) Hence, my topic is budgeting for the adolescents. Budgeting is a crucial financial tool, it is also a basis that can assist adolescents in reducing their financial problems.(2) Not only does budgeting help adolescents develop a spending plan and future goals, but it also leads them to acknowledge their income accurately, and develop advanced money management skills for their future planning.(2) 000000 research shows that high school students who had a personal financial education have higher rate of saving their income in comparison to students who didn’t undertake the program.(1) For most students, over 92%, acknowledged that having good money management can surely assist them in living a successful and financially stable life.(1) Task 2 In order to develop good budgeting, there are three factors to...

Words: 1181 - Pages: 5

Premium Essay

...Chapter 01 - Why Are Financial Institutions Special? Chapter One Why Are Financial Institutions Special? True/False 1-1 Prior to the financial crisis of 2007-2008, J.P. Morgan Chase was the largest bank holding company in the world and operations in 60 countries. Answer: F 1-2 As of 2009, U.S. FIs held assets totaling over $35 trillion Answer: T 1-3 Financial institutions act as intermediaries between suppliers and demanders of money. Answer: T 1-4 If a household invests in corporate securities and does not supervise how the funds are invested or used by the corporation, the risk of not earning the desired return or not having the funds returned increase. Answer: T 1-5 If not done by FIs, the process of monitoring the actions of borrowers would reduce the attractiveness and increase the risk of investing in corporate debt and equity by individuals. Answer: T 1-6 Failure to monitor the actions of firms in a timely and complete fashion after purchasing securities in that firm exposes the investor to agency costs. Answer: T 1-7 The risk that the sale price of an asset will be less than the purchase price of an asset is called liquidity risk. Answer: F 1-8 Because bank loans have a shorter maturity than most debt contracts, FIs typically exercise less monitoring power and control over the borrower. Answer: F 1-9 FIs typically provide secondary claims to household savers that have inferior liquidity than primary securities of corporations such as equity and bonds. Answer: F......

Words: 4188 - Pages: 17

Premium Essay

...Chapter 8 PROBLEM SET B Problem 8-1B (20 minutes) 1. Violates both applying technological control and effective segregation of duties. It is safe to assume that Latisha Tally has knowledge of employee passwords since she implemented the system of password protection companywide. It is a potentially insecure situation that Latisha processes payroll and can now probably change employee pay rates at will, or add a fictitious employee to the file. The company should hire an outside consultant to rework the password protection system so Latisha will not have the knowledge that she currently possesses. 2. Violates applying technological controls. The theater’s system needs to be backed up at least daily, not weekly. The theater needs to change the backup policy and make sure the backup copies are stored off premises. 3. Violates segregation of duties. The company needs to have three employees handle these functions instead of two. One employee should place purchase orders, one should receive merchandise, and the third should pay vendors. 4. Violates applying technological controls. The use of the check protector is a good internal control. However the company needs to keep the checks and check protector in a locked environment to prevent unauthorized use. 5. Violates segregation of duties. It is good internal control to separate duties for cash receipts and cash disbursements. Moreover, an employee independent of these two functions should......

Words: 3277 - Pages: 14

Premium Essay

...finance TEST BANK Chapter 1 Introduction 1. Which of the following is the primary objective of a firm? A. employees' benefits B. satisfaction of customers C. satisfaction of suppliers D. prompt payment to creditors * E. maximize stockholder wealth 2. Financial risk involves ___. A. fluctuation in exchange rates B. different interest and inflation rates C. balance of payments position D. A and B * E. A, B, and C 3. Three sweeping changes include ___. A. the end of Cold War B. industrialization and growth of the developing world C. the creation of the North American Trade Agreement D. increased globalization * E. A, B, and D 4. Managers are generally defined as ___. A. stockholders * B. agents C. creditors D. suppliers E. customers 5. Which of the following is not one of seven principles of global finance? A. market imperfection B. risk-return tradeoff C. portfolio effect D. comparative advantage * E. company advantage 6. Incentives for multinational company managers include the following except ___. A. stock options B. bonuses C. perquisites D. salary increases * E. vacation 7. Environmental factors affecting international operations are as follows except ___. A. foreign customs B. foreign economic factors C. foreign political situations D. foreign legal aspect * E. international distance 8. Three major risks in international business are ___. A. political, financial and......

Words: 26027 - Pages: 105

Premium Essay

...CHAPTER 1 TEACHING NOTES You have substantial latitude about what to emphasize in Chapter 1. I find it useful to talk about the economics of crime example (Example 1.1) and the wage example (Example 1.2) so that students see, at the outset, that econometrics is linked to economic reasoning, if not economic theory. I like to familiarize students with the important data structures that empirical economists use, focusing primarily on cross-sectional and time series data sets, as these are what I cover in a first-semester course. It is probably a good idea to mention the growing importance of data sets that have both a cross-sectional and time dimension. I spend almost an entire lecture talking about the problems inherent in drawing causal inferences in the social sciences. I do this mostly through the agricultural yield, return to education, and crime examples. These examples also contrast experimental and nonexperimental data. Students studying business and finance tend to find the term structure of interest rates example more relevant, although the issue there is testing the implication of a simple theory, as opposed to inferring causality. I have found that spending time talking about these examples, in place of a formal review of probability and statistics, is more successful (and more enjoyable for the students and me). 3 CHAPTER 2 TEACHING NOTES This is the chapter where I expect students to follow most, if not all, of the algebraic derivations. In class I like to......

Words: 73034 - Pages: 293

Premium Essay

...1 350 000 Book value net fixed assets = 750 000 Book value assets = 1 350 000 + 750 000 = 2 100 000 Market value current assets = 1 500 000 Market value net fixed assets = 2 000 000 Market value assets = 1 500 000 + 2 000 000 = 3 500 000 Task 6 Tax rate = 39% Taxable income = 145 000 Income taxes: 1) 0,15 * 50 000 = 7 500 2) 0,25 * (75 000 – 50 000) = 6 250 3) 0,34 * (100 000 – 75 000) = 8 500 4) 0,39 * (145 000 – 100 000) = 17 550 Total income tax = 1 + 2 + 3 + 4 = 39 800 Task 7 Average tax rate = Total income tax/Net income = 39 800/145 000 = 27,45% Marginal tax rate = 39% Task 11 Cash flow to cresitors = Interest paid - Net new borrowing = 700000-900000=-200000 Task 12 Cash flow to stockholders= Dividents paid - Net New equity raised = 300000-450000=-150000 Task 13 Відповіді з 11 і 12 разом формують cash flow from assets. OCF = Net capital spending + Change in NWC + cash flow from assets = 500000-135000-200000-150000=15000 Task 14 65 000 - 41 000 - 3 000 - 1 750 = 19 250 EBIT 19 250 - 7 000 = 12 250 Taxable income 12 250 - 4 165 = 8 085 Net income a. OCF = 19 250 + 3 000 – 4 165 = 18 085 b. Cash Flow to Creditors = Interest – Net new borrowings = 7 000 – (– 3 000) = 10 000 c. Cash Flow to Stockholders = Dividends – Net new Equity = 3 200 – 1 415 = 1 785 d.......

Words: 760 - Pages: 4

Premium Essay

...Solutions to Questions 8-1 Activity-based costing differs from tradi-tional costing systems in a number of ways. In activity-based costing, nonmanufacturing as well as manufacturing costs may be assigned to products. And, some manufacturing costs—including the costs of idle capacity—may be excluded from prod-uct costs. An activity-based costing system typically includes a number of activity cost pools, each of which has its unique measure of activity. These measures of activity often differ from the allocation bases used in traditional costing systems. 8-2 When direct labor is used as an allocation base for overhead, it is implicitly assumed that overhead cost is directly proportional to direct labor. When cost systems were originally devel-oped in the 1800s, this assumption may have been reasonably accurate. However, direct labor has declined in importance over the years while overhead has been increasing. This suggests that there is no longer a direct link between the level of direct labor and overhead. Indeed, when a company automates, direct labor is replaced by machines; a decrease in direct labor is accompa-nied by an increase in overhead. This violates the assumption that overhead cost is directly propor-tional to direct labor. Overhead cost appears to be driven by factors such as product diversity and complexity as well as by volume, for which direct labor has served as a convenient measure. 8-3 Top managers provide leadership that is needed to properly motivate...

Words: 837 - Pages: 4

Premium Essay

...CHAPTER 8 Valuation of Inventories: A Cost-Basis Approach ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC) Topics Questions Brief Exercises Exercises Problems Concepts for Analysis 1, 2, 3, 5 1. Inventory accounts; 1, 2, 3, 4, determining quantities, 5, 6, 8, 9 costs, and items to be included in inventory; the inventory equation; balance sheet disclosure. 1, 3 1, 2, 3, 4, 5, 6 1, 2, 3 2. Perpetual vs. periodic. 2 9, 13, 17, 20 4, 5, 6 3. Recording of discounts. 10, 11 7, 8 3 4. Inventory errors. 7 4 5, 10, 11, 12 2 5. Flow assumptions. 12, 13, 16, 18, 20 5, 6, 7 9, 13, 14, 15, 16, 17, 18, 19, 20, 21, 22 1, 4, 5, 6, 7 5, 6, 7, 8, 11 6. Inventory accounting changes. 18 7 6, 7, 10 7. Dollar-value LIFO methods. 22, 23, 24, 25, 26 1, 8, 9, 10, 11 8, 9 Copyright © 2013 John Wiley & Sons, Inc. 14, 15, 17, 18, 19 8, 9 Kieso, Intermediate Accounting, 15/e, Solutions Manual 4 (For Instructor Use Only) 8-1 ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE) Learning Objectives Questions Brief Exercises Exercises Problems Concepts for Analysis 1. Identify major classifications of inventory. 1 1 2. Distinguish between perpetual and periodic inventory systems. 3 2 4, 9, 13, 17 4, 5, 6 3. Determine the goods included in inventory and the effects of inventory......

Words: 20989 - Pages: 84

Premium Essay

...intentionally left blank Introductory Econometrics for Finance SECOND EDITION This best-selling textbook addresses the need for an introduction to econometrics speciﬁcally written for ﬁnance students. It includes examples and case studies which ﬁnance students will recognise and relate to. This new edition builds on the successful data- and problem-driven approach of the ﬁrst edition, giving students the skills to estimate and interpret models while developing an intuitive grasp of underlying theoretical concepts. Key features: ● Thoroughly revised and updated, including two new chapters on ● ● ● ● ● ● panel data and limited dependent variable models Problem-solving approach assumes no prior knowledge of econometrics emphasising intuition rather than formulae, giving students the skills and conﬁdence to estimate and interpret models Detailed examples and case studies from ﬁnance show students how techniques are applied in real research Sample instructions and output from the popular computer package EViews enable students to implement models themselves and understand how to interpret results Gives advice on planning and executing a project in empirical ﬁnance, preparing students for using econometrics in practice Covers important modern topics such as time-series forecasting, volatility modelling, switching models and simulation methods Thoroughly class-tested in leading ﬁnance schools Chris Brooks is Professor of Finance at the......

Words: 195008 - Pages: 781

Premium Essay

... Chapter 1 The Financial Manager and the Firm Learning Objectives 1. Identify the key financial decisions facing the financial manager of any business firm. 2. Identify the basic forms of business organization used in the United States, and review their respective strengths and weaknesses. 3. Describe the typical organization of the financial function in a large corporation. 4. Explain why maximizing the current value of the firm’s stock price is the appropriate goal for management. 5. Discuss how agency conflicts affect the goal of maximizing stockholder wealth. 6. Explain why ethics is an appropriate topic in the study of corporate finance. I. Chapter Outline 1.1 The Role of the Financial Manager A. It’s All about Cash Flows • The financial manager is responsible for making decisions that are in the best interest of the firm’s owners. • A firm generates cash flows by selling the goods and services produced by its productive assets and human capital. After meeting its obligations, the firm can pay the remaining cash, called residual cash flows, to the owners as a cash dividend, or it can keep the money and reinvest the cash in the business. • A firm is unprofitable when it fails to generate sufficient cash flows to pay operating expenses, creditors, and taxes. Firms that are unprofitable over time will be forced into bankruptcy by their creditors. In bankruptcy, the company will be reorganized, or the......

Words: 7130 - Pages: 29

Premium Essay

...8-1 = (0.1)(-50%) + (0.2)(-5%) + (0.4)(16%) + (0.2)(25%) + (0.1)(60%) = 11.40% 2 = (-50% – 11.40%)2(0.1) + (-5% – 11.40%)2(0.2) + (16% – 11.40%)2(0.4) + (25% – 11.40%)2(0.2) + (60% – 11.40%)2(0.1) 2 = 7.12%; = 26.69% CV = 26.69%/11.40% CV = 2.34 8-2 | Investment | Ratio | Beta | | A | $ 35,000 | 47% | 0.8 | 0.37 | B | $ 40,000 | 53% | 1.4 | 0.75 | | $ 75,000 | 100% | | 1.12 | The portfolio’s beta is 1.12. 8-3 r = rRF + (rM – rRF)b = 6% + (13% – 6%) (0.7) = 10.9% 8-4 r = rRF + (rM – rRF)b = 5% + (11% – 5%) (1.2) = 12.20% 8-5 a.) r = rRF + (market risk premium)b 11% =7% + (4%)(beta) Beta = (11%-7%)/4% Beta = 1.0 b.) r = rRF + (market risk premium)b =7% + (6%) (1) r = 13% The stock’s required rate of return will increase to 13%. There is an increase of 2% on the required rate of return. 8-6 Computations for stock Y = (0.1)(-35%) + (0.2)(0%) + (0.4)(20%) + (0.2)(25%) + (0.1)(45%) = 14 % 2 = (-35% – 14 %)2(0.1) + (0% – 14 %)2(0.2) + (20% – 14 %)2(0.4) + (25% – 14 %)2(0.2) + (45% – 14 %)2(0.1) 2 = 4.14 %; = 20.35% CV = 20.35%/14% CV = 1.45 Computations for stock X = (0.1)(-10%) + (0.2)(2%) + (0.4)(12%) + (0.2)(20%) + (0.1)(38%) = 12 % 2 = (-10% – 12 %)2(0.1)...

Words: 310 - Pages: 2