Principles of cororate finance 6th brealey myers chapter 13

Principles of Corporate Finance Brealey and Myers  Sixth Edition Corporate Financing and the Six Lessons of Market Efficiency Slides by Matthew Will Irwin/McGraw Hill Chapter 13 ©The McGraw-Hill Companies, Inc., 200 13- Topics Covered  We Always Come Back to NPV  What is an Efficient Market?  Random Walk  Efficient Market Theory  The Evidence on Market Efficiency  Six Lessons of Market Efficiency Irwin/McGraw Hill ©The McGraw-Hill Companies, Inc., 200 13- Return to NPV  NPV employs discount rates  These discount rates are risk adjusted  The risk adjustment is a byproduct of market established prices  Adjustable discount rates change asset values Irwin/McGraw Hill ©The McGraw-Hill Companies, Inc., 200 13- Return to NPV Example The government is lending you $100,000 for 10 years at 3% and only requiring interest payments prior to maturity Since 3% is obviously below market, what is the value of the below market rate loan? NPV amount borrowed - PV of interest pmts - PV of loan repayment Irwin/McGraw Hill ©The McGraw-Hill Companies, Inc., 200 13- Return to NPV Example The government is lending you $100,000 for 10 years at 3% and only requiring interest payments prior to maturity Since 3% is obviously below market, what is the value of the below market rate loan? Assume the market return on equivalent risk projects is 10%  10 3,000  100,000 NPV 100,000     t 10 ( 10 ) ( 10 )  t 1  100,000  56,988 $43,012 Irwin/McGraw Hill ©The McGraw-Hill Companies, Inc., 200 13- Random Walk Theory  The movement of stock prices from day to day DO NOT reflect any pattern  Statistically speaking, the movement of stock prices is random (skewed positive over the long term) Irwin/McGraw Hill ©The McGraw-Hill Companies, Inc., 200 13- Random Walk Theory Coin Toss Game Heads Heads $106.09 $103.00 Tails $100.43 $100.00 Heads Tails $97.50 Tails Irwin/McGraw Hill $100.43 $95.06 ©The McGraw-Hill Companies, Inc., 200 13- Random Walk Theory S&P 500 Five Year Trend? or yrs of the Coin Toss Game? Level 180 130 80 Month Irwin/McGraw Hill ©The McGraw-Hill Companies, Inc., 200 13- Random Walk Theory S&P 500 Five Year Trend? or yrs of the Coin Toss Game? Level 230 180 130 80 Month Irwin/McGraw Hill ©The McGraw-Hill Companies, Inc., 200 13- 10 Irwin/McGraw Hill Random Walk Theory ©The McGraw-Hill Companies, Inc., 200 13- 11 Irwin/McGraw Hill Random Walk Theory ©The McGraw-Hill Companies, Inc., 200 13- 12 Irwin/McGraw Hill Random Walk Theory ©The McGraw-Hill Companies, Inc., 200 13- 13 Irwin/McGraw Hill Random Walk Theory ©The McGraw-Hill Companies, Inc., 200 13- 14 Irwin/McGraw Hill Random Walk Theory ©The McGraw-Hill Companies, Inc., 200 13- 15 Efficient Market Theory  Weak Form Efficiency  Market prices reflect all historical information  Semi-Strong Form Efficiency  Market prices reflect all publicly available information  Strong Form Efficiency  Market prices reflect all information, both public and private Irwin/McGraw Hill ©The McGraw-Hill Companies, Inc., 200 13- 16 Efficient Market Theory  Fundamental Analysts  Research the value of stocks using NPV and other measurements of cash flow Irwin/McGraw Hill ©The McGraw-Hill Companies, Inc., 200 13- 17 Efficient Market Theory  Technical Analysts  Forecast stock prices based on the watching the fluctuations in historical prices (thus “wiggle watchers”) watchers Irwin/McGraw Hill ©The McGraw-Hill Companies, Inc., 200 13- 18 Efficient Market Theory $90 Microsoft Stock Price 70 50 Cycles disappear once identified Irwin/McGraw Hill Last Month This Month Next Month ©The McGraw-Hill Companies, Inc., 200 13- 19 Efficient Market Theory Cumulative Abnormal Return (%) Announcement Date Irwin/McGraw Hill 39 34 29 24 19 14 -1 -6 -11 -16 Days Relative to annoncement date ©The McGraw-Hill Companies, Inc., 200 13- 20 Efficient Market Theory Average Annual Return on 1493 Mutual Funds and the Market Index 40 30 Return (%) 20 10 -10 Funds Market -20 -30 -40 19 Irwin/McGraw Hill 19 19 ©The McGraw-Hill Companies, Inc., 200 13- 21 Efficient Market Theory IPO Non-Excess Returns Average Return (%) 20 IPO Matched Stocks 15 10 First Irwin/McGraw Hill Second Third Fourth Fifth Year After Offering ©The McGraw-Hill Companies, Inc., 200 13- 22 Efficient Market Theory 1987 Stock Market Crash PV (index) pre crash Irwin/McGraw Hill Div 16.7   1193 r  g 114  10 ©The McGraw-Hill Companies, Inc., 200 13- 23 Efficient Market Theory 1987 Stock Market Crash PV (index) pre crash Div 16.7   1193 r  g 114  10 PV (index) post crash Div 16.7   928 r  g 114  096 Irwin/McGraw Hill ©The McGraw-Hill Companies, Inc., 200 13- 24 Lessons of Market Efficiency Markets have no memory Trust market prices Read the entrails There are no financial illusions The it yourself alternative Seen one stock, seen them all Irwin/McGraw Hill ©The McGraw-Hill Companies, Inc., 200 13- 25 Example: How stock splits affect value 35 30 Cumulative abnormal return % 25 20 15 10 -29 30 Month relative to split Source: Fama, Fisher, Jensen & Roll Irwin/McGraw Hill ©The McGraw-Hill Companies, Inc., 200 ... market, what is the value of the below market rate loan? NPV amount borrowed - PV of interest pmts - PV of loan repayment Irwin/McGraw Hill ©The McGraw-Hill Companies, Inc., 200 13- Return to NPV Example... Year Trend? or yrs of the Coin Toss Game? Level 180 130 80 Month Irwin/McGraw Hill ©The McGraw-Hill Companies, Inc., 200 13- Random Walk Theory S&P 500 Five Year Trend? or yrs of the Coin Toss... Companies, Inc., 200 13- 12 Irwin/McGraw Hill Random Walk Theory ©The McGraw-Hill Companies, Inc., 200 13- 13 Irwin/McGraw Hill Random Walk Theory ©The McGraw-Hill Companies, Inc., 200 13- 14 Irwin/McGraw