Lectures On Corporate Finance (2nd Edition)

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Lectures On Corporate Finance (2nd Edition)

Hardcover(Second Edition)

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Hardcover(Second Edition)
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Overview

This course of lectures introduces students to elementary concepts of corporate finance using a more systematic approach than is generally found in other textbooks.Axioms are first highlighted and the implications of these important concepts are studied afterwards. These implications are used to answer questions about corporate finance, including issues related to derivatives pricing, state-price probabilities, dynamic hedging, dividends, capital structure decisions, and risk and incentive management. Numerical examples are provided, and the mathematics is kept simple throughout.In this second edition, explanations have been improved, based on the authors' experience teaching the material, especially concerning the scope of state-price probabilities in Chapter 12. There is also a new Chapter 22: Fourteen Insights.

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ISBN-13:	9789812568991
Publisher:	World Scientific Publishing Company, Incorporated
Publication date:	10/17/2006
Edition description:	Second Edition
Pages:	268
Product dimensions:	6.70(w) x 9.80(h) x 0.90(d)

	Introductory Remarks	vii
	Contents	xi
I	Introduction to Finance	1
1	Finance	3
1.1	What is Finance?	3
1.2	Corporate Finance	3
1.3	Financial Markets	4
2	Axioms of Modern Corporate Finance	6
2.1	The Axioms	6
2.1.1	Financial Markets are Competitive	6
2.1.2	Value Additivity	6
2.1.3	No Free Lunches	7
2.1.4	The Efficient Markets Hypothesis	7
3	On Value Additivity	8
3.1	Value Additivity	8
3.2	The Value of the Firm	8
3.3	A Couple of Brain Teasers	9
4	On the Efficient Markets Hypothesis	12
4.1	The Idea	12
4.2	Traditional Formulation of the Efficient Markets Hypothesis	12
4.3	What Information?	13
4.4	What Does "Correctly Reflected" Mean?	14
4.4.1	Rational Learning	14
4.4.2	Unbiased Beliefs	15
4.4.3	Adding Compensation for Waiting and Risk	15
4.5	Empirical Evidence	16
4.6	Some Implications of the Efficient Markets Hypothesis	16
4.6.1	One Cannot Time the Market	16
4.6.2	Average Returns in Excess of the Risk Free Rate are Solely Determined by Risk	17
4.6.3	Expected Returns Can Vary Over Time	17
II	Basic Finance	21
5	Present Value	23
5.1	Definition of Present Value	23
5.2	Pricing in Markets for Dated Riskfree Cash Flows	25
5.3	Interest Rates	25
5.4	Term Structure of Interest Rates	26
5.5	Net Present Value	28
5.6	Capital Budgeting	28
5.7	Perpetuities	29
5.8	Annuities	30
5.9	Compound Interest	31
5.10	Valuing Fixed Income Securities	32
5.11	Valuing Equities	33
5.12	Risky Cash Flows	35
6	Capital Budgeting	40
6.1	Capital Budgeting	40
6.2	Evaluating Projects using NPV	41
6.2.1	Calculation of NPV	41
6.2.2	Only Cash Flows	41
6.2.3	Accountants	41
6.2.4	After Tax Cash Flows	42
6.2.5	What are Relevant Cash Flows?	42
6.2.6	Inflation	43
6.2.7	Projects with Different Life Lengths	44
6.3	Alternative Valuation Methods	44
6.3.1	Payback Period	44
6.3.2	Internal Rate of Return	45
6.3.3	Profitability Index	49
6.3.4	Accounting Measures of Return	49
6.4	Some Fancy Acronyms	49
6.4.1	EVA (Economic Value Added)	50
6.4.2	MVA (Market Value Added)	50
6.4.3	TSR (Total Shareholder Return)	50
7	Valuation Under Uncertainty: The CAPM	53
7.1	Asset Pricing Theory	53
7.2	Portfolio Returns	54
7.3	Diversifiable and Nondiversifiable Risk	55
7.4	The Set of Efficient Portfolios	56
7.5	The Possibility Set with a Risk Free Security	57
7.6	The Capital Asset Pricing Model	57
7.7	Using CAPM for Pricing	59
7.8	Using CAPM for Capital Budgeting	60
7.9	Empirical Evidence	61
7.10	Experimental Evidence	61
7.11	The Arbitrage Pricing Theory	62
7.12	When the CAPM Would Fail	62
III	Multiperiod Pricing and Derivatives	67
8	Valuing Risky Cash Flows	69
8.1	Valuation of Dated, Risky Cash Flows	69
8.2	States	70
8.3	States and Digital Options	70
8.4	Expectations and Digital Options	72
8.5	Trees	74
8.6	Summarizing	74
9	Introduction to Derivatives	77
9.1	Derivatives	77
9.2	Definitions	78
9.3	Option Cashflows	79
9.4	Bounds on Option Prices	81
9.4.1	Positivity	81
9.4.2	Simple Upper Bounds	81
9.4.3	European Call Lower Bound	82
9.4.4	Should American Options be Exercised Early?	84
9.5	Put-Call Parity	84
9.6	Rounding Off	86
10	Pricing Derivatives	90
10.1	Pricing Risky Cash Flows	90
10.2	Pricing Derivatives	91
10.3	Interpreting Equity as an Option	93
11	Pricing of Multiperiod, Risky Investments	97
11.1	Multiple States	97
11.2	Getting to Two States by Adding Time Steps	98
11.3	A Real-Life Example: Pricing An MCI Call Option	100
11.4	General Strategy	103
12	Where To Get State Price Probabilities?	106
12.1	Implementation	106
12.2	Generating the Possible Future States	106
12.3	Now the State Price Probabilities	109
12.4	Pricing Call Options: The MCI Example Again	110
12.5	State Price Probabilities and True Probabilities	112
13	Warrants	115
13.1	Definition	115
13.2	Firm Value and Warrants	115
13.3	Valuation	116
14	The Dynamic Hedge Argument	119
14.1	Pricing	119
14.2	Why State Prices must be Equal	119
14.3	The Binomial Option Pricing Model	120
15	Multiple Periods in the Binomial Option Pricing Model	128
15.1	Multiple Periods	128
15.2	The Binomial Formula and the Black Scholes Model	132
15.3	Early Exercise of Puts in the Binomial Model	132
15.4	Adjusting for Dividends in the Binomial Model	134
15.5	Implementing the binomial option formula	136
16	An Application: Pricing Corporate Bonds	139
16.1	Corporate Bonds	139
16.2	The Risky Part of Corporate Bonds	139
16.3	Risk Free Bonds with Put Option	141
16.4	Shareholder Incentives	145
16.5	A Solution: Convertible Bonds	146
16.6	Callable Convertible Bonds	148
IV	Corporate Finance	153
17	Are Capital Structure Decisions Relevant?	155
17.1	The Capital Structure Problem	155
17.2	The Problem with "Assets In Place"	156
17.3	Shareholder Preferences for Firm Value	160
17.4	Implications for Cost of Equity Capital: MM II	161
17.5	What if Assets are Not In Place?	162
18	Maybe Capital Structure Affects Firm Value After All?	167
18.1	Only Through Changes in Assets	167
18.2	Corporate Taxes	167
18.3	Bankruptcy Costs	170
18.4	Agency Costs	173
18.5	Personal Taxes	173
18.6	General Equilibrium Effects Restore Irrelevance	174
19	Valuation Of Projects Financed Partly With Debt	177
19.1	Adjusting for Taxes	177
19.2	Three Strategies That Have Been Suggested	177
19.2.1	Adjusted Present Value	177
19.2.2	Flow to Equity	178
19.2.3	Weighted Average Cost of Capital	178
19.3	The General Principle: Net Present Value Again	179
20	And What About Dividends?	181
20.1	Dividends	181
20.2	The Miller and Modigliani Argument	181
20.3	Why Pay Taxes if Only the IRS Gains?	182
20.3.1	Double Taxation	182
20.3.2	Individual Preferences for Capital Gains	182
20.4	Does the Market Agree?	183
20.4.1	The Ex-day Drop	183
20.4.2	Looking Beyond the Border	184
20.4.3	The Evidence from Returns on Investment	184
20.5	Share Repurchases	184
20.6	So, Why do Firms Pay Dividends? The Signalling Hypothesis	184
20.7	Irrelevance Again	185
V	Risk Management	189
21	Risk And Incentive Management	191
21.1	Hedging	191
21.2	Hedging with Readily Available Contracts	191
21.2.1	Forward and Futures Contracts	191
21.2.2	Pricing of Forward and Futures Contracts	192
21.2.3	Options	193
21.2.4	Other Derivatives	193
21.3	Synthetic Static Hedges	193
21.4	Synthetic Dynamic Hedges	194
21.5	The Metallgesellschaft Case	197
21.6	Value At Risk (VaR)	199
21.7	Should Corporations Hedge?	202
21.8	Managing Incentives	202
VI	Longer Examples	207
22	Longer Examples	209
22.1	Determining the Maximum Bid on a Gold Mining License	209
22.2	Chippawhip	210
VII	Appendix	217
	A Notation and Formulas	219
A.1	Notation	219
A.2	Formulas	220
	Index	224
	Bibliography	228

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