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#./0123 &4 5 #671 68 92:1 /;< =01>?/@ #/0>1/@ -13AB1A32

Foimulas

vl = vu + PvTS - PvCFB

CFB = Costs of Financial Bistiess

Notes

Stockholueis beai ieuuction in stock piice costs fiom bankiuptcy

CFB high when:assets lost uuiing bankiupt, assets geneiate volatile eainings, much of value uepenus on

futuie investment ie R&B

Risk is a function of: Business iisk(iisk fiom all equity going bioke) anu Financial leveiage(iisk foim

leveiaging). Companies with high business iisk have low leveiage

Agency Costs - self inteiesteu manageis, exec peiks, ieuuceu effoit

o Fiee Cash Flow Theoiy - lots of money to squanuei

LB0's - manageis buy out stockholueis with lots of uebt at piemium

o up tax shielu, uown agency costs, up CFB(bc moie uebt)

o Iueal foi companies with stable cf's tangible assets

C6<23; D63186@>6 ,.263E 5 #. &'F &G

Foimulas

Retuin =R=

!"#

!!

!

!!!!!

!!

= Biv Yielu + Capital uain

Fishei Eq = (1+R) = (1+i)(1+h), i = ieal ietuin, h = inf iate, R = nom ietuin

Avg Risk Piemium = AvgRetuin - AvgRiskFieeRate

vaiiance = Sum(x-xbai)2n-1

SB Yeaily = sqit(12)*SB|monthlyj

!" ! !" ! !" ! !! ! !", X = piopoition in poit, R = expecteu ietuin on asset

vai(Rp) = !"

!

!

!

! !"

!

!

!

! !!"!# ! !"#!!"! !"! = o2 , if p = 1 o = XaXb + oa ob

= iesponsiveness of the funu to movements in the maiket =

!"#!!"!!"!

!!!!"!

!

!!!

!"

Expecteu Naiket Retuin = E(Rm) = Rf + Bistoiical Risk Piemium

Foiecasteu Stock Retuin = Rf + *|E(Rm)-Rfj

Notes

Bell Cuive: piobability of mkt ietuins: mean is ietuin of .1

SB foi inuiviuual secuiities: highei than those foi mkt

Systematic iisk - maiket iisk that you cant avoiu

Iuiosynciatic iisk - can be eliminateu by uiveisification

Expecteu ietuin with any numbei of secuiities is same, only vaiiance uecieases as n incieases. Expecteu

ietuin giaph will be hoiizontal, auuing secuiities loweis iisk while maintaining ietuin

As you uiveisify moie, vaiiance of poitfolio is mostly ueteimineu by numbei of covaiiance teims

H21A3; /;< H>7I 5 #. &&

Foimulas

Notes

-0ppoitunity Set - cuiveu line uepicting possible achievable points of combinations of two secuiities - ueteimineu by

iate ietuin on each stock, Backwaiu benuing on left siue inuicates that SB uecieases as ietuin incieases -uue to

uiveisification, Efficient Fiontiei - fiom min poit vai to highest point on ,Noimal cuive case is of u coiielation, line is

1uu% coii, kinkeu < looking line is 1uu% negative coii

-Best point on a efficient fiontiei cuive to combine with cash is wheie it anu the inuiviuual asset line aie tangent

-Beta is a measuie of funu iesponsiveness to mkt, poitfolio beta is the weighteu avg of betas of inuiviuual stocks. Beta

mkt = 1

-Beta of a Pioject: Scale Enhancing Pioject - pioject has fiim's beta, Non Scale Enhancing Pioject - pioject shoulu be

uiscounteu at beta ielateu to pioject anu to its leveiage

-Beteimining a pioject's cost of capital:1)finu inuustiy that miiiois pioject 2) finu ie foi each fiim in inuustiy S) finu

ia foi each fiim in inuustiy 4) finu avg ia S) iinu ie anu iwacc foi pioject

=01>6;7 5 #.J KK

Foimulas

Put Call Paiity: Piice 0nueilying Stock = Piice Call - Piice Put + Pv Stiike

Coveieu Call: Piice 0nueilying Stock - Piice Call = -Piice Put + Pv Stiike

Black Scholes Nouel: C = SN(u1) - Ee-RtN(u2)

u1=|ln(SE) + (R+ o22)tjV ( o2t)

u2 = u1-V ( o2t)

Notes

0ption - contiact giving ownei iight to by oi sell an asset at a fixeu piice on oi befoie a given uate

o Exeicising 0ption - buying oi selling the actual stock

o Stiike Piice - Fixeu piice at which holuei can buy oi sell

o Expiiation Bate - Natuiity uate, on oi befoie it is ueau

Call 0ption - gives ownei iight to buy asset at fixeu piice

Piicing a Call 0ption - Exeicise Piice, Expiiation Bate, Stock Piice, vaiiability of 0nueilying Asset, Inteiest

Rate

Put 0ption - gives holuei the iight to sell 1uu shaies of a secuiity at fixeu piice within a fixeu time peiiou

0ption Stiategies: Stiauule - Both a put anu a call on the same secuiity at the same stiiking piice, Stiangle -

Both a put anu a call on the same secuiity at uiffeient stiiking piices

Put Call Paiity - two ways of buying a piotective put(buying a put then buying the unueilying stock

|piotective measuie if you have an uniealizeu gain anu uon't want to lose itj)

o Buy a put anu buy the unueilying stock simultaneously. Cost = piice of unueilying stock +

piice of put

o Buy the call anu buy a zeio coupon bonu. Cost = piice call + piice of zeio coupon bonu =

piice call + Pv exeicise piice

Coveieu Call: Buying a stock anu wiiting the call on the stock simultaneously. == selling a put anu buying a

zeio coupon bonu

!A1A32 /;< D3272;1 L/@A2

Notes

APR compounueu annually = EAY

APR = annual peicentage iate, EAY = Effective Annual Yielu

APR to EAY = APR = x%, x%12 = monthly iate, (1+monthlyiate)^12 -1 = EAY

EAY to APY=EAY^12-1=monthly iate, monthly iate*12=APR=

Annuity valueu at peiiou befoie fiist peiiou is uue

Annuity in auvance same as annuity in aiieais plus initial payment

#/0>1/@ MA<N21>;N

Foimulas

lRR: u= -0F +

!!

!!!

, i = x then accept if I >R

CF = !"# ! !"#!!"#$ ! ! !"#$"%& ! !"#$"%& ! !"#$"%&'(&)*

CF = AT Income + Bepieciation

-Auu in aftei tax salvage value uiscounteu by T at the enu of the CF line foi IRR calculation |anu any othei one time

inciuental cost oi ievenuej)

-Initial investments foi pioject aie subtiacteu at beginning anu auueu back uiscounteu at the enu anu aujusteu foi

taxes

EAC =

!"#$$

!!!

! Equivalent Annual Cost lets you compaie NPv's of uiffeient times, compaie the cash flows, pick the highei

Cash fiom Asset Sale = Nv - Tax(Nv-Bv)

Net Woiking Capital = Biff Cuiient Assets - Cuiient Liabilities, inciease in NWC is an outflow, ueciease is an inflow

Notes

-NPv Appioach - Finu total NPv of piojecteu cash flows, accept if NPv >u

Payback -p is the numbei of yeais befoie the sum of cash flows exceeus the initial outlay, P* is the amount of

maximum yeais willing foi payback, Accept if p < oi equal to p*, ieject if not

-IRR - Inteinal Rate of Retuin -Befineu as the uiscount iate that makes the NPv of uiscounteu CF's equal u, Accept if

IRR > i, ieject if not

-Nutually Exclusive Piojects -Biffeiing uecisions between piojects, one has highei NPv, one has highei IRR, 0se an

"Inciemental Cash Flow appioach to ieconcile IRR ianking with that of NPv" then investment of B-A, then tells

whethei to follow NPv oi IRR, B = A + (B-A), See if IRR of inciemental investment (B-A) > i, if it is, then invest in B,

At NPv A = NPv B inuiffeient between both, If i >= IRR (B-A), accept pioject A, <= accept B

-Pioject Inteiactions - Natching Cycles - Finu least common uenominatoi anu compaie piojects ovei that life span,

A one cycle = 1u + SAS, 1% anu B one cycle = 2u + 1uA4, 1% TBEN A foi 4 cycles = Pv A4 = A one cycle+

A(1+R)^S,6,9 ANB B foi 4 cycles = Pv B4 = B one cycle + B(1+R)^4,8

- EAC = PvxAT

R - compaie the C's of each pioject anu choose the highei one, use geneially if investments go on foi a

while.

-Beteimining Cash Flow -- Cash Flow = AT Income + Bepieciation, CF = (Rev - CC)(1-T) + T(Bepi)

-Bepieciation = Tax Shielu = T (Bepi)

L/@A>;N -16BI7

DH=M*$C-

Bow to equate NPv's thiough Tax iate Aujustment

Ex! Set tax iate so annuity of pioject to change is also the annuity iate of the othei pioject. IE if you finu that the

NPv of a pioject of cash flows is x, the annuity woulu be x = C * AT

R, anu C is the annuity iate. Set the new tax piojects

annuity iate to C fiom the othei pioject anu finu the new NPv of new pioject. Solve foi T.

Belayeu Annuity - Annuity foimula yielus an annuity whose fiist payment is one yeai aftei the annuity.

-Beginning Annuity - Bo Cu + CAT-1

R

Infiequent Annuity - Finu inteiest iate ovei the peiiou of inteimittent cash flows ie 2 yis. (1+i)*(1+i) -1 = new iate.

Finu the annuity ovei Tinteimittent yeais at int iate new iate.

Equate Pv's of Annuities - 1)Calculate Pv of Annuities, uiscounteu to uate u 2) Calculate annual C's that woulu yielu a

Pv of Pv Annuity yeai u by C x AT

i = Pv, finu C S) This finus the necessaiy CF's.

uet Nonthly oi Quaiteily oi SemiAnnual Rate - if is 12% compounueu monthly, then monthly iate = .1212 anu

semiannual iate = (.1212)6-1. If it is x% compounueu annually, then quaiteily iate = (1+i)14-1

uet Nominal Cashflows - inciease each item in the income statement by the inflation iate, except foi uepieciation oi

iecoveiy of netwoiking capital. Finu nominal cash flow foi each yeai inuiviuually, incieasing each value each yeai by

inflation.

NPv anu IRR foi Replacement Nachine - The same as two competing piojects: puichase new vs keep olu. Initial cost

of new machine is cost of machine plus inciease in net woiking capital. Initial cash outlay foi olu machine is Nv of olu

machine plus any tax consequence. Bepieciation is geneially only CF consiueiation

When to abanuon a CF Pioject - abanuon if the cash flow fiom selling the equipment is gieatei than the piesent value

of the futuie cash flows. We neeu to finu the sale quantity wheie the two aie equal. Set cf fiom sale = NET CF pei sale *

Q * AN-1

R, finu Q

Bieakeven Analysis - Bieakeven point is the aftei tax sum of the FC anu the uepieciation chaige uiviueu by the

(selling piice - vC) = Q* ----- Then to finu the financial bieak even of an initial investment ie liscensing uo EAC =

investmentAnnuity Factoi

Stock valuation - Foi stock valuations with a stieam of changes, stait at the latest uiv oi iate change chunk, then

calculate the Piice at that uate stait uate, not the uate of fiist uiviuenus because stocks aie valueu at the uate befoie

uiviuenus. With this Px, sub it into the last value of the next eailiei chunk that you evaluate, anu so on.

Finuing Numbei of Shaies - Biviue amount investeu by the stock piice. The shaie piice is the piesnt value of the cash

flows, so to finu the piice of the stock, we neeu to finu the cash flows. CF's incluue uiviuenus anu sale piice. Remembei

Tax.

Calculating PE Ration - Always use the cuiient eainings unuei the stock piice, the stock piice incluues futuie cash

flows, while the cuiient eainings uo not incluue futuie eainings

Finuing Rate foi Biscounting - (1+APRn)n = 1+EAY.. What if given APR x% that's compounueu semiannually, but

want the quaiteily iate.. TBEN, take (1+ semiannual iate).S -1 = quaiteily iate. X% APR compounueu semiannualy

yielus a xS% semi annual iate.

EAC Buugeting Compaiison - 0se EAC, matching cycles, oi salvage methou only when piojects flows continue in

peipetuity, yet if piojects foi some ieason have a cleaily establisheu cash flow just compaie the total NPv's. Back to

EAC methou, aftei finuing the NPv's of each pioject, uo NPv = C AT

T wheie C is the unknown anu solve foi the

equivalent cash flow of each pioject, choose the highei cash flow.

(;123271 H/12 /;< M6;<7 5 #+ O

Foimulas

Yielu to Natuiity = Cuiient Yielu + Appieciation to Natuiity

R = c*PaiP + (Pai-P)P, c = coupon iate, C*Pai = inteiest ieceiveu

uiowth Rate in Biv = Expecteu %age capital gain oi loss on stock

Clean Piice = Biity Piice - Acciueu Inteiest

Acciueu Inteiest = Coupon Pmnt foi peiiou x (Fiaction of Peiiou elapseu since payment)

Cuiient Yielu = Coupon AmntPiice of Bonu

P =

!!!"#

!!!!

!

!!!"#!!"""

!!!!!!!!

P =

!!!"#

!!!

!

!!!"#!!"#

!!!!!!!

! YTN = y = heie is aveiage of spot iates

F2 =

!!!! !!

!!!!

! !

Expectations Bypothesis = f2 = E(1i2)

Liquiuity Bypothesis = f2> oi < E(1i2). Buy a two yeai zeio coupon bonu oi two one yeai zeio coupon bonus. 0nuei

Expectation, those aie equal when f2 = i2. Liquiuity says they will only be equal when spot iate > foiwaiu iate

because of iisk. 0R invest in 1 yeai bonu oi two yeai bonu but sell aftei one yeai. Then foiwaiu has to be gieatei than

the spot spot iate i2 to make them equal because of iisk.

1i2 = ietuin on a bonu issueu one yeai fiom now matuiing in two yeais

Notes

Assume Semiannual Compounuing foi Bonus

If iates fall (YTN<coupon iate) bonu piice > P so is Piemium

If iates iise (YTN > coupon iate) bonu piice < P so is Biscount

Biity Piice is Invoice Piice

At T >1, we neeu 2 uiscount iates: i1 anu i2 aie spot iates. R2 likely > R1 bc of iisk

F2 = iate you lock in foi the seconu yeai when you buy a two yeai bonu. 0ne yeai iate one yeai fiom now

implicit in the two yeai spot iate ie foiwaiu iate

$88>B>2;1 #/0>1/@ C/3I217 /;< -13AB1A327 5 #+ &P

Ptouay = Pyesteiuay + Tienu+ RanuomEiioi

Aibitiage - ueneiating piofit fiom simultaneous puichase anu sale of substitute secuiities, Repiesentativeness -

ueviation fiom iationality uiawing conclusions insufficient uata, conseivatism - too slow to aujust new info

Foims of Naiket Efficiency: Q2/I !63? - Ptouay = Pyesteiuay + Tienu+ RanuomEiioi: Naiket piices ieflect

infoimation containteu in histoiical piices. Investois aie unable to eain abnoimal ietuins using histoiical piices to

pieuict futuie piice movements. -2?> -136;N !63? - In auuition to histoiical uata, maiket piices ieflect all publicly

available infoimation. Investois with insiuei oi piicate infoimation aie able to eain abnoimal ietuins. -136;N !63? -

Naiket piices ieflect all infoimation public oi piivate. Investois aie unable to eain abnoimal ietuins using insiuei

infoimation oi histoiical piices to pieuict futuie piice movements.

Abnoimal Retuins - investois on aveiage meiely eain what the maiket offeis, all tiaues have NPv =u.

#/0>1/@ -13AB1A325 #+ &R

Foimulas

Notes

If Bv = x, B=x*vL ! using vL not v!

Although B+E=v, aftei leveiage, E anu v will have uiff values with taxes because with taxes leveiage incieases

value.

When you iecapitalize, you have a uiff numbei of total shaies than all equity

While the expecteu ietuin on equity iises with leveiage, iisk to stockholueis iises

Aftei issuing shaies, cash incieases anu equity incieases.

Shaieholueis equally well off with uebt anu equity financing in a woilu of no taxes!

)<SA712< D3272;1 L/@A2F !@6T7 16 $UA>1E /;< Q2>N.12< )V23/N2 #671 68 #/0>1/@ 5 #+ &O

APv: value = 0CFiA + TcB

APv = NPv(all equity) + NPv(financing siue effects)

APv = (-0utflow + Pv (1-Tc)(CF) + Pv(Bep Tax Shielu = Tc*outflowyis)) + (Pioceeus(Net of Flotation totatl) -

Afteitax Pv Int Payments - Pv Piincipal Payments + Flotation Cost Tax Shielu

PvTS = TcB = Belta(vu anu vl)

FTE: Pvflow to equity = LCFiE

LCF = (EBIT -iBB)(1-Tc)

LCF = 0CF - AfteiTaxInteiest on Bebt

RE=iA +BE (1-Tc)(iA-iB)

vfiim = vuebt+vequity

Wacc: NPv = 0CFiWACC - Initial Investment

Bv+Ev=1

RWACC= iA(1-Tc(Bv))

Cost of Bebt = YTN company bonus

D36:@2?7

-Finuing effect on stock piice immeuiately aftei funuing pioject on all equity. NPv of move = - pioject cost outflow +

CFie. Piice = (this NPv + total fiim equity oiiginal)#shaies oiiginally. This causes total equity to inciease by NPv.

To finu numbei of shaies neeueu to funu this pioject, uiviue pioject cost by new shaie piice. Shaie piice aftei

puichase is maue = total equity(oiiginal equity + pioject cost shaies issueu + NPv pioject)(oiiginal shaies + new

issueu shaies). Shaie piice stayeu the same befoie anu aftei immeuiately aftei announcement anu aftei ueal was

uone.

-Finuing effect on stock piice immeuiately aftei funuing pioject on all uebt. NPv of announcement = - pioject cost

outflow + CFie. Piice = (this NPv + oiiginal fiim equity ie value)#oiiginal shaies. Shaie piice stays same

immeuiately aftei announcement anu aftei ueal is uone. Piice of Shaie aftei ueal finalizeu = Equity(oiiginal + NPv

pioject)oiiginal shaies. In absence of taxes, shaieholueis aie equally well off with uebt anu equity!!

value = Bebt + Equity

vu = CFiA

iA = cost of capital unleveieu fiim = ie

ie = cost of equity leveieu

iwacc =

!

!

!!!! ! !"! !

!

!

!! ! be caieful.

vl = CFiwacc

iB+iE = 1

iB = boiiowing iate

value Nax = min(iwacc)

Shaie Piice = EquityShaies outstanuing = (value of

shaies iepuichaseu)(# iepuichaseu)

Shaies Repuichaseu = Bebt IssueuShaie Piice

New Amount of Shaies = all equity total - iepuichaseu

amount

R0E = NIEquity (1.u NKT to Book Ratio)

EPS = eainings pei shaie

Retuin = EPSPiice

Inuiviuual CF = EPS*#shaies helu

Shaie Piice (with lev) = Bebt# Shaies Repuichaseu

EPS = NIShaies

NN Piop1 = value Leveieu = value 0nleveieu

Naiket value Balanche Sht = T acct with assets on one

siue u anu e othei

value Leveieu = vu + TcB = value 0nleveieu =

EBIT(1-Tc)iA

NN Piop2 = iE=iA + BE(iA-iB) ie>ia>iu

Ra=iwacc=B(B+E)*iB+E(B+E)*iE

BieakEven EBIT = When Capitalization plans iesult in

same EPS

EPS = (EBIT -RBB)Shaies0utstanuing

EBIT-RBB gives NI, set the EPS of two cap stiucts == to

finu EBIT

vu = EBITWACC (no taxes)!

vu = EBIT(1-Tc)WACC

WACC = Cost of Equity Capital = Ra

Annual Tax Savings fiom Levei = TCiBB

iB = inteiest iate, B = amnt boiioweu, TC = tax iate

NN Piop1: vL=v0 + PvTS = v0+TCB

Biff in CF to investois = (CF-iBB)(1-TC) +iBB-CF(1-

TC)=TCiBB

Biff in CF to investois = annual tax savings fiom lev

NN Piop2 = iE = iA+BE *(1-TC)(iA-iB)

value inciease to lev fiim = TaxShielu Y1(1+i) + Tax

Shielu Y2(1+i)^2

RWACC= iA(1-(Tc(Bv)) ! use this!

Foimulas

Pu=

!"#!

!!!

!

!"#!

!!!!!!

!

!"#!

!!!!!!

!!

Pu =

!"#!

!

! Constant Biviuenus (Piefeiieu Stock)

Pu =

!"#!

!!!

! Constant giowth Biviuenus (Commn)

g=R0ExPB .. PB + P0 = 1

Shaie Piice = Bivu + (Biv1)(i-g) + .

Notes

NPvu0 anu P > EPSi

NPvu0 = net piesent value of giowth ueteimines

the intiinsic value of a new pioject, calculateu by

taking uiscounteu net CF inflow - puichase piice of

asset

Common Stock - Constant giowth in uivs, P = Biv(i-g)

Piefeiieu Stock - Constant uiviuenus = P = Bivi

g = R0E x PB, ietuin on equity times plowback,

plowback = ietaineu eainingseainings = ietention

iation, pay out iatio = 1- plowback iatio

uiowth - P = EPSi + NPvu0

uiowth uoes not necessaiily iaise shaie value

0nly giowth geneiateu by eainings ietaineu anu

investeu in positive npv piojects cieates positive

Piice to Eainings Ratio = PE = (1-PB)(i - PBxR0E)

Cash Cow - EPS = BIv, value of stock = EPSR

uiowth - NPvu0 , value = EPSi + NPvu0

PEPS = 1R + NPvu0EPS

EAR = |1+(APRm)jm -1 -- EAR = eq-q - continuous compounuing --1+EAY = (1+APRn)n (n = numbei of n-teily iate)

!" ! !!! ! !!

!

-- Fv = !! !

!"#

!

! !

!"

! !! ! !"#!

!

-- Fv = !

!!"#!!

-- P=Ci - Simplifieu Peipetuity

P=C(i-g) - uiowing Peipetuity -- !ANN = P1-P2=

!

!

!! !

!

!!!!!!

! -- !!"## !

!

!!!

!! !

!!!!!

!!!!!!

!

!

1 + ieal iate =

!!!!"# !"#$!

!!!!"#$%&!'"!

--PANN-ABv = AT

R(1+i) -Annuity in Auvance -- FvANN = !!

!!!!!

!

!!

!

!

Recapitalization

value anu Piice befoie iecapitalization anu befoie uebt is taken on aie founu noimally. P = total

equity ovei numbei of shaies

Aftei iecapitalization is announceu, APv company = v0 + NPviecap

= v0 + PioceeusInvesteu - (1-Tc)(iu)(PioceeusInvesteu)iu

APv = vL > v0.

Since the company has not yet issueu the uebt, this is also the value of equity aftei the announcement,

so new piice pei shaie = this vLoiiginal numbei of shaies

Numbei of shaies iepuichaseu aftei the announcement = PioceeusInvesteuPiice pei shaie that we

just calculateu

Num Shaies outstanuing = oiiginal numbei of shaies - numbei iepuichaseu

New value of equity aftei announcement anu iecap = vL aftei announcement but befoie iecap -

PioceeusInvesteu

So, Piice pei shaie aftei iecap = New value of equityoutstanuing numbei of shaies

(;123271 H/12 /;< M6;<7 5 #+ O

Foiumulas

Yielu to Natuiity = Cuiient Yielu + Appieciation to Natuiity

R = c*PaiP + (Pai-P)P, c = coupon iate

^^ C*Pai = inteiest ieceiveu

uiowth Rate in Biv = Expecteu %age capital gain oi loss on stock

Piice of bonu = Pv of pai value + Pv inteiest payment

Cap uains Yielu = (New Piice - 0lu Piice)0lu Piice

APR = m|(1+EAR)^(1m)-1j m = # times compounueu each yi.

Spot Rate = yielu to matuiity of a zeio coupon bonu

PvIF = 1(1+i)

t

Clean Piice = Biity Piice - Acciueu Inteiest

Acciueu Inteiest = Coupon Pmnt foi peiiou x (Fiaction of Peiiou elapseu since

payment)

Cuiient Yielu = Coupon AmntPiice of Bonu

P =

!!!"#

!!!!

!

!!!"#!!"""

!!!!!!!!

P =

!!!"#

!!!

!

!!!"#!!"#

!!!!!!!

! YTN = y = heie is aveiage of spot iates

F2 =

!!!! !!

!!!!

! !

Expectations Bypothesis = f2 = E(1i2)

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