Prof.

Roberto Steri Financial Markets Spring 2019

Formula Sheet (with Notation of Class Materials)

The Time Value of Money

Geometric Series
X
1
1
xt = , if jxj < 1
t=0
1 x

Present values of special streams of cash ‡ows

– Standard Perpetuity
X
1
C C
t =
t=1
(1 + r) r

– Growing Perpetuity
X1
C (1 + g)t 1
C
=
t=1
(1 + r)t r g

– In-Advance Perpetuity
X
1
C 1+r
t = C
t=0
(1 + r) r

– Standard Annuity
X
N
C C 1
t = 1
t=1
(1 + r) r (1 + r)N
– Growing Annuity
" #
XN
C (1 + g)t 1
C 1+g
N
= 1
t=1
(1 + r)t r g 1+r

– In-Advance Annuity

X1
N
C C (1 + r) 1
t = 1
t=0
(1 + r) r (1 + r)N

– Delayed Annuity

X1
+N
C C 1 1
t = 1 N 1
t=
(1 + r) r (1 + r) (1 + r)

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Prof. Roberto Steri Financial Markets Spring 2019

Interest rates with di¤erent frequencies

– Compounding frequency and e¤ective rate

rnom m
ref f = 1 + 1
m
– Continuous compounding
rnom m
lim 1+ 1 = ernom 1
m!1 m
Interest Rates

Nominal and real rates

1 + rn
1 + rr =
1+i
E¤ective Annual Rate (EAR) and Annual Percentage Rate (APR)
m
AP R
EAR = 1+ 1
m

Valuation of Bonds

Bond Price
X
T
rt t rT T
P = C e +F e
t=1

Accrued Interest, Clean, and Dirty Prices

days since last coupon payment
Accrued Interest = coupon amount
days in current coupon period
Clean Price = Dirty Price - Accrued Interest

Yield-to-Maturity (YTM). Y T M such that

X
T
Y TM t Y TM T
P = C e +F e
t=1

C
Par Yield: F
such that
XT
C rt t rt T
F = e +F e
t=1
m

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Prof. Roberto Steri Financial Markets Spring 2019

Forward rates with continuous compounding

rt+ rt
ft;t+ = rt+ + t

Instantaneous forward rate

@rt
ft = lim ft;t+ = rt + t
!0 @t
Macaulay’s Duration
X
T
CFt e Y TM t
D= t
t=1
P

Modi…ed Duration
D
D =
1 + Y TmM

Duration, Bond Prices, and YTM

P
' D Y TM
P
P
' D Y TM
P
Valuation of Stocks

Prices, Net Returns, and Dividends

Pt+1 + Dt+1 Pt
Rt+1 =
Pt

Dividend Discount Model (DDM)

X
1
E[Dt+ ]
Pt =
=1
(1 + rE )t+

Dividend Discount Model (DDM) with constant growth

X
1
Dt (1 + g) 1
Dt
Pt = =
=1
(1 + rE ) rE g

Free Cash Flows to the Firm (FCFF)

F CF F = EBIT (1 ) (CAP EX Depreciation) Net Working Capital

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Prof. Roberto Steri Financial Markets Spring 2019

Enterprise Value
X
1
F CF Ft+
EVt =
=1
(1 + W ACC)t+

Enterprise Value = Equity Value + Debt - Cash

Weighted-Average Cost of Capital (WACC)

D E
W ACC = (1 ) rD + rE
D+E D+E

Introduction to Capital Markets and Trading

Value-Weighted Index V W It
X
N
pi;t Qi;t
i=1
V W It =
Dt
Price-Weighted Inded P W It
X
N
pi;t
i=1
P W It =
Dt

Portfolio Theory

Realized Returns
Pt + dt Pt 1
Rt =
Pt 1

Expected Returns
X
S
P
E [Rt jIt 1 ] = Rt (s) P (s)
s=1

Ex-ante Variance of Returns

2
X
S
2
P P P
V ar [Rt jIt 1 ] = E [ Rt E [Rt jIt 1 ] jIt 1 ] = Rt (s) E P [Rt jIt 1 ] P (s)
s=1

Estimated Expected Return

1 X
T
d
P
E[R] = E [Rt ] = Rt
T t=1

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Prof. Roberto Steri Financial Markets Spring 2019

Estimated Variance

1 X
T
V ar[R] = V ard
P [R ] =
t (Rt E[R])2
T 1 t=1

Portfolio Return and Expected Return

X
N X
N
RP = wi Ri E[RP ] = wi E[Ri ]
i=1 i=1

Ex-Ante and Estimated Covariances Between Returns

Cov[Ri ; Rj ] = E[(Ri E[Ri ]) (Rj E[Rj ])]

di ; Rj ] = 1
PT di ] dj ]
Cov[R T 1 t=1 Ri E[R Rj E[R

Correlations Between Returns

Cov[Ri ; Rj ]
Corr[Ri ; Rj ] = p
V ar(Ri ) V ar(Rj )

Portfolio Variance
X
N X
N
V ar[RP ] = Cov[RP ; RP ] = wi wj Cov[Ri ; Rj ] =
i=1 j=1

X
N X
N q
= wi wj Corr[Ri ; Rj ] V ar(Ri ) V ar(Rj )
i=1 j=1

Sharpe Ratio
E[RP ] rF
SR = p
V ar(RP )
Mean-Variance Optimization

– De…nitions 2 3
w1
6 7
6 7
6 w 7
6 2 7
6 7
w=6 7
6 7
6 ::: 7
6 7
4 5
wN

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Prof. Roberto Steri Financial Markets Spring 2019

2 3
E[R1 ]
6 7
6 7
6 E[R ] 7
6 2 7
6 7
R=6 7
6 7
6 ::: 7
6 7
4 5
E[RN ]
2 3
V ar[R1 ] Cov[R1 ; R2 ] Cov[R1 ; RN ]
6 7
6 7
6 Cov[R ; R ] V ar[R2 ] 7
6 1 2 7
6 7
V =6 ::: 7
6 7
6 ::: 7
6 7
4 5
Cov[R1 ; RN ] ::: V ar[RN ]
– Optimization Problem

minw 21 wT V w
s.t.
w T R = RP
wT e = 1
– Solution

w = vA R P + vB

sC V 1R s V 1e sB V 1e s V 1R
vA = A
sB sC s2A
vB = A
sB sC s2A
T
sA = eT V 1
R sB = R V 1
R sC = eT V 1
e

CAPM
E[Ri ] RF = i (E[Rm ] RF )
Cov[Rm ; Ri ]
i =
V ar[Rm ]

Developing Investment Strategies

Arbitrage Pricing Theory (APT)

E[Ri ] RF = i;1 (E[f1 ] RF ) + i;2 (E[f2 ] RF ) + ::: + i;k (E[fk ] RF )

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Prof. Roberto Steri Financial Markets Spring 2019

Fama-French Three-Factor Model

E[Ri ] RF = (E[RM ] RF ) + S (E[SM B] RF ) + H (E[HM L] RF )