Download 06-finance - Eric Rasmusen

G601, IO I
Eric Rasmusen, [email protected]
13 September 2006
Accounting Data, and Finance II
This is for one 75 minute session .
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Readings
14 September, Thursday. Accounting Data, and Finance II
"Notes on Present Discounted Value," 2003, in ascii-latex and pdf.
Powerpoint Finance Slides.
For reference: Ivo Welch (Yale) "A 3-Hour Tour of Finance,"
February 26, 2003, Yale SOM,
http://welch.som.yale.edu/teaching/financetouri.pdf.
Due 10 PM Sunday Sept 17: The Latex project.
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NEXT TIME
chpater 4, 5.
L:atex assignment .
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Handouts
• PS 2 answers
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Eli Lilly Annual Report
• Annual reports are interesting to read
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EXAMPLE:
AVERAGE COST
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Earnings per share in 2005: $1.81
Dividend per share: $1.52
Stock price: Between $49 and $60
Owners’ equity per share: $10.02
1.81/60 = .03
.05 = 3/60
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FINANCE
The Economics of
RISK
and
TIME
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TYPES OF SECURITIES
Common stock:
Pays a dividend only
when the directors decide to.
Usually gives voting rights.
Preferred stock: Pays a fixed dividend
out of profits before any common stock
dividends are paid, but the company
can skip dividends without declaring
bankruptcy.
No voting rights.
Bonds:
Pays
fixed interest unless
the company goes bankrupt.
No voting rights.
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ISSUING STOCK
ENTREPRENEURS are people who
start businesses. They usually use
their own money, but often they sell
shares to VENTURE CAPITAL FIRMS.
Eventually, firms get big enough
to need more capital and they GO
PUBLIC-- they sell shares to the
general public in an INITIAL PUBLIC
OFFERING (IPO).
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ISSUING STOCK II
An INVESTMENT BANKER such as
Goldman Sachs agrees to UNDERWRITE the
stock offering, buying the stock and
immediately reselling it to the public.
An IPO requires filing a 10-K FORM with
the SECURITIES AND EXCHANGE COMMISSION
(SEC) and issuing
a PROSPECTUS, both of
which have detailed financial information.
IPO's and SECONDARY OFFERINGS of
stock later are publicized by TOMBSTONE
announcements.
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SELLING SHORT
If you think Apple Computer stock is going to
fall in price, you sell it short.
1. You borrow 100 shares of Apple from your
broker, and sell them at $50
per share,
for $5000.
2.
A month later, you buy 100 shares of
Apple to repay the loan. If the price has
dropped to $30/share, you pay $3,000, and
make $2,000 in gross profit.
3. You also pay
commissions to your broker,
and interest on the $5,000 in stock you
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borrowed for a month.
THE RISK OF SELLING SHORT
1. You borrow 100 shares of Apple from your
broker, and sell them at $50
per share,
for $5000.
2. A month later, you buy 100 shares of
Apple to repay the loan. If the price has
risen to $200/share, you pay $20,000, and
lose $18,000, even before you pay
commissions. You've lost more than your
initial investment.
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BUYING ON MARGIN
1. Borrow $5,000 from a broker.
2. Buy 1,000 shares of stock at $10 each,
for $10,000.
3. If the stock rises to $15/share, sell the
stock for $15,000.
4. Repay the loan, for a net profit of
$5,000 minus interest.
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MARGIN CALLS
1. Borrow $5,000 from a broker.
2. Buy 1,000 shares of stock at $10/share,
for $10,000.
3. If the stock falls to $5.60/share, pay
back $400 of the loan, so your loan is
just $4,600, which is 75 % of $5,600.
The request for $400 is a MARGIN CALL.
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MUNICIPAL BONDS
Municipal Bonds are bonds issued by state
or local governments.
Interest Income from them is exempt from
federal income tax.
As a result, they have lower yields.
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SPECIAL BONDS
Subordinated bonds are junior bonds, which
pay off if funds remain after paying off the
senior bonds.
Floating rate bonds have interest rates that
adjust to inflation.
Convertible bonds can be converted by the
holder to stock whenever they desire.
Callable bonds can be paid off early by the
issuing company (like refinancing a
mortgage).
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T-Bill Auctions
Every Monday the U.S. Treasury has an
auction of the $10,000 short-term
bonds.
These are ZERO-COUPON bonds-- they
pay no interest, just $10,000 at maturity.
Investors buy them at a DISCOUNT, for
less than $10,000. For example, the
winning bid might be $9,500.
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BIDS IN T-BILL AUCTIONS
Competitive bids (like a limit order). How
many and at what price. “Three bonds at
$9,600 each.’’ The highest bids are
successful, up to the competitive quota.
Noncompetitive bids (like a market order).
How many. “Three bonds.’’ The price is the
average of the competitive bid prices.
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MUTUAL FUNDS
Open-End funds sell as many shares as people
want to buy.
Closed-End funds have a fixed number of shares.
Index Funds: The manager buys stocks
according to a formula, with no discretion.
Tax-exempt Funds: These own only municipal
bonds.
Money-market funds: These own short-term
bonds, and often allow checks to be written.
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Course Website
A link to the course website
http://www.rasmusen.org/g601/0.g601.htm
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