RSM332: Capital Market Theory

100 dollar today is better than getting a 100 in a year (inflation, uncertainties,
opportunity costs)

Discount rate

Required rate of return = K

Total risk = Relevant + Irrelevant risk. CAPM and APT model

Finance: money from households to corporations/govs. Foreign flows in and out. All
wealth is in household. Money from household to large-scale projects (increases
specialization)

Financial Institutions are responsible for connecting households to corp/gov
- Direct investment (rarely happens). Money flowing straight
- Intermediate transaction: someone in middle (broker/agent) easier to find
each other. Buying on behalf but ultimately you own it
- Indirect intermediation: largely how corps get financed, an agent in this case
is institution, but this agent has legal claim on the thing. Indirectly wealth
will comeback, an indirect fashion
Financial Institutions
- Banks
o Lender providing cash to bank, banks lend to people who need it
o Banking involves loans, loans can go bust
o Banks do not create money
o Key: banks add value to society by assessing risk. P2P is not that good
at knowing risks.
- Insurance
o Vast amount of resource that needs to be allocated
o People who look to collectivize their risks
o When insurance and if insurance
o Life insurance (long term-infra), probably insurance (short term-short
term project)
- Pension funds
o Helping workers, make up the contribution to take care of elders.
- Mutual fund
o Pooling technology
o Cost of diversification is supppper high
o Collectivize the cash, invest, more people its cheaper.
o Cost of everything becomes cheaper
o We allow people not to have actively manage their portfolio
Debt: under contract law -
Equity: under security law buying a piece of business, taking business risk,
generates higher risk/return
Market Cap: focus on market valuation of the equity. Price of last trade * number of
shares
Enterprise value: value of all equity + value of all the debt. Value of all its assets, all
its deployed capital. Enteprise value market cap = liabilities
Primary market: market capitalization IPO the only time comps get money from
you trading their stocks
Secondary market: stock market, does not help the comps.

Sole Prop: unlimited liability
GP: can be disruptive
Corps: transferability, limited liability (but not to execs, CEOs)
Agency problem: