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Corporate Finance
R. Elul
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Yield:
E.g. for annual compounding: solves the equation P0 = c0 + c1/(1+y) ++cn/(1+y)n
3. Compound Interest:
PV of $1 paid t years from now:
If r1 is the annually compounded rate: 1/(1+r1)t
If r2 is the semi-annually compounded rate: 1/(1+r2/2)2t
If there are n compounding intervals per year: 1/(1+rn/n)nt
Continuous compounding: 1e-rct
Converting:
rn = n[(1+r1)1/n-1]
rc = ln(1+r1)
4. Converting Between Real and Nominal Figures
a. Interest rates:
Fisher Approximation: rr +i rn
Precise formula: (1+rr) (1+i) = (1+rn)
b. Cash Flows: ct(real) = ct(nominal)/(1+i)t
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Valuing Stocks
Gordon model: PV = DIV1/(r-g)
Holding-period: PV = (DIV1+P1)/(1+r)
Market-capitalization rate in Gordon model: r = DIV1/P0 + g
Estimating g: g = (Plowback Ratio) (Return on Retained Earnings)
PVGO: P0 = EPS1/r + PVGO
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Portfolio Mathematics
Expected Value: E(r) = iiri
Variance: 2 = ii[ri-E(r)]2
Standard Deviation: 2
Covariance: xy = ii[xi-E(x)] [yi-E(y)]
Correlation Coefficient: = xy/(xy)
Portfolio with asset weights wi, asset expected returns ri, return SD i.
Portfolio Expected return: E(rp) = iwiri
Portfolio Variance: var(rp) = i wi2i2 + 2i>j wiwjij