Formulas You NEED to know by heart

NB Other formulas discusses in lectures, chapters and case book do not need to be learnt by heart
BUT you must be able to interpret the formula on the exam

Cost of equity (leverage premium) in an MM world

Cost of equity (leverage premium) in an MM world + corporate tax: Is equal to formula 2.6 but D/EL is
multiplied with (1 – T), T = corporate tax rate.

Hamada formulas: equavalent to formulas for rLE but replace rLE by βL, rA by βU and rD by βD or 0

CML (Capital market line)

CAPM (plus equation 2.27 for beta)

WACC

Note =, with corporate tax rD has to be replaced by rD(1-T)

Value of a leverage firm (MM + corporate tax)

Spread price for credit risk (from a banking perspective)

Spread = rental income R ─ funding costs R

L F
= expected loss + costs buffer K + operational costs (costs buffer K is for the unexpected losses)
= PD × LGD + K × shareholder expected return + operational costs
= PD × LGD + K(Basel I or Basel II) × 15% + operational costs
Put call parity relation ship

Value of debt

Default free debt

Delta hedge formula

C = ∆S − B

The (small) delta formula for the delta hedging portfolio to replicate the (call) equity value

A formula to calculate the equity value (formula 2.30 can be derived from this formula)

Transformation formulas: up factor (2.11) and down factor ( d = 1/u, in this case)
 Formulas for the one period model (binomial pricing)

1. “Risk neutral probabilities”

p=
(1 + rF ) − d
T

u−d
2. Pricing of a security P

p × P u + (1 − p ) × P d
P=
exp(rF × T )

Alternative ways to represent the discount factor

(1 + k )a = exp(a × ln(1 + k )) ≈ exp(a × k ), with k = discount rate