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Dr. Eduardo
Study Guide Test III
General Format:
The test will be similar in format to the first test. That is, there will be some theory questions (multiple choice) and there will be problems (some multiple choice, some in short written problems, and a larger problem)
The weights will be roughly 30% theory and 70% problems.
Do not disregard the theory-you need to have a good understanding of the concepts we covered and there is always detail in the MPC questions
Have a good intuition and feel for the problems. At all times when you work/study the problems, ask yourself what it is that you are doing. Avoid simply memorizing steps or relying on your calculator as a black box that always gives you an answer
In my view, good studying of the problems means that you should be able to work a problem conceptually in your mind and only plug the numbers later
Chapter 8
As far as theory, make sure you understand the following:
Define risk; what is the average investors risk profile; what do investors require in order to take on risk
What happens to risk as you increase the number of stocks in your portfolio
What are the two types of risk-explain ands understand each one
Why is there a decline in portfolio risk first and then it stops decreasing
Which risk is irrelevant; which is relevant
How do you measure the relevant portfolio risk
What is beta-explain what it measures-what is a beta of 2 means or .5?
What is CAPM-what are its components-what variables do you use to measure each component in practice
What is the market risk premium
What is the SML
In the context of one single security, how do you measure return
How do you measure risk-what would a tighter or wider distribution of returns mean in terms of risk
Have a good feel for expected return and the risk premium that it requires given risk (lottery problem)
What is the difference between expected return, required return and actual return
As far a problems:
Memorize the CAPM equation
More importantly-understand it
I will give you the formula for standard deviation but know how to use it
Be able to compute expected return and standard deviation
Chapter 9:
As far as theory, make sure you understand the following:
2. What is intrinsic price? What is the growth rate? What is the required rate of return?
3. How do you value a stock? What cash flows are included? Why all you need is dividends? What is the model if you are going to keep it forever? What if you sell it? Same model regardless?
4. What basic patterns would dividends follow? What is a zero growth stock?
5. When can the constant growth model be used? Can we have g > rs?
6. How do you compute the expected rate of return of a constant growth stock? What are the two components of this return- dividend yield/ capital gains yield
7. What is the difference between normal growth and supernormal growth?
8. How does equilibrium in the stock market happen? What is the condition that must be met. Otherwise what takes place?
9. How would equilibrium change?
10. Understand how the corporate value model works./FCF/WACC/terminal value
11. How do you arrive at the value of the equity from the value of the entire corporation?
12. What is preferred stock?
13. How do you value preferred stock (assume a perpetuity)
As far as problems:
1. Be able to price a constant growth stock
2. Be able to price a supernormal growth stock
3. Be able to compute the expected return using the Gordon model (r hat)
4. Be able to understand a problem relating to stock equilibrium (see example problem I worked on the board).
5. Be able to compute what the equilibrium price or equilibrium return should be and compare it to the actual price or return
6. Be able to value the entire corporation and then arrive at the value of the equity
7. Work the homework problems
*Formulas:
I will give you this one: FCF = EBIT (1-t) (change in fixed assets + change in NWC)
* You will need to know/memorize how to compute (no formulas given here):
Change in fixed assets and change in NWC
Gordon Model (constant growth)
Expected return (derived from the constant growth model)
Compute intrinsic price with both dividend model and corporate model
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