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Slides by Matthew Will

Principles of Corporate Finance Brealey and Myers Sixth Edition. Corporate Financing and the Six Lessons of Market Efficiency. Slides by Matthew Will. Chapter 13. Irwin/McGraw Hill. The McGraw-Hill Companies, Inc., 2000. Topics Covered. We Always Come Back to NPV

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Slides by Matthew Will

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  1. Principles of Corporate Finance Brealey and Myers Sixth Edition • Corporate Financing and the Six Lessons of Market Efficiency Slides by Matthew Will Chapter 13 Irwin/McGraw Hill • The McGraw-Hill Companies, Inc., 2000

  2. Topics Covered • We Always Come Back to NPV • What is an Efficient Market? • Random Walk • Efficient Market Theory • The Evidence on Market Efficiency • Six Lessons of Market Efficiency

  3. Return to NPV • NPV employs discount rates. • These discount rates are risk adjusted. • The risk adjustment is a byproduct of market established prices. • Adjustable discount rates change asset values.

  4. Return to NPV Example The government is lending you $100,000 for 10 years at 3% and only requiring interest payments prior to maturity. Since 3% is obviously below market, what is the value of the below market rate loan?

  5. Return to NPV Example The government is lending you $100,000 for 10 years at 3% and only requiring interest payments prior to maturity. Since 3% is obviously below market, what is the value of the below market rate loan? Assume the market return on equivalent risk projects is 10%.

  6. Random Walk Theory • The movement of stock prices from day to day DO NOT reflect any pattern. • Statistically speaking, the movement of stock prices is random (skewed positive over the long term).

  7. Random Walk Theory Coin Toss Game Heads $106.09 Heads $103.00 $100.43 Tails $100.00 Heads $100.43 $97.50 Tails $95.06 Tails

  8. Random Walk Theory

  9. Random Walk Theory

  10. Random Walk Theory

  11. Random Walk Theory

  12. Random Walk Theory

  13. Random Walk Theory

  14. Random Walk Theory

  15. Efficient Market Theory • Weak Form Efficiency • Market prices reflect all historical information. • Semi-Strong Form Efficiency • Market prices reflect all publicly available information. • Strong Form Efficiency • Market prices reflect all information, both public and private.

  16. Efficient Market Theory • Fundamental Analysts • Research the value of stocks using NPV and other measurements of cash flow.

  17. Efficient Market Theory • Technical Analysts • Forecast stock prices based on the watching the fluctuations in historical prices (thus “wiggle watchers”).

  18. Efficient Market Theory $90 70 50 Microsoft Stock Price Cycles disappear once identified Last Month This Month Next Month

  19. Efficient Market Theory Announcement Date

  20. Efficient Market Theory Average Annual Return on 1493 Mutual Funds and the Market Index

  21. Efficient Market Theory IPO Non-Excess Returns Year After Offering

  22. Efficient Market Theory 1987 Stock Market Crash

  23. Efficient Market Theory 1987 Stock Market Crash

  24. Lessons of Market Efficiency • Markets have no memory • Trust market prices • Read the entrails • There are no financial illusions • The do it yourself alternative • Seen one stock, seen them all

  25. Example: How stock splits affect value -29 0 30 Source: Fama, Fisher, Jensen & Roll

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