Corporate Financial Strategy Lecture 12: Revision Lecture Module Leader: Professor Jon Tucker Selected slides by McGraw Hill

Lecture Objectives Summary of topics covered on the module Exam structure Exam technique

Introduction to Corporate Finance, Valuing Bonds and Shares What we covered: Shareholder maximization as goal of corporation Valuing bonds Term structure of interest rates Real and nominal interest rates Valuing stocks Key revision tasks: Be able to calculate bonds values, duration and volatility Explain theory and evidence on the term structure of interest rates Be able to calculate stock values, including DDM, plowback, DCF

Revision of Investment Appraisal Techniques What we covered: Different investment appraisal techniques – Book rate of return, Payback, IRR, and their drawbacks Profitability index Applying the NPV rule – ‘the 4 rules’ Choosing among competing projects Key revision tasks: Be able to use each investment appraisal technique Discuss the relative merits of each technique Be able to work a detailed NPV example

Risk and Return, Portfolio Theory, and the CAPM What we covered: Computation of stock returns through time Meaning of risk premium Computing portfolio risk – variance, standard deviation Understand how diversification reduces risk Concept of beta and its computation Markowitz portfolio theory Discussion of foundations of CAPM, APT, 3-factor model Key revision tasks: Be able to compute all aspects of stock and portfolio risk e.g. portfolio return, standard deviation, variance, beta Discuss development of Markowitz theory Understand theory and evidence for basic CAPM and alternatives

Current Practice in Capital Budgeting and Real Options What we covered: Computation of project and company cost of capital and WACC How to estimate beta Determination of asset betas Certainty equivalent cash flows Basic capital investment process and sensitivity analysis Real options and decision tree problems Key revision tasks: Be comfortable with cost of capital and WACC calculations Be able to draw decision trees and compute NPVs, particularly for examples with expansion and abandonment real options

Market Efficiency, Behavioural Finance, and Corporate Financing What we covered: Efficient markets, EMH, and tests Evidence, anomalies, behavioural finance Six lessons of market efficiency Financing patterns in the real world Different financial markets and institutions Key revision tasks: Be able to discuss the issue whether markets are efficient or not Identify and seek to explain why anomalies exist Understand the scope and variation of financial markets and institutions

Issuing Equity, Dividend Policy and Debt Policy What we covered: Understand the process of issuing equity – VC and IPO Rights issue calculations Payout debate, theory and evidence – value relevance? Dividends vs. repurchases, high vs. low dividends? Key revision tasks: Understand mechanics of equity financing methods Be able to tackle rights issue calculations Be able to discuss in detail the dividend debate

Debt Policy, Financing and Business Valuation What we covered: The range of capital structure theories (Traditional through to Miller (1977), TO and PO theories Valuing an entire business Adjusted present value – meaning and calculation Key revision tasks: Be able to discuss the key theories and (value relevance) debate relating to capital structure Understand how to value an entire business using DCF Appreciate how APV can help adjust for financing side effects

Derivatives and Option Pricing Methods What we covered: Basic options terminology – option, put, call, position diagrams Determination of options values, put-call parity equation Basic options valuation - replicating portfolio approach, risk-neutral method, binomial method, Black-Scholes Key revision tasks: Be able to compute the value of financial options using the various techniques Understand position diagrams and the factors driving the value of financial options

Bond Markets and Ratings, Debt Instruments What we covered: Difference between promised and expected yields on corporate debt, credit default swaps The option to default on a bond Bond ratings and default probability Different types of bonds and debt, bond contract details Key revision tasks: Be able to explain what drives bond yields Understand the basic models which help us to predict debt default

Forwards, Futures and Risk Management What we covered: Risk management and the firm, insurance Forwards, futures, swaps markets and valuation of these How the forex market works Four exchange rate parity relationships and evidence Key revision tasks: How can we use various instruments and techniques to control for risk? Definitions and calculations for forwards, future, swaps Calculate various rates from parity conditions formulae and define/explain the four relationships

Mergers and Acquisitions, Corporate Restructuring, and Governance What we covered: Types of mergers, good and questionable reasons for mergers Merger calculations – gains, costs, NPV using cash/stock Who invests in what and how does it change by country? Definition of corporate governance and different models Key revision tasks: Be able to define different merger types and good/bad reasons for mergers Be able to compute basic merger calculations Be able to define corporate governance and competing models

Exam structure and technique Section A (40%) Answer ALL questions 6 x short calculation / discussion questions Section B (30%) Answer ONE question only 3 x longer calculation / discussion questions Section C (30%) Answer ONE question only 3 x discussion / essay questions You will be provided with a basic formula sheet at the end of the paper – do not rely on this (learn the formulae!) 2 hour paper, thus: A: 48 minutes B: 36 minutes C: 36 minutes

Exam structure and technique Short calculation / discussion questions – section A Practice using all of the tutorial and lecture examples we have gone through The scope here spans the entire syllabus Start by extracting the numbers from the question and write them at the top of your answer Always show all of your workings Do not spend too much time on one particular question – move on if you get stuck and then come back to it Write down any assumptions you make to help you answer the question Make sure to write something for the discussion parts of a question (even if you are not sure)

Exam structure and technique Longer calculation / discussion questions – section B Will often come with discussion elements too – do the calculations first and then the discussion parts Always have a go at the discussion parts At times discussion parts may ask you about whether you think a particular technique is useful or not – learn their relative merits Show your workings – tell the marker what you are doing, keep it tidy Remember currency, units, magnitude, UK convention for commas and decimals Write out the expression for calculations before you attempt them where appropriate

Exam structure and technique Discussion/essay questions – section C Structure essay-style questions: Introduction Outline structure of rest of answer Define terms of reference Arguments in support of answer to question Summary and conclusion – re-address the question and give conclusion based on your most important points Read the question carefully and make some attempt to answer what is asked for (rather than what you would like the question to ask) You must have at least 6 good points to make in an essay answer – do not focus on one small part of a given topic Don’t simply list everything you have learned You should be able to write at least two pages for an answer in 36 minutes

Exam structure and technique General points: Make sure your calculator/pens, etc., work before the exam Look at your watch and have a strict cut-off point for each section If you are running out of time (ONLY) then bullet-point the other things you intended to cover Spend the first 5 minutes of each section B and C question just thinking (for essay questions you could even write a very short essay plan before your answer if you like) Answer all questions you have chosen and all parts to each question

Exam structure and technique Good luck and thanks for studying Corporate Financial Strategy!