Principles of cororate finance 6th brealey myers chapter 13
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Principles of Corporate Finance
Brealey and Myers
Sixth Edition
Corporate Financing and the Six
Lessons of Market Efficiency
Slides by
Matthew Will
Irwin/McGraw Hill
Chapter 13
©The McGraw-Hill Companies, Inc., 200
13- 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
Irwin/McGraw Hill
©The McGraw-Hill Companies, Inc., 200
13- 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.
Irwin/McGraw Hill
©The McGraw-Hill Companies, Inc., 200
13- 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?
NPV amount borrowed - PV of interest pmts
- PV of loan repayment
Irwin/McGraw Hill
©The McGraw-Hill Companies, Inc., 200
13- 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%.
10 3,000 100,000
NPV 100,000
t
10
(
1
.
10
)
(
1
.
10
)
t 1
100,000 56,988
$43,012
Irwin/McGraw Hill
©The McGraw-Hill Companies, Inc., 200
13- 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).
Irwin/McGraw Hill
©The McGraw-Hill Companies, Inc., 200
13- 7
Random Walk Theory
Coin Toss Game
Heads
Heads
$106.09
$103.00
Tails
$100.43
$100.00
Heads
Tails
$97.50
Tails
Irwin/McGraw Hill
$100.43
$95.06
©The McGraw-Hill Companies, Inc., 200
13- 8
Random Walk Theory
S&P 500 Five Year Trend?
or
5 yrs of the Coin Toss Game?
Level
180
130
80
Month
Irwin/McGraw Hill
©The McGraw-Hill Companies, Inc., 200
13- 9
Random Walk Theory
S&P 500 Five Year Trend?
or
5 yrs of the Coin Toss Game?
Level
230
180
130
80
Month
Irwin/McGraw Hill
©The McGraw-Hill Companies, Inc., 200
13- 10
Irwin/McGraw Hill
Random Walk Theory
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13- 11
Irwin/McGraw Hill
Random Walk Theory
©The McGraw-Hill Companies, Inc., 200
13- 12
Irwin/McGraw Hill
Random Walk Theory
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13- 13
Irwin/McGraw Hill
Random Walk Theory
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13- 14
Irwin/McGraw Hill
Random Walk Theory
©The McGraw-Hill Companies, Inc., 200
13- 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.
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13- 16
Efficient Market Theory
Fundamental Analysts
Research the value of stocks using NPV and other
measurements of cash flow.
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13- 17
Efficient Market Theory
Technical Analysts
Forecast stock prices based on the watching the
fluctuations in historical prices (thus “wiggle
watchers”).
watchers
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©The McGraw-Hill Companies, Inc., 200
13- 18
Efficient Market Theory
$90
Microsoft
Stock Price
70
50
Cycles
disappear
once
identified
Irwin/McGraw Hill
Last
Month
This
Month
Next
Month
©The McGraw-Hill Companies, Inc., 200
13- 19
Efficient Market Theory
Cumulative Abnormal Return (%)
Announcement Date
Irwin/McGraw Hill
39
34
29
24
19
14
9
4
-1
-6
-11
-16
Days Relative to annoncement date
©The McGraw-Hill Companies, Inc., 200
13- 20
Efficient Market Theory
Average Annual Return on 1493 Mutual Funds and the
Market Index
40
30
Return (%)
20
10
0
-10
Funds
Market
-20
-30
-40
6
19
Irwin/McGraw Hill
2
7
19
7
9
19
2
©The McGraw-Hill Companies, Inc., 200
13- 21
Efficient Market Theory
IPO Non-Excess Returns
Average Return (%)
20
IPO
Matched Stocks
15
10
5
0
First
Irwin/McGraw Hill
Second
Third
Fourth
Fifth
Year After
Offering
©The McGraw-Hill Companies, Inc., 200
13- 22
Efficient Market Theory
1987 Stock Market Crash
PV (index) pre crash
Irwin/McGraw Hill
Div
16.7
1193
r g .114 .10
©The McGraw-Hill Companies, Inc., 200
13- 23
Efficient Market Theory
1987 Stock Market Crash
PV (index) pre crash
Div
16.7
1193
r g .114 .10
PV (index) post crash
Div
16.7
928
r g .114 .096
Irwin/McGraw Hill
©The McGraw-Hill Companies, Inc., 200
13- 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
Irwin/McGraw Hill
©The McGraw-Hill Companies, Inc., 200
13- 25
Example: How stock splits affect value
35
30
Cumulative
abnormal
return %
25
20
15
10
5
0
-29
0
30
Month relative to split
Source: Fama, Fisher, Jensen & Roll
Irwin/McGraw Hill
©The McGraw-Hill Companies, Inc., 200
