ABSTRACT Pro forma analysis is often performed with the idea that a firm's cash flows are... more ABSTRACT Pro forma analysis is often performed with the idea that a firm's cash flows are cyclic. Yet, after forecasting cash flows following a cyclic pattern, the remaining cash flows are calculated using a constant growth perpetuity calculation as a "terminal value". Such a calculation for the terminal value is inconsistent with the nature of cyclic cash flows that do not grow at a constant rate. In this paper, a method is developed for calculating the terminal value that incorporates the cyclic nature of cash flows into perpetuity. The method is easily incorporated into Excel and is very amenable to Excel's data table and "spinner" features, as well as monte carlo software packages for extensive sensitivity analysis.
The matrix algebra associated with finding minimum variance portfolio weights and tangency portfo... more The matrix algebra associated with finding minimum variance portfolio weights and tangency portfolio weights is greatly simplified by using an Excel presentation. A further simplification of the tangency portfolio weights process is also presented using excess returns for the risky securities. The lesson drawn from this presentation is readily performed online by sharing or recording an Excel screen with students.
In the third chapter, binomial trees were introduced to price European style options in which the... more In the third chapter, binomial trees were introduced to price European style options in which the mean of the value of the moption at maturity was computed and then discounted to produce the price of the option (i.e., the option premium). Inputs for building the tree, U, D, P(U), and P(D), and the discount rate were provided for the exercise. In this chapter, the calculation of these pieces of the model will be revealed based on a model by Cox, Ross, and Rubinstein (1979). Further, risk-neutral pricing used within the binomial tree will be demonstrated to be a mathematical convenience and not a necessary condition for pricing options (i.e., there is no need for an assumption that all investors are risk neutral). Finally, the process for pricing an American style option with the binomial tree will be explained, which will allow for the pricing of real options in the next chapter.
ABSTRACT Pro forma analysis is often performed with the idea that a firm's cash flows are... more ABSTRACT Pro forma analysis is often performed with the idea that a firm's cash flows are cyclic. Yet, after forecasting cash flows following a cyclic pattern, the remaining cash flows are calculated using a constant growth perpetuity calculation as a "terminal value". Such a calculation for the terminal value is inconsistent with the nature of cyclic cash flows that do not grow at a constant rate. In this paper, a method is developed for calculating the terminal value that incorporates the cyclic nature of cash flows into perpetuity. The method is easily incorporated into Excel and is very amenable to Excel's data table and "spinner" features, as well as monte carlo software packages for extensive sensitivity analysis.
Newly public companies must disclose significant risk factors in the offering prospectus. These d... more Newly public companies must disclose significant risk factors in the offering prospectus. These disclosures are examples of “soft” or ambiguous information. Ambiguity models predict that investors will alter their portfolio weights and react to subsequent signals about such information. We test for these effects in a sample of 1,398 initial public offerings (IPOs) using word count ratios between soft and hard information as measures of ambiguity. We find a significant relationship between the soft information on risk and both initial and ex post measures of returns. These results support the view that soft information embeds ambiguity and that it influences investors’ portfolio choices.
Firms featured in cover stories collected from Business Week, Fortune, and Forbes over a 20-year ... more Firms featured in cover stories collected from Business Week, Fortune, and Forbes over a 20-year period (1983–2002) are examined to determine whether risk-adjusted contrarian performance in the stock price occurs after the publication of the story. Positive cover stories lead to abnormally low performance in stock price on a risk-adjusted basis, although the returns are still positive. Negative cover stories lead to positive returns on the stock,but the returns are still not superior on a risk-adjusted basis.
ABSTRACT Regulation S-K requires newly public companies to disclose the most significant risk fac... more ABSTRACT Regulation S-K requires newly public companies to disclose the most significant risk factors affecting their business in the offering prospectus. We investigate whether these revealed risk factors affect investors by examining their impact on returns. We develop risk measures using word count ratios and the number of named risks as proxies for the risk-related information contained in the prospectus. Using IPO data from 1999-2004, we find a significant relationship between these risk measures, initial returns and ex post measures of return volatility. We use these measures and subsequent IPO returns to test whether firms fully disclose all risks in the offering prospectus. The evidence indicates a lack of full disclosure. Our results support the view that companies make meaningful, but not full disclosures in the offering prospectus, and provide support for the view that the long run average underperformance of IPOs is partly due to the realization of some undisclosed risks.
In the previous two chapters a number of different real options were implemented using net presen... more In the previous two chapters a number of different real options were implemented using net present value or NPV-embedded binomial trees. In chapter 5, a five-year project had cash flows forecasted through a binomial tree, which was then converted into an NPV-embedded binomial tree. There was an initial value for the cash flow that was forecasted forward using the multipliers “U” and “D.” Then mean future cash flows were discounted backward through the tree to produce an NPV calculation at the beginning of the tree.
ABSTRACT We give a simple pragmatic justification for risk neutral pricing that can be presented ... more ABSTRACT We give a simple pragmatic justification for risk neutral pricing that can be presented in a classroom without the explicit use of any advanced mathematics. We do this by exploiting a generalized binomial option pricing model developed by Arnold and Crack [2000]. This model allows for a spreadsheet demonstration that the price of an option is immune to choice of discount rate. We show that the pragmatic choice is to price the option as if investors are risk neutral. Our argument also allows us to step into some properties of martingale measure with very little preparation.
Tom Arnold The Robins School of Business Department of Finance University of Richmond, VA 23173 O... more Tom Arnold The Robins School of Business Department of Finance University of Richmond, VA 23173 O: 804-287-6399 F: 804-289-8878 [email protected] ... Timothy Falcon Crack Dept. Finance and Quant. Analysis, Otago University, PO Box 56, Dunedin, New Zealand. ...
Altman\u27s Z-score is introduced in an Excel framework to produce a quick calculation of the Z-s... more Altman\u27s Z-score is introduced in an Excel framework to produce a quick calculation of the Z-score with actual financial data available through the Internet. The lesson plan developed is easily introduced with topics covering ratio analysis, financial risk, bond rating changes, and bankruptcy. Given the wide use of the Z-score in practice to evaluate credit risk (or bankruptcy risk), the lesson plan produces a skill set that is very marketable
... opportunities to best take advantage of the options that come with investment, including crea... more ... opportunities to best take advantage of the options that come with investment, including creating options in the original project design for ... David N Ford, Diane M Lander, John J Voyer in Construction Management Economics (2002). 8 readers Save reference to library · Related ...
ABSTRACT Pro forma analysis is often performed with the idea that a firm's cash flows are... more ABSTRACT Pro forma analysis is often performed with the idea that a firm's cash flows are cyclic. Yet, after forecasting cash flows following a cyclic pattern, the remaining cash flows are calculated using a constant growth perpetuity calculation as a "terminal value". Such a calculation for the terminal value is inconsistent with the nature of cyclic cash flows that do not grow at a constant rate. In this paper, a method is developed for calculating the terminal value that incorporates the cyclic nature of cash flows into perpetuity. The method is easily incorporated into Excel and is very amenable to Excel's data table and "spinner" features, as well as monte carlo software packages for extensive sensitivity analysis.
The matrix algebra associated with finding minimum variance portfolio weights and tangency portfo... more The matrix algebra associated with finding minimum variance portfolio weights and tangency portfolio weights is greatly simplified by using an Excel presentation. A further simplification of the tangency portfolio weights process is also presented using excess returns for the risky securities. The lesson drawn from this presentation is readily performed online by sharing or recording an Excel screen with students.
In the third chapter, binomial trees were introduced to price European style options in which the... more In the third chapter, binomial trees were introduced to price European style options in which the mean of the value of the moption at maturity was computed and then discounted to produce the price of the option (i.e., the option premium). Inputs for building the tree, U, D, P(U), and P(D), and the discount rate were provided for the exercise. In this chapter, the calculation of these pieces of the model will be revealed based on a model by Cox, Ross, and Rubinstein (1979). Further, risk-neutral pricing used within the binomial tree will be demonstrated to be a mathematical convenience and not a necessary condition for pricing options (i.e., there is no need for an assumption that all investors are risk neutral). Finally, the process for pricing an American style option with the binomial tree will be explained, which will allow for the pricing of real options in the next chapter.
ABSTRACT Pro forma analysis is often performed with the idea that a firm's cash flows are... more ABSTRACT Pro forma analysis is often performed with the idea that a firm's cash flows are cyclic. Yet, after forecasting cash flows following a cyclic pattern, the remaining cash flows are calculated using a constant growth perpetuity calculation as a "terminal value". Such a calculation for the terminal value is inconsistent with the nature of cyclic cash flows that do not grow at a constant rate. In this paper, a method is developed for calculating the terminal value that incorporates the cyclic nature of cash flows into perpetuity. The method is easily incorporated into Excel and is very amenable to Excel's data table and "spinner" features, as well as monte carlo software packages for extensive sensitivity analysis.
Newly public companies must disclose significant risk factors in the offering prospectus. These d... more Newly public companies must disclose significant risk factors in the offering prospectus. These disclosures are examples of “soft” or ambiguous information. Ambiguity models predict that investors will alter their portfolio weights and react to subsequent signals about such information. We test for these effects in a sample of 1,398 initial public offerings (IPOs) using word count ratios between soft and hard information as measures of ambiguity. We find a significant relationship between the soft information on risk and both initial and ex post measures of returns. These results support the view that soft information embeds ambiguity and that it influences investors’ portfolio choices.
Firms featured in cover stories collected from Business Week, Fortune, and Forbes over a 20-year ... more Firms featured in cover stories collected from Business Week, Fortune, and Forbes over a 20-year period (1983–2002) are examined to determine whether risk-adjusted contrarian performance in the stock price occurs after the publication of the story. Positive cover stories lead to abnormally low performance in stock price on a risk-adjusted basis, although the returns are still positive. Negative cover stories lead to positive returns on the stock,but the returns are still not superior on a risk-adjusted basis.
ABSTRACT Regulation S-K requires newly public companies to disclose the most significant risk fac... more ABSTRACT Regulation S-K requires newly public companies to disclose the most significant risk factors affecting their business in the offering prospectus. We investigate whether these revealed risk factors affect investors by examining their impact on returns. We develop risk measures using word count ratios and the number of named risks as proxies for the risk-related information contained in the prospectus. Using IPO data from 1999-2004, we find a significant relationship between these risk measures, initial returns and ex post measures of return volatility. We use these measures and subsequent IPO returns to test whether firms fully disclose all risks in the offering prospectus. The evidence indicates a lack of full disclosure. Our results support the view that companies make meaningful, but not full disclosures in the offering prospectus, and provide support for the view that the long run average underperformance of IPOs is partly due to the realization of some undisclosed risks.
In the previous two chapters a number of different real options were implemented using net presen... more In the previous two chapters a number of different real options were implemented using net present value or NPV-embedded binomial trees. In chapter 5, a five-year project had cash flows forecasted through a binomial tree, which was then converted into an NPV-embedded binomial tree. There was an initial value for the cash flow that was forecasted forward using the multipliers “U” and “D.” Then mean future cash flows were discounted backward through the tree to produce an NPV calculation at the beginning of the tree.
ABSTRACT We give a simple pragmatic justification for risk neutral pricing that can be presented ... more ABSTRACT We give a simple pragmatic justification for risk neutral pricing that can be presented in a classroom without the explicit use of any advanced mathematics. We do this by exploiting a generalized binomial option pricing model developed by Arnold and Crack [2000]. This model allows for a spreadsheet demonstration that the price of an option is immune to choice of discount rate. We show that the pragmatic choice is to price the option as if investors are risk neutral. Our argument also allows us to step into some properties of martingale measure with very little preparation.
Tom Arnold The Robins School of Business Department of Finance University of Richmond, VA 23173 O... more Tom Arnold The Robins School of Business Department of Finance University of Richmond, VA 23173 O: 804-287-6399 F: 804-289-8878 [email protected] ... Timothy Falcon Crack Dept. Finance and Quant. Analysis, Otago University, PO Box 56, Dunedin, New Zealand. ...
Altman\u27s Z-score is introduced in an Excel framework to produce a quick calculation of the Z-s... more Altman\u27s Z-score is introduced in an Excel framework to produce a quick calculation of the Z-score with actual financial data available through the Internet. The lesson plan developed is easily introduced with topics covering ratio analysis, financial risk, bond rating changes, and bankruptcy. Given the wide use of the Z-score in practice to evaluate credit risk (or bankruptcy risk), the lesson plan produces a skill set that is very marketable
... opportunities to best take advantage of the options that come with investment, including crea... more ... opportunities to best take advantage of the options that come with investment, including creating options in the original project design for ... David N Ford, Diane M Lander, John J Voyer in Construction Management Economics (2002). 8 readers Save reference to library · Related ...
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