Class 1 Notes
Goal of a manager of a public company?
- Maximize shareholder value
Two most important Companies in Society
- You inc.
o Your job is to maximize to the value of equity (net worth) of you.
o Shareholders of You inc. today is you.
o Later in life, different shareholders include your partner, children,
beneficiaries of your estate.
- Family inc.
o You are chief financial officer of Family inc.
o You are also a shareholder.
o You should maximize the value of Family inc.
Three types of decisions managers make to achieve their goal
1. Investment Decisions
- You inc. is investing in your future by going to University.
2. Financing Decisions
3. Dividend Decisions
- How much of the company’s net income did it pay out as a dividend
- You inc. is concerned with how much of your net income do you save.
6 Concepts of Finance
1. Time Value of Money
2. Risk and Return
a. Standard deviation of returns, Beta, Premature death, Disability,
Outliving your money.
b. MLGIC, where the investor always gets back the amount they invested.
But is it a risk-free investment? If you get $1,000 today and get back
$1,000 in 7 years time, it is not worth the same amount in 7 years
because of the TVM. You could have invested that money somewhere
else and earned more.
3. Cash Flow (cash) Not Net Income
a. Looking at the difference between cash flow and net income.
4. What matters is the future and not the past. Cash Flow Statement, Budgeting.
5. Market Efficiency
a. What we mean by market efficiency is that the price of some security
= value of some security. What we’re paying for the security is what it
is actually worth and we are not getting overcharged.
b. Are markets in personal finance efficient?
6. Understand People, greed, fear, legacies, shareholders / stakeholders of You
inc.
What makes markets efficient?
1. Profit maximizing, well educated, knowledgeable, experienced investors who
value securities independently
2. Information regarding the securities is available to investors and new information
is generated.
3. Competing investors adjust their estimates for the value / price of a security
based on new information and act accordingly.
4. Ability and willingness of some investors to short sell overvalued securities.
- securities have to trade in a market that permits short selling.
Ex. 1 Notes
- They will buy it until it gets closer to $55
Ex. 2 notes
- They now think it is only worth $40 when the stock is trading at $50.
- If they owned it, they would sell it.
- If they didn’t own it and were willing to, they would short sell it.
Two Potential Issues with Short Selling
1. Some investors are not prepared to short sell.
a. Have to be willing to short sell
2. Have to be able to short sell the stock (market)
a. No restrictions on short selling the securities
Ex. 3 Notes
- What does New Investment Bank do?
- They buy a lot of it because it is undervalued because they estimate it is
worth $14 when priced at $10.
- They now value it at $7,
Ex. 4 Notes
- Newer security will not trade in any stock market.
- If the price is 10 and the value is 7, it is overvalued.
- Only retail investors would buy it because they wouldn’t be able to value it.
Who will Anderson Bank be able to sell newest security to?
- When securities are over-valued and short selling cannot be done, the only
people that can only buy these securities are retail investors.
Additional securities for sale from Anderson bank
- Institutional investors would not buy any of these securities.
- Anderson Bank would want to sell Security E because it has the lowest cost to
create.
- How do we sell lots of E vs. A security?
o We would set targets for how much of security E they sell, and they get
rewarded.
o We would set a high commission on selling security E, make people
greedy.
What is the legal obligation of Anderson Bank to its customers?
- Contractual Duty (creating a contract)
- Negligence
o Duty of care
- Fiduciary Duty
o Fiduciary - put the interest of someone else in front of their own.
o If BMO offers 4% on a GIC and has a fiduciary to you, and RBC offers
5%, BMO has to let you know the other options like RBC. They have to
put the interest of the customer in front of their own.
