tag:blogger.com,1999:blog-4752305472275937172024-03-20T02:01:48.644-07:00Investments Video Log EntriesInvestments Teamhttp://www.blogger.com/profile/12325160016387519644noreply@blogger.comBlogger6125tag:blogger.com,1999:blog-475230547227593717.post-85484825147975339972012-11-26T20:59:00.003-08:002012-11-27T13:41:06.111-08:00 A New Narrative on Asset Allocation<!--[if gte mso 9]><xml>
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<span style="background: white; color: #222222; font-family: Arial; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman"; mso-fareast-language: EN-US;">How
does AlphaSimplex use futures contracts to implement its strategies?<o:p></o:p></span></div>
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<br /></div>
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<span style="background: white; color: #222222; font-family: Arial; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman"; mso-fareast-language: EN-US;">Given
the volatility in the markets over the past few years, the need to manage risk
allocation has become more crucial for investors. The volatility of volatility
can change rapidly and this would be reflected in the VIX. Andrew Lo, MIT
professor and alternative money manager, mentions that in the investing arena,
there are new rules to abide by. The first is that markets are not stable and
you cannot be reasonably assured of the volatility in your traditional 60%
stock / 40% bond portfolio. The second rule is that while most people think
they are well diversified amongst different asset classes, it is not true.
There is a need to diversify across stocks, bonds, currencies, commodities and
interest rates. The third rule is that we have to be aware that while stocks
provide good returns in the long run, we are dead in the long run. Hence we
have to be able to manage the short term swings.<o:p></o:p></span></div>
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<br /></div>
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<span style="background: white; color: #222222; font-family: Arial; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman"; mso-fareast-language: EN-US;">These
rules lead to the new narrative that we cannot allocate funds to asset classes
without looking at their associated volatility. AlphaSimplex seeks to cater to
the need for risk allocation for portfolios. The fund takes an approach where
they establish a volatility goal, for example 8%. They invest in futures
contracts across a variety of asset classes in order to maintain that level of
volatility. They rebalance on a daily basis. For example, if the volatility of
the underlying asset spikes, the fund will reduce exposure in that asset class
via futures. When the volatility subsides, the fund will increase exposure in
that asset class via futures. The act of managing this volatility on a daily
basis is something that individual investors would have a difficult time
replicating. The fund has established a goal of 8% volatility. <o:p></o:p></span></div>
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<span style="background: white; color: #222222; font-family: Arial; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman"; mso-fareast-language: EN-US;">This
method of risk allocation comes in contrast to the traditional asset allocation
approach, which does not account for wild swings in volatility which have been omnipresent
over the past 4-5 years. <o:p></o:p></span><br />
<br />
<span style="color: #222222; font-family: Arial;">Lo discusses that it would be difficult for an individual investor to replicate this sort of daily rebalancing. However, he mentions that investors should still be knowledgeable about correlations amongst asset classes and cognizant of risk not only when markets are volatile but also during calmer periods. </span><br />
<br />
<br /></div>
<!--EndFragment-->Investments Teamhttp://www.blogger.com/profile/12325160016387519644noreply@blogger.com0tag:blogger.com,1999:blog-475230547227593717.post-22478035432707057522012-11-20T14:02:00.001-08:002012-11-20T14:04:22.874-08:00Debtco's Debt Debate <!--[if !mso]>
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<span style="font-family: Times, Times New Roman, serif;">This week we are looking at different pricing methods for securities. In this case company Debtco
has a total enterprise value (1) of $100 million and has issued zero-coupon
bonds with an aggregate face value of $80 million (80,000 bonds each with a
face value of $1,000) with a one-year maturity date. The risk free interest rate is 8% and the
volatility of the firms’ assets are 30%. Using the </span><b style="font-family: Times, 'Times New Roman', serif;">Black-Scholes </b><span style="font-family: Times, 'Times New Roman', serif;">model:</span></div>
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<span style="font-family: Times, 'Times New Roman', serif;"><br /></span></div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgmQGPlLezRB4pqTc2Ja_a5KNTkly-n1S2QODDx2jbo6sJOe4RkuGtPFFEwyerW3alCQqPS9eKKtD5l0Rbne1pdkJE0NJsNxC4fGxH3HocRZuaj-oB_lysqsol8YTLtSrS4TBGMCakDPSoz/s1600/Black-Scholes+1.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><span style="font-family: Times, Times New Roman, serif;"><img border="0" height="115" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgmQGPlLezRB4pqTc2Ja_a5KNTkly-n1S2QODDx2jbo6sJOe4RkuGtPFFEwyerW3alCQqPS9eKKtD5l0Rbne1pdkJE0NJsNxC4fGxH3HocRZuaj-oB_lysqsol8YTLtSrS4TBGMCakDPSoz/s400/Black-Scholes+1.png" width="400" /></span></a></div>
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<span style="font-family: Times, Times New Roman, serif;"><br /></span></div>
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<span style="font-family: Times, Times New Roman, serif;"><br /></span></div>
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<span style="font-family: Times, Times New Roman, serif;">and substituting the call
option for Debtco’s equity and the exercise price for the face value of
Debtco’s debt, we can use the following formula to find the value of Debtco’s
equity:<o:p></o:p></span></div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjY9JC39kTFedbyarMucJFaYtAyYSGwJ509t1w0r_y0fjgfIZVmx0UIxab3zV13xv1XamNgxlrzkgc2SY1GMr5we1G3rjB65lyyIqnS3sEAzWDgIVhF00vfWTSeFHc83xCvXpsNq1VsSTHQ/s1600/Black+Scholes.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><span style="font-family: Times, Times New Roman, serif;"><img border="0" height="164" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjY9JC39kTFedbyarMucJFaYtAyYSGwJ509t1w0r_y0fjgfIZVmx0UIxab3zV13xv1XamNgxlrzkgc2SY1GMr5we1G3rjB65lyyIqnS3sEAzWDgIVhF00vfWTSeFHc83xCvXpsNq1VsSTHQ/s320/Black+Scholes.png" width="320" /></span></a></div>
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<span style="font-family: Times, Times New Roman, serif;">V= 100<o:p></o:p></span></div>
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<span style="font-family: Times, Times New Roman, serif;">B = 80<o:p></o:p></span></div>
<div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">T = 1<o:p></o:p></span></div>
<div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">SD = 0.3<o:p></o:p></span></div>
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<br /></div>
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<span style="font-family: Times, Times New Roman, serif;">Using this formula we find
the value of equity is $28.24 million, making the value of debt (D) worth
$71.86 million. Because Debtco issued zero-coupon, one year bonds<o:p></o:p></span></div>
<div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">the yield-to-maturity will
equal the promised rate of interest (R), found in this formula:<o:p></o:p></span></div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhnA-bilCDO3DPcfCl_m1ZNmNSAJG7OxEVe05gJ7S5QbPUY2PrX2Arzckp0x8A7dytUgSw1s9L3YT22HDYJMXUgxbM8vw7e5eHivoenUQqBzgnvCAFuzA9W6ABZRusRqCG_k5nvjAt2k9Zg/s1600/YTM.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><span style="font-family: Times, Times New Roman, serif;"><img border="0" height="144" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhnA-bilCDO3DPcfCl_m1ZNmNSAJG7OxEVe05gJ7S5QbPUY2PrX2Arzckp0x8A7dytUgSw1s9L3YT22HDYJMXUgxbM8vw7e5eHivoenUQqBzgnvCAFuzA9W6ABZRusRqCG_k5nvjAt2k9Zg/s320/YTM.png" width="320" /></span></a></div>
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<span style="font-family: Times, Times New Roman, serif;"><br /></span></div>
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<span style="font-family: Times, Times New Roman, serif;">The YTM equals:
(ln(80/71.86))/1 = <b>10.87%<o:p></o:p></b></span></div>
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<br /></div>
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<span style="font-family: Times, Times New Roman, serif;">This computation can also be
done in excel using the options valuing spread-sheet provided at <u><a href="http://www.mhhe.com/bkm">www.mhhe.com/bkm</a></u><o:p></o:p></span></div>
<div class="MsoNormal">
<br /></div>
<table border="0" cellpadding="0" cellspacing="0" class="MsoNormalTable" style="border-collapse: collapse; margin-left: 4.65pt; mso-padding-alt: 0in 5.4pt 0in 5.4pt; mso-yfti-tbllook: 1184; width: 404px;">
<tbody>
<tr style="height: 15.0pt; mso-yfti-firstrow: yes; mso-yfti-irow: 0;">
<td nowrap="" style="border-right: none; border: solid windowtext 1.0pt; height: 15.0pt; mso-border-bottom-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext 1.0pt; mso-border-top-alt: solid windowtext 1.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div class="MsoNormal">
<b><span style="font-family: Times, Times New Roman, serif;">INPUTS<o:p></o:p></span></b></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: none; border-top: solid windowtext 1.0pt; height: 15.0pt; mso-border-bottom-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext 1.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div class="MsoNormal">
<br /></div>
</td>
<td nowrap="" style="background: black; border-bottom: solid windowtext 1.0pt; border-left: none; border-right: none; border-top: solid windowtext 1.0pt; height: 15.0pt; mso-border-bottom-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext 1.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 7.0pt;" valign="bottom" width="7"><div class="MsoNormal">
<br /></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: none; border-top: solid windowtext 1.0pt; height: 15.0pt; mso-border-bottom-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext 1.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 73.0pt;" valign="bottom" width="73"><div class="MsoNormal">
<b><span style="font-family: Times, Times New Roman, serif;">OUTPUTS<o:p></o:p></span></b></div>
</td>
<td nowrap="" style="border-left: none; border: solid windowtext 1.0pt; height: 15.0pt; mso-border-bottom-alt: solid windowtext .5pt; mso-border-right-alt: solid windowtext 1.0pt; mso-border-top-alt: solid windowtext 1.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 122.0pt;" valign="bottom" width="122"><div class="MsoNormal">
<br /></div>
</td>
</tr>
<tr style="height: 15.0pt; mso-yfti-irow: 1;">
<td nowrap="" style="background: #D9D9D9; border-left: solid windowtext 1.0pt; border: none; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">Standard
Deviation<o:p></o:p></span></div>
</td>
<td nowrap="" style="height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">0.3<o:p></o:p></span></div>
</td>
<td nowrap="" style="background: black; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 7.0pt;" valign="bottom" width="7"><div class="MsoNormal">
<br /></div>
</td>
<td nowrap="" style="background: #D9D9D9; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 73.0pt;" valign="bottom" width="73"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">d1<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-right: solid windowtext 1.0pt; border: none; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 122.0pt;" valign="bottom" width="122"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">1.1605<o:p></o:p></span></div>
</td>
</tr>
<tr style="height: 15.0pt; mso-yfti-irow: 2;">
<td nowrap="" style="background: #D9D9D9; border-left: solid windowtext 1.0pt; border: none; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">Maturity
(in years)<o:p></o:p></span></div>
</td>
<td nowrap="" style="height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">1<o:p></o:p></span></div>
</td>
<td nowrap="" style="background: black; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 7.0pt;" valign="bottom" width="7"><div class="MsoNormal">
<br /></div>
</td>
<td nowrap="" style="background: #D9D9D9; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 73.0pt;" valign="bottom" width="73"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">d2<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-right: solid windowtext 1.0pt; border: none; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 122.0pt;" valign="bottom" width="122"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">0.8605<o:p></o:p></span></div>
</td>
</tr>
<tr style="height: 15.0pt; mso-yfti-irow: 3;">
<td nowrap="" style="background: #D9D9D9; border-left: solid windowtext 1.0pt; border: none; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">Risk-free
rate<o:p></o:p></span></div>
</td>
<td nowrap="" style="height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">0.08<o:p></o:p></span></div>
</td>
<td nowrap="" style="background: black; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 7.0pt;" valign="bottom" width="7"><div class="MsoNormal">
<br /></div>
</td>
<td nowrap="" style="background: #D9D9D9; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 73.0pt;" valign="bottom" width="73"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">n(d1)<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-right: solid windowtext 1.0pt; border: none; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 122.0pt;" valign="bottom" width="122"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">0.8771<o:p></o:p></span></div>
</td>
</tr>
<tr style="height: 15.0pt; mso-yfti-irow: 4;">
<td nowrap="" style="background: #D9D9D9; border-left: solid windowtext 1.0pt; border: none; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">Value
of Firm<o:p></o:p></span></div>
</td>
<td nowrap="" style="height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">100<o:p></o:p></span></div>
</td>
<td nowrap="" style="background: black; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 7.0pt;" valign="bottom" width="7"><div class="MsoNormal">
<br /></div>
</td>
<td nowrap="" style="background: #D9D9D9; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 73.0pt;" valign="bottom" width="73"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">N(d2)<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-right: solid windowtext 1.0pt; border: none; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 122.0pt;" valign="bottom" width="122"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">0.8052<o:p></o:p></span></div>
</td>
</tr>
<tr style="height: 15.0pt; mso-yfti-irow: 5;">
<td nowrap="" style="background: #D9D9D9; border-left: solid windowtext 1.0pt; border: none; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">Bond
Value<o:p></o:p></span></div>
</td>
<td nowrap="" style="height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">80<o:p></o:p></span></div>
</td>
<td nowrap="" style="background: black; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 7.0pt;" valign="bottom" width="7"><div class="MsoNormal">
<br /></div>
</td>
<td nowrap="" style="background: #D9D9D9; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 73.0pt;" valign="bottom" width="73"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">Equity
Value<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-right: solid windowtext 1.0pt; border: none; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 122.0pt;" valign="bottom" width="122"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">28.2411<o:p></o:p></span></div>
</td>
</tr>
<tr style="height: 16.0pt; mso-yfti-irow: 6;">
<td nowrap="" style="background: #D9D9D9; border-bottom: solid windowtext 1.0pt; border-left: solid windowtext 1.0pt; border-right: none; border-top: none; height: 16.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">Dividend
Yield<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border: none; height: 16.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">0<o:p></o:p></span></div>
</td>
<td nowrap="" style="background: black; border-bottom: solid windowtext 1.0pt; border: none; height: 16.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 7.0pt;" valign="bottom" width="7"><div class="MsoNormal">
<br /></div>
</td>
<td nowrap="" style="background: #D9D9D9; border-bottom: solid windowtext 1.0pt; border: none; height: 16.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 73.0pt;" valign="bottom" width="73"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">B/S put
value<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 16.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 122.0pt;" valign="bottom" width="122"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">2.0904<o:p></o:p></span></div>
</td>
</tr>
<tr style="height: 16.0pt; mso-yfti-irow: 7;">
<td nowrap="" style="height: 16.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"></td>
<td nowrap="" style="height: 16.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"></td>
<td nowrap="" style="height: 16.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 7.0pt;" valign="bottom" width="7"></td>
<td nowrap="" style="height: 16.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 73.0pt;" valign="bottom" width="73"></td>
<td nowrap="" style="height: 16.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 122.0pt;" valign="bottom" width="122"></td>
</tr>
<tr style="height: 15.0pt; mso-yfti-irow: 8;">
<td nowrap="" style="background: #D9D9D9; border-bottom: none; border-left: solid windowtext 1.0pt; border-right: none; border-top: solid windowtext 1.0pt; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">Value
of Debt<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-bottom: none; border-left: none; border-right: solid windowtext 1.0pt; border-top: solid windowtext 1.0pt; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">71.7589<o:p></o:p></span></div>
</td>
<td nowrap="" style="height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 7.0pt;" valign="bottom" width="7"></td>
<td nowrap="" style="height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 73.0pt;" valign="bottom" width="73"></td>
<td nowrap="" style="height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 122.0pt;" valign="bottom" width="122"></td>
</tr>
<tr style="height: 16.0pt; mso-yfti-irow: 9; mso-yfti-lastrow: yes;">
<td nowrap="" style="background: #D9D9D9; border-bottom: solid windowtext 1.0pt; border-left: solid windowtext 1.0pt; border-right: none; border-top: none; height: 16.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">YTM<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 16.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">10.87%<o:p></o:p></span></div>
</td>
<td nowrap="" style="height: 16.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 7.0pt;" valign="bottom" width="7"><br /></td>
<td nowrap="" style="height: 16.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 73.0pt;" valign="bottom" width="73"></td>
<td nowrap="" style="height: 16.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 122.0pt;" valign="bottom" width="122"></td>
</tr>
</tbody></table>
<span style="font-family: Times, 'Times New Roman', serif;"><br /></span>
<span style="font-family: Times, 'Times New Roman', serif;">The aggregate face value of Debtco’s bond increased to $108.33 million. Using the same formula, the new YTM on Debtco’s debt is <b>20.70%.</b></span><br />
<span style="font-family: Times, Times New Roman, serif;"><br /></span>
<table border="0" cellpadding="0" cellspacing="0" class="MsoNormalTable" style="border-collapse: collapse; margin-left: 4.65pt; mso-padding-alt: 0in 5.4pt 0in 5.4pt; mso-yfti-tbllook: 1184; width: 404px;">
<tbody>
<tr style="height: 15.0pt; mso-yfti-firstrow: yes; mso-yfti-irow: 0;">
<td nowrap="" style="border-right: none; border: solid windowtext 1.0pt; height: 15.0pt; mso-border-bottom-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext 1.0pt; mso-border-top-alt: solid windowtext 1.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div class="MsoNormal">
<b><span style="font-family: Times, Times New Roman, serif;">INPUTS<o:p></o:p></span></b></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: none; border-top: solid windowtext 1.0pt; height: 15.0pt; mso-border-bottom-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext 1.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div class="MsoNormal">
<br /></div>
</td>
<td nowrap="" style="background: black; border-bottom: solid windowtext 1.0pt; border-left: none; border-right: none; border-top: solid windowtext 1.0pt; height: 15.0pt; mso-border-bottom-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext 1.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 7.0pt;" valign="bottom" width="7"><div class="MsoNormal">
<br /></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: none; border-top: solid windowtext 1.0pt; height: 15.0pt; mso-border-bottom-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext 1.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 73.0pt;" valign="bottom" width="73"><div class="MsoNormal">
<b><span style="font-family: Times, Times New Roman, serif;">OUTPUTS<o:p></o:p></span></b></div>
</td>
<td nowrap="" style="border-left: none; border: solid windowtext 1.0pt; height: 15.0pt; mso-border-bottom-alt: solid windowtext .5pt; mso-border-right-alt: solid windowtext 1.0pt; mso-border-top-alt: solid windowtext 1.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 122.0pt;" valign="bottom" width="122"><div class="MsoNormal">
<br /></div>
</td>
</tr>
<tr style="height: 15.0pt; mso-yfti-irow: 1;">
<td nowrap="" style="background: #D9D9D9; border-left: solid windowtext 1.0pt; border: none; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">Standard
Deviation<o:p></o:p></span></div>
</td>
<td nowrap="" style="height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">0.3<o:p></o:p></span></div>
</td>
<td nowrap="" style="background: black; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 7.0pt;" valign="bottom" width="7"><div class="MsoNormal">
<br /></div>
</td>
<td nowrap="" style="background: #D9D9D9; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 73.0pt;" valign="bottom" width="73"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">d1<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-right: solid windowtext 1.0pt; border: none; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 122.0pt;" valign="bottom" width="122"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">0.1500<o:p></o:p></span></div>
</td>
</tr>
<tr style="height: 15.0pt; mso-yfti-irow: 2;">
<td nowrap="" style="background: #D9D9D9; border-left: solid windowtext 1.0pt; border: none; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">Maturity
(in years)<o:p></o:p></span></div>
</td>
<td nowrap="" style="height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">1<o:p></o:p></span></div>
</td>
<td nowrap="" style="background: black; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 7.0pt;" valign="bottom" width="7"><div class="MsoNormal">
<br /></div>
</td>
<td nowrap="" style="background: #D9D9D9; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 73.0pt;" valign="bottom" width="73"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">d2<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-right: solid windowtext 1.0pt; border: none; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 122.0pt;" valign="bottom" width="122"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">-0.1500<o:p></o:p></span></div>
</td>
</tr>
<tr style="height: 15.0pt; mso-yfti-irow: 3;">
<td nowrap="" style="background: #D9D9D9; border-left: solid windowtext 1.0pt; border: none; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">Risk-free
rate<o:p></o:p></span></div>
</td>
<td nowrap="" style="height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">0.08<o:p></o:p></span></div>
</td>
<td nowrap="" style="background: black; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 7.0pt;" valign="bottom" width="7"><div class="MsoNormal">
<br /></div>
</td>
<td nowrap="" style="background: #D9D9D9; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 73.0pt;" valign="bottom" width="73"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">n(d1)<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-right: solid windowtext 1.0pt; border: none; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 122.0pt;" valign="bottom" width="122"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">0.5596<o:p></o:p></span></div>
</td>
</tr>
<tr style="height: 15.0pt; mso-yfti-irow: 4;">
<td nowrap="" style="background: #D9D9D9; border-left: solid windowtext 1.0pt; border: none; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">Value
of Firm<o:p></o:p></span></div>
</td>
<td nowrap="" style="height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">100<o:p></o:p></span></div>
</td>
<td nowrap="" style="background: black; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 7.0pt;" valign="bottom" width="7"><div class="MsoNormal">
<br /></div>
</td>
<td nowrap="" style="background: #D9D9D9; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 73.0pt;" valign="bottom" width="73"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">N(d2)<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-right: solid windowtext 1.0pt; border: none; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 122.0pt;" valign="bottom" width="122"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">0.4404<o:p></o:p></span></div>
</td>
</tr>
<tr style="height: 15.0pt; mso-yfti-irow: 5;">
<td nowrap="" style="background: #D9D9D9; border-left: solid windowtext 1.0pt; border: none; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">Bond
Value<o:p></o:p></span></div>
</td>
<td nowrap="" style="height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;"><span style="background-color: yellow;">108.33</span><o:p></o:p></span></div>
</td>
<td nowrap="" style="background: black; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 7.0pt;" valign="bottom" width="7"><div class="MsoNormal">
<br /></div>
</td>
<td nowrap="" style="background: #D9D9D9; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 73.0pt;" valign="bottom" width="73"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">Equity
Value<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-right: solid windowtext 1.0pt; border: none; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 122.0pt;" valign="bottom" width="122"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">11.9230<o:p></o:p></span></div>
</td>
</tr>
<tr style="height: 16.0pt; mso-yfti-irow: 6;">
<td nowrap="" style="background: #D9D9D9; border-bottom: solid windowtext 1.0pt; border-left: solid windowtext 1.0pt; border-right: none; border-top: none; height: 16.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">Dividend
Yield<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border: none; height: 16.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">0<o:p></o:p></span></div>
</td>
<td nowrap="" style="background: black; border-bottom: solid windowtext 1.0pt; border: none; height: 16.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 7.0pt;" valign="bottom" width="7"><div class="MsoNormal">
<br /></div>
</td>
<td nowrap="" style="background: #D9D9D9; border-bottom: solid windowtext 1.0pt; border: none; height: 16.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 73.0pt;" valign="bottom" width="73"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">B/S put
value<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 16.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 122.0pt;" valign="bottom" width="122"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">11.9242<o:p></o:p></span></div>
</td>
</tr>
<tr style="height: 16.0pt; mso-yfti-irow: 7;">
<td nowrap="" style="height: 16.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"></td>
<td nowrap="" style="height: 16.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"></td>
<td nowrap="" style="height: 16.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 7.0pt;" valign="bottom" width="7"></td>
<td nowrap="" style="height: 16.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 73.0pt;" valign="bottom" width="73"></td>
<td nowrap="" style="height: 16.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 122.0pt;" valign="bottom" width="122"></td>
</tr>
<tr style="height: 15.0pt; mso-yfti-irow: 8;">
<td nowrap="" style="background: #D9D9D9; border-bottom: none; border-left: solid windowtext 1.0pt; border-right: none; border-top: solid windowtext 1.0pt; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">Value
of Debt<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-bottom: none; border-left: none; border-right: solid windowtext 1.0pt; border-top: solid windowtext 1.0pt; height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">88.0770<o:p></o:p></span></div>
</td>
<td nowrap="" style="height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 7.0pt;" valign="bottom" width="7"></td>
<td nowrap="" style="height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 73.0pt;" valign="bottom" width="73"></td>
<td nowrap="" style="height: 15.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 122.0pt;" valign="bottom" width="122"></td>
</tr>
<tr style="height: 16.0pt; mso-yfti-irow: 9; mso-yfti-lastrow: yes;">
<td nowrap="" style="background: #D9D9D9; border-bottom: solid windowtext 1.0pt; border-left: solid windowtext 1.0pt; border-right: none; border-top: none; height: 16.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">YTM<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 16.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 101.0pt;" valign="bottom" width="101"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;"><span style="background-color: yellow;">20.70%</span><o:p></o:p></span></div>
</td>
<td nowrap="" style="height: 16.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 7.0pt;" valign="bottom" width="7"></td>
<td nowrap="" style="height: 16.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 73.0pt;" valign="bottom" width="73"></td>
<td nowrap="" style="height: 16.0pt; padding: 0in 5.4pt 0in 5.4pt; width: 122.0pt;" valign="bottom" width="122"></td>
</tr>
</tbody></table>
<br />
<div class="MsoNormal">
<b><span style="font-family: Times, Times New Roman, serif;">Assume that the firm's
management swaps its assets for riskier assets of the same total value.
How would this asset swap affect the value of its debt and equity?
Explain<o:p></o:p></span></b></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">Later, Debtco decides to swap its assets for riskier assets of the same total value (100 million). When the volatility of Debtco’s
assets increases, the value of the equity must increase to offset lower value of the the debt due to uncertainty in
repayment (lower value, higher yields).<o:p></o:p></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;"> In the below example, the face
value of debt is 80 million and the total value is 100 million, the volatility has increased to 50%. We find that the value of equity has increased to 33.2 million and the value of debt has decreased to 66.8 million. The YTM on the debt has increased to 18.04%. <o:p></o:p></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<br /></div>
<table border="0" cellpadding="0" cellspacing="0" class="MsoNormalTable" style="border-collapse: collapse; margin-left: 4.65pt; width: 404px;"><tbody>
<tr style="height: 15pt;"><td nowrap="" style="border-bottom-color: windowtext; border-bottom-width: 1pt; border-left-color: windowtext; border-left-width: 1pt; border-style: solid none solid solid; border-top-color: windowtext; border-top-width: 1pt; height: 15pt; padding: 0in 5.4pt; width: 101pt;" valign="bottom" width="101"><div class="MsoNormal">
<b><span style="font-family: Times, Times New Roman, serif;">INPUTS<o:p></o:p></span></b></div>
</td><td nowrap="" style="border-bottom-color: windowtext; border-bottom-width: 1pt; border-style: solid none; border-top-color: windowtext; border-top-width: 1pt; height: 15pt; padding: 0in 5.4pt; width: 101pt;" valign="bottom" width="101"><div class="MsoNormal">
<br /></div>
</td><td nowrap="" style="background-color: black; background-position: initial initial; background-repeat: initial initial; border-bottom-color: windowtext; border-bottom-width: 1pt; border-style: solid none; border-top-color: windowtext; border-top-width: 1pt; height: 15pt; padding: 0in 5.4pt; width: 7pt;" valign="bottom" width="7"><div class="MsoNormal">
<br /></div>
</td><td nowrap="" style="border-bottom-color: windowtext; border-bottom-width: 1pt; border-style: solid none; border-top-color: windowtext; border-top-width: 1pt; height: 15pt; padding: 0in 5.4pt; width: 73pt;" valign="bottom" width="73"><div class="MsoNormal">
<b><span style="font-family: Times, Times New Roman, serif;">OUTPUTS<o:p></o:p></span></b></div>
</td><td nowrap="" style="border-bottom-color: windowtext; border-bottom-width: 1pt; border-right-color: windowtext; border-right-width: 1pt; border-style: solid solid solid none; border-top-color: windowtext; border-top-width: 1pt; height: 15pt; padding: 0in 5.4pt; width: 122pt;" valign="bottom" width="122"><div class="MsoNormal">
<br /></div>
</td></tr>
<tr style="height: 15pt;"><td nowrap="" style="background-color: #d9d9d9; background-position: initial initial; background-repeat: initial initial; border-left-color: windowtext; border-left-width: 1pt; border-style: none none none solid; height: 15pt; padding: 0in 5.4pt; width: 101pt;" valign="bottom" width="101"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">Standard Deviation<o:p></o:p></span></div>
</td><td nowrap="" style="height: 15pt; padding: 0in 5.4pt; width: 101pt;" valign="bottom" width="101"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">0.5<o:p></o:p></span></div>
</td><td nowrap="" style="background-color: black; background-position: initial initial; background-repeat: initial initial; height: 15pt; padding: 0in 5.4pt; width: 7pt;" valign="bottom" width="7"><div class="MsoNormal">
<br /></div>
</td><td nowrap="" style="background-color: #d9d9d9; background-position: initial initial; background-repeat: initial initial; height: 15pt; padding: 0in 5.4pt; width: 73pt;" valign="bottom" width="73"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">d1<o:p></o:p></span></div>
</td><td nowrap="" style="border-right-color: windowtext; border-right-width: 1pt; border-style: none solid none none; height: 15pt; padding: 0in 5.4pt; width: 122pt;" valign="bottom" width="122"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">0.8563<o:p></o:p></span></div>
</td></tr>
<tr style="height: 15pt;"><td nowrap="" style="background-color: #d9d9d9; background-position: initial initial; background-repeat: initial initial; border-left-color: windowtext; border-left-width: 1pt; border-style: none none none solid; height: 15pt; padding: 0in 5.4pt; width: 101pt;" valign="bottom" width="101"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">Maturity (in years)<o:p></o:p></span></div>
</td><td nowrap="" style="height: 15pt; padding: 0in 5.4pt; width: 101pt;" valign="bottom" width="101"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">1<o:p></o:p></span></div>
</td><td nowrap="" style="background-color: black; background-position: initial initial; background-repeat: initial initial; height: 15pt; padding: 0in 5.4pt; width: 7pt;" valign="bottom" width="7"><div class="MsoNormal">
<br /></div>
</td><td nowrap="" style="background-color: #d9d9d9; background-position: initial initial; background-repeat: initial initial; height: 15pt; padding: 0in 5.4pt; width: 73pt;" valign="bottom" width="73"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">d2<o:p></o:p></span></div>
</td><td nowrap="" style="border-right-color: windowtext; border-right-width: 1pt; border-style: none solid none none; height: 15pt; padding: 0in 5.4pt; width: 122pt;" valign="bottom" width="122"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">0.3563<o:p></o:p></span></div>
</td></tr>
<tr style="height: 15pt;"><td nowrap="" style="background-color: #d9d9d9; background-position: initial initial; background-repeat: initial initial; border-left-color: windowtext; border-left-width: 1pt; border-style: none none none solid; height: 15pt; padding: 0in 5.4pt; width: 101pt;" valign="bottom" width="101"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">Risk-free rate<o:p></o:p></span></div>
</td><td nowrap="" style="height: 15pt; padding: 0in 5.4pt; width: 101pt;" valign="bottom" width="101"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">0.08<o:p></o:p></span></div>
</td><td nowrap="" style="background-color: black; background-position: initial initial; background-repeat: initial initial; height: 15pt; padding: 0in 5.4pt; width: 7pt;" valign="bottom" width="7"><div class="MsoNormal">
<br /></div>
</td><td nowrap="" style="background-color: #d9d9d9; background-position: initial initial; background-repeat: initial initial; height: 15pt; padding: 0in 5.4pt; width: 73pt;" valign="bottom" width="73"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">n(d1)<o:p></o:p></span></div>
</td><td nowrap="" style="border-right-color: windowtext; border-right-width: 1pt; border-style: none solid none none; height: 15pt; padding: 0in 5.4pt; width: 122pt;" valign="bottom" width="122"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">0.8041<o:p></o:p></span></div>
</td></tr>
<tr style="height: 15pt;"><td nowrap="" style="background-color: #d9d9d9; background-position: initial initial; background-repeat: initial initial; border-left-color: windowtext; border-left-width: 1pt; border-style: none none none solid; height: 15pt; padding: 0in 5.4pt; width: 101pt;" valign="bottom" width="101"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">Value of Firm<o:p></o:p></span></div>
</td><td nowrap="" style="height: 15pt; padding: 0in 5.4pt; width: 101pt;" valign="bottom" width="101"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">100<o:p></o:p></span></div>
</td><td nowrap="" style="background-color: black; background-position: initial initial; background-repeat: initial initial; height: 15pt; padding: 0in 5.4pt; width: 7pt;" valign="bottom" width="7"><div class="MsoNormal">
<br /></div>
</td><td nowrap="" style="background-color: #d9d9d9; background-position: initial initial; background-repeat: initial initial; height: 15pt; padding: 0in 5.4pt; width: 73pt;" valign="bottom" width="73"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">N(d2)<o:p></o:p></span></div>
</td><td nowrap="" style="border-right-color: windowtext; border-right-width: 1pt; border-style: none solid none none; height: 15pt; padding: 0in 5.4pt; width: 122pt;" valign="bottom" width="122"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">0.6392<o:p></o:p></span></div>
</td></tr>
<tr style="height: 15pt;"><td nowrap="" style="background-color: #d9d9d9; background-position: initial initial; background-repeat: initial initial; border-left-color: windowtext; border-left-width: 1pt; border-style: none none none solid; height: 15pt; padding: 0in 5.4pt; width: 101pt;" valign="bottom" width="101"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">Bond Value<o:p></o:p></span></div>
</td><td nowrap="" style="height: 15pt; padding: 0in 5.4pt; width: 101pt;" valign="bottom" width="101"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">80<o:p></o:p></span></div>
</td><td nowrap="" style="background-color: black; background-position: initial initial; background-repeat: initial initial; height: 15pt; padding: 0in 5.4pt; width: 7pt;" valign="bottom" width="7"><div class="MsoNormal">
<br /></div>
</td><td nowrap="" style="background-color: #d9d9d9; background-position: initial initial; background-repeat: initial initial; height: 15pt; padding: 0in 5.4pt; width: 73pt;" valign="bottom" width="73"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">Equity Value<o:p></o:p></span></div>
</td><td nowrap="" style="border-right-color: windowtext; border-right-width: 1pt; border-style: none solid none none; height: 15pt; padding: 0in 5.4pt; width: 122pt;" valign="bottom" width="122"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;"><span style="background-color: yellow;">33.2045</span><o:p></o:p></span></div>
</td></tr>
<tr style="height: 16pt;"><td nowrap="" style="background-color: #d9d9d9; background-position: initial initial; background-repeat: initial initial; border-bottom-color: windowtext; border-bottom-width: 1pt; border-left-color: windowtext; border-left-width: 1pt; border-style: none none solid solid; height: 16pt; padding: 0in 5.4pt; width: 101pt;" valign="bottom" width="101"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">Dividend Yield<o:p></o:p></span></div>
</td><td nowrap="" style="border-bottom-color: windowtext; border-bottom-width: 1pt; border-style: none none solid; height: 16pt; padding: 0in 5.4pt; width: 101pt;" valign="bottom" width="101"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">0<o:p></o:p></span></div>
</td><td nowrap="" style="background-color: black; background-position: initial initial; background-repeat: initial initial; border-bottom-color: windowtext; border-bottom-width: 1pt; border-style: none none solid; height: 16pt; padding: 0in 5.4pt; width: 7pt;" valign="bottom" width="7"><div class="MsoNormal">
<br /></div>
</td><td nowrap="" style="background-color: #d9d9d9; background-position: initial initial; background-repeat: initial initial; border-bottom-color: windowtext; border-bottom-width: 1pt; border-style: none none solid; height: 16pt; padding: 0in 5.4pt; width: 73pt;" valign="bottom" width="73"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">B/S put value<o:p></o:p></span></div>
</td><td nowrap="" style="border-bottom-color: windowtext; border-bottom-width: 1pt; border-right-color: windowtext; border-right-width: 1pt; border-style: none solid solid none; height: 16pt; padding: 0in 5.4pt; width: 122pt;" valign="bottom" width="122"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">7.0538<o:p></o:p></span></div>
</td></tr>
<tr style="height: 16pt;"><td nowrap="" style="height: 16pt; padding: 0in 5.4pt; width: 101pt;" valign="bottom" width="101"></td><td nowrap="" style="height: 16pt; padding: 0in 5.4pt; width: 101pt;" valign="bottom" width="101"></td><td nowrap="" style="height: 16pt; padding: 0in 5.4pt; width: 7pt;" valign="bottom" width="7"></td><td nowrap="" style="height: 16pt; padding: 0in 5.4pt; width: 73pt;" valign="bottom" width="73"></td><td nowrap="" style="height: 16pt; padding: 0in 5.4pt; width: 122pt;" valign="bottom" width="122"></td></tr>
<tr style="height: 15pt;"><td nowrap="" style="background-color: #d9d9d9; background-position: initial initial; background-repeat: initial initial; border-left-color: windowtext; border-left-width: 1pt; border-style: solid none none solid; border-top-color: windowtext; border-top-width: 1pt; height: 15pt; padding: 0in 5.4pt; width: 101pt;" valign="bottom" width="101"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">Value of Debt<o:p></o:p></span></div>
</td><td nowrap="" style="border-right-color: windowtext; border-right-width: 1pt; border-style: solid solid none none; border-top-color: windowtext; border-top-width: 1pt; height: 15pt; padding: 0in 5.4pt; width: 101pt;" valign="bottom" width="101"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;">66.7955<o:p></o:p></span></div>
</td><td nowrap="" style="height: 15pt; padding: 0in 5.4pt; width: 7pt;" valign="bottom" width="7"></td><td nowrap="" style="height: 15pt; padding: 0in 5.4pt; width: 73pt;" valign="bottom" width="73"></td><td nowrap="" style="height: 15pt; padding: 0in 5.4pt; width: 122pt;" valign="bottom" width="122"></td></tr>
<tr style="height: 16pt;"><td nowrap="" style="background-color: #d9d9d9; border-bottom-color: windowtext; border-bottom-width: 1pt; border-left-color: windowtext; border-left-width: 1pt; border-style: none none solid solid; height: 16pt; padding: 0in 5.4pt; width: 101pt;" valign="bottom" width="101"><div class="MsoNormal">
<span style="font-family: Times, Times New Roman, serif;">YTM<o:p></o:p></span></div>
</td><td nowrap="" style="border-bottom-color: windowtext; border-bottom-width: 1pt; border-right-color: windowtext; border-right-width: 1pt; border-style: none solid solid none; height: 16pt; padding: 0in 5.4pt; width: 101pt;" valign="bottom" width="101"><div align="right" class="MsoNormal" style="text-align: right;">
<span style="font-family: Times, Times New Roman, serif;"><span style="background-color: yellow;">18.04%</span><o:p></o:p></span></div>
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<span style="background-color: white;"><span style="font-family: Times, Times New Roman, serif;">(1) TEV =
Market Capitalization + Interest Bearing Debt + Preferred Stock - Excess Cash</span></span><span style="font-size: 11.0pt;"><o:p></o:p></span></div>
<!--EndFragment-->Investments Teamhttp://www.blogger.com/profile/12325160016387519644noreply@blogger.com0tag:blogger.com,1999:blog-475230547227593717.post-40010900457516990342012-11-13T07:44:00.002-08:002012-11-13T07:51:50.920-08:00Hartford to Buy Out AnnuitiesThe Hartford just announced to investors and analysts that they are seeking regulatory approval to make offers to a small number of annuity owners to swap the income guarantees on their contracts for boosts to the amounts that they have invested in underlying stock and bond funds.<br />
<br />
A variable annuity is an insurance contract that delays payment of income until the investor chooses to receive them. There are typically two phases: a savings phase and an income phase. Earnings within the contract are tax deferred until withdrawal, similar to a 401K plan. Similar to a 401K plan, there is a 10% early withdrawal penalty if funds are taken out before the age of 59 and 1/2. If an annuity is held within a retirement plan, it is considered a "qualified" annuity and distributions are completely taxable. If held outside of a retirement plan, it is known as "non-qualified" and only earnings are taxed. Withdrawals are made on a earnings first, basis last principle. Variable annuities come with an assortment of insurance options, all of which add to the cost of investment in the contract.<br />
<br />
The basic insurance benefit associated with variable annuities is the death benefit. It assures the beneficiaries of the annuity guaranteed payment if the contract owner dies before annuitizing the contract. There are several options for this, each with different costs associated with it.<br />
<br />
Among the living benefits, which include annuitizing your investment to receive guaranteed minimum income, the benefit to discuss here is the Guaranteed Lifetime Withdrawal Benefit (GLWB), which does not require annuitizing, and therefore handing over control, of your investment. The guarantee is a set percentage of your investment, which increases the longer you delay payment. The company may agree to pay you 5% at age 55, but might increase it to 5.5% or 6% if you wait until age 70 or 80. Coupled with death benefits, insurance companies make money off these contracts based on the underlying fees charged to clients because they don't get to keep the account balance like an annuitized contract e.g. an immediate annuity.<br />
<br />
The Hartford is seeking permission to ask variable annuity owners to give up their guarantee of lifetime income probably because the projections on how the market would perform, which the guarantees the Hartford were giving as part of their VA products were based, were way off. A lot of analysts were expecting a correction of some sort but very few thought we'd have the magnitude of a recession like we did in 2008-2009. Even with hedging programs in place, it's difficult to maintain a level of guaranteed payment to investors under contract until they die (defined benefit plans, anyone?).<br />
<br />
The Hartford is offering a boost to the amount of money in accounts held by owners of these contracts in exchange for canceling the guaranteed lifetime withdrawal.<br />
<br />
The people who would most likely benefit from accepting this offer are people who are close to death and the expected value of the future guaranteed payments are less than the boost the Hartford is offering. It is likely by this stage, surrender charges have disappeared and they can try to roll over this account into a traditional mutual fund company in similar investments and save on fees.<br />
<br />
The people who are worse off accepting this offer are those that are expected to take the guaranteed withdrawals for decades in retirement and the expected value of these future payments outweigh the boost the Hartford is offering.Investments Teamhttp://www.blogger.com/profile/12325160016387519644noreply@blogger.com0tag:blogger.com,1999:blog-475230547227593717.post-3897361807994008732012-11-06T06:14:00.000-08:002012-11-06T06:14:30.065-08:00Honda Analysis <div class="separator" style="clear: both; text-align: left;">
15.</div>
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In the first scenario where the PV of CF is 39.71, let’s
make note that ROE is greater than cost of equity. If this relationship holds, we can assert that any
change in the growth rate, all else the same, will increase the PV of CF. This
is the profitable growth that investors look for. <o:p></o:p></div>
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In the second scenario, we have lowered the ROE where it is
less than the cost of equity. Therefore, this translates into growth that is
not profitable. This is why the PV of CF has decreased. If such a situation
were to persist, then one of the ways to increase intrinsic value is to
increase the dividend payout ratio. <o:p></o:p></div>
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<div class="MsoNormal">
In the third scenario, we have manipulated beta upwards and
this has increased the cost of equity such that it is equal to ROE. In
comparison to the first scenario where ROE>cost of equity, the intrinsic
value has fallen. <o:p></o:p></div>
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<br /></div>
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In the last scenario we have indirectly manipulated the cost
of equity such that ROE is slightly greater than cost of equity. In comparison
to the third scenario, the intrinsic value has increased because of the
relationship between these two variables. <o:p></o:p></div>
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<!--StartFragment-->
</div>
<div class="MsoNormal">
In this example we are using the discounted cash flow method
to determine the intrinsic value of a company and its stock. As we will see
below, the primary change in the intrinsic values will be derived from the fact
that the cost of equity and WACC are changing. The results are outlined in Exhibit B.
<o:p></o:p></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
If we assume the P/E multiple to be 16 in 2012, we derive
intrinsic values of $37.61 for FCFF and $38.55 for FCFE (Exhibit A). When compared to the benchmark, the intrinsic
values are higher because investors are willing to pay more for each dollar of
income than in 2011. The assumptions for this example are outlined in Exhibit A. <o:p></o:p></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
When the unlevered beta is increased from 0.79 to 0.8
(scenario 2), the cost of equity and consequently the WACC increases. This
intrinsic value is reduced as a result because investors demand a higher
premium <o:p></o:p></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
Notably, in scenario 3, the market risk premium has
increased by a full percentage point. This has served to increase the cost of
equity from 11.7% to 12.6%. This also increases the WACC and as a result the
cash flows are discounted by a higher figure and lower intrinsic values ensue. <o:p></o:p></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
The dividend discount model in comparison to the DCF model
is more simplistic given the less number of variables required. However it can
be argued the DCF model is more complete given its wholistic approach.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<br /></div>
<!--EndFragment--><br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg8zA45c-_DpT-v4i5HEBeZuYOo-vSmS8QIp-YvcCepdiXIEHAdibU4l2jwiAr21eZTXDrNAXTydwczqs66wyjeA7Fv_rvEQxXJOiyGrEQ7d-_khSYr80lj0UptYH_oclMA8si2LzVlhVpA/s1600/18.2+p.e+.tiff" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="260" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg8zA45c-_DpT-v4i5HEBeZuYOo-vSmS8QIp-YvcCepdiXIEHAdibU4l2jwiAr21eZTXDrNAXTydwczqs66wyjeA7Fv_rvEQxXJOiyGrEQ7d-_khSYr80lj0UptYH_oclMA8si2LzVlhVpA/s400/18.2+p.e+.tiff" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Exhibit A</td></tr>
</tbody></table>
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhSsXVcotGjxqxNeqT6Zw9d5uMOWmL52CW11PVhOcI_rlihPgNeAha7yGFUMAnFcqP7C6ogL1xKkHsleWr6ir7mb4Rk_Rd2mNO5EeIPlH343L_GuLUAFvbrrDyreZeFc-azoaJvEH5VXcc6/s1600/18.2+general+findings.tiff" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="75" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhSsXVcotGjxqxNeqT6Zw9d5uMOWmL52CW11PVhOcI_rlihPgNeAha7yGFUMAnFcqP7C6ogL1xKkHsleWr6ir7mb4Rk_Rd2mNO5EeIPlH343L_GuLUAFvbrrDyreZeFc-azoaJvEH5VXcc6/s400/18.2+general+findings.tiff" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Exhibit B</td></tr>
</tbody></table>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
- Akhil P</div>
<div class="MsoNormal">
<br /></div>
<!--EndFragment-->Investments Teamhttp://www.blogger.com/profile/12325160016387519644noreply@blogger.com0tag:blogger.com,1999:blog-475230547227593717.post-72307607396572114892012-10-01T20:42:00.001-07:002012-10-01T20:42:50.547-07:00<div class="separator" style="clear: both; text-align: center;">
<span style="background-color: white;"><iframe allowfullscreen='allowfullscreen' webkitallowfullscreen='webkitallowfullscreen' mozallowfullscreen='mozallowfullscreen' width='320' height='266' src='https://www.blogger.com/video.g?token=AD6v5dwZV_GB5qcbPuVGlUePooTAx7CM44AHUz5_0iXMk9Aeye0zfxXHpISkqJtilMgiXswoVHdvwfN_B9zLOfpsUQ' class='b-hbp-video b-uploaded' frameborder='0'></iframe></span></div>
<span style="background-color: white;"><span style="color: blue;"><span style="font-size: large;">Fidelity MyPlan </span></span></span><br />
In this video we provide a short overview of the pros and cons of the Fidelity MyPlan Investments Teamhttp://www.blogger.com/profile/12325160016387519644noreply@blogger.com0tag:blogger.com,1999:blog-475230547227593717.post-12890249428126206942012-09-17T17:48:00.000-07:002012-09-17T17:48:01.296-07:00I-bonds or Roth IRA?I discuss the differences between I-bonds and a Roth IRA and how Jennifer Student should decide what to invest her money in.
<iframe width="560" height="315" src="http://www.youtube.com/embed/Co0jU6I_e7U" frameborder="0" allowfullscreen></iframe>Investments Teamhttp://www.blogger.com/profile/12325160016387519644noreply@blogger.com0