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G 601, IO I Eric Rasmusen, erasmuse@indiana. edu 13 September 2006 Accounting Data, and G 601, IO I Eric Rasmusen, [email protected] edu 13 September 2006 Accounting Data, and Finance II This is for one 75 minute session. 1

Readings 14 September, Thursday. Accounting Data, and Finance II Readings 14 September, Thursday. Accounting Data, and Finance II "Notes on Present Discounted Value, " 2003, in ascii-latex and pdf. Powerpoint Finance Slides. For reference: Ivo Welch (Yale) "A 3 -Hour Tour of Finance, " February 26, 2003, Yale SOM, http: //welch. som. yale. edu/teaching/financetouri. pdf. Due 10 PM Sunday Sept 17: The Latex project. 2

NEXT TIME chpater 4, 5. L: atex assignment. 3 NEXT TIME chpater 4, 5. L: atex assignment. 3

Handouts • PS 2 answers 4 Handouts • PS 2 answers 4

Eli Lilly Annual Report • Annual reports are interesting to read 5 Eli Lilly Annual Report • Annual reports are interesting to read 5

EXAMPLE: AVERAGE COST 6 EXAMPLE: AVERAGE COST 6

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Earnings per share in 2005: $1. 81 Dividend per share: $1. 52 Stock price: Earnings per share in 2005: $1. 81 Dividend per share: $1. 52 Stock price: Between $49 and $60 Owners’ equity per share: $10. 02 1. 81/60 =. 03. 05 = 3/60 12

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FINANCE The Economics of RISK and TIME 15 FINANCE The Economics of RISK and TIME 15

TYPES OF SECURITIES Common stock: Pays a dividend only when the directors decide to. TYPES OF SECURITIES Common stock: Pays a dividend only when the directors decide to. Usually gives voting rights. Preferred stock: Pays a fixed dividend out of profits before any common stock dividends are paid, but the company can skip dividends without declaring bankruptcy. No voting rights. Bonds: Pays fixed interest unless the company goes bankrupt. No voting rights. 16

ISSUING STOCK ENTREPRENEURS are people who start businesses. They usually use their own money, ISSUING STOCK ENTREPRENEURS are people who start businesses. They usually use their own money, but often they sell shares to VENTURE CAPITAL FIRMS. Eventually, firms get big enough to need more capital and they GO PUBLIC-- they sell shares to the general public in an INITIAL PUBLIC OFFERING (IPO). 17

ISSUING STOCK II An INVESTMENT BANKER such as Goldman Sachs agrees to UNDERWRITE the ISSUING STOCK II An INVESTMENT BANKER such as Goldman Sachs agrees to UNDERWRITE the stock offering, buying the stock and immediately reselling it to the public. An IPO requires filing a 10 -K FORM with the SECURITIES AND EXCHANGE COMMISSION (SEC) and issuing a PROSPECTUS, both of which have detailed financial information. IPO's and SECONDARY OFFERINGS of stock later are publicized by TOMBSTONE announcements. 18

SELLING SHORT If you think Apple Computer stock is going to fall in price, SELLING SHORT If you think Apple Computer stock is going to fall in price, you sell it short. 1. You borrow 100 shares of Apple from your broker, and sell them at $50 per share, for $5000. 2. A month later, you buy 100 shares of Apple to repay the loan. If the price has dropped to $30/share, you pay $3, 000, and make $2, 000 in gross profit. 3. You also pay commissions to your broker, and interest on the $5, 000 in stock you 19 borrowed for a month.

THE RISK OF SELLING SHORT 1. You borrow 100 shares of Apple from your THE RISK OF SELLING SHORT 1. You borrow 100 shares of Apple from your broker, and sell them at $50 per share, for $5000. 2. A month later, you buy 100 shares of Apple to repay the loan. If the price has risen to $200/share, you pay $20, 000, and lose $18, 000, even before you pay commissions. You've lost more than your initial investment. 20

BUYING ON MARGIN 1. Borrow $5, 000 from a broker. 2. Buy 1, 000 BUYING ON MARGIN 1. Borrow $5, 000 from a broker. 2. Buy 1, 000 shares of stock at $10 each, for $10, 000. 3. If the stock rises to $15/share, sell the stock for $15, 000. 4. Repay the loan, for a net profit of $5, 000 minus interest. 21

MARGIN CALLS 1. Borrow $5, 000 from a broker. 2. Buy 1, 000 shares MARGIN CALLS 1. Borrow $5, 000 from a broker. 2. Buy 1, 000 shares of stock at $10/share, for $10, 000. 3. If the stock falls to $5. 60/share, pay back $400 of the loan, so your loan is just $4, 600, which is 75 % of $5, 600. The request for $400 is a MARGIN CALL. 22

MUNICIPAL BONDS Municipal Bonds are bonds issued by state or local governments. Interest Income MUNICIPAL BONDS Municipal Bonds are bonds issued by state or local governments. Interest Income from them is exempt from federal income tax. As a result, they have lower yields. 23

SPECIAL BONDS Subordinated bonds are junior bonds, which pay off if funds remain after SPECIAL BONDS Subordinated bonds are junior bonds, which pay off if funds remain after paying off the senior bonds. Floating rate bonds have interest rates that adjust to inflation. Convertible bonds can be converted by the holder to stock whenever they desire. Callable bonds can be paid off early by the issuing company (like refinancing a mortgage). 24

T-Bill Auctions Every Monday the U. S. Treasury has an auction of the $10, T-Bill Auctions Every Monday the U. S. Treasury has an auction of the $10, 000 short-term bonds. These are ZERO-COUPON bonds-- they pay no interest, just $10, 000 at maturity. Investors buy them at a DISCOUNT, for less than $10, 000. For example, the winning bid might be $9, 500. 25

BIDS IN T-BILL AUCTIONS Competitive bids (like a limit order). How many and at BIDS IN T-BILL AUCTIONS Competitive bids (like a limit order). How many and at what price. “Three bonds at $9, 600 each. ’’ The highest bids are successful, up to the competitive quota. Noncompetitive bids (like a market order). How many. “Three bonds. ’’ The price is the average of the competitive bid prices. 26

MUTUAL FUNDS Open-End funds sell as many shares as people want to buy. Closed-End MUTUAL FUNDS Open-End funds sell as many shares as people want to buy. Closed-End funds have a fixed number of shares. Index Funds: The manager buys stocks according to a formula, with no discretion. Tax-exempt Funds: These own only municipal bonds. Money-market funds: These own short-term bonds, and often allow checks to be written. 27

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Course Website A link to the course website http: //www. rasmusen. org/g 601/0. g Course Website A link to the course website http: //www. rasmusen. org/g 601/0. g 601. htm 29