1) Expense ratio is a total annual cost charged by mutual funds to manage investors' money, expressed as a percentage of assets. It is calculated by dividing operating expenses by average net assets.
2) Expense ratio impacts long-term returns more significantly than short-term returns. For example, a 2% expense ratio fund would grow to only 64% of a 0% expense fund over 25 years.
3) Lower expense ratio funds provide better long-term returns than higher expense ratio funds due to compounding of returns over time. Equity funds can charge marginally more than debt funds due to higher volatility.
The document discusses the pension fund of ABN AMRO Bank and how it employs dynamic asset allocation (DAA) to meet pension promises and improve investment decision making. It outlines the stakeholders and their interests, the annual review process of the strategic investment policy where the board selects a policy based on risk-reward tradeoffs, and how experiences since 2007 show DAA provides a better match of risk-reward preferences than static mixes, particularly during downturns like 2008-2009. DAA has helped maintain the fund's funded ratio 10-20 percentage points higher than alternatives.
The document discusses liability management strategies at General Motors in 1992, including issuing a $400 million public bond offering or engaging in interest rate swaps and derivatives to hedge against interest rate risk. It analyzes the costs and risks of different options like doing nothing, issuing fixed rate bonds, or entering swap agreements to exchange fixed rate payments for floating rates. The best strategy depends on Stephane Bello's predictions for interest rate trends in the coming years.
The document discusses asset liability management systems. It describes pooling funds and allocating them to primary reserves, secondary reserves, loans, long-term investments, and fixed assets. It then explains three methods for managing assets and liabilities: the pool of funds approach, conversion of funds approach, and maturity method. The duration method is also covered, which uses duration to measure interest rate risk. Finally, it discusses liquidity measurement and capital management in asset liability management.
Chapter 4 focuses on describing how to estimate and calculate Weighted Average Cost of Capital, answering the following questions:
How is the WACC calculated?
What is the Cost of Debt, Cost of Equity and Beta?
What is the Market Risk Premium and Country Risk Premium?
What is the periodicity of WACC calculation?
The document discusses different perspectives on how much of investment performance can be attributed to asset allocation versus active management. It summarizes that:
1) A seminal 1986 study found asset allocation explained over 90% of performance variation, but this was largely due to general market movements.
2) More recent studies find asset allocation explains around 40-75% of differences in returns between funds, depending on the time period and funds analyzed.
3) The portion of a single fund's return variation attributed to its specific asset allocation policy versus active management or market movements depends on the fund, but generally asset allocation and active management each explain around half.
Dividend Policy of Sensex Companies using Walter's ModelKandarp Desai
The document discusses Walters model for studying the dividend policy of Sensex companies. It provides background on dividend policy and its relationship to the market value of equity shares. Walters model states that a firm's dividend policy depends on the relationship between its return on capital (r) and cost of capital (k). If r>k, the firm should plow back profits for reinvestment. If r<k, the firm should pay out all profits as dividends. The model makes unrealistic assumptions about constant r and k over time. It provides a framework to explain share price movements based on dividend policy but limitations must be considered in real world applications.
This chapter discusses risk and return, including defining and measuring expected return, risk, and the relationship between risk and return. It covers calculating expected cash flows and returns based on probabilities of different outcomes. Risk is defined as variability in future cash flows and can be measured using standard deviation, which measures volatility of returns. The chapter also discusses how diversifying investments can reduce risk and the relationship between an investor's required return and the riskiness of an investment.
The document discusses the pension fund of ABN AMRO Bank and how it employs dynamic asset allocation (DAA) to meet pension promises and improve investment decision making. It outlines the stakeholders and their interests, the annual review process of the strategic investment policy where the board selects a policy based on risk-reward tradeoffs, and how experiences since 2007 show DAA provides a better match of risk-reward preferences than static mixes, particularly during downturns like 2008-2009. DAA has helped maintain the fund's funded ratio 10-20 percentage points higher than alternatives.
The document discusses liability management strategies at General Motors in 1992, including issuing a $400 million public bond offering or engaging in interest rate swaps and derivatives to hedge against interest rate risk. It analyzes the costs and risks of different options like doing nothing, issuing fixed rate bonds, or entering swap agreements to exchange fixed rate payments for floating rates. The best strategy depends on Stephane Bello's predictions for interest rate trends in the coming years.
The document discusses asset liability management systems. It describes pooling funds and allocating them to primary reserves, secondary reserves, loans, long-term investments, and fixed assets. It then explains three methods for managing assets and liabilities: the pool of funds approach, conversion of funds approach, and maturity method. The duration method is also covered, which uses duration to measure interest rate risk. Finally, it discusses liquidity measurement and capital management in asset liability management.
Chapter 4 focuses on describing how to estimate and calculate Weighted Average Cost of Capital, answering the following questions:
How is the WACC calculated?
What is the Cost of Debt, Cost of Equity and Beta?
What is the Market Risk Premium and Country Risk Premium?
What is the periodicity of WACC calculation?
The document discusses different perspectives on how much of investment performance can be attributed to asset allocation versus active management. It summarizes that:
1) A seminal 1986 study found asset allocation explained over 90% of performance variation, but this was largely due to general market movements.
2) More recent studies find asset allocation explains around 40-75% of differences in returns between funds, depending on the time period and funds analyzed.
3) The portion of a single fund's return variation attributed to its specific asset allocation policy versus active management or market movements depends on the fund, but generally asset allocation and active management each explain around half.
Dividend Policy of Sensex Companies using Walter's ModelKandarp Desai
The document discusses Walters model for studying the dividend policy of Sensex companies. It provides background on dividend policy and its relationship to the market value of equity shares. Walters model states that a firm's dividend policy depends on the relationship between its return on capital (r) and cost of capital (k). If r>k, the firm should plow back profits for reinvestment. If r<k, the firm should pay out all profits as dividends. The model makes unrealistic assumptions about constant r and k over time. It provides a framework to explain share price movements based on dividend policy but limitations must be considered in real world applications.
This chapter discusses risk and return, including defining and measuring expected return, risk, and the relationship between risk and return. It covers calculating expected cash flows and returns based on probabilities of different outcomes. Risk is defined as variability in future cash flows and can be measured using standard deviation, which measures volatility of returns. The chapter also discusses how diversifying investments can reduce risk and the relationship between an investor's required return and the riskiness of an investment.
This chapter discusses key financial statements and concepts. It covers the income statement and how it measures profits, the balance sheet and how it reflects a company's financial position, and cash flow measurement. Specific topics include revenue, expenses, assets, liabilities, equity, profit margins, net working capital, debt ratios, accrual accounting, and the conversion of net income to cash flows. Key terms like earnings, assets, liabilities, equity, and various profitability metrics are also defined.
This document discusses the cost of capital and how to calculate it. It defines cost of capital as the rate of return a firm must earn on its investments to maintain its market value and attract funds. It then discusses how to calculate the costs of different sources of capital including long-term debt, preferred stock, common stock, and retained earnings. It explains how to calculate the weighted average cost of capital (WACC) and discusses weighting schemes. Finally, it discusses how to determine break points and calculate the weighted marginal cost of capital (WMCC), which can be used with the investment opportunities schedule to make financing decisions.
This presentation is an overview of Leverage.
Dr. Soheli Ghose ( Ph.D (University of Calcutta), M.Phil, M.Com, M.B.A., NET (JRF), B. Ed).
Assistant Professor, Department of Commerce,St. Xavier's College, Kolkata.
Guest Faculty, M.B.A. Finance, University of Calcutta, Kolkata
The document discusses cost of capital, including its meaning, significance, components, and calculation of average weighted cost of capital. It defines cost of capital as the minimum required rate of return for a project given its riskiness. The firm's overall cost of capital is the average required rate of return across all investment projects. It identifies the key components of cost of capital as cost of debt, preference shares, equity shares, and retained earnings. It also discusses the significance of cost of capital for investment decisions, capital structure design, performance evaluation, and dividend policy formulation. Finally, it provides the formula for calculating weighted average cost of capital and discusses using it to evaluate project net present value.
This presentation is an overview Cost of Capital.
Dr. Soheli Ghose ( Ph.D (University of Calcutta), M.Phil, M.Com, M.B.A., NET (JRF), B. Ed).
Assistant Professor, Department of Commerce,St. Xavier's College, Kolkata.
Guest Faculty, M.B.A. Finance, University of Calcutta, Kolkata
The document summarizes key aspects of capital structure and target capital structure. It discusses four main factors that influence capital structure decisions: business risk, tax position, financial flexibility, and managerial attitude. It also covers topics like operating leverage, financial risk, the tradeoff theory of capital structure, and signaling theory. Capital structures can vary significantly between firms and countries.
This document discusses the cost of capital and how it is calculated. It begins by defining cost of capital as the minimum rate of return a company must earn on an investment to maintain its value. It then discusses the different costs that make up the overall cost of capital, including:
- Cost of equity, which is the rate investors use to value the company's future dividend payments. It can be calculated using the dividend valuation model or capital asset pricing model.
- Cost of debt, which is the after-tax interest rate the company pays on its borrowed funds.
- Cost of preferred shares.
It explains that the weighted average cost of capital (WACC) weights each of these costs based on the
This document discusses the valuation and characteristics of stocks. It covers preferred stock, which is a hybrid security with characteristics of both common stock and bonds. Preferred stock pays fixed dividends, has priority over common stock in claims to assets and income, and may be cumulative or convertible. Common stock represents ownership in a company and entitles the owner to voting rights and residual claims to income and assets. The document discusses how to value preferred stock as a perpetuity and common stock using the dividend valuation model that incorporates growth. It also defines the expected rate of return for stocks.
This document discusses interest rate risk and gap analysis for managing that risk. It defines key terms like rate sensitive assets and liabilities, funding gap, duration gap, and positive and negative gaps. It also covers traditional static gap analysis, factors that affect net interest income, and advantages and disadvantages of gap analysis. The primary purpose of gap analysis is to measure a bank's interest rate risk by comparing rate sensitive assets and liabilities over different time periods.
This document discusses the cost of capital. It begins by defining key concepts like capital, investor required rate of return, and financial policy. It then discusses how to calculate the costs of different sources of capital like debt, preferred stock, and common equity. Next, it explains how to calculate a firm's weighted average cost of capital. It provides an example of how PepsiCo calculates divisional costs of capital. The document concludes by discussing how cost of capital can be used to evaluate investments and how interest rates differ internationally.
This document discusses leverage in hedge funds. It defines leverage as using borrowed capital to amplify returns. While leverage can boost returns when asset prices rise, it also amplifies losses when prices fall. The author believes leverage is a valid tool when used judiciously but cautions against using too much leverage to boost low-return strategies. Typical leverage levels vary by strategy from 1x to 6x of gross assets. Analyzing balance sheets and understanding strategies is important for evaluating appropriate leverage levels.
This M Intelligence piece will explore the product mechanics and design considerations of Whole Life (WL) insurance. There are two general categories of WL...
Asset liability management (ALM) is a process for managing a bank's assets and liabilities to maintain liquidity and net interest income. It aims to stabilize profits and the bank's financial position over time by managing factors like interest rate risk from differences between rate-sensitive assets and liabilities. Regulators require banks to analyze gaps between asset and liability maturity profiles and interest rate sensitivities to manage these risks. Liquidity risk, from insufficient funds to meet withdrawals, is also a key risk managed under ALM.
The document discusses various methods for valuing firms, including market value of equity (MVE), total enterprise value (TEV), and book value (BV). MVE is based on share price and shares outstanding for public companies. TEV includes debt, preferred stock, and minority interests in addition to MVE. Valuation considers both controlling and minority interests and can vary based on the type of buyer.
This document discusses dividend policy and the various theories around it. It defines dividends and discusses Walter's model and Gordon's model, which propose that dividend policy affects firm value. It also covers the irrelevance theories of Modigliani-Miller and the traditional approach, which argue that dividend policy does not impact value. The document provides formulas for the different models and discusses their assumptions and criticisms.
Dividend policy
What is Dividend?
What is dividend policy?
Theories of Dividend Policy
Relevant Theory
Walter’s Model
Gordon’s Model
Irrelevant Theory
M-M’s Approach
Traditional Approach
Referred to:
Prasanna Chandra
Analysis of Financial Statements.(Ratio analysis, Du Pont system ,Effects of ...Tanjin Tamanna urmi
Five Categories of Fin. Ratios
Liquidity: Ability to meet current obligations
Asset Mgmt: Proper & effective use of assets
Asset utilization (i.e., Total Asset Turnover Ratio:
TAT = Sales / T. Assets
Debt Mgmt: extent of debt & level of safety afforded creditors
Debt utilization (i.e., Equity Multiplier:
EM = T. Assets / T. Eqty
Profitability: reflects effects of liquidity, asset mgmt, & debt on operating results
Expense Control: Profit Margin:
PM = Net Income / Sales
Market Value: indicators of what investors think of firm’s past results & future prospects
This document assesses the capital structure of Hutchison Whampoa based on its future financing needs. It analyzes Hutchison Whampoa's current capital structure ratios and compares them to industry averages. It also models how different ratios would be impacted by raising $500 million through various combinations of debt and equity. Overall, the analysis finds that Hutchison Whampoa's current capital structure ratios are healthy but could be optimized further to improve profitability and cash flow while maintaining financial stability.
The document discusses capital structure and various theories related to it. It defines capital structure as the combination of capital from different sources of financing. It then discusses factors that affect capital structure decisions like control, risk, cost, size and nature of business. It explains optimal capital structure as the perfect mix of debt and equity that maximizes firm value while minimizing cost of capital. It also discusses various methods of analyzing optimal capital structure including EBIT-EPS analysis and indifference point analysis. Finally, it summarizes different theories around capital structure like net income, net operating income, traditional and Modigliani-Miller approaches.
This document discusses various financial ratios used to analyze company performance, including liquidity, asset management, debt, profitability, and market value ratios. It explains how ratios can be used to compare companies and assess financial health. Examples are provided to illustrate how specific ratios like debt-to-asset, times interest earned, and return on equity are calculated and interpreted.
Franco Modigliani and Merton H Miller Irrelevance Theory, Financial Indifference Point, Financial Leverage, Operating Leverage, Combined Leverage, Financial Break Even Point,
This chapter discusses key financial statements and concepts. It covers the income statement and how it measures profits, the balance sheet and how it reflects a company's financial position, and cash flow measurement. Specific topics include revenue, expenses, assets, liabilities, equity, profit margins, net working capital, debt ratios, accrual accounting, and the conversion of net income to cash flows. Key terms like earnings, assets, liabilities, equity, and various profitability metrics are also defined.
This document discusses the cost of capital and how to calculate it. It defines cost of capital as the rate of return a firm must earn on its investments to maintain its market value and attract funds. It then discusses how to calculate the costs of different sources of capital including long-term debt, preferred stock, common stock, and retained earnings. It explains how to calculate the weighted average cost of capital (WACC) and discusses weighting schemes. Finally, it discusses how to determine break points and calculate the weighted marginal cost of capital (WMCC), which can be used with the investment opportunities schedule to make financing decisions.
This presentation is an overview of Leverage.
Dr. Soheli Ghose ( Ph.D (University of Calcutta), M.Phil, M.Com, M.B.A., NET (JRF), B. Ed).
Assistant Professor, Department of Commerce,St. Xavier's College, Kolkata.
Guest Faculty, M.B.A. Finance, University of Calcutta, Kolkata
The document discusses cost of capital, including its meaning, significance, components, and calculation of average weighted cost of capital. It defines cost of capital as the minimum required rate of return for a project given its riskiness. The firm's overall cost of capital is the average required rate of return across all investment projects. It identifies the key components of cost of capital as cost of debt, preference shares, equity shares, and retained earnings. It also discusses the significance of cost of capital for investment decisions, capital structure design, performance evaluation, and dividend policy formulation. Finally, it provides the formula for calculating weighted average cost of capital and discusses using it to evaluate project net present value.
This presentation is an overview Cost of Capital.
Dr. Soheli Ghose ( Ph.D (University of Calcutta), M.Phil, M.Com, M.B.A., NET (JRF), B. Ed).
Assistant Professor, Department of Commerce,St. Xavier's College, Kolkata.
Guest Faculty, M.B.A. Finance, University of Calcutta, Kolkata
The document summarizes key aspects of capital structure and target capital structure. It discusses four main factors that influence capital structure decisions: business risk, tax position, financial flexibility, and managerial attitude. It also covers topics like operating leverage, financial risk, the tradeoff theory of capital structure, and signaling theory. Capital structures can vary significantly between firms and countries.
This document discusses the cost of capital and how it is calculated. It begins by defining cost of capital as the minimum rate of return a company must earn on an investment to maintain its value. It then discusses the different costs that make up the overall cost of capital, including:
- Cost of equity, which is the rate investors use to value the company's future dividend payments. It can be calculated using the dividend valuation model or capital asset pricing model.
- Cost of debt, which is the after-tax interest rate the company pays on its borrowed funds.
- Cost of preferred shares.
It explains that the weighted average cost of capital (WACC) weights each of these costs based on the
This document discusses the valuation and characteristics of stocks. It covers preferred stock, which is a hybrid security with characteristics of both common stock and bonds. Preferred stock pays fixed dividends, has priority over common stock in claims to assets and income, and may be cumulative or convertible. Common stock represents ownership in a company and entitles the owner to voting rights and residual claims to income and assets. The document discusses how to value preferred stock as a perpetuity and common stock using the dividend valuation model that incorporates growth. It also defines the expected rate of return for stocks.
This document discusses interest rate risk and gap analysis for managing that risk. It defines key terms like rate sensitive assets and liabilities, funding gap, duration gap, and positive and negative gaps. It also covers traditional static gap analysis, factors that affect net interest income, and advantages and disadvantages of gap analysis. The primary purpose of gap analysis is to measure a bank's interest rate risk by comparing rate sensitive assets and liabilities over different time periods.
This document discusses the cost of capital. It begins by defining key concepts like capital, investor required rate of return, and financial policy. It then discusses how to calculate the costs of different sources of capital like debt, preferred stock, and common equity. Next, it explains how to calculate a firm's weighted average cost of capital. It provides an example of how PepsiCo calculates divisional costs of capital. The document concludes by discussing how cost of capital can be used to evaluate investments and how interest rates differ internationally.
This document discusses leverage in hedge funds. It defines leverage as using borrowed capital to amplify returns. While leverage can boost returns when asset prices rise, it also amplifies losses when prices fall. The author believes leverage is a valid tool when used judiciously but cautions against using too much leverage to boost low-return strategies. Typical leverage levels vary by strategy from 1x to 6x of gross assets. Analyzing balance sheets and understanding strategies is important for evaluating appropriate leverage levels.
This M Intelligence piece will explore the product mechanics and design considerations of Whole Life (WL) insurance. There are two general categories of WL...
Asset liability management (ALM) is a process for managing a bank's assets and liabilities to maintain liquidity and net interest income. It aims to stabilize profits and the bank's financial position over time by managing factors like interest rate risk from differences between rate-sensitive assets and liabilities. Regulators require banks to analyze gaps between asset and liability maturity profiles and interest rate sensitivities to manage these risks. Liquidity risk, from insufficient funds to meet withdrawals, is also a key risk managed under ALM.
The document discusses various methods for valuing firms, including market value of equity (MVE), total enterprise value (TEV), and book value (BV). MVE is based on share price and shares outstanding for public companies. TEV includes debt, preferred stock, and minority interests in addition to MVE. Valuation considers both controlling and minority interests and can vary based on the type of buyer.
This document discusses dividend policy and the various theories around it. It defines dividends and discusses Walter's model and Gordon's model, which propose that dividend policy affects firm value. It also covers the irrelevance theories of Modigliani-Miller and the traditional approach, which argue that dividend policy does not impact value. The document provides formulas for the different models and discusses their assumptions and criticisms.
Dividend policy
What is Dividend?
What is dividend policy?
Theories of Dividend Policy
Relevant Theory
Walter’s Model
Gordon’s Model
Irrelevant Theory
M-M’s Approach
Traditional Approach
Referred to:
Prasanna Chandra
Analysis of Financial Statements.(Ratio analysis, Du Pont system ,Effects of ...Tanjin Tamanna urmi
Five Categories of Fin. Ratios
Liquidity: Ability to meet current obligations
Asset Mgmt: Proper & effective use of assets
Asset utilization (i.e., Total Asset Turnover Ratio:
TAT = Sales / T. Assets
Debt Mgmt: extent of debt & level of safety afforded creditors
Debt utilization (i.e., Equity Multiplier:
EM = T. Assets / T. Eqty
Profitability: reflects effects of liquidity, asset mgmt, & debt on operating results
Expense Control: Profit Margin:
PM = Net Income / Sales
Market Value: indicators of what investors think of firm’s past results & future prospects
This document assesses the capital structure of Hutchison Whampoa based on its future financing needs. It analyzes Hutchison Whampoa's current capital structure ratios and compares them to industry averages. It also models how different ratios would be impacted by raising $500 million through various combinations of debt and equity. Overall, the analysis finds that Hutchison Whampoa's current capital structure ratios are healthy but could be optimized further to improve profitability and cash flow while maintaining financial stability.
The document discusses capital structure and various theories related to it. It defines capital structure as the combination of capital from different sources of financing. It then discusses factors that affect capital structure decisions like control, risk, cost, size and nature of business. It explains optimal capital structure as the perfect mix of debt and equity that maximizes firm value while minimizing cost of capital. It also discusses various methods of analyzing optimal capital structure including EBIT-EPS analysis and indifference point analysis. Finally, it summarizes different theories around capital structure like net income, net operating income, traditional and Modigliani-Miller approaches.
This document discusses various financial ratios used to analyze company performance, including liquidity, asset management, debt, profitability, and market value ratios. It explains how ratios can be used to compare companies and assess financial health. Examples are provided to illustrate how specific ratios like debt-to-asset, times interest earned, and return on equity are calculated and interpreted.
Franco Modigliani and Merton H Miller Irrelevance Theory, Financial Indifference Point, Financial Leverage, Operating Leverage, Combined Leverage, Financial Break Even Point,
This document summarizes key concepts regarding capital structure analysis:
1) EBIT/EPS analysis examines how different capital structures affect earnings available to shareholders and risk based on different levels of EBIT. Leverage increases EPS at high EBIT levels but decreases it at low levels.
2) Debt provides a tax shield benefit as interest payments reduce taxable income. This increases overall returns to investors compared to an unlevered firm.
3) There is a trade-off between the tax benefits of debt and the financial distress and agency costs of debt as leverage increases. Optimal capital structure balances these factors.
4) Practical considerations like industry standards, creditor requirements, maintaining borrowing capacity, and manager
The document summarizes key investment management practices used by large university endowments to balance spending needs with long-term growth. It outlines four steps: 1) defining a spending rule to balance income and growth, 2) determining the required return to meet spending needs, 3) creating a policy portfolio to achieve the required return, and 4) testing the strategy through simulations. By studying top endowments, other long-term investors can learn strategies to effectively manage investments for both current and future spending requirements.
This document provides an overview of working capital management. It discusses key concepts like working capital, components of working capital, factors that influence working capital, and how working capital is projected. It also covers operating cycle calculation, importance of working capital, various committees that shaped working capital financing in India, and strategies for managing inventory, receivables, payables, and cash. The document provides practical insights and recommendations for efficient working capital management.
The document discusses capital structure and its components. It defines capitalization as the total amount of securities issued by a company, including equity share capital, preference share capital, long-term loans, retained earnings, and capital surplus. Capital structure refers to the proportion of different types of securities that make up the total capitalization. Financial structure includes all financial resources, both short-term and long-term, including current liabilities. The document then discusses various theories of capital structure, including the net income approach, net operating income approach, and traditional approach. It provides examples to illustrate how these approaches analyze the impact of leverage on firm value and cost of capital.
The document discusses cash flow estimation and risk analysis for a proposed capital project. It provides details of the project costs, revenues, expenses, tax rates, and other assumptions to estimate annual and terminal cash flows. Sensitivity analysis is performed considering changes to the sales forecast. Scenario analysis is conducted based on possible sales cases, and expected NPV, standard deviation of NPV, and coefficient of variation of NPV are calculated. The project is determined to be a high-risk project compared to the firm's average risk profile.
Capital budgeting is the process of evaluating potential long-term investments and capital expenditures. It involves estimating cash flows, assessing risk, determining discount rates, and calculating metrics like net present value and internal rate of return to determine if a project is economically acceptable and should receive funding. Capital is a limited resource for companies, so capital budgeting helps management identify projects that will contribute most to profits and shareholder value. The key steps are to focus on incremental cash flows, account for the time value of money using techniques like NPV, and make go/no-go decisions on whether projects are worth undertaking based on their expected returns.
Capital budgeting is the process of evaluating potential long-term investments and capital expenditures. It involves estimating cash flows, assessing risk, determining discount rates, and calculating metrics like net present value and internal rate of return to determine which projects to accept. Capital is a limited resource, so management must carefully evaluate projects and allocate capital to the most economically acceptable and profitable opportunities. However, net present value and internal rate of return sometimes select different projects, usually due to differences in project size, life, or cash flow patterns. Both metrics can be reliably used if the discount rate reflects true risk and an internal rate of return is reasonably achievable.
Capital budgeting is the process of evaluating potential long-term investments and capital expenditures. It involves estimating cash flows, assessing risk, determining discount rates, and calculating metrics like net present value and internal rate of return to determine which projects will provide the highest returns and contribute most to firm value. The key challenges are that capital resources are limited, projects have different sizes, lives, and cash flow patterns, so the net present value and internal rate of return methods do not always agree on the best project selection. Reliable capital budgeting requires using realistic discount rates that account for project risk when applying net present value, and ensuring projected internal rates of return are reasonably achievable.
The chairman of an aerospace manufacturing company is concerned about the accumulation of cash on the company's balance sheet. The company has grown through acquisitions rather than R&D, and now faces competitive pressures and lower government spending. It has a history of project overruns and unaccountable managers. The chairman suggests using cash reserves to improve facilities, pay, environmental performance, and board compensation, though he admits business opportunities may not return to previous levels. He seeks advice on how to best deploy the accumulated cash.
This document provides information on financial management concepts including:
- The differences between wealth maximization and profit maximization, and the relationship between finance and accounting.
- Factors that affect capital structure such as leverage, cost of capital, cash flow projections, and dilution of control.
- The capital budgeting process including project screening, market appraisal, technical appraisal, economic appraisal, and financial appraisal.
- Concepts of working capital such as gross working capital, net working capital, permanent working capital, and temporary working capital. Determinants of working capital such as nature of business, operating cycle, and growth of the firm are also discussed.
This document discusses the Modigliani-Miller capital structure theory, which states that a firm's value and cost of capital are independent of its capital structure under certain assumptions. It provides examples to illustrate the theory, showing that the overall cost of capital remains constant regardless of the debt-to-equity ratio. The document also notes that according to MM, while the cost of debt is lower than the cost of equity, the cost of equity increases in a way that offsets the benefits of using debt.
The document appears to be a practice exam for a finance course. It contains multiple choice questions testing concepts such as financial statements, ratios, time value of money, capital budgeting, cost of capital, risk and return. The questions cover topics like the statement of cash flows, primary vs secondary markets, financial ratios, net present value, weighted average cost of capital, the risk-return relationship, and bond pricing.
This document provides a guide to questions that will be on a FIN 370 final exam, including questions about financial statements, ratios, time value of money, stocks, bonds, capital budgeting, and other finance topics. It lists multiple choice questions about items like the statement of cash flows, primary markets, current and quick ratios, weighted average cost of capital, bond yields, compound interest, and the balance sheet. It also provides a link to purchase the full tutorial with answers to the exam questions.
1) The document discusses how a company's capital structure and use of debt can impact its value and shareholder returns. It considers how debt can lower the weighted average cost of capital but also increase bankruptcy risk.
2) An example is provided showing how debt can increase earnings per share but also expose shareholders to more risk in economic downturns. The optimal level of debt depends on factors like a company's fixed costs and risk of bankruptcy.
3) Tax benefits of debt are discussed, as interest expenses are tax deductible. However, higher debt also increases financial risk and the required return on equity. The overall impact on the weighted average cost of capital from debt is uncertain and depends on specific company and economic conditions
Part 1Halliburton company beta 1.6, Helix energy solutions beta .docxsmile790243
Part 1
Halliburton company beta 1.6, Helix energy solutions beta 1.71, Superior energy services beta 1.69 and Schlumberger limited 1.65
Beta is the extent of a company’s stock's tremor, similar to the general market. By definition, the market, for instance, has a beta of 1.0, and individual stocks are situated by the sum they veer off.
Stocks that change all the more frequently after some time have a beta above 1.0. If a stock moves not decisively the market, the stock's beta is under 1.0. High-beta stocks ought to be progressively risky; notwithstanding, give better yield potential; low-beta stocks present less danger yet also lower returns.
One course for a stock money related authority to consider an opportunity is to part it into two characterizations. The fundamental class is called efficient peril, which is the threat of the entire market declining. The money related crisis in 2008 is an instance of a productive peril event when no proportion of expanding could shield examiners from losing a motivating force in their stock portfolios. Systematic hazard is, in any case, called un-diversifiable risk.
Unsystematic or diversifiable perils are identified with an individual stock. The surprising assertion that Lumber Liquidators (LL) had been selling hardwood flooring with unsafe degrees of formaldehyde in 2015 is an instance of an unsystematic peril that was express to that association. Unsystematic hazards can be, for the most part, directed through expanding.
A beta of 1.0 shows that its worth activity is immovably connected to the industry. A stock that has a beta of 1.0 indicates a valid risk. In any case, the beta estimation can't perceive any unsystematic hazard.
A beta estimation of under 1.0 suggests that the security is theoretically less eccentric than the market, which implies the portfolio is less risky with the stock included than without it. For example, utility stocks consistently have low betas since they will, by and large, move more continuously than grandstand midpoints.
Another factor that is incorporated would be the capital structure of each firm. Firms that have assorted capital structures will have different betas. For example, an association with less commitment financing will have a lower beta than an association with higher commitment financing.
Section 2: Capital Budgeting
IRR and NPV are both used in the evaluation methodology for capital utilization. Net present worth (NPV) limits the flood of expected wages identified with a proposed dare to their present value, which presents a cash surplus or deficiency for the undertaking. Internal rate of return (IRR) figures the evaluated speed of return at which those proportional earnings will achieve a net present estimation of zero. The two capital arranging systems have some similarities and differences listed: Result. The NPV system realizes dollar regard that an errand will convey, while IRR produces the rate return that the endeavor is required to make.
Reason. The.
Similar to MF Analysis - Impact of high expense ratio on returns (20)
Fixed Maturity Plans (FMP) – an attractive Debt Mutual fund OptionDhuraivel Gunasekaran
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MF Analysis - Impact of high expense ratio on returns
1. 1
Mutual Fund Analysis July 27, 2011
Impact of Expense Ratio on Returns:
Prologue: The performance of mutual fund schemes is invariably affected by costs that are charged by the mutual
fund companies for their services. The impact of such costs on returns is considerably larger for the investments
that are kept over long term. These charges called as expense ratio, deducted from the net assets, impair the
returns of the mutual funds schemes.
What is an Expense Ratio? Expense Ratio is a total annual cost charged by mutual fund companies to manage
investors’ money. Expense ratio, expressed in percentage form, is calculated by dividing the operating expenses by
the average daily or weekly net assets. It is calculated or estimated on an annual basis and deducted from the net
assets on a daily basis. That means, the NAV of a scheme is declared on a daily basis after deducting the expenses.
The asset management company which manages the fund, the custodian who is responsible for maintaining the
funds and securities, the R&T agent who maintains the investor records, distributors who bring the investors to the
fund, the trustees, the auditors, all charge a fee for their services. All these expenses constitute expense ratio and
is deducted from the net assets / corpus of the fund. For example, if a pool of Rs.100 crore is invested and is worth
Rs.120 crore after a year. The return is 20%, but this is before charging costs. If the fund charges a cost of 1% on the
portfolio, the value of the portfolio would be Rs.119 crore and the return would be 19%.
Expense ratio measures the total cost of investing in a fund for an investor. Generally, a fund with lower expense
ratio is considered more attractive than the one with higher expense ratio.
Components of Expenses: The components of such operating expenses usually consist annual Management Charge
(charged by the fund manager for managing the fund), Trustee, Audit and Legal Fees, Administration and
Operational Fee – (Such as cost for premise / establishment, customer servicing, delivery of statement, marketing
& selling and other process charges) and transaction Fees (cost incurred in buying or selling underlying assets for
rebalancing / subscription / redemption purpose).
Impact of Expense Ratio on MF Returns Retail Research
2. 2
Mutual Fund Analysis contd…
Impact on schemes returns: Performance of mutual fund schemes is affected by expense ratio since it is
deducted from the net assets.
To illustrate how much the expense ratio can impact the returns, we considered three schemes which are assumed
to have grown in the same compounded rate of 10% per annum for next 25 years. Rs. 1,00,000 each is invested in
the Schemes –A, B and C with varying expense ratio of 1.00%, 1.50% and 2.00% respectively. Apparently, the final
returns from these schemes will turn out to be widely different depending on their expense ratios. The growth of
the investment at the compound rate of 10% for 25 years without any deduction would have reached to Rs.
10,83,471.
In the case of Scheme C having 2% as expense ratio, would have grown to Rs. 6,84,848 or 37% lower than a no
expense fund due to the higher expense ratio of 2%. On the other hand, the corpuses of fund ‘A’ and ‘B’ would
have reduced by 20% and 29% respectively at the end of 25 years since their expense ratios were at 1% and 1.5%
respectively.
High Expense Ratio impairs the performance of Mutual Funds:
1,200,000
1,000,000
800,000
600,000
400,000
200,000
0
1 4 7 10 13 16 19 22 25
Grow th at the rate of 10% CAGR Fund A (1%) Fund B (1.5%) Fund C (2%)
Impact of Expense Ratio on MF Returns Retail Research
3. 3
Mutual Fund Analysis contd…
Comparison of reduction on returns with different expense ratios: CAGR growth of Rs. 1,00,000 over 25 years.
Impact of Expense Ratio on MF Returns Retail Research
4. 4
Mutual Fund Analysis contd…
The above table shows that the difference in the returns is higher in long term holding compared to short term
holding. In a nut shell, mutual fund schemes with lower expense ratio would provide better returns over the long
run compared to schemes with higher expense ratio.
Impact of Expense ratio on different categories of Mutual fund schemes:
On Equity oriented schemes: The impact of expense ratio on equity oriented schemes is lower than that in the
case of debt funds as the return expected from the schemes is significantly higher than expense ratio. As equity
funds are more volatile than other mutual fund categories like debt, they require extra effort to be managed and
they are allowed to charge marginally more than what debt funds can charge.
Distribution of Expense Ratios of Equity Diversified Category – 250 schemes:
160
135
120
80
47
40 34
3 2
0
1.50 to 1.75 1.75 to 2.00 2.00 to 2.25 2.25 to 2.50 Above 2.50
Total of Corpus (RS Crs) 177 90,424 20,208 23,007 330
It is observed that the schemes with expense ratio between 1.75% and 2.25% are mostly top rated and yield better
than average returns.
Impact of Expense Ratio on MF Returns Retail Research
5. 5
Mutual Fund Analysis contd…
On Equity Index schemes: The performance of index fund is dependent on the expense ratio and tracking error.
Tracking error indicates how closely the index fund return matches with of the underlying tracked index. The index
funds are passive funds requiring less effort to manage them. Lower expense ratio and lower tracking error will
make sure that the index fund performance matches the underlying index performance.
On Debt schemes: In debt mutual fund, expense ratio is an important parameter to consider. The gross return from
debt mutual funds are in the range of 5% to 8%, so expense ratio of 0.5% to 1% will have significant impact on the
net return of the debt fund. In case of liquid and ultra short term schemes, the returns are even lesser and even
small differences in the expense ratio of schemes can make significant impact on their net returns.
It is to be noted that there is an inverse relationship between the expenses and the value of corpus, whenever the
corpus is affected by not flows but change in values. Whenever the yields of debt instruments fall, the bond prices
rise and along with the value of corpus of the schemes. At such times, though the expenses remain largely fixed,
the denominator (I.e. the corpus) rises, leading to a fall in the expense ratio. Conversely in times of falling values,
expense ratio could rise. The chart below portrays the fluctuation in the expense ratios of Income and Gilt Medium
& LT category in relation with the 10 Year benchmark yield over the last five years.
Inverse relationship between Expense ratio and 10 Yr G sec Benchmark Yield:
1.60 Income Funds Gilt Funds - Medium & LT 10 Yr Yield 9.00
1.50 8.50
8.00
1.40
7.50
1.30
7.00
1.20
6.50
1.10 6.00
1.00 5.50
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Mar-11
Sep-06
Sep-07
Sep-08
Sep-09
Sep-10
Impact of Expense Ratio on MF Returns Retail Research
6. 6
Mutual Fund Analysis contd…
Trend in Expense Ratio in MF Categories over periods:
2.35
Period betw een March 2005 to m arch 2011
1.85
1.35
0.85
0.35
-0.15
Liquid Funds Ultra Short Term ST Income Funds Income Funds Equity Diversified
SEBI’s regulation on Expense ratio against the corpus: SEBI’s Mutual Fund Regulations specify the maximum limit
of the expenses that can be recovered from the investors every year. For equity schemes the maximum limit that
can be assigned is 2.50% of the assets of the fund while for debt funds the limit is 2.25%. This is 1.50% in case of
passively managed funds such as index and ETFs.Depending on the type of scheme and the net assets, operating
expenses are determined by limits mandated by the SEBI Mutual Fund Regulations, which are as follows:
The above table shows that the expenses of the scheme decreases if the corpus increases. So, investors have to
consider the size of the funds while making investment decisions.
SEBI specifies only those expenses that can be directly related to a scheme, such as investment management fee,
custodian, R&T agent and other constituents, can be charged to investors. The investment management fee is a
part of these total costs, and cannot exceed 1.25%.
Impact of Expense Ratio on MF Returns Retail Research
7. 7
Mutual Fund Analysis contd…
Category wise Highest and Lowest Expense Ratio schemes from top 10 schemes in terms of corpus:
Equity Diversified – Large Cap: Note: The returns given in the tables below are absolute up to 1 year and above one year are CAGR. NAV values are as on July 26, 2011.
Equity Diversified – Mid & Small Cap:
Equity Diversified – Multi Cap:
Impact of Expense Ratio on MF Returns Retail Research
8. 8
Mutual Fund Analysis contd…
Hybrid - Equity Oriented:
Gilt – Medium and LT:
Income Funds:
Liquid Funds:
Impact of Expense Ratio on MF Returns Retail Research
9. 9
Mutual Fund Analysis contd…
Ultra Short Term Funds:
Short Term Funds:
Conclusion: It is to be noted that schemes with lower expense ratios are not necessarily better than the schemes
with higher expense ratios. It can be one of the parameters amongst many others to choose a scheme to invest. If
the returns delivered by a scheme are consistently commendable, investors need not to pay more attention to
expense ratio even if they are high as he is concerned with the net return to himself. Expense ratios can be useful
in choosing between funds of comparable track record, size and investment strategy. The difference in expense
ratio could compound into a sizeable difference in returns over long run.
Analyst: Dhuraivel Gunasekaran.
RETAIL RESEARCH Fax: (022) 3075 3435
Corporate Office: HDFC Securities Limited, I Think Techno Campus, Building –B, ”Alpha”, Office Floor 8, Near Kanjurmarg Station, Opp. Crompton Greaves,
Kanjurmarg (East), Mumbai 400 042 Fax: (022) 30753435 Website: www.hdfcsec.com
Disclaimer: Mutual Fund investments are subject to risk. Past performance is no guarantee for future performance. This document has been prepared by HDFC
Securities Limited and is meant for sole use by the recipient and not for circulation. This document is not to be reported or copied or made available to others. It
should not be considered to be taken as an offer to sell or a solicitation to buy any security. The information contained herein is from sources believed reliable.
We do not represent that it is accurate or complete and it should not be relied upon as such. We may have from time to time positions or options on, and buy
and sell securities referred to herein. We may from time to time solicit from, or perform investment banking, or other services for, any company mentioned in this
document. This report is intended for Retail Clients only and not for any other category of clients, including, but not limited to, Institutional Clients.
Impact of Expense Ratio on MF Returns Retail Research