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Alan Cring Productions in association with Emergent Light Studio presents

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the Illinois State Collegiate Compendium, academic lectures in business and economics.

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This is business finance, FIL 341 for autumn semester 2024.

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Today, review for the midterm exam. I will go through what I think you should probably know

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to be successful on the midterm exam and I will then entertain questions you have about what you

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what you think might be on there. If it's not something that's on the midterm exam, I will,

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and you ask about it, I will say I'm not going to ask you about that for the midterm exam

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because it's to let you try to help you narrow down your study.

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But as always, we all look at the numbers first and this time it's part of the review

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because on the midterm exam I will give you a screen.

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I will anticipate that you can read a stock screen. It shouldn't be hard for you at all.

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Certainly I do this at 240, but I just want to make sure that you are capable of looking at basic

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information about stocks and ETFs, maybe bonds and all that.

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As you can see, we have a bold day, but it has fizzled out a lot, at least on,

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there was good rise, but now it's turning its tail a little bit.

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Well, the Dow has just dropped down to nothing again.

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The big concern, of course, is interest rates, and interest rates have done something very bad

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just today, and you'll see that in a minute here.

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Fortunately, the crude oil has fallen as the rumors have subsided about a major confrontation

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that was thought to happen last night, and it did not, and so oil prices have taken a bit of a dip.

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They're still above where they had been in the upper 60s per barrel.

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Now they're back up there in the mid 70s, and they had spiked up there as high,

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I think they were up as high as $77 a barrel there for a while, but fortunately that's eased off.

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We still have a problem with oil prices. They're higher than they were.

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That's bad for a recovery.

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Now, interestingly enough, a couple of things that have happened on other sides of the world,

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one is that the Eurozone cut its basic rate by a quarter of a percent.

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That's not spectacular, but that, of course, will strengthen the dollar against the Euro, we would hope.

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We'll see if that's what happened today.

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Well, it did strengthen the dollar, and now the dollar is going back down again.

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Well, anyway, here's the bad news. We are above 4% on the 10-year benchmark treasury.

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We thought we had seen the last of that.

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We were down there, we were going toward sort of a psychological neckline at 3.5%,

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and we got down as far as about 3.62%, I think, and then it turned tail and it went back.

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It really was up there earlier today.

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Actually, that was like real early this morning. It was up there.

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It was bad, and now it's tailed back down, but we're still above 4%.

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The concern is that the Fed may not lower interest rates.

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First, it was they're going to do two more discount rate cuts before the end of the year, both quarter of a percent.

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Yay for that.

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Then it was, well, maybe they won't do one of them, and now the rumors are they might not do either of them

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because the jobs market data was so strong, and the Fed never met a job that it didn't want to kill off in a recovery.

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That's an old thing. A huge criticism for a long, long time about the Fed is that if employment gets too good,

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it's time to slow down the economy.

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Never mind if businesses are making too many profits.

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No, always the emphasis has been on, well, if jobs markets are getting too good, then we have to kill off this recovery.

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That goes clear back to the 1990s of spectacular example was that in the years of the Clinton administration,

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the budget deficit was falling year over year over year.

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First time in decades, we were heading for surpluses, and we actually got to surpluses, not budget surpluses.

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Whoever heard of that?

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Plus, the stock market was just going wild, going up.

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Plus, we had the longest, lowest sustained unemployment rate in history.

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It was below what economists always say, the natural unemployment rate.

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It's about 4.4% would be the good unemployment rate.

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The unemployment rate was plummeting, and it wasn't bouncing back up. It just stayed down there.

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The economy kept rolling. Inflation didn't show up, and spank me Jesus,

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Alan Greenspan was pissed off about all of this. He was a Fed chairman. He was just furious about this.

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He went before Congress, and he said the stock market is irrationally exuberant.

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His famous line, which anyone with an ounce of knowledge of markets, you don't say markets are irrational.

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That's like saying a shark is coming at you, and you say you're irrational and stop him a shark.

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No, markets do what they do, whatever TF they do they want to do.

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But he did the longest sustained series of increases in the discount rate in American history under the Fed.

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He just kept going up and up and up. He was damn determined. He was going to kill the recovery.

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Here we go again. Markets are beginning to think, is this what this Fed is going to do?

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They don't like these low unemployment rates.

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So like Feds in the past, once they see the unemployment rate go down enough, job formations going up enough,

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they start to slow down the economy.

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Which means that the markets are now saying, we bet the Fed isn't going to cut the rate any further for the rest of this year.

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And hence those expectations of lower bond yields are now turning into expectations that bond yields are going to stay the same.

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And so hence the information, the expectation of declining interest rates, which was making yields fall, is now gone, so they're going to go back up.

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Nasty stuff. And that's our blessed Fed.

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But anyway, enough of that rant.

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Now, the Euro was cut, the discount rate was cut. We didn't count ours.

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And so that would cause the dollar to strengthen against the Euro.

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However, the news is that, well, you know, the American economy could start to really begin to sputter.

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And that would weaken the dollar.

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So you had to surge on the relative interest rate differential going in favor of American interest rates being stronger, being relatively weak,

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to now they're going to be stronger than the Euro. That would have pushed it up.

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And now the other factor that is big in currencies, relative strength of the economies.

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If the Euro is able to stay strong and the American economy is going to weaken, well, there you go.

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And you can see the same pattern to some extent over on the pound sterling.

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And you can see the opposite pattern, which because of the backward quotation, happening on the yen.

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And of course, we have the Nikkei. As usual, it plunges on the opening.

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And then this time it just for pissed its way down for a while.

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The FTSE is in bad shape now, too.

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Where's all this bad sentiment coming from? Well, there is still a concern of a war in the Middle East.

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The scuttlebutt is a little less excited today than it was last night,

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through the night when there was expectation that there was going to be some kind of a major bombing in Iran,

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which might actually have hit oil well, their oil refinery capacity.

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But they didn't do it, so crude, thank goodness, took a little bit of a toilet break.

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Now, you're going to have on the exam screens, I'm just going to ask you basic questions.

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You should know them. This would be, let me see, what do I want to do here?

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I don't know, I'll just do, well, no, I don't think I should, well, yeah, I'll do Palantir.

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Palantir is one of Wall Street's favorite whipsaw boys. It's up and then it's down and it's up.

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I used to play options on Palantir until I got tired of the heart problems I was having on it.

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But here's a good example. God, I hate Yahoo, I can't do it.

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Yahoo's quotes are off. They're lagging quotes. I've got to do something else.

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Give me a stock, for God's sake, I'm freezing. Waiting for, fine, what the hell, I'll do Target.

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Okay, there we go, that's better. I can say, okay, is this a stock that is riskier than the market,

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about the same risk as the market or less risky than the market?

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And you'll say it's riskier than the market. That's beta. Beta is above one.

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Then I'll say is it undervalued or overvalued?

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Well, you say, by golly, that is undervalued because it's 15 and intrinsic is at about 30, 35, whatever you want to say.

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But it's definitely somewhat undervalued.

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So is it a profitable company? Well, hell to the yeah. It is making $9.69 a share.

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That's pretty profitable. And so, well, does it pay a dividend? Sure it does.

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It pays $3.01 dividend. That's a darn handsome dividend.

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Now, if I wanted to go long one share of Target, I would pay $150.50.

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If I want to go sell a share of Target, I would receive $150.40.

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So there you are. There's your Uncle Bob right there.

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So we got, and then finally, those are the questions, I would ask you those questions.

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And then I would finally ask you, okay, a one-year holding period return on the stock,

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if Yahoo's projection is correct.

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Then you're going to whip out a little calculator here.

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This is too modest for a spreadsheet.

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You're going to say the end of a one-year hold is at $177.24, according to Yahoo,

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divided by your buying price one year previously, which would, and use the one on top, for God's sake.

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Don't play bid and ask on this. But just take that number on top.

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$150.74. And then don't forget to subtract one, for heaven's sakes, equals.

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Now, I multiply that by 100 to give us our percent.

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And the capital gain yield is going to be 17.58%.

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That's, then you also, since a target pays a dividend, will add in the 3.01% dividend yield.

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And there's your Uncle Bob. The thing is paying a 20.59% return.

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Total holding period annual return.

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That's all you have to do to get the points.

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Now, what am I thinking on this?

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Now, just as a side note, that is a very healthy return.

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That's a darn fine return. But of course you should expect a return like that.

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It's a high beta stock. The greater the risk, the greater the expected return.

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If I saw a return on the stock like 9%, 8%, I'd say, no, this is a bad investment.

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I'm taking all that risk to get such a lousy return. I don't think so.

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So just make sure that you know how to do these kinds of, this kind of calculation.

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Get some decent points on the exam just to show that you understand the basics of reading stock information.

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Now, on to the party.

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Well, actually, I suppose I could just put the exam up here on the overhead, let you see it, but I won't.

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Here's the thing. It's approximately, as far as the technicals go, approximately 40 questions.

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The thing about that is, though, that some of them will have multiple parts.

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Two fill in the blanks in a question or multiple answers in a multiple choice.

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Very similar to what you've seen on the quizzes.

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Those quizzes are a great source of inspiration, as it were, for the exam.

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Now, you can use your notes for this exam.

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I really recommend that you, before you start the exam, pull up those spreadsheets that I've given you so far.

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Have them up and running, because when the exam clock starts at 12.35 p.m. on Thursday,

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you got exactly 75 minutes to finish up.

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You don't need to be prowling around trying to find your Excel sheets.

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Get in here, get those pulled up so that you don't have to worry about that mess for the exam.

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As far as anything else goes, I really, I know there are people who are trying to think,

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well, I've got a chat GPT I can use. I can go right there and get these, have it,

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and I have 240 students doing it, and they're getting problems wrong.

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They're just getting them wrong, and then they're all muffed.

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One of them actually argued with me. He said, I know what I'm doing here,

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and I can tell he'd done a chat. He was just getting consistently wrong on every numerical question.

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I said, let me see your Excel sheets. Well, I deleted those.

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Oh, okay, good, sure. And be careful, because chats are just not,

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especially unless you have constructed it yourself and tested it and retrained it over and over,

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it's not going to give you good answers on a finance exam, even the qualitative answers.

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But anyway, enough of that. Now, let me do something else.

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Let me go through some questions here for you on this.

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Okay, as far as the basics go, now remember, my exams are based upon my lectures.

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If it's in the book, but I haven't talked about it, I'm not going to ask you on an exam.

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You've got plenty of homework in Cengage you can do for the book.

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This is based upon lectures, and the lectures, if they, sometimes you'll have the material also in the book,

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sometimes you won't, but it's fair game if I brought it up in class.

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Now, as far as the test goes, you'll have to answer basic questions about what financial management is

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and understanding of the different kinds of business structures, just some bunny questions

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just to lull you into a sense of safety before I destroy you later in the exam or somewhere else in the exam.

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Now, remember, always, if you don't know this already, test taking 101, do the easy's first.

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Save the hard ones for later, because you could get a hard one early on, grind out 15 minutes of your time,

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and then you don't have time to answer all the easy ones.

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Now, as far as the setup of the exam, I did forget, multiple choice, true and false, fill in the blank,

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little drop down menus.

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I have a matching section, should be easy for you.

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It's a big matching section, just matching terminology, and I do that.

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It's like 10 questions, 10, and I do put in some distractors.

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In other words, there are some responses that don't have a match, so keep that in mind.

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I think I have five distractors, four or five distractors, and those are just to keep you on your toes.

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But, oh, and then the numerical questions.

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The numerical questions are, except for maybe the capital gains one,

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the numerical questions should be in your, you should be able to do them in your Excel sheets.

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The present value and future value kinds of questions are pretty basic stuff,

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and looking at the exam right now, bond valuation, find the price, find the yield, find a loan payment,

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just the basic classics of financial management, 240 kind of territory,

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and we do overlap just to make sure that you're out of this course fully in command of those.

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And you have a net operating working capital problem, very basic.

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I gave you current assets, current liabilities for two years,

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and you tell me to change the net operating working capital.

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Oh, yeah, and you can also have your financial ratio sheet printed out or just have it up on your screen.

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I don't hit hard with calculating.

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I want you to be able to interpret those ratios.

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What happens?

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Let's say you've got the, you're looking at the liquidity ratios.

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The company decides that it is going to reduce its inventories, lower its average inventory in its warehouses.

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What will that do to the ratios?

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Well, the first thing is that it will certainly, because the top is current assets,

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if inventories go down, your current assets go down, so the quick ratio, I'm sorry, the current ratio goes down.

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Okay, so then it gets a little trickier.

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What happens to the acid test?

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Because remember, you subtract inventory, you take current assets minus inventories

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divided by current liabilities.

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So what happens to the acid test if you reduce your inventories, the quick ratio?

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Let me write it down for you.

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The current is current assets over current liabilities.

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The acid quick ratio is current assets less inventories over current liabilities.

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The cash ratio, otherwise called the burn ratio in the old term, is just cash over current liabilities.

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Okay, what's going to happen to the, we, obviously, if you reduce inventories, don't do anything else,

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current assets go down, so your current ratio is going to slide.

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But if you reduce your inventories, what happens to the quick ratio, the acid test?

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You tell me. What do you think?

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That's right, it'll go up.

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You'll actually have, those two will converge on each other, and that's something you can look at,

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really do an analysis if you've done a couple of years, you see that the quick and,

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the current and acid are converging, then that would tell us that it looks like an inventory thing.

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And then what happens to the cash ratio?

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Nothing, because inventory isn't in it before, it's not in it afterwards.

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So the cash ratio just sits there, not worrying about this that's happening.

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Those are the kind of questions, they require that you think a little bit,

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maybe go through those ratios and just ask yourself some questions about relationships among ratios.

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What happens when the company pays off, retires one of its bonds, it retires a bond.

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Okay, what does that do to the capital structure of the corporation?

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Well, it certainly is going to change it, and another part of that is that it's going to change,

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in changing the capital structure, you will also see a change,

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that means that you will see a change in the leverage of this company.

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The leverage will change, which is kind of an interesting thing.

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And what will that do to the ROA?

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Well, that's certainly going to cause something to happen to the return on assets,

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because ROA is your net income over your total assets.

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But if you cut out, now remember the total assets is your equity and your debt,

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if you reduce the debt, then something interesting happens.

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Okay, all of that. So there's some ratios types of questions.

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They are not math in the sense of calculating.

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We can get Excel to calculate, we can get artificial intelligence to calculate,

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we can get our calculators to calculate.

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It's the thinking that is where we will keep our jobs in the 21st century,

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is in understanding what this all means as we go along.

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Okay, now I will ask, I'm going to go really lightweight on options.

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Something like what I did on quiz four, because this is not an options course.

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If you want options, take my 347.

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If you want an easier options course, you take it from someone besides me.

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That's just the way it works.

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But I mean, if I ask questions, it will be about what happens to a call,

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what happens to a put, as you get closer to maturity,

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or if you buy a call option at a specific strike price,

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and the ending is with the underlying being at a higher or lower than the strike.

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Basic questions like that. I'm not going to beat you up with that kind of stuff.

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Maybe some definitional stuff on it is fair game, but certainly nothing heavy duty.

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I'm not going to be asking you about condors and butterfly spreads and corridor barrier options, stuff like that.

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Okay, now, accounting, I'm not going to hit you over the head with accounting.

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This is not an accounting course.

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We use accounting numbers, but we have to twist them, mangle them, beat the crap out of them,

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so that they'll confess to what we want them to tell us.

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So the accounting is going to be lightweight, not even as tough as some of the problems in Cengage.

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You're having to put together puzzles. I don't want puzzles on my exam.

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So it's going to be fairly lightweight stuff.

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Where do you find this? Where do you find that?

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Can you calculate a NOPAT, a Net Operating Profit After Taxes, along that line?

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A Net Operating Working Capital. Can you calculate a Net Operating Working Capital for a company?

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More or less those...

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There's a...

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Is that a spider? A tiny little spider is floating around...

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No, right here in front of me.

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What the hell, man? You don't do finance.

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See, it's right there.

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Oh, it's on me now. God.

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Probably one of those deadly spiders.

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Anyway, might have been my imagination. I drank a lot of coffee today.

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Okay, now... risk and return. There's beaten potatoes.

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Now, CAPM. Obviously, I'm going to ask you a CAPM question.

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It's just find the R sub... I give you the R sub F, the risk-free rate, the expected return to the market portfolio, the beta, that kind of stuff.

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But you also have to understand, make sure that you know terms like capital market line and securities market line.

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And what happens to the beta of a stock if you reduce the risk-free rate but the expected return to the market portfolio stays the same?

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In other words, those ones where the securities market line shifts up and down or pivots this way and that way.

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Those are fair game kind of questions. Just to understand the dynamics at the theoretical level of what the capital asset pricing model tells us.

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And also in that same regard, the underlying issues with the capital asset pricing model regarding the risk-free rate and the expected return to the market portfolio themselves.

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How do we calculate a beta? I may actually ask you to find a beta.

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If I give you some information, I gave you a formula for how a beta is calculated.

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You should be able to calculate a beta in just a couple of strokes on a calculator.

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It's not even worth Excel to do something like that.

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Let me check something here. I'm going to scroll up and down this.

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While I'm doing that, another thing that I would strongly encourage you to do is to...

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There's a lot of definitions on it.

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Like in the matching.

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The basics like primary and secondary markets, spot and forward.

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Capital versus money. Primary versus secondary.

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Those kinds of terminology types of questions.

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Financial intermediation. Things like that are always on the table, always fun to talk about.

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Let me go back through here real quick.

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I'm going up and down this exam.

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But again, use your quizzes as a good basis.

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I tried not to throw you too hard a curve ball.

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If the wording was like this on a quiz, the wording would be very similar on the midterm exam.

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Let me check here.

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What's the difference between a big thing of course, systematic versus non-systematic risk?

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How is that related to the frontier of efficient investments?

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What do I mean by sigma versus beta?

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Yeah, you too.

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Going through here.

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In that same vein, what do I mean by standalone risk?

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How is that different from the risk that we're interested in?

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Throw a hint question at you.

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What happens as you put more stocks into a portfolio?

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What happens to the relationship between beta and sigma?

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As you put more stocks into a portfolio, more securities let's say,

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what happens to the relationship between beta and sigma?

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You'll have to think about it. This is a think question.

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More about risk and return, expected risk, return.

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What is the correct definition of the relationship between risk and return?

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Is it the greater the risk, the greater the return?

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Or is it something else, something that sounds almost the same but is not?

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Now as far as expected return goes,

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how do I frame this without telling you the question?

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How do I frame this?

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I'm trying to think how I would frame that, how I would tell you what the question is

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without giving away just the question itself.

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Well obviously I'm going to have you do a CAPM or two and all that kind of stuff.

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But anyway, let me go on. My memory might be jogging.

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You might ask me a question about it when it's your turn.

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But again, also let me emphasize again, I spent time on risk and return.

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I also spent time on bonds.

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And both of those subjects are more to the core of the 341 class.

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And so you should expect more on terminology of those particular topics in this class.

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And like I said, a little terminology in options is also on the table too.

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So nothing really heavy duty as far as calculations go.

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But I did teach you some of the terminology of options,

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so I would expect you to know what I taught you on that.

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The book went further than I did in that.

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So restrict yourself to what I lectured on and spare yourself.

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They went into some pretty heavy, a little bit deeper detail on the binary options, pricing and all that.

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I didn't.

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Anyway, let me take this off the table now.

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It's your turn to ask me questions.

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This is your chance.

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And if it's on there, I'll say, yeah, that's going to be on there.

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And if it's not, I'll say, no, are you crazy?

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I'm not going to do that.

335
00:35:24,000 --> 00:35:28,000
So what do you want to ask me about this?

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Anything at all?

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It's not going to be...

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You should finish within about 40 minutes.

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And don't just run. Just look back over.

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Do we have to know anything about standard efficiency or...

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Yes. Those are classic.

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Those first couple of lectures, I was laying out all this base terminology

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and things about different types of company, organization, how it's organized, IPOs, 10Ks, 8Ks.

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What are these?

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Where do you find the financial statements in what SEC document?

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Where would you find the management discussion and analysis of the results of operations?

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What form would you find a report of a non-recurring event?

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Those kinds of things.

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I brought up initial public offerings, investment bank versus a normal bank.

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How does that whole thing work?

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What is a prospectus? Hint, it's a selling document.

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Those kinds of things.

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I think I brought up Form S1.

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That would be obviously an IPO document.

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Those kinds of things.

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The different types of trading symbols.

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What happens if I see a trading symbol that is just the letter C?

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What do you know about where that stock is traded?

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What's the difference between an index and an exchange?

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What's the difference between a broker and a dealer?

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I brought that up very briefly.

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I don't know if I'd ask you that.

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I'm sure I didn't ask you that.

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Those kinds of basics of how trading works in the market.

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What constitutes a primary transaction versus a secondary transaction?

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Which one is more common?

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As far as bonds go.

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Which is overall a safer investment?

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Bonds or stock?

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Just in general.

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Hint, it sure isn't stocks.

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Those kinds of things.

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Let me go back.

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I want to make sure that I don't cheat you on this review about ratios.

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A lot of things I said about ratios.

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Some ratios, there isn't a great and there isn't an awful.

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There are some ratios, however, where you don't want to see that number for a ratio.

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You just don't want to see that number for a ratio.

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That would be very, very sad if you saw that.

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Other ratios.

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I could even ask you one, which one of these ratios doesn't make any sense?

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Which one of these ratios could not happen?

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If you saw it, you'd know something was really phony about whoever calculated the ratios.

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What ratios would concern you?

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Remember that most ratios, they can be too high or too low.

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But there is a happy place somewhere in there.

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But there are some places where it's just obvious that there is a problem.

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A few ratios especially.

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There is something seriously wrong going on here.

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So just make sure that you have used some mathematical common sense, if there's such a thing,

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to figure out what could not possibly.

392
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Well, suppose I told you debt to total assets is 2.3.

393
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Is that a reasonable number for debt to total assets?

394
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It's 2.3.

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Hint. No, it couldn't be.

396
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That's impossible.

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Although God knows some companies have actually tried it.

398
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I shouldn't be so adamant.

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I brought up a company last year.

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They actually had negative shareholders' equity.

401
00:39:51,000 --> 00:39:57,000
So in other words, the shareholders' equity was subtracting.

402
00:39:57,000 --> 00:40:06,000
It was actually one of those companies where their shareholders' equity was a drain on the company's total assets.

403
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What happens if a company stops investing in the short run?

404
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A company stops investing in property, plant, and equipment.

405
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What happens to ROA?

406
00:40:19,000 --> 00:40:23,000
Well, it's naturally the total fixed assets are going to go down.

407
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So total assets will go down because of depreciation.

408
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So as total assets go down, the net income over total assets is going to go up.

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So I can ask you what effect does this have, that have on this particular ratio?

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I could ask you things like that.

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I mean, a stupid one, but think about it.

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It's not hard. Don't overthink it.

413
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What happens if a company...what do you know about the dividend ratio if the company doesn't pay dividends?

414
00:41:00,000 --> 00:41:03,000
Yeah, that's right. It doesn't have one. It's zero.

415
00:41:03,000 --> 00:41:07,000
So it's a pure plowback company, plowback.

416
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Other questions from you?

417
00:41:10,000 --> 00:41:15,000
Eat your Wheaties and come early and often to the exam.

418
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Make sure that you've got plenty of battery power.

419
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And again, just make sure that you have good notes.

420
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And also, I've been podcasting lectures since the eighth or ninth lecture.

421
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They're on RSS.com, Illinois State Collegiate Compendium.

422
00:41:32,000 --> 00:41:36,000
You can listen to those. Good stuff.

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If you don't have anything else, that's all I have for you today. I thank you.