Alan Cring Productions in association with Emergent Light Studio presents
the Illinois State Collegiate Compendium, academic lectures in business and economics.
This is business finance, FIL 341 for autumn semester 2024.
Today, review for the midterm exam. I will go through what I think you should probably know
to be successful on the midterm exam and I will then entertain questions you have about what you
what you think might be on there. If it's not something that's on the midterm exam, I will,
and you ask about it, I will say I'm not going to ask you about that for the midterm exam
because it's to let you try to help you narrow down your study.
But as always, we all look at the numbers first and this time it's part of the review
because on the midterm exam I will give you a screen.
I will anticipate that you can read a stock screen. It shouldn't be hard for you at all.
Certainly I do this at 240, but I just want to make sure that you are capable of looking at basic
information about stocks and ETFs, maybe bonds and all that.
As you can see, we have a bold day, but it has fizzled out a lot, at least on,
there was good rise, but now it's turning its tail a little bit.
Well, the Dow has just dropped down to nothing again.
The big concern, of course, is interest rates, and interest rates have done something very bad
just today, and you'll see that in a minute here.
Fortunately, the crude oil has fallen as the rumors have subsided about a major confrontation
that was thought to happen last night, and it did not, and so oil prices have taken a bit of a dip.
They're still above where they had been in the upper 60s per barrel.
Now they're back up there in the mid 70s, and they had spiked up there as high,
I think they were up as high as $77 a barrel there for a while, but fortunately that's eased off.
We still have a problem with oil prices. They're higher than they were.
That's bad for a recovery.
Now, interestingly enough, a couple of things that have happened on other sides of the world,
one is that the Eurozone cut its basic rate by a quarter of a percent.
That's not spectacular, but that, of course, will strengthen the dollar against the Euro, we would hope.
We'll see if that's what happened today.
Well, it did strengthen the dollar, and now the dollar is going back down again.
Well, anyway, here's the bad news. We are above 4% on the 10-year benchmark treasury.
We thought we had seen the last of that.
We were down there, we were going toward sort of a psychological neckline at 3.5%,
and we got down as far as about 3.62%, I think, and then it turned tail and it went back.
It really was up there earlier today.
Actually, that was like real early this morning. It was up there.
It was bad, and now it's tailed back down, but we're still above 4%.
The concern is that the Fed may not lower interest rates.
First, it was they're going to do two more discount rate cuts before the end of the year, both quarter of a percent.
Yay for that.
Then it was, well, maybe they won't do one of them, and now the rumors are they might not do either of them
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.
That's an old thing. A huge criticism for a long, long time about the Fed is that if employment gets too good,
it's time to slow down the economy.
Never mind if businesses are making too many profits.
No, always the emphasis has been on, well, if jobs markets are getting too good, then we have to kill off this recovery.
That goes clear back to the 1990s of spectacular example was that in the years of the Clinton administration,
the budget deficit was falling year over year over year.
First time in decades, we were heading for surpluses, and we actually got to surpluses, not budget surpluses.
Whoever heard of that?
Plus, the stock market was just going wild, going up.
Plus, we had the longest, lowest sustained unemployment rate in history.
It was below what economists always say, the natural unemployment rate.
It's about 4.4% would be the good unemployment rate.
The unemployment rate was plummeting, and it wasn't bouncing back up. It just stayed down there.
The economy kept rolling. Inflation didn't show up, and spank me Jesus,
Alan Greenspan was pissed off about all of this. He was a Fed chairman. He was just furious about this.
He went before Congress, and he said the stock market is irrationally exuberant.
His famous line, which anyone with an ounce of knowledge of markets, you don't say markets are irrational.
That's like saying a shark is coming at you, and you say you're irrational and stop him a shark.
No, markets do what they do, whatever TF they do they want to do.
But he did the longest sustained series of increases in the discount rate in American history under the Fed.
He just kept going up and up and up. He was damn determined. He was going to kill the recovery.
Here we go again. Markets are beginning to think, is this what this Fed is going to do?
They don't like these low unemployment rates.
So like Feds in the past, once they see the unemployment rate go down enough, job formations going up enough,
they start to slow down the economy.
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.
And hence those expectations of lower bond yields are now turning into expectations that bond yields are going to stay the same.
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.
Nasty stuff. And that's our blessed Fed.
But anyway, enough of that rant.
Now, the Euro was cut, the discount rate was cut. We didn't count ours.
And so that would cause the dollar to strengthen against the Euro.
However, the news is that, well, you know, the American economy could start to really begin to sputter.
And that would weaken the dollar.
So you had to surge on the relative interest rate differential going in favor of American interest rates being stronger, being relatively weak,
to now they're going to be stronger than the Euro. That would have pushed it up.
And now the other factor that is big in currencies, relative strength of the economies.
If the Euro is able to stay strong and the American economy is going to weaken, well, there you go.
And you can see the same pattern to some extent over on the pound sterling.
And you can see the opposite pattern, which because of the backward quotation, happening on the yen.
And of course, we have the Nikkei. As usual, it plunges on the opening.
And then this time it just for pissed its way down for a while.
The FTSE is in bad shape now, too.
Where's all this bad sentiment coming from? Well, there is still a concern of a war in the Middle East.
The scuttlebutt is a little less excited today than it was last night,
through the night when there was expectation that there was going to be some kind of a major bombing in Iran,
which might actually have hit oil well, their oil refinery capacity.
But they didn't do it, so crude, thank goodness, took a little bit of a toilet break.
Now, you're going to have on the exam screens, I'm just going to ask you basic questions.
You should know them. This would be, let me see, what do I want to do here?
I don't know, I'll just do, well, no, I don't think I should, well, yeah, I'll do Palantir.
Palantir is one of Wall Street's favorite whipsaw boys. It's up and then it's down and it's up.
I used to play options on Palantir until I got tired of the heart problems I was having on it.
But here's a good example. God, I hate Yahoo, I can't do it.
Yahoo's quotes are off. They're lagging quotes. I've got to do something else.
Give me a stock, for God's sake, I'm freezing. Waiting for, fine, what the hell, I'll do Target.
Okay, there we go, that's better. I can say, okay, is this a stock that is riskier than the market,
about the same risk as the market or less risky than the market?
And you'll say it's riskier than the market. That's beta. Beta is above one.
Then I'll say is it undervalued or overvalued?
Well, you say, by golly, that is undervalued because it's 15 and intrinsic is at about 30, 35, whatever you want to say.
But it's definitely somewhat undervalued.
So is it a profitable company? Well, hell to the yeah. It is making $9.69 a share.
That's pretty profitable. And so, well, does it pay a dividend? Sure it does.
It pays $3.01 dividend. That's a darn handsome dividend.
Now, if I wanted to go long one share of Target, I would pay $150.50.
If I want to go sell a share of Target, I would receive $150.40.
So there you are. There's your Uncle Bob right there.
So we got, and then finally, those are the questions, I would ask you those questions.
And then I would finally ask you, okay, a one-year holding period return on the stock,
if Yahoo's projection is correct.
Then you're going to whip out a little calculator here.
This is too modest for a spreadsheet.
You're going to say the end of a one-year hold is at $177.24, according to Yahoo,
divided by your buying price one year previously, which would, and use the one on top, for God's sake.
Don't play bid and ask on this. But just take that number on top.
$150.74. And then don't forget to subtract one, for heaven's sakes, equals.
Now, I multiply that by 100 to give us our percent.
And the capital gain yield is going to be 17.58%.
That's, then you also, since a target pays a dividend, will add in the 3.01% dividend yield.
And there's your Uncle Bob. The thing is paying a 20.59% return.
Total holding period annual return.
That's all you have to do to get the points.
Now, what am I thinking on this?
Now, just as a side note, that is a very healthy return.
That's a darn fine return. But of course you should expect a return like that.
It's a high beta stock. The greater the risk, the greater the expected return.
If I saw a return on the stock like 9%, 8%, I'd say, no, this is a bad investment.
I'm taking all that risk to get such a lousy return. I don't think so.
So just make sure that you know how to do these kinds of, this kind of calculation.
Get some decent points on the exam just to show that you understand the basics of reading stock information.
Now, on to the party.
Well, actually, I suppose I could just put the exam up here on the overhead, let you see it, but I won't.
Here's the thing. It's approximately, as far as the technicals go, approximately 40 questions.
The thing about that is, though, that some of them will have multiple parts.
Two fill in the blanks in a question or multiple answers in a multiple choice.
Very similar to what you've seen on the quizzes.
Those quizzes are a great source of inspiration, as it were, for the exam.
Now, you can use your notes for this exam.
I really recommend that you, before you start the exam, pull up those spreadsheets that I've given you so far.
Have them up and running, because when the exam clock starts at 12.35 p.m. on Thursday,
you got exactly 75 minutes to finish up.
You don't need to be prowling around trying to find your Excel sheets.
Get in here, get those pulled up so that you don't have to worry about that mess for the exam.
As far as anything else goes, I really, I know there are people who are trying to think,
well, I've got a chat GPT I can use. I can go right there and get these, have it,
and I have 240 students doing it, and they're getting problems wrong.
They're just getting them wrong, and then they're all muffed.
One of them actually argued with me. He said, I know what I'm doing here,
and I can tell he'd done a chat. He was just getting consistently wrong on every numerical question.
I said, let me see your Excel sheets. Well, I deleted those.
Oh, okay, good, sure. And be careful, because chats are just not,
especially unless you have constructed it yourself and tested it and retrained it over and over,
it's not going to give you good answers on a finance exam, even the qualitative answers.
But anyway, enough of that. Now, let me do something else.
Let me go through some questions here for you on this.
Okay, as far as the basics go, now remember, my exams are based upon my lectures.
If it's in the book, but I haven't talked about it, I'm not going to ask you on an exam.
You've got plenty of homework in Cengage you can do for the book.
This is based upon lectures, and the lectures, if they, sometimes you'll have the material also in the book,
sometimes you won't, but it's fair game if I brought it up in class.
Now, as far as the test goes, you'll have to answer basic questions about what financial management is
and understanding of the different kinds of business structures, just some bunny questions
just to lull you into a sense of safety before I destroy you later in the exam or somewhere else in the exam.
Now, remember, always, if you don't know this already, test taking 101, do the easy's first.
Save the hard ones for later, because you could get a hard one early on, grind out 15 minutes of your time,
and then you don't have time to answer all the easy ones.
Now, as far as the setup of the exam, I did forget, multiple choice, true and false, fill in the blank,
little drop down menus.
I have a matching section, should be easy for you.
It's a big matching section, just matching terminology, and I do that.
It's like 10 questions, 10, and I do put in some distractors.
In other words, there are some responses that don't have a match, so keep that in mind.
I think I have five distractors, four or five distractors, and those are just to keep you on your toes.
But, oh, and then the numerical questions.
The numerical questions are, except for maybe the capital gains one,
the numerical questions should be in your, you should be able to do them in your Excel sheets.
The present value and future value kinds of questions are pretty basic stuff,
and looking at the exam right now, bond valuation, find the price, find the yield, find a loan payment,
just the basic classics of financial management, 240 kind of territory,
and we do overlap just to make sure that you're out of this course fully in command of those.
And you have a net operating working capital problem, very basic.
I gave you current assets, current liabilities for two years,
and you tell me to change the net operating working capital.
Oh, yeah, and you can also have your financial ratio sheet printed out or just have it up on your screen.
I don't hit hard with calculating.
I want you to be able to interpret those ratios.
What happens?
Let's say you've got the, you're looking at the liquidity ratios.
The company decides that it is going to reduce its inventories, lower its average inventory in its warehouses.
What will that do to the ratios?
Well, the first thing is that it will certainly, because the top is current assets,
if inventories go down, your current assets go down, so the quick ratio, I'm sorry, the current ratio goes down.
Okay, so then it gets a little trickier.
What happens to the acid test?
Because remember, you subtract inventory, you take current assets minus inventories
divided by current liabilities.
So what happens to the acid test if you reduce your inventories, the quick ratio?
Let me write it down for you.
The current is current assets over current liabilities.
The acid quick ratio is current assets less inventories over current liabilities.
The cash ratio, otherwise called the burn ratio in the old term, is just cash over current liabilities.
Okay, what's going to happen to the, we, obviously, if you reduce inventories, don't do anything else,
current assets go down, so your current ratio is going to slide.
But if you reduce your inventories, what happens to the quick ratio, the acid test?
You tell me. What do you think?
That's right, it'll go up.
You'll actually have, those two will converge on each other, and that's something you can look at,
really do an analysis if you've done a couple of years, you see that the quick and,
the current and acid are converging, then that would tell us that it looks like an inventory thing.
And then what happens to the cash ratio?
Nothing, because inventory isn't in it before, it's not in it afterwards.
So the cash ratio just sits there, not worrying about this that's happening.
Those are the kind of questions, they require that you think a little bit,
maybe go through those ratios and just ask yourself some questions about relationships among ratios.
What happens when the company pays off, retires one of its bonds, it retires a bond.
Okay, what does that do to the capital structure of the corporation?
Well, it certainly is going to change it, and another part of that is that it's going to change,
in changing the capital structure, you will also see a change,
that means that you will see a change in the leverage of this company.
The leverage will change, which is kind of an interesting thing.
And what will that do to the ROA?
Well, that's certainly going to cause something to happen to the return on assets,
because ROA is your net income over your total assets.
But if you cut out, now remember the total assets is your equity and your debt,
if you reduce the debt, then something interesting happens.
Okay, all of that. So there's some ratios types of questions.
They are not math in the sense of calculating.
We can get Excel to calculate, we can get artificial intelligence to calculate,
we can get our calculators to calculate.
It's the thinking that is where we will keep our jobs in the 21st century,
is in understanding what this all means as we go along.
Okay, now I will ask, I'm going to go really lightweight on options.
Something like what I did on quiz four, because this is not an options course.
If you want options, take my 347.
If you want an easier options course, you take it from someone besides me.
That's just the way it works.
But I mean, if I ask questions, it will be about what happens to a call,
what happens to a put, as you get closer to maturity,
or if you buy a call option at a specific strike price,
and the ending is with the underlying being at a higher or lower than the strike.
Basic questions like that. I'm not going to beat you up with that kind of stuff.
Maybe some definitional stuff on it is fair game, but certainly nothing heavy duty.
I'm not going to be asking you about condors and butterfly spreads and corridor barrier options, stuff like that.
Okay, now, accounting, I'm not going to hit you over the head with accounting.
This is not an accounting course.
We use accounting numbers, but we have to twist them, mangle them, beat the crap out of them,
so that they'll confess to what we want them to tell us.
So the accounting is going to be lightweight, not even as tough as some of the problems in Cengage.
You're having to put together puzzles. I don't want puzzles on my exam.
So it's going to be fairly lightweight stuff.
Where do you find this? Where do you find that?
Can you calculate a NOPAT, a Net Operating Profit After Taxes, along that line?
A Net Operating Working Capital. Can you calculate a Net Operating Working Capital for a company?
More or less those...
There's a...
Is that a spider? A tiny little spider is floating around...
No, right here in front of me.
What the hell, man? You don't do finance.
See, it's right there.
Oh, it's on me now. God.
Probably one of those deadly spiders.
Anyway, might have been my imagination. I drank a lot of coffee today.
Okay, now... risk and return. There's beaten potatoes.
Now, CAPM. Obviously, I'm going to ask you a CAPM question.
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.
But you also have to understand, make sure that you know terms like capital market line and securities market line.
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?
In other words, those ones where the securities market line shifts up and down or pivots this way and that way.
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.
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.
How do we calculate a beta? I may actually ask you to find a beta.
If I give you some information, I gave you a formula for how a beta is calculated.
You should be able to calculate a beta in just a couple of strokes on a calculator.
It's not even worth Excel to do something like that.
Let me check something here. I'm going to scroll up and down this.
While I'm doing that, another thing that I would strongly encourage you to do is to...
There's a lot of definitions on it.
Like in the matching.
The basics like primary and secondary markets, spot and forward.
Capital versus money. Primary versus secondary.
Those kinds of terminology types of questions.
Financial intermediation. Things like that are always on the table, always fun to talk about.
Let me go back through here real quick.
I'm going up and down this exam.
But again, use your quizzes as a good basis.
I tried not to throw you too hard a curve ball.
If the wording was like this on a quiz, the wording would be very similar on the midterm exam.
Let me check here.
What's the difference between a big thing of course, systematic versus non-systematic risk?
How is that related to the frontier of efficient investments?
What do I mean by sigma versus beta?
Yeah, you too.
Going through here.
In that same vein, what do I mean by standalone risk?
How is that different from the risk that we're interested in?
Throw a hint question at you.
What happens as you put more stocks into a portfolio?
What happens to the relationship between beta and sigma?
As you put more stocks into a portfolio, more securities let's say,
what happens to the relationship between beta and sigma?
You'll have to think about it. This is a think question.
More about risk and return, expected risk, return.
What is the correct definition of the relationship between risk and return?
Is it the greater the risk, the greater the return?
Or is it something else, something that sounds almost the same but is not?
Now as far as expected return goes,
how do I frame this without telling you the question?
How do I frame this?
I'm trying to think how I would frame that, how I would tell you what the question is
without giving away just the question itself.
Well obviously I'm going to have you do a CAPM or two and all that kind of stuff.
But anyway, let me go on. My memory might be jogging.
You might ask me a question about it when it's your turn.
But again, also let me emphasize again, I spent time on risk and return.
I also spent time on bonds.
And both of those subjects are more to the core of the 341 class.
And so you should expect more on terminology of those particular topics in this class.
And like I said, a little terminology in options is also on the table too.
So nothing really heavy duty as far as calculations go.
But I did teach you some of the terminology of options,
so I would expect you to know what I taught you on that.
The book went further than I did in that.
So restrict yourself to what I lectured on and spare yourself.
They went into some pretty heavy, a little bit deeper detail on the binary options, pricing and all that.
I didn't.
Anyway, let me take this off the table now.
It's your turn to ask me questions.
This is your chance.
And if it's on there, I'll say, yeah, that's going to be on there.
And if it's not, I'll say, no, are you crazy?
I'm not going to do that.
So what do you want to ask me about this?
Anything at all?
It's not going to be...
You should finish within about 40 minutes.
And don't just run. Just look back over.
Do we have to know anything about standard efficiency or...
Yes. Those are classic.
Those first couple of lectures, I was laying out all this base terminology
and things about different types of company, organization, how it's organized, IPOs, 10Ks, 8Ks.
What are these?
Where do you find the financial statements in what SEC document?
Where would you find the management discussion and analysis of the results of operations?
What form would you find a report of a non-recurring event?
Those kinds of things.
I brought up initial public offerings, investment bank versus a normal bank.
How does that whole thing work?
What is a prospectus? Hint, it's a selling document.
Those kinds of things.
I think I brought up Form S1.
That would be obviously an IPO document.
Those kinds of things.
The different types of trading symbols.
What happens if I see a trading symbol that is just the letter C?
What do you know about where that stock is traded?
What's the difference between an index and an exchange?
What's the difference between a broker and a dealer?
I brought that up very briefly.
I don't know if I'd ask you that.
I'm sure I didn't ask you that.
Those kinds of basics of how trading works in the market.
What constitutes a primary transaction versus a secondary transaction?
Which one is more common?
As far as bonds go.
Which is overall a safer investment?
Bonds or stock?
Just in general.
Hint, it sure isn't stocks.
Those kinds of things.
Let me go back.
I want to make sure that I don't cheat you on this review about ratios.
A lot of things I said about ratios.
Some ratios, there isn't a great and there isn't an awful.
There are some ratios, however, where you don't want to see that number for a ratio.
You just don't want to see that number for a ratio.
That would be very, very sad if you saw that.
Other ratios.
I could even ask you one, which one of these ratios doesn't make any sense?
Which one of these ratios could not happen?
If you saw it, you'd know something was really phony about whoever calculated the ratios.
What ratios would concern you?
Remember that most ratios, they can be too high or too low.
But there is a happy place somewhere in there.
But there are some places where it's just obvious that there is a problem.
A few ratios especially.
There is something seriously wrong going on here.
So just make sure that you have used some mathematical common sense, if there's such a thing,
to figure out what could not possibly.
Well, suppose I told you debt to total assets is 2.3.
Is that a reasonable number for debt to total assets?
It's 2.3.
Hint. No, it couldn't be.
That's impossible.
Although God knows some companies have actually tried it.
I shouldn't be so adamant.
I brought up a company last year.
They actually had negative shareholders' equity.
So in other words, the shareholders' equity was subtracting.
It was actually one of those companies where their shareholders' equity was a drain on the company's total assets.
What happens if a company stops investing in the short run?
A company stops investing in property, plant, and equipment.
What happens to ROA?
Well, it's naturally the total fixed assets are going to go down.
So total assets will go down because of depreciation.
So as total assets go down, the net income over total assets is going to go up.
So I can ask you what effect does this have, that have on this particular ratio?
I could ask you things like that.
I mean, a stupid one, but think about it.
It's not hard. Don't overthink it.
What happens if a company...what do you know about the dividend ratio if the company doesn't pay dividends?
Yeah, that's right. It doesn't have one. It's zero.
So it's a pure plowback company, plowback.
Other questions from you?
Eat your Wheaties and come early and often to the exam.
Make sure that you've got plenty of battery power.
And again, just make sure that you have good notes.
And also, I've been podcasting lectures since the eighth or ninth lecture.
They're on RSS.com, Illinois State Collegiate Compendium.
You can listen to those. Good stuff.
If you don't have anything else, that's all I have for you today. I thank you.