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Summary Real Estate Finance Master FSS
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Summary statements- Higher expected returns are explained by higher levels of systematic risks. That why
shareholders don’t prefer this.
- Increase of leverage (debt) increases the volatility and decreases the WACC, because
higher use of debt reduces the corporate income tax bill.
- Three-year bond price is higher than an identical five-year bond, because the price of
face value is received earlier.
- A 4% coupon bond is higher priced than a three year zero coupon bond because the
future payments will be higher.
- Semi-annual bonds have a higher price than annual because they expected to receive
earlier.
- Expected return on a corporate bond is lower than the yield to maturity because
there is a probability that the corporation will default on promises.
- An investment in a default free government bond is not risk free because it’s possible
that the timing doesn’t match.
- If operating costs fall, future returns will be higher and the P/E ratio will increase.
- Growing the earnings of a company doesn’t increase the equity of the company, it
only does when the earnings are higher than the opportunity costs of capital.
- Risk averse is investing in more risk-free assets.
- Investing in risk-free assets is passive investment.
- The value of an asset depends on the expected size, timing and systematic risk of the
future cash flow.
- In the CAPM, investors are compensated by bearing systematic risk and the time
value of money.
- Highly correlating securities have high systematic risk.
- Unsystematic risk can be diversified away without any costs.
- In perfect markets, financial decisions are irrelevant.
- In imperfect markets, financial decisions become relevant.
- Secured risk = with collateral. = onderpand
- Returns above cost of capital = creating value = higher enterprise value
- Listed = sold by one click
- Unlisted = not trading on regular basis
- Preferred shares = fixed dividend, more like a loan.
- IPO = initial public offering price. Is lower than the price at the end of the first trading
day.
- New shares in a SEO leads to a price drop.
- Rank on basis of PI, not NPV.
- Higher risk = lower NPV
- Lower risk = higher NPV
- IRR doesn’t take size in account.
- Payback Rule = take any project with payback period that is less than the prespecified
period. Doesn’t take the value of money and the cashflows after the payback period
in account.
- Value of an option increases when property and land price correlate positively.
- Architect costs and option costs are sunk costs.
,- Cap rate = value is the present value of all cashflows. Use to value remaining cash
flows.
- Higher cap rate = higher opportunity costs = lower value
- Lower cap rate = higher growth rate = higher value
- Low rate = higher property values
- Systematic/dependent/common risks are measured by covariation and correlation.
- Investors are compensated for bearing systematic risk + the time value of money.
- Higher expected return = higher systematic risk.
- Risk and return are key for portfolio investments
- Optimal portfolios averaging out unsystematic risk.
- No risk = no volatility
- All optimal portfolios are on the CAL. There is the highest expected return and lowest
volatility.
- Mispriced securities offer an unusual high return, the demand for the asset increases,
the asset price increases immediately.
- WACC is key discount rate in business valuation. Based on market values.
- Yield to maturity = cost of debt capital
- Weight of debt and equity are in the SML of the CAPM.
- Hurdle rate = minimaal aanvaardbaar rendement. Is determined by the demands of
clients, historical returns and risk-free + risk premium.
- Black scholes formula is in European options: share prices rise, call prices rise, put
prices drop.
- The beta of a put option is always negative.
- EAR takes interest over interest in account.
- APR ignores interest over interest.
- If short term interest rates are expected to increase, today’s long-term interest rates
are higher than the current short-term interest rate. Expected future short-term
interest rates depend on expected future macro-economic conditions.
- Yield to maturity is the key metric in bond valuation.
- If the coupon rate is equal to the maturity, the value is equal to the face value.
- In the coupon rate is higher than the maturity, you get more of the investment than
the bank requires.
- Long term investments are much more sensitive to yield changes than shot term
bonds. Long term bonds are riskier.
- Volatility includes systematic and unsystematic risk.
- In CAPM, investors can diversify away unsystematic risk without any costs. Therefore
you are not compensated for bearing unsystematic risk.
- Systematic risk is measured by beta.
- Levered firm uses debt
- Unlevered firm doesn’t use debt
- Equity financing = sell shares and lose a part of eigendom
- Debt financing = loan and pay interest
,Week 1
You expect that next year's cash flow will be EUR 250, and that this cash flow will grow with
1.9% forever. The market price of this stream of cash flows is EUR 4,388. The expected
return of an investment in these cash flows is
- use formula of a growing perpetuity: V = C+1 / (r – g) - plug in the numbers: 4,388 = 250 /(r
– 0.019)
- rewrite: r = 250/4,388+ 0.019 = 0.07597 => 7.60%
Corporate Social Responsibility (CSR) integrates the interests of all stakeholders
• A distinction by Adam Smith (1776)
– value (in use) is in the eyes of the beholder and is subjective
– value (in exchange) is the price in a transaction and is objective (can be observed)
• In (the equilibrium of) a competitive market, value equals price, if not positive NPV
transactions exist
• Interpret value “$150 million” in
“Lionel Messi signed a contract extension with FC Barcelona in 2013 giving him a “$150
million” contract through 2018”
• The $150 million in such a context is typically 5 x annual payments of $30 million (or
something equivalent), and not a present value.
To determine the present (economic) value of the contract one needs to know the timing
and risks of the future payments
Valuing a property (as a team)
• The market prices and future payoffs of a
– €10 mln investment in the stock market
– €10 mln investment in the risk-free asset
– the property
• Set the future value of an investment of 10xA stock market and of 10xB in the risk-free
asset equal to the future value of the property
good state: 12.0xA + 10.2xB = 12 bad state: 10.5xA + 10.2xB = 10
• Solve for A and B
1) subtract 2nd equation from 1st equation to determine A:
1.5xA = 2 => A = 1.333
2) use A = 1.333 in 1st equation to determine B: B = (12 - 12x1.333)/10.2 = -0.392
Valuing a property (as a team) cont’d
So, an investment of €13.33 mln in the stock market financed with a risk-free loan of €3.92
mln has always the same future value as the property
, The value of the property is equal to the market value of an investment of €13.33 mln in the
stock market financed with a risk-free loan of €3.92 mln
Hence, today’s value of the property is 10x1.333 - 10x0.392 = €9.4 mln
Week 2
TRUE or FALSE and explain
1) A three-year zero-coupon bond has a higher price than an otherwise identical five-year
bond.
TRUE The face value of a three-year zero-coupon bond is received earlier than the face value
of the five-year zero- coupon bond. So the price of the three-year zero-coupon bond is
higher than the price of the otherwise identical five- year zero-coupon bond.
2) A three-year zero-coupon bond has a higher price than an otherwise identical 4% coupon
bond.
FALSE The promised future payments of the 4% coupon bond are higher than the promised
future payments of the zero- coupon bond. So the price of the 4% coupon bond is higher
than the otherwise identical zero-coupon bond.
3) A bond with annual coupons has a higher price than an otherwise identical bond with
semi-annual coupons.
FALSE The size of the promised future payments of both bonds is the same. However, part of
the promised future payments of the bond with the semi-annual coupons are expected to be
received earlier than those of the bond with annual coupons. So the bond with semi-annual
coupons has a higher price than an otherwise identical bond with annual coupons
4) The expected return of an investment in a corporate bond is lower than the yield to
maturity of that bond
TRUE The expected return of an investment in a bond is based on the expected future bond
payments whereas the yield to maturity is based on the promised future bond payments.
Since corporate bonds are risky – there is always a probability that the corporation will
default on its promises – the expected bond payments of a corporate bond are lower than
the promised bond payments. Hence, the expected return of an investment in the corporate
bond is lower than the yield to maturity of that bond.
5) An investment in a default-free government bond is a risk- free investment
FALSE The timing of the default-free cash flows may not match the investment horizon of an
investor. Consider a default-free zero-coupon bond with a maturity of 2 years. For an
investor with an investment horizon of
― 1 year, the proceeds of selling the bond in 1 year are uncertain. Next year’s one-year spot
rate may be different from what is now expected
― 3 years, the payoff of the bond in 2 year is risk free. However, the return of investing this
payoff in year 3 is uncertain
― 2 years, the payoff of the bond is risk free in nominal terms, but not in real terms!
A bond has a face value of $1,000, annual coupons, a coupon rate of 4%, a remaining
maturity of 5 years, and a price of $979.98.
What is the yield to maturity of this bond? 4,46%
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