POFI Winter 2022-23 EN - Working Version - v2

Principles of Corporate Finance – winter semester 2022-23 Page 1
Principles of Corporate Finance
Winter semester 2022-23

Stefan Artner

Course organization
Instructor
■ Stefan Artner
■ E-Mail: e.artner@doz.hwr-berlin.dehwr-berlin.de
■ Questions preferably via forum in Moodle (or via email)
Time and location

■ Weekly on Tuesdays
■ First class on October 4 and last class on January 24
■ No class on December 26 (winter break)
■ Starting at 6:00 PM (roughly until 9:15 PM)
■ House E, room 3.22
■ Classes on December 20 and January 3 will be held online (campus
mostly closed for energy saving)

Course organization
Materials provided on Moodle

■ Lecture slides
■ Intended to support discussion, but not word-for-word transcript
■ Include gaps with questions, graphs or calculations, which will be
filled/solved together in class
■ Annotated slides will be uploaded after class
■ Important: please do take own notes!
■ Problem sets
■ Should be worked on independently (or in learning groups)
■ Solutions will be provided, discussion in class only on demand
■ Additional material and tools, e.g. formula sheet (will also be part of
exam)

Course organization
Readings
■ “Fundamentals of Corporate Finance” (“Grundlagen der
Finanzwirtschaft”) by Berk and DeMarzo
■ Main book for this course
■ German edition is available online through HWR library (not
downloadable)
■ “Principles of Corporate Finance” by Brealey, Myers and Allen
■ “Corporate Finance” by Ivo Welch
■ Available online for free (downloadable PDF with watermark)
■ https://book.ivo-welch.info/home/
■ “Finanzwirtschaft” by Martin Bösch
■ “Finanzwirtschaft der Unternehmung” by Perridon, Steiner and
Rathgeber

Course organization
Grading (5 ECTS)
■ Written exam
■ Choice between two exam dates (set by examinations office)
■ Duration of 120 minutes (1 point per minute)
■ Permitted tools: calculator, formula sheet (included), cheat sheet
(one A4 size piece of paper with handwritten notes)
■ Voluntary presentations
■ Chance to receive 6 bonus points (5%) counting towards exam
■ Short presentation in class of 10 minutes for single student or
15-20 minutes for group of 2 or 3 students
■ Free choice of topic, but needs to be related to Finance (and not
already covered by lecture itself or textbook)
■ Slides and 1 page summary to be shared to Moodle
■ Register via e-Mail with topic, date and names of all students
Motivation
Why is it important to study Finance?

Motivation
Why is it important to study Finance?

■ Everyone in economy inevitably faces financial decisions
■ Corporations
■ Banks
■ Central banks
■ Institutional investors
■ Private households
■ Financial decisions typically have huge impact
■ Large amounts of money involved
■ Long lasting consequences
■ Almost always involve taking risks
■ Important to understand financial terminology
■ Media
■ Policy and regulation
Motivation
Financial decisions of corporations

Motivation
Financial decisions of corporations

Motivation
Financial decisions of private households

Motivation
Financial decisions of private households

Motivation
Methods
■ Fundamental question: What is the value of something?
■ Example
■ Bank sells financial product, which promises a payment of 100
Euros in 2 years from now
■ What price would you be willing to pay for this product today?
■ Two approaches
■ Comparison with other financial products for which we can
observe market prices
■ Computation of present value accounting for
■ Time value of money
■ Risk

Related fields
■ Objective: documentation, information, payout policy

Accounting ■ Recipient: external
■ Data: book values, revenues (“Ertrag”) and expenditures
(“Aufwand”) from annual report
■ Methods: legal framework according to HGB or IFRS
■ Objective: planning and steering of operative business
Controlling (e.g. pricing of products)
■ Recipient: internal
■ Data: income (“Erlöse”) and costs (“Kosten”)
■ Methods: cost/activity accounting, balanced scorecard
■ Objective: investment and financing decisions

Finance
■ Recipient: internal
■ Data: market values, cash flows (“Zahlungsströme”,
“Einzahlungen und Auszahlungen”), discount rates
■ Methods: present value approach, law of one price
Course outline
Introduction Banking
1. Key terminology 8. Deposits
9. Loans
Fundamentals of valuation
2. Law of one price Securities markets
3. Time value of money 10. Bonds
4. Risk and return 11. Stocks
5. Portfolios 12. Investing
13. Derivatives (optional)
Corporate finance
6. Capital budgeting
7. Capital structure

Key terminology
Important concepts:
Equity and debt, insolvency and bankruptcy, cash flow priority, (limited)
liability, decision rights, legal form of corporation, capital market, traded
securities (stocks and bonds)
Readings:
Berk/DeMarzo chapter 1

The balance sheet
Left side:
Right side:
Where does the
Where does the
money go 
money come from?
investment
Investments are always

on the left side of the
balance sheet

Key terminology
Definitions
■ Firms make investments (left-hand side of balance sheet)
■ Typically cash outflow (investment cost) today
■ Expectation of cash inflows in the future
■ Financial investments vs. real investments
■ Firms issue corporate claims which are purchased by investors (right-
hand side of balance sheet)
■ Legal contracts that govern the relationship between a company
and its investors
■ Equity capital (Eigenkapital) provided by firm’s owners
■ Debt capital (Fremdkapital) provided by banks and other lenders
■ Classical objective of corporations: maximize shareholder value
■ Further non-monetary objectives are feasible

Corporate claims
Important properties
■ Cash flow rights: In what order are claims of investors repaid by the
corporation?
■ Decision rights: Who is making the decisions in the corporation? Can
those decisions be delegated (e.g. to managers)?
■ Liability (Haftung): Can the private wealth of equity holders be seized
to repay debt of the firm?

Bankruptcy
Bankruptcy code (in Germany: Deutsche Insolvenzordnung InsO)

■ Reasons for bankruptcy
■ Insolvency (Zahlungsunfähigkeit): at least 10% of liabilities,
which are due immediately cannot be repaid for 3 weeks or more
■ Impending insolvency (drohende Zahlungsunfähigkeit): foresee-
able that insolvency will occur within the next 3 to 6 months
■ Overindebtness (Überschuldung): book value of assets drops
below the book value of liabilities
■ Consequences
■ Firm needs to file for bankruptcy (Insolvenzverfahren) at court
■ Appointment of trustee (Insolvenzverwalter)
■ Possible outcomes of bankruptcy proceedings
■ Liquidation (US bankruptcy code: chapter 7)
■ Reorganization (US bankruptcy code: chapter 11 )
Bankruptcy
Bankruptcy code (in Germany: Deutsche Insolvenzordnung InsO)

■ Reasons for bankruptcy
■ Insolvency (Zahlungsunfähigkeit): at least 10% of liabilities,
which are due immediately cannot be repaid for 3 weeks or
more
■ Impending insolvency (dohende Zahlungsunfähigkeit): foresee-
able that insolvency will occur within the next 3 to 6 months
■ Overindebtness (Überschuldung): book value of assets
drops below the book value of liabilities
■ Consequences
■ Firm needs to file for bankruptcy (Insolvenzverfahren) at
court
■ Appointment of trustee (Insolvenzverwalter)
■ Possible outcomes of bankruptcy proceedings
■ Liquidation (US bankruptcy code: chapter 7)
■Corporate
Principles of Reorganization (US bankruptcy
Finance – winter semester 2022-23 code: chapter 11 ) Page 21
Legal forms in Germany
■ Owner and Manager are same person

Individual ■ Owner receives all profits, pays all cost
entrepreneur ■ Personal unlimited liability
■ Typically small firms
■ Owned by group of multiple partners
Private
partnership
■ Articles of partnership (Gesellschaftsvertrag) govern
(OHG, GbR) decision rights and distribution of profits
■ Jointly unlimited personal liability of all partners
■ Two types of owners, which can be companies themselves
Private limited
partnership
■ General partner (Komplementär): unlimited liability
(KG) ■ Limited partner (Kommanditist): liability limited, usually
limited decision and control rights
■ Unlimited number of owners
Limited liability
corporation
■ Firma is legal person
(GmbH, AG, SE) ■ Limited liability
■ Allows separation of ownership and management

■ Owner and Manager are same person
Individual ■ Owner receives all profits, pays all cost
entrepreneur ■ Personal unlimited liability
■ Typically small firms
■ Owned by group of multiple partners
Private ■ Articles of partnership (Gesellschaftsvertrag) govern
partnership
decision rights and distribution of profits
(OHG,
GbR) ■ Jointly unlimited personal liability of all partners
■ Two types of owners, which can be companies themselves
Private limited ■ General partner (Komplementär): unlimited liability
partnership
■ Limited partner (Kommanditist): liability limited, usually
(KG)
limited decision and control rights
■ Unlimited number of owners
Limited liability ■ Firma is legal person
corporation
■ Limited liability
(GmbH, AG, SE)
■ Oftentimes separation of ownership and management

Organization of stock company
General shareholder
Supervisory board
assembly
Board of Chief Executive Officer

(CEO)
directors
Chief Financial Officer Chief Operating Officer
(CFO) (COO)
Controlling department Finance department
Accounting Capital budgeting
Taxation Loan department
Risk management

Data from Germany in 2016 (source: Bösch book)

Number Revenue Revenue
Legal form Number in % bln. EUR in %
Single entrepreneur 2,176,944 66.8% 585.6 9.6%
OHG and GbR 274,677 8.4% 194.4 3.2%
KG 161,158 4.9% 1,364.8 22.4%
AG 8,219 0.3% 1,064.3 17.5%
GmbH 566,049 17.4% 2,347.2 38.6%
Cooperative 5,597 0.2% 67.8 1.1%
Other 67,459 2.1% 464.3 7.6%
Summe 3,260,103 6,088,3

Capital market
Definitions
■ In the capital market, the demand for capital by corporations (or the
government) meets the supply of capital by investors
■ Private capital market: banks, large institutional investors (e.g.
venture capital, private equity), wealthy individuals
■ Public capital market: securities exchanges
■ Securities (Wertpapiere) are financial instruments, which can be
traded on exchanges
■ Stocks or shares (Aktien) are tradeable equity securities
■ Bonds (Anleihen) are tradeable debt securities
■ Government bonds (Staatsanleihen)
■ Corporate bonds (Unternehmensanleihen)

Capital market
Market segments
■ Primary market: corporations sell securities to investors (effect is
prolongation of balance sheet)
■ Initial public offering (Neuemission): stocks are listed on
exchange for the first time
■ Seasoned equity offering: sale of additional stocks
■ Secondary market: securities are traded between investors (trades
have no effect on balance sheet of corporation)

Should firms go public?
Advantages of going public

■ Access to large number of potential investors
■ Trading in secondary market (providing transparency and liquidity)
■ Easier to sell additional securities
■ Public monitoring of management due to reporting requirements
Advantages of private financing

■ Contracts can be tailored and individualized
■ Typically lower administrative costs
■ Less information has to be revealed publicly
■ Easier to get in contact with small number of investors (e.g. when
reorganization is )

Stocks
■ Regulated in Germany by the Aktiengesetz (AktG) as well as

additional rules of exchanges
■ Unlimited lifetime (no maturity date)
■ May receive part of firm’s profit as dividend (paid usually once a year)
■ Allows separation of ownership and control
■ Shareholders have voting rights in annual meeting
■ Types of shares
■ Definition: with notional amount (Nennwertaktie) or without
notional (Stückaktien)
■ Tradability: bearer share (Inhaberaktie) or registered share
(Namensaktie) potentially with restricted transferability
(vinkuliert)
■ Voting rights: ordinary share (Stammaktie) or preferred share
(Vorzugsaktie)
■ Purchase warrant (Bezugsrecht) for new shares in capital increase
Stocks
■ Regulated in Germany by the Aktiengesetz (AktG) as well as

additional rules of exchanges
■ Unlimited lifetime (no maturity date)
■ May receive part of firm’s profit as dividend (paid usually once a
year)
■ Allows separation of ownership and control
■ Shareholders have voting rights in annual meeting
■ Types of shares
■ Definition: with notional amount (Nennwertaktie) or
without
notional (Stückaktien)
■ Tradability: bearer share (Inhaberaktie) or registered share
(Namensaktie) potentially with restricted transferability
(vinkuliert)
■ Voting rights: ordinary share (Stammaktie) or preferred share
(Vorzugsaktie)
■ Purchase
Principles of Corporate warrant (Bezugsrecht)
Finance – winter for
semester 2022-23 new shares in capital increase Page 30
Debt and bonds
Typical properties
■ Fixed maturity (Fälligkeit) date and lifetime
■ Notional amount (Nennwert) which has to be paid back at maturity
■ Interest payments (Zinsen), which are called coupon in case of an
exchange traded bond
■ No voting right in general assembly, but information rights
■ Protective covenants might restrict managers’ decisions
■ Cash flow priority always higher than equity
■ Different types of seniority (Rangfolge): senior debt has to be repaid
before subordinated (or junior) debt
■ Might be secured by collateral (Kreditsicherheiten)

Overview of financing instruments
Key properties of financing instruments
High
Control
rights
Low
Low High
Cash flow priority

Overview of financing instruments
Key properties of financing instruments
High
Control
rights
Low
Low High
Cash flow priority

Law of one price
Important concepts:
Valuation principle, arbitrage (free lunch, free lottery), law of one price,
perfect market, (uncovered/covered) short sale
Readings:
Berk/DeMarzo chapters 3.4 und 3.5

Competitive markets
Valuation principle
■ Value of real or financial asset for corporation is determined by its
price in competitive markets
■ Competitive market prices are based on supply and demand
■ Value of asset does not depend on subjective views or preferences of
decision maker
■ Hence, benefits and costs of a decision should be judged based on
competitive market prices
■ If value of resulting cash inflows exceeds value of cash outflows, then
decision increases market value of corporation

Price differences
Example
■ At the Frankfurt stock exchange, the price of the Daimler AG common
stock is 76.5 Euros
■ At the same time, the Daimler AG common stock trades at the stock
exchange at a price of 74 Euros
■ How could you take advantage of this price difference? Under which
conditions is it possible?

Price differences
Example
■ At the Frankfurt stock exchange, the price of the Daimler AG
common stock is 76.5 Euros
■ At the same time, the Daimler AG common stock trades at the stock
exchange at a price of 74 Euros
■ How could you take advantage of this price difference? Under
which conditions is it possible?

Arbitrage
Generalization
■ Trading strategy to take advantage of price differences of equivalent
goods (i.e. with exactly identical cash flows) is called arbitrage
■ Properties of arbitrage
■ Risk-free profit
■ Zero cost
■ Two archetypes
■ Free lunch: profit is achieved immediately without any obligation
in the future
■ Free lottery: zero cost strategy that has positive probability of
future profit, but zero probability of loss
■ Law of one price (Gesetz des einheitlichen Preises): if the market is
free of arbitrage, then equivalent goods or financial products must
have the same price today

Arbitrage
Example
■ In November 2020, the price of 1 ton of coal in Richards Bay (export
harbor in South Africa) was 63 US Dollar and in Amsterdam (most
important import harbor in Europe) was 51 US Dollar
■ Is this an arbitrage opportunity? How much profit could be made?

Arbitrage
Example
■ In November 2020, the price of 1 ton of coal in Richards Bay
(export harbor in South Africa) was 63 US Dollar and in Amsterdam
(most important import harbor in Europe) was 51 US Dollar
■ Is this an arbitrage opportunity? How much profit could be made?

Perfect market
■ Simplified framework for analysis: perfect (or frictionless) market

■ No taxes
■ No transaction cost
■ Symmetric information
■ All market participants are price takes
■ Violations of perfect market assumptions in real word may make
arbitrage more difficult or prevent it altogether
■ Careful
■ Perfect market is not automatically free of arbitrage
■ Perfect market is not the same as efficient market
■ In the following, we generally assume that markets are perfect (if not
explicitly stated otherwise)

Arbitrage
Example
■ Bank offers following financial products with maturity in 1 year
■ Investment of 952 Euros today for repayment of 1000 Euros
■ Loan of 952 Euros today with repayment of 1000 Euros
■ Exchange traded risk-free bond promises repayment of 1000 Euros
after 1 year
■ Is there an arbitrage opportunity if the bond trades at 940 Euros?

Arbitrage
Example
■ Bank offers following financial products with maturity in 1 year
■ Investment of 952 Euros today for repayment of 1000 Euros
■ Loan of 952 Euros today with repayment of 1000 Euros
■ Exchange traded risk-free bond promises repayment of 1000
Euros
after 1 year
■ Is there an arbitrage opportunity if the bond trades at 940 Euros?

Arbitrage
Example continued
■ Is there an arbitrage opportunity given the bond trades at 960 Euros?
Compute the profit and identify potential problems.
■ Application of law of one price

Arbitrage
Example continued
■ Is there an arbitrage opportunity given the bond trades at 960
Euros? Compute the profit and identify potential problems.

Short sales
■ Short sales (Leerverkauf) allows making profits when prices are

falling
■ Uncovered short sales
■ Sale of security without owning it
■ Before security is delivered to buyer, it has to be bought back
■ Works only for very short time periods (intraday) and might be
legally restricted
■ Covered short sale
■ Before selling, security is borrowed from someone for small fee
■ At the end of borrowing period, security must be bought back
and returned to lender
■ Short sales typically have to be reported to regulatory authority
■ Cash flow of buying security (long position) is identical in terms of
magnitude to cash flow of selling security (short position) but with
opposite signs
Short sales
■ Short sales (Leerverkauf) allows making profits when prices are falling
■ Uncovered short sales
■ Sale of security without owning it
■ Before security is delivered to buyer, it has to be bought back
■ Works only for very short time periods (intraday) and might be
legally restricted
■ Covered short sale
■ Before selling, security is borrowed from someone for small fee
■ At the end of borrowing period, security must be bought back
and
returned to lender
■ Short sales typically have to be reported to regulatory authority
■ Cash flow of buying security (long position) is identical in terms of
magnitude to cash flow of selling security (short position) but with
opposite signs

Arbitrage
Discussion: Are financial markets free of arbitrage?

Arbitrage
Discussion: Are financial markets free of

arbitrage?

Time value of money
Important concepts:
cash flows, time value of money, interest (or discount) rate, compounding
and terminal value, discounting and present value, net present value,
perpetuity, Gordon’s growth formula
Readings:
Berk/DeMarzo chapters 3 and 4

Cash flows
■ Projects (or more general: investments) are characterized by their

cash flows
■ Only those cash flows are relevant for the purpose of valuation
(caution: not the same as accounting income and expense)
■ Cash flows have three properties
■ Amount (positive means inflow, negative means outflow)
■ Point in time (measured in years, is today)
■ Risk
■ Timeline with points in time
𝑡=0 𝑡=1 𝑡=2 𝑡=3
Time
𝑋0 𝑋1 𝑋2 𝑋3
■ Time period is interval between two points in time

Cash flows
Example
■ Two investments with same price have following repayments
𝑡=1 𝑡=2 𝑡=3
Time
5000 5000 5000
Investment 1: 16000
Investment 2:
■ Discussion: For which investment did you decide? Why?

Reinvestment of 500 euros after ½ year
Investment 1 percieved to be les visble
Sum of all cash flows bigger with investments 2
Flexibility when do i need money???

Time value of money
■ Time value of money

■ If money is not required today, it can be invested and earn
interest
■ If money is required today, it can be borrowed in exchange for
paying interest
■ Difference between money today and money in the future is
called time value of money
■ Interest rate is exchange rate over time
■ Assumption of full certainty (i.e. no risk)
■ All cash flows are known today
■ In this chapter: only consideration of time, risk comes later
■ Consequence: risk-free interest rate
■ Further simplification: interest rate is the same for all maturities and
also the same for investing and borrowing

Future value
Example
■ Put 100 Euro in bank account
■ Interest rate of 5% p.a. (per annum) paid at year end
𝑡=0 𝑡=1
Time
100
?
■ How100 *5% = 105 EUR

much money is in the bank account after 1 year?

Future value
Example
■ Again, put 100 Euro in bank account
■ Interest rate of 5% p.a. paid at year end
𝑡=0 𝑡=1 𝑡=2
Time
100
?
100*5% + 105*5%=110,25 EUR

■ How much money is in the bank account after 2 years?
100 + 2.5 + 0.25 = 100* (1+5%)^2

Future value
Generalization
■ Future value (Endwert) of Euro investment after years
■ Computation is called compounding (Aufzinsen)

■ Important assumption: received interest is not paid out, but also earn
interest, which is called compound interest (Zinseszins)
■ Careful: accumulated interest over years is not equal to

Future value
Future value of 1 Euro investment after years with

18
Initial capital
16
Interest on initial capital
14
Compound interest
12
10
8
6
4
2
0
Time in years

Present value
Example
■ Amount of 100 Euro is required in 3 years
■ Bank account with interest rate of 5% p.a. paid at year end
𝑡=0 𝑡=1 𝑡=2 𝑡=3
Time
100
?
100
■ (1+5%)^3
How much money needs to be put in bank account today?

Present value
Generalization
■ Present value (Barwert) of Euro, which are paid in years
■ Computation is called discounting (Abzinsen oder Diskontierung)

■ Thus, interest rate is often referred to as discount rate
■ The term is called discount factor for year

Present value
Discount factors for 1 Euro payment at time with
1.0
0.8
0.6
0.4
0.2
0.0
0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30
Time in years

Present value of multiple cash flows
Example with multiple payments

■ Interest rate of 10% p.a.
■ Project with three cash flows
𝑡=0 𝑡=1 𝑡=2 𝑡=3
Time
120 180 240
Pedir foto a ine

■ Sum of present values of individual payments

Present value of multiple cash flows
Generalization
■ Present value of all future cash flows of a project or investment
■ Important: cash flows shall only be added after they have been
discounted to the same point in time

Net present value
Explains if you should or not make an investment
Extension
■ Net present value (Nettobarwert oder Kapitalwert) is present value of
all cash flows including today (i.e. )
■ Reminder:
■ Cash flows can be positive (i.e. cash inflow) and/or negative (cash
outflow)
■ Typically, cash flow in is negative, i.e. , which can be interpreted as
the cost of undertaking a project

Decision rule
Example
■ Interest rate of 10% p.a. (per annum)
■ Financial security with two payments
𝑡=0 𝑡=1 𝑡=2
Time
110 121
■ Compute the present value first. Would you be willing to buy the
financial product
110 / 1.1 + 121 at the market
/ 1.1^2 = 200 price of 205 Euros?
Buy a 205 End at 200 = LOSS OF 5

Decision rule
Example continued
■ Suppose a bank account is available offering the same interest rate.
■ How could one get the same cash flows as the security using the
bank account? How much money needs to be invested in?
1) Invest 100 euros for 1 year receiving 110 euros in T1
2) Invest 100 euros for 2 years (1+10%)^2 gerring 121 euros T2
3) Arbirtage strategy by short-selling the financial porfit of 205-200= 5

today

Decision rule
Generalization
■ Interpretation of : immediate change of wealth inwhen project or
financial investment us undertaken
■ Rule for decisions
■ : reject investment
■ : indifferent
■ : undertake investment

Special formulas
Perpetuity or perpetual rent (ewige Rente)

■ Infinite annual payment of constant amount starting in one year from
now, i.e. at
■ Timeline
𝑡 =0 𝑡 =1 𝑡 =2 𝑡
Time
0 𝑋 𝑋 𝑋
■ Present value at time
■ Caution: What happens when

Special formulas
Application of perpetuity
■ Present value of infinite annual payment of 100 Euros which starts in
1 year when the applicable interest rate is 5%
100/ 0.05 = 2000
■ Present value of infinite annual payment of 100 Euros which starts in

6 years from now when the applicable interest rate is 5%
PV 5= 2000/ (1+5%)^5 = 1567.07

Special formulas
Gordon‘s growth formula

■ Infinite annual payment which grows at constant growth rate every
year starting with amount in year
■ Timeline
𝑡 =0 𝑡 =1 𝑡 =2 𝑡 =3 𝑡
Zeit
0 𝑋 𝑋 (1+ 𝑔) 𝑋 (1+ 𝑔)2 𝑋 (1+ 𝑔)𝑡 −1
■ Present value at time
■ Caution: What happens when or ?

Special formulas
Application of growth formula

■ Cash flow in first year and interest rate
■ Case 1:
■ Case 2:

Risk and return
Important concepts:
Return, historical return, arithmetic and geometric average return, return
triangle, uncertainty and risk, expected return, risk preferences, risk
premium
Readings:
Berk/DeMarzo chapter 3 appendix and chapter 10

Returns
Definition
■ Value at time
𝑡=0 𝑡=1 𝑡=2
Time
𝑉0 𝑉1 𝑉2
■ Return (Rendite) is percentage change in value between two arbitrary

points in time and
■ Typically, returns are expressed per year

■ The start date is often omitted for annual returns, i.e. and are
denoting the returns in the first and second year, respectively
■ Interest rates and discount rates (as well as cost of capital) are
special forms of returns
Returns
Example
■ German stock market index DAX at year end
2016 2017 2018 2019
Index value 11,481.06 12,917.64 10,558.96 13,249.01
Return
■ Compute the annual returns

■ Return of 3-year investment from year end 2016 until year end 2019

Average returns
Example continued
■ What is the average return, when repeatedly investing same amount
of money every year and selling at the end of the year (i.e. three
investments with holding period of 1 year)?
■ What is the average return per year, when you invest once at the end
of 2016 and sell after 3 years (i.e. holding period of 3 years)?

Average returns
Computing averages of historical returns

■ Historical return shows development of value or price in the past
(backward looking perspective)
■ Arithmetic average: annualized average return of trading strategy with
holding period of 1 year, which is repeated with equal invested
amount each year over years
■ Geometric average: annualized average return of trading strategy,

which invests once with holding period of years

Average returns

Uncertainty and risk
Definition
■ So far: assumption that all payments are made with certainty
■ Certainty (Sicherheit): there is only one possible outcome for the
future cash flow and we know its amount and point in time
■ Uncertainty (Unsicherheit): there are multiple possible outcomes for a
promised payment
■ Risk: the following pieces of information are known
■ All possible scenarios (or states)
■ Cash flow consequences in each scenario (outcomes)
■ Probability of each scenario
■ Ambiguity: at least one of the three above pieces elements of
risk are unknown

Risk
Key sources of risk (not exhaustive)

■ Economic risks
■ General economic trends
■ Industry trends (e.g. because of technological change)
■ Political and regulatory risk
■ Market risk
■ Price risk
■ Interest rate risk
■ Liquidity risk: securities or assets cannot be sold any time or only
at price discount
■ Firm specific risk
■ Insolvency risk
■ Operative risk
■ Disasters and accidents
Risk
Example
Cash flow after 1 year
Market
price today
Recession Growth
Risk-free bond 1057.7 1100 1100
Stock market 1000 800 1400
■ Economic development can be regarded as random variable

■ Risk-free assets (e.g. government bonds) have identical, certain cash
flows in each possible scenario
■ Risky assets (e.g. stock market) have different cash flows in each
possible scenario
■ For simplicity, each scenario has probability 50%
Expected returns
Example continued
■ Expected payoff and return of risk-free bond
■ Expected payoff and return of stock market

Expected returns
Definition
■ Expected returns are showing today‘s information about possible
developments in the future (forward looking perspective)
■ Computation of expected returns
■ Probability weighted average of returns in each future scenario
■ Expected change in value

Risk preferences
Example
■ Compare two alternatives with identical expected value
■ Sure payment of 300 Euros
■ Risky payment (lottery) with probability 50% of each outcome
(e.g.coin toss)
500 Euro
100 Euro
■ Cash flows occur immediately, i.e. time value of money negligible

■ For simplicity, assume price of both alternatives identical and already
paid (i.e. sunk costs)
■ Choose between the two alternatives. Which one do you prefer?
Risk preferences
Definition
■ Risk preferences
■ Risk-averse: preference for certain payment
■ Risk-neutral: indifferent between both alternatives
■ Risk-seeking: preference for risky lottery
■ Typical observations
■ Participants of lottery or gambling are typically risk-seeking
■ For low amounts at stake, individuals are close to risk-neutral
■ For large amounts of money at stake, individuals typically tend to
be more risk-averse
■ Aggregate capital market is unanimously considered to be risk-
averse

Risk premia
Definition
■ If investors are risk-averse, prices of risky assets have to be lower
than prices of risk-free assets with identical expected cash flows
■ Consequence: risk-averse investors demand higher expected returns
compared to risk-neutral investors (due to inverse relationship
between price and expected return)
■ Expected return of risk-free asset is called risk-free rate
(identical to expected return demanded by risk-neutral investors)
■ Difference between return of risky asset and risk-free rate is
called risk premium

Risk premia
Example continued
■ Both economic scenarios have equal probability
Market
price today
Recession Growth
Risk-free bond 1 769.2 800 800
Security A 0 600
Stock market 1000.0 800 1400
Security B 600 0
Risk-free bond 2 1346.2 1400 1400

Risk premia
Example continued
■ Apply the law of one price to compute the missing security prices
■ Security A
■ Security B

Risk premia
Example continued
■ Determine the risk premia of both securities and find an economic
explanation
■ Security A
■ Security B

Historical returns and risk premia
Histogram of annual return in the US from 1926 until 2014

1-month treasury bills
AAA rated corporate bonds
S&P 500 (large stocks)
Small stocks
3.5%
Frequency (number of years)
6.5%
12.0%
18.8%
Annual return

Historical returns and risk premia
Definition
■ Risk premium of aggregate stock market is called market risk
premium
■ Estimation of market risk premium using historical excess returns of

stock market index S&P500 over US treasury bonds
Holding period Estimation period
1926-2015 1965-2015
1 year 7.7% 5.0%
10 years 5.9% 3.9%

Present value and risk
Generalization
■ Formula for computation of present value still valid
■ For we must use expected cash flows

■ Discount rate must be adjusted with appropriate risk premium, which
is linked to the riskiness of the cash flow
■ Risk-free rate is only applicable as discount rate in one of the
following cases
■ Cash flows are certain (independent of risk preferences)
■ Investors are risk-neutral (independent of cash flow risk)

Portfolios
Important concepts:
Portfolio, portfolio value and return, portfolio weight, diversification
Readings:

Portfolio
Definitions
■ Collection or basket of (usually tradeable) assets is called portfolio
■ Portfolios are typically booked in brokerage account (Depot)
■ Brokers are financial intermediaries who pass on their customer‘s
orders to exchanges or other traders
■ Mutual fund (Fonds) is portfolio, whose management has been
delegated to professional fund manager
■ Stock market index tracks development of reference portfolio, which
is constructed according to specific set of rules (e.g. German stock
market index DAX tracks developments of 40 largest exchange
traded German companies)

Portfolio
Example
■ Portfolio of 50 stocks of company A and 125 stocks of company B
■ Computation of portfolio value and return
day stock A stock B portfolio value portfolio return
0 57.5 37.0
1 53.0 42.6
2 49.5 44.0
3 51.0 49.0

Portfolio value
Notation
■ Portfolio constituents
■ Number of asset
■ Value of asset at time
■ Value additivity: portfolio value is sum of the values of its components

Portfolio return
Example continued with alternative

■ Computation of returns of stocks A and B from first day until final day
■ Computation of portfolio return from individual stocks‘ returns

Portfolio return
Notation
■ Portfolio weight is relative share of value attributed to particular asset
■ Timeline with two arbitrary points in time
𝑠 𝑡
Time
■ Computation of portfolio weight at initial point in time for asset
■ Sum of all portfolio weights at any point in time

Portfolio return
Two alternative ways to get portfolio return

■ Computation from portfolio value
■ Computation from individual assets‘ returns
Where denotes return of individual asset between initial time until

final point in time

Portfolio return
Example continued
■ Verification of alternative approach to compute portfolio return
returns portfolio weights
day stock A stock B stock A stock B portfolio return
0 38.33% 61.67%
1 -7.83% 15.14% 33.23% 66.77%
2 -6.60% 3.29% 31.03% 68.97%
3 3.03% 11.36% 29.39% 70.61%

Portfolio risk
Example
■ Equal weighted portfolio of two risky securities
■ Four equally likely scenarios
■ Computation of portfolio return and expected return
scenarios
expected
1 2 3 4 return
Stock A -3% +3% +5% +11%
Stock B 3% +11% -3% +5%
Portfolio

Portfolio risk
Example continued
■ Graphical illustration of returns in each scenario
Stock A
Portfolio
Stock B
-10% -5% 0 +5% +10% +15%

Portfolio risk
Generalization
■ Dispersion of returns across scenarios (e.g. difference between
highest and lowest return) is intuitive measure of risk
■ Combination of many different assets can reduce dispersion of
portfolio return and thus risk
■ Risk reduction through portfolio construction called diversification
■ Diversification works best, when
■ Number of different assets in portfolio is large
■ Assets are unrelated or even negatively related to each other
■ However, portfolio risk may also increase in some instances, e.g.
through borrowing

Capital budgeting
Important concepts
Net present value rule, separation of decisions about consumption and
investment, internal rate of return, amortization
Readings:

Net present value
Decision rule
■ Interpretation of : Change of wealth inwhen investment is undertaken
■ Optimal decision
■ Single Project: invest only if
■ Multiple mutually exclusive projects: selection of project with
highest net present value
■ There is no better decision rule in perfect capital market (i.e. any
further information is redundant)
■ Critical question: Should the individual preferences of the individual,
who considers the investment, matter for the optimal decision?

Separation of decisions
Example
■ Available cash of 150
■ Exclusive project
𝑡=0 𝑡=1
Time
−100 +150
■ Bank interest rate for borrowing and investment
■ Discount rate for project is also
■ Possible actions (can be combined)
■ Undertake project
■ Put money in bank account
■ Borrow from bank (condition: needs to be repaid in )
■ Spend money for consumption
Consumption versus investment

■ How can you maximize consumption in ?
■ How can you maximize consumption in ?

Consumption versus investment

■ Result: Doing project is beneficial in both cases (i.e. preference for
consumption either today or tomorrow does not matter)
■ Condition: perfect (frictionless) capital market
■ Investment decision solely based on
■ Capital market (here represented by bank) makes it feasible to
shift consumption over time
■ Another alternative: undertake project and sell it on to someone
else already in (in this example, fair price is equal to present
value of )
■ Consequence: perfect capital market allows for separation of
decisions about consumption and investment (Fisher separation)

Internal rate of return
Definition
■ Net present value is function of discount rate
■ Internal rate of return (Interner Zinsfuß) is the discount rate which
makes the net present value become zero, i.e.
■ Mathematically: root of net present value function

■ Interpretation: is expected return of project
■ Optimal decision
■ Invest into project, when internal rate of return is higher than
comparable capital market return
■ Careful: Decisions based on returns often problematic

Example
■ Initial cost of 250 million Euro
■ Forecasted regular income of 35 million Euro per year
■ Simplification: infinite time horizon
■ Appropriate market based discount rate of
■ Net present value and internal rate of return

Net present value function
500
400
300
200
100
0
5% 10% 15% 20% 25% 30%
-100
-200

Additional example
Project
A +1000 -500 -500 -500 0
B +550 -500 -500 -500 +1000
C +750 -500 -500 -500 +1000
■ Discount rate
■ Which projects are worthwhile if decision solely based on internal rate
of return?
■ Graphical solution (see next page)

Net present value as function of discount rate
300
200
100
0
0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50%
-100
-200 A B C
-300

Results and issues

Project
■ Decision rule not applicable for projects, when cash inflows occur in
time before cash outflows
■ Net present value function may have multiple roots, e.g. when stream
of cash flows changes sign more than once
■ Extreme case: net present value function may not have any root, i.e.
project is either optiomal or not independent of discount rate

Amortization
Definition
■ Answer to question: When have we recouped the initial cost of
investment?
■ Payback period: Time period which is necessary to pay back the
initial cost of investment (or price of financial asset)
■ Typical decision rules
■ When comparing two projects, the one with the shortest payback
period is best
■ Provide limit of maximally allowed payback period as addition to
standard present value rule

Amortization
Example
Payback period
A -5 +8
B -5 +4 +100
C -5 +4 0 +100,000
■ Criticism

Mutually exclusive investments
Example
■ You consider renting out an empty store and start your own business
■ Four different business models are feasible (see information below,
infinite time horizon, annual growth)
Initial Income Growth Discount

cost first year Rate rate
Book store -300,000 +63,000 3% 8%
Café -400,000 +80,000 3% 8%
Music store -400,000 +104,000 0% 8%

Electronics
-400,000 +100,000 3% 11%
store

Result
(in Thousands) Internal rate of return
Book store
Café
Music store
Electronics
store

■ Derivation of internal rate of return in Gordon‘s growth model
■ Problem: Internal rate does not account for differences in

Capital structure
Important concepts:
Capital structure, leverage ratio and debt ratio, corporate actions, cash
flows with bankruptcy, cost of capital, cost of equity and debt, company
cost of capital, leverage effect, assumptions and result of Modigliani und
Miller, optimal capital structure
Readings:
Capital structure
Definitions
■ Capital structure denotes mix of equity and debt
■ Cost of capital (Kapitalkosten) denotes risk-adjusted discount rate (as
well as expected return) of financing instruments (e.g. equity and
debt) issued by companies
■ Firm which is only financed with equity (i.e. not debt) is called
unlevered firm
■ Management can influence capital structure through corporate
actions

Notation
Abbreviation of values
■ Value of equity
■ Value of debt
■ Firm (or enterprise) value
Time
■ Point in time at which value is calculated (or cash flow occurs) is
denoted with subscript, e.g. is value of equity at time
■ Today corresponds to
■ Oftentimes, time subscript is omitted if it is clear that we refer to
today’s (present) value, e.g.

Capital structure ratios
Measurement of capital structure

■ Debt ratio (Fremdkapitalquote)
■ Equity ratio (Eigenkapitalquote)
■ Debt-to-equity ratio (Verschuldungsgrad)

Source of data
Which data source for capital structure ratios would you prefer?
■ Advantages of book values
■ Advantages of market values

Capital structure ratios
Relationship between ratios

■ Capital structure ratios are transformations of each other
■ Computation of debt ratio from debt-to-equity ratio
■ Computation of debt-to-equity ratio from debt ratio

Corporate actions
Effect of corporate actions

Action (or event) Cash D/V
Sale of corporate bond
Retirement of debt
Issuance of new shares (IPO)
Payment of dividend
Share repurchase
Stock split
Increase of share price

Corporate actions
Illustration of share repurchase (similar to dividend payment)

Cash flows in case of bankruptcy
Simplified structural model of Merton

■ Firm has only two financial instruments: shares and bonds
■ Examination of only one single period from time to
■ Value of assets at time are available to repay debt
■ Simple debt contract
■ Zero-coupon bond with nominal amount
■ Maturity at time
■ Consequence: no bankruptcy before maturity date
■ Effects of bankruptcy
■ Limited liability of equity holders
■ If nominal amount cannot be repaid in full, debt holders receive
all remaining assets instead

Example
■ Bond‘s nominal amount Mio. Euro

Graphical illustration of cash flows
𝐷𝑇 𝐸𝑇
𝐴𝑇 𝐴𝑇

Capital structure
Example
■ Risky project
Cost of
investment
Recession Growth
Project -800 900 1400
■ Risk-free rate of 5%
■ Risk premium of unlevered project (i.e. no debt) is 10%
■ Scenarios are equally likely
Capital structure
Analysis of investment opportunity

■ Ignore financing choice for the beginning
■ Present value
■ Net present value

Capital structure
Comparison of financing choices

■ Alternative A: all equity and no debt
■ Alternative B: take loan of 500 at 5% interest rate
Present
value
Recession Growth
Equity of
A 900 1400
unlevered firm
Debt 500
B
Equity of
levered firm

Capital structure
Comparison of financing choices

■ Cash flows of project are distributed according to seniority
■ Equity holders receive residual after debt has been paid back
■ Consequence of limited liability: cash flow of equity holders can
never become negative
■ If someone holds all debt and equity of levered firm B, they
receive the same cash flows as the unlevered firm A
■ Consequence: Sum of debt and equity values of levered firm B
have to be equal to equity value of unlevered firm A
■ Important: this finding only holds when some important
assumptions are met (see next page)

Capital structure
Theorem of Modigliani and Miller

■ Assumptions
■ Perfect capital market, i.e. no frictions (especially important: no
transaction cost or taxes)
■ Cash flows of project are independent of financing choice
■ Market is free of arbitrage
■ Consequence
■ Sum of equity and debt values is constant and independent of
capital structure choice (i.e. how much debt is issued)
■ Important: Value and risk of equity can vary significantly
depending capital structure choice
■ Remark: Modigliani and Miller received the Nobel (memorial) price in
economics for their research (in 1985 and 1990)

Capital structure
Illustration of Modigliani and Miller theorem
Firm with low debt ratio: Firm with high debt ratio:

Capital structure
Illustrative proof
■ Assumption: stocks of levered firm trade on exchange with market
capitalization of 550
■ Consequence: theorem of Modigliani and Miller violated
■ Idea for trading strategy
■ Replication of levered firm by buying unlevered firm’s equity and
private borrowing (homemade leverage)
■ Short-sale of stocks of levered firm
■ Requirements
■ Unlevered firm (or assets) are tradeable
■ Borrowing feasible at same rate as levered firm
■ Result: arbitrage is feasible (risik-free profit at zero cost)

Capital structure
Illustrative proof
■ Resulting cash flows from proposed trading strategy
Cash flow
today
Recession Growth
Buy stocks of
900 1400
unlevered firm A
Private borrowing
Sell shares of
levered firm B
Sum

Cost of capital
Effects on return and risk
Returns after 1 year

Expected
return
Recession Growth
Equity of
A
unlevered firm
Debt
B
Equity of
levered firm

Cost of capital
Company cost of capital

■ The value weighted average of equity and debt‘s cost of capital is
called company cost of capital
■ Company cost of capital of unlevered firm A
■ Company cost of capital of levered firm B

Cost of capital
Company cost of capital

■ Important: the following relationships only hold for market values!
■ Portfolio view (balance sheet identity): levered company can be
interpreted as portfolio of equity and debt
■ Determination of portfolio weights
■ Application of computational rules for portfolio return to obtain

company cost of capital (sometimes referred to as WACC: weighted
average cost of capital)

Cost of capital
Cost of equity derivation (leverage formula)

Cost of capital
Example continued
■ Management wants to increase debt ratio to 80%
■ Borrowing still feasible at 5% interest rate
Present
value
Recession Growth
Equity of
A 1000 900 1400
unlevered firm
Debt
C
Equity of
levered firm

Cost of capital
Effect on equity
■ Determine leverage ratio
■ Cost of equity according to leverage formula

Cost of capital
Effect on equity
■ Equity value according to present value method
■ Remark: approach when leverage ratio is unknown

Cost of capital
Analysis of cost of capital

■ Leverage formula for cost of equity
■ Case 1: no bankruptcy (e.g. little debt) or unlimited liability

■ Debt is almost risk-free
■ Cost of debt equal to risk-free interest rate:
■ Case 2: limited liability
■ Debt is risky
■ Cost of debt include risk-premium:

Cost of capital
Analysis of cost of capital (in %, , )

100
𝑟 𝐸 (no default)
EK
80 𝑟 𝐸 (limited liability)
EK
𝑟 𝐷 (limited liability)
FK
60
40
20
𝐷
0
0 1 2 3 4 5 6 7 8 9 10 𝐸

Cost of capital
Summary of key results

■ Leverage effect: cost of capital increase with leverage ratio
■ Reason: more debt increases risk of insolvency and thus also
increases the risk-premium of equity
■ Careful: This does not imply that equity is more profitable! The higher
return of equity is merely fair compensation for increased risk
■ In case of limited liability, insolvency risk is shared by equity and debt
holders, i.e. limited liability reduces risk of equity holders compared to
unlimited liability where equity holders carry full risk
■ Modigliani and Miller show (given their set of assumptions) that
company cost of capital is constant and independent of capital
structure choice

Optimal capital structure
Core question of corporate finance

■ Is there an optimal capital structure?
■ Answer of Modigliani and Miller: No!
■ How useful is this result? (Did they deserve the Nobel price for this?)

Optimal capital structure
Important factors that influence capital structure choices

(must be violations of Modigliani and Miller‘s assumptions!)
■ Issuance cost and transaction cost
■ Taxes: interest payments on debt is tax deductible (interpreted as cost
in contrast to dividends, which are profits) and thus reduce tax burden
■ Bankruptcy cost
■ Agency conflicts and asymmetric information
■ Between equity and debt holders (e.g. incentive problems arising
from limited liability of equity holders)
■ Between management and investors (classical agency conflict)
■ Between management and employees
■ Corporate strategy
■ Inefficiencies in capital market

Bank deposits
Important concepts:
Types and functions of banks, interest rates for different transactions and
accounts, deposit insurance, nominal and effective annual rate
Readings:

Banking system
Terminology
■ Types of banks
■ Central banks
■ Commercial banks
■ Investment banks
■ Banking systems
■ Universal banking system: banks may offer all services
■ Separation of commercial and investment banking (e.g. in US
through Glass-Steagall Act of 1933, repealed in 1999)
■ Three pillars of banking system in Germany
■ Private banks
■ Savings banks (Sparkassen)
■ Cooperative banks (Volks- und Raiffeisenbanken)

Banking system
Typical balance sheet of banks

Banking system
Tasks and functions of banks

■ Central banks
■ Monetary policy
■ Printing of money
■ Banking supervision
■ Surveillance of transactions
■ Commercial banks
■ Settlement of transactions
■ Taking deposits and granting loans
■ Size transformation
■ Term transformation
■ Risk transformation
■ Investment banks
■ Issuance and Trading of securities
Banking rates
Interest rates charged for different transactions and accounts

■ European central bank rates
■ Deposit facility rate (Einlagensatz)
■ Main refinancing operations rate (Hauptrefinanzierungssatz)
■ Marginal lending facility rate (Spitzenrefinanzierungssatz)
■ Rates for borrowing/lending between banks
■ Repurchase agreement (repo) rate
■ Euro Interbank offered rate (EURIBOR)
■ Rates for deposits
■ Checking account (Girokonto) rate
■ Money market account (Tagesgeldkonto) rate
■ Rates for savings account (Sparkonto) or fixed-term deposit
account (Festgeldkonto)
■ Rates for loans and credit (see next chapter)
Deposit insurance
System of deposit insurance

■ Problem of bank run: when bank is rumored to be in distress,
depositors may withdraw their funds immediately in fear of losses,
thereby worsening the problem or even causing short-term insolvency
■ Idea: give legal guarantee that losses will be reimbursed by
government (or fund created by government) to eliminate urge of
withdrawel
■ European legislation: insurance of up to 100,000 Euro per bank
account and depositor
■ Banks may jointly create additional voluntary insurance scheme (e.g.
in Germany through the association of private banks or association of
public banks)

Nominal and effective annual rate
Example
■ Account balance of 1000 Euro
■ Which of the following offerings is better?
■ Interest rate of 11.5% per year paid quarterly
■ Interest rate of 11% per year paid monthly

Calculation of bank interest

■ Banks quote interest as nominal annual rates , which does not
incorporate compound interest
■ Bank makes payments per year
■ Market convention: interest paid at each payment date is nominal rate
divided by number of payments per year, i.e.
■ Effective annual rate incorporates compound interest
■ Continuously compounded annual rate is mathematical limit of

effective rate when number of payments per year goes to infinity

Development of 1 Euro investment at nominal rate of 20%

1.25
Quarterly
1.20 Monthly
Weekly
1.15 Daily
1.10
1.05
1.00
0 30 60 90 120 150 180 210 240 270 300 330 360
Day of calendar year

Bank loans
Important concepts:
Bank loans and credit, types of repayment, repayment schedule, annuity,
present value factor of annuity
Readings:

Bank loans and credit
Terminology
■ Loan (Kredit or Darlehen): bank lends fixed amount of money to
borrower (individual or corporation) usually for fixed time-period
■ Credit (Kreditlinie): bank promises to lend money up to pre-
determined maximum limit, which can be used by borrower at any
point in time
■ Borrower has to repay the borrowed amount (Tilgung), which can be
made in different ways, and additionally has to pay interest
■ Bank sets interest rate based on
■ Borrower’s creditworthiness (Bonität)
■ Maturity of loan
■ Use of funds
■ Collateral

Types of loans
Types of repayment
■ Loan without repayment before maturity (endfälliger Kredit)
■ Constant regular interest paid per period
■ Loan is repaid in full at maturity date
■ Amortizing loan with constant repayment (Tilgungskredit)
■ Constant repayment every period determined as total amount of
borrowed money divided by number of periods
■ Interest payments decreasing over time
■ Annuity (Annuitätenkredit)
■ Constant sum of repayment and interest per period
■ Decreasing interest over time as outstanding balance decreases
■ Consequence: repayment increases over time

Types of loans
Examples of typical loans for private customers

■ Overdraft credit (Kontoüberziehungskredit) or credit card: permanent
credit line without maturity date at typically very high rates
■ Consumer loan: typically small amounts of money in form of annuity
with unrestricted use and rather short maturities, which aims at
consumers with low creditworthiness
■ Installment plan (Ratenkauf): loan granted by seller of item (e.g. TV or
mobile phone) usually in form of annuity over short time periods
■ Mortgage: long-term loan in form of annuity at rather low rates to
purchase real estate with purchased land or house as collateral (in
Germany: Grundschuld)

Repayment schedule
Example
■ Maturity years, amount , interest rate p.a.
Repayment at maturity Constant repayment per period
Residual Repay- Residual Repay-
Year Interest Interest
debt ment debt ment
0 10,000 10,000
1
2
3
4
5

Repayment schedule
Example
Constant total payment per period
Year Residual debt Annuity Interest Repayment
0 10,000
1 2,638
2 2,638
3 2,638
4 2,638
5 2,638

Repayment schedule
Example
■ Breakdown of annuity payment of per year
100%
80%
60%
Repayment
40%
Interest
20%
0%
1 2 3 4 5
Year

Annuity
Determination of constant annual payment

■ Assumption: loan amount should be equal to present value of
payments (i.e. profit margin of bank incorporate in interest payment)
■ Timeline of cash flows
Year 0 1 2 3 4 5 6 7 8 9 …
Annuity 0 0 0 0 …
■ Standard formula for present value could be applied, however difficult

to solve for many periods
■ Question: can present value be determined quicker?

Annuity
Determination of constant annual payment (continued)

■ First Idea: could formula for perpetuity be used?
Year 0 1 2 3 4 5 6 7 8 9 …
Annuity 0 0 0 0 …
Perpetuity 0 …
■ Cash flows agree for lifetime of loan (here: first 5 years)

■ Present value of perpetuity
■ Problem: perpetuity has additional payments after maturity date of

loan (here: year 6 and thereafter)
Annuity

■ Analysis of difference between perpetuity and annuity
Year 0 1 2 3 4 5 6 7 8 9 …
Annuity 0 0 0 0 …
Perpetuity 0 …
Difference 0 0 0 0 0 0 …

Annuity

■ Difference itself is perpetuity with first payment in year 6 and present
value
■ Application of law of one price: present value of annuity can be

expressed by present value of perpetuity (first payment in) minus
present value of difference term (first payment in )
■ Careful: this formula only holds for 1 payment per year

Annuity
Computation of annuity in initial example


Annuity
Multiple payments per year

■ Generalization to payments per year, i.e. total number of over whole
lifetime of loan
■ Per period interest rate for period of length
■ Resulting formula
■ Interpretation: annuity present value factor (Rentenbarwertfaktor)

gives present value of constant cash flow stream of 1 Euro over
years with number of payments per year

Annuity
Application example
■ Terms for mortgage financing: maturity years, annual nominal interest
rate of () and monthly payments
■ Annuity present value factor

Bonds
Important concepts:
Cash flows of bonds, coupon, notional, coupon bond, zero coupon bond,
term structure, no-arbitrage relationships between bonds, yield to maturity,
relationship between price and yield, par value, accrued interest, credit
risk, credit spread, probability of default, loss given default, rating
Readings:
Berk/DeMarzo chapters 6 and 11
Types of bonds
Key terminology
■ Bonds are traded loans issued by governments, municipalities,
financial institutions, corporations or international organizations
■ Government bonds (Staatsanleihen) in Germany
■ Bundeschatzanweisungen: 2 years time to maturity
■ Bundesobligationen: 5 years time to maturity
■ Bundesanleihen: 10 to 30 years time to maturity
■ Government bonds (also referred to as sovereign bonds) in the
biggest developed economies are assumed to be risk-free
■ Credit risk denotes the risk of insolvency (or default risk) of the issuer
■ Asset backed securities are bonds that have some form of collateral,
e.g. Pfandbriefe in Germany are mortgage-backed securities
■ Convertible bonds are corporate bonds, where buyer has the right to
receive new shares instead of repayment

Bond properties
Notation
■ Notional (or principal, nominal amount, face value)
■ Maturity date
■ Interest payments are called coupons
■ Coupon bonds
■ Number of coupon payments per year
■ In total coupon payments
■ Coupon rate in percent
■ Coupon payment
■ For simplicity, we consider only one payment per year, i.e.

■ Zero coupon bonds only have single payment at maturity, i.e.

Term structure
Required input data for valuation

■ Empirical observation: interest rates are not the same for different
time to maturity
■ Term structure is depiction of interest rates (y-axis in plot) depending
on time to maturity (x-axis in plot)
■ Typical patterns
■ normal (upward sloping): rates increase with time to maturity
■ flat: interest rates are constant for all maturities
■ inverse (downward sloping): rates decrease with time to maturity
■ Term premium: difference between long-term interest rates and short-
term rates
■ Interest rate for government bonds considered to be risk-free

Term structure
Term structure of German government bonds (Source: Bundesbank)
Jan. 2010 Sept. 1992 Sept. 2020

4.5 8.5 0.0
4.0 -0.1
3.5 8.0
-0.2
3.0
7.5 -0.3
2.5
-0.4
2.0
7.0 -0.5
1.5
1.0 -0.6
6.5
0.5 -0.7
0.0 6.0 -0.8
0 5 10 15 20 0 5 10 15 20 0 5 10 15 20

Term structure and present value
Extension of present value approach

■ Assumption here: all payments made with certainty
■ Interest rate for investment from time up to time denoted as
■ Present value of future cash flows

Present value of coupon bonds
Example
■ Coupon bond with 2 years time to maturity, notional of 1000 Euros
and 5.5% annual coupon rate
■ Risk-free term structure given as follows
Year
Risk-free rate per year 5% 6%
■ Present value of coupon bond

Present value of coupon bonds
Generalization
■ Remember simplification of only one coupon payment per year
■ Present value of coupon bond
■ When term structure is flat, annuity factor () can be used

Replication and arbitrage
Example continued
■ Present value of zero coupon bond with notional of 5 Euro and time to
maturity of 1 year
■ Present value of zero coupon bond with notional of 5 Euro and time to
maturity of 2 years

Example continued
■ Suppose coupon bond has price equal to 1000 Euro
■ Both zero bonds correctly trade at their present value
■ Can you find a profitable trading strategy?

Finding
■ Coupon bonds can be interpreted as portfolio of zero bonds
■ Condition: zero bonds need to be available with maturity at each
payment date of coupon bond
■ Notation: denotes price of zero bond with face value and time to
maturity of years
■ Consequence: price of coupon bond can be computed from prices of
zero bonds by applying the law of one price
■ Violation of this relationship implies an arbitrage opportunity

Yield to maturity
Example continued
■ Average annual return of coupon bond with market price of 991.33

Yield to maturity
Generalization
■ Yield to maturity is average annual return of buying bond and holding
it until maturity under the assumption that no default occurs
■ Yield to maturity is determined as single interest rate, which results in
present value equal to market price
■ Yield to maturity of zero coupon bond
■ Flat term structure: yield to maturity same for all bonds

Yield to maturity and bond prices
Price of coupon bond for given yield to maturity

(Parameters: , annual coupon, )
3500
3000
2500
2000
1500
1000
500
0
0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20%

Bond markets
Jargon of bond trading

■ Prices and par value
■ at par: price equals notional, coupon rate equals yield to maturity
■ above par: price above notional, coupon rate higher than yield to
maturity
■ below par: price below notional, coupon rate smaller than yield to
maturity
■ Accrued interest (Stückzinsen)
■ Market convention: buyer of bond pays price plus accrued
interest to seller
■ Accrued interest is next coupon payment distributed linearly over
time period since last coupon payment
■ Clean Price: price without accrued interest (as quoted)
■ Dirty Price: price plus accrued interest (as paid)
Bond markets
Prices and accrued interest over lifetime of bonds

(Assumption: flat and constant term structure with )
bond price (in percent of notional)
10% coupon rate
5% coupon rate
3% coupon rate
zero coupon bond
Year

Credit risk
Corporate bond with default risk

■ Promised repayment
■ Actual cash flows after 1 year
210 with probability 98%
50 with probability 2%
■ Investors are risk-neutral
■ Risk-free interest rate
■ Present value of corporate bond

Credit risk
Example continued
■ Expected return
■ Promised return

Credit risk
Definition
■ Credit Spread is difference between yield to maturity (promised
return) and risk-free interest rate for same maturity

Credit risk
Result
■ Even risk-neutral investors demand default premium for
compensation of possible losses in case of insolvency (in addition to
risk premium for risk aversion)
■ Key parameters determining credit risk
■ Probability of default
■ Loss given default
■ General cash flows of defaultable bond
with probability
with probability
■ Expected cash flow is

Bond ratings
■ Idea: simplified measure of credit risk comparable to school grades

■ Most well-known rating agencies
■ Moody’s
■ Standard & Poor’s
■ Fitch
■ Applications
■ Input for present value computation
■ Restrictions for institutional investors
■ Mutual funds
■ Pension funds
■ Insurance companies
■ Capital requirements for banks

Bond ratings
Moody’s S&P’s Description Grouping

Aaa AAA Prime
Aa1, Aa2, Aa3 AA+, AA, AA- High grade Investment
A1, A2, A3 A+, A, A- Upper medium grade grade
Baa1, Baa2, Baa3 BBB+, BBB, BBB- Lower medium grade

Ba1, Ba2, Ba3 BB+, BB, BB- Speculative
B1, B2, B3 B+, B, B- Highly speculative
Non-invest-
Caa1 CCC+ Substantial risks ment grade
(speculative,
Caa2 CCC Extremely speculative high yield,
junk)
Caa3, Ca CCC-, CC, C Default imminent
C D In default

Bond ratings
S&P global cumulative average default frequencies, 1981-2019, in %

Rating 1 yr 2 yrs 3 yrs 4 yrs 5 yrs 10 yrs 15 yrs
AAA 0.00 0.03 0.13 0.24 0.35 0.70 0.91
AA 0.02 0.06 0.12 0.21 0.31 0.72 1.02
A 0.05 0.14 0.23 0.35 0.47 1.24 1.89
BBB 0.16 0.45 0.78 1.17 1.58 3.32 4.69
BB 0.61 1.92 3.48 5.05 6.52 11.78 14.67
B 3.33 7.71 11.55 14.58 16.93 23.74 27.12
CCC/C 27.08 36.64 41.41 44.10 46.19 50.38 52.59
Investment 0.09 0.24 0.42 0.65 0.88 1.91 2.71
Speculative 3.61 7.00 9.93 12.31 14.26 20.22 23.28
All rated 1.48 2.89 4.13 5.17 6.04 8.80 10.32

Bond ratings
S&P worldwide default frequencies per year, 1981-2019, in %

12
Total
10 Investment
Speculative
8
0
1980 1985 1990 1995 2000 2005 2010 2015 2020

Stocks
Important concepts:
Dividend discount model, comparable company analysis, peer group,
valuation multiples, price-earnings ratio, dividend yield, market-to-book
ratio
Readings:

Stock returns
Review of definition
■ Stock or share is tradeable piece of securitized equity
■ Cash flow to shareholders: residual of profit after payments to
debtholders in form of dividend
■ Assumption of infinite lifetime (without bankruptcy)
Example
■ Stock price increases from initially 75 Euros to 97 Euros after 1 year
■ Company is paying dividend of 5 Euro at year end
■ Computation of stock return

Stock returns
Derivation
■ Expected stock return
■ Solve for today‘s stock price

Dividend discount model
■ Extension to multiple periods

Generalization
■ Share price is present value of expected future dividends
■ Resulting expression with constant discount rate
■ Cost of equity is relevant discount rate

■ Empirical estimation, e.g. from historical returns
■ Derivation of appropriate risk-premium from financial theory
■ Problem: valuation approach not applicable for companies that do not
pay dividends, e.g. because earnings are retained

Special case
■ When expected dividends are growing at constant growth rate ,
dividend discount model simplifies to
■ When share price is observed, dividend discount model can be

rearranged to estimate implied cost of equity

Example BASF
■ Dividends in Euros (grey bars, left scale) and dividend yield in percent
(red line, red scale) for fiscal years 2000 to 2021
4.0 8
3.5 7
3.0 6
2.5 5
2.0 4
1.5 3
1.0 2
0.5 1
0.0 0
0 00 00 1 00 2 003 00 4 00 5 006 00 7 008 00 9 01 0 011 01 2 013 014 01 5 016 01 7 018 019 02 0 021
2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2

Example BASF
■ Last dividend for year 2021 of 3.4 Euros (paid in March 2022)
■ Historical averages over total time period from 2000 to 2021
■ Dividend growth of 9% for full time period (average growth rate
over last 10 years only 3.1%)
■ Dividend yield of 4.1%
■ Application of dividend discount model

Valuation ratios
■ Earnings per share
■ Price-earnings ratio (Kurs-Gewinn-Verhältnis)
■ Dividend yield

Valuation ratios
■ Market capitalization
■ Market-to-book ratio

Valuation ratios
Interpretation
■ Often made statements about valuation ratios
■ If market-to-book ratio larger than 1 ist (or PE ratio high),
company is regarded as overvalued (or expensive)
■ In contrast, if market-to-book ratio smaller than 1 ist (or PE ratio
low), company is regarded as undervalued (or cheap)
■ Discussion

Comparable company analysis
Idea
■ Reminder: Law of one price says that two assets with identical stream
of cash flows (with respect to amount, time and risk) should have the
same price today
■ Empirical observation: similar assets do often have similar prices
■ Open questions
■ How to define “similar“?
■ How large is the valuation error?
■ Resulting valuation approach by comparison of valuation ratios with
comparable companies very popular in practice

Example
■ Sample of 25 firms with relevant value attribute
200
175
150
Firm value V
125
100
75
50
0 20 40 60 80 100 120 140 160 180 200
Attribute X

Example
■ Which value would you assign to a firm with attribute based on the
observed sample? Evaluate the accuracy of this valuation.
■ Which value would you assign to a firm with attribute based on the
observed sample? Evaluate the accuracy of this valuation.

Summary of findings
■ Intuitive approach like in statistics
■ Select sample of comparable firms
■ Determine relationship between attribute and firm value in
sample (e.g. linear relationship)
■ Extrapolate relationship for target firm whose value you are
interested in
■ Evaluation of accuracy
■ In-sample: dispersion within sample of observed firm values
provides hint for estimation error
■ Out-of-sample: however, actual estimation error for unobserved
target firm cannot be measured directly

Typical approach in practice

■ Select peer group of comparable companies (e.g. from same industry
or direct competitors)
■ Select relevant attribute which drives firm values
■ Annual report data: revenues, EBITDA, profits, …
■ Other ratios: Number of sold products, users, clicks, …
■ Determine firm values for peer group (e.g. market capitalization,
prices of IPOs, prices of takeovers, …)
■ Compute valuation ratio (multiple) for each firm in peer group
■ Compute average or median multiple

■ Estimate unknown firm value of target firm

Example continued
250
200
Firm value V
150
100
50
0
0 10 20 30 40 50 60 70 80 90 100
Attribute X
Example continued
■ Draw the firm values predicted by the comparable company analysis
in the plot on previous page
■ Median multiple
■ Average multuple
■ Discussion of accuracy of comparable company analysis

Link to present values

■ Simplified assumption of constant growth rate
■ Dividend per share determined as paid out earnings (with payout ratio
denoted by )
■ Application of dividend discount model

Discussion of practitioner approach

Exam information
■ Exam duration is 120 minutes

■ Permitted tools
■ Non-programmable calculator
■ Cheat sheet: one A4 size piece of paper with handwritten notes
on both sides (printouts or photocopies not permitted)
■ Formula sheet will be part of the exam (do not bring yourself)
■ Exam structure
■ Mix of verbal questions (define or explain) and calculations
■ Points indicate time (one point per minute)
■ Verbal questions need to be answered in full sentences
■ Answers to true/false questions will only get full points if
reasoning is correct (to avoid guessing)
■ Final results should be accurate to 2 decimals (i.e. round
intermediate results to 3 decimals)

Practice problems
Verbal questions
■ Provide a definition for the term “arbitrage”.
■ Explain three important differences between the rights of equity

holders and debt holders.

Practice problems
Verbal questions
■ Explain the difference between the primary capital market and the
secondary capital market.
■ Explain the difference between coupon bonds and zero bonds.

Practice problems
Are the following statements true or false? Provide an explanation

■ Preferred shares have higher voting rights than ordinary shares.
■ The geometric average annual return is always larger than the

arithmetic average annual return.

Practice problems

■ If markets are not perfect (e.g. short selling is not feasible), then the
law of one price does not hold.
■ If the law of one price holds, there are no arbitrage opportunities

Practice problems

■ The equity cost of capital increases when the firm issues a bond.
■ Limited liability increases the risk of debt holders (in comparison to

unlimited liability).

Practice problems

■ The effective interest rate is never below the nominal interest rate.
■ If interest rates are strictly positive, the prices of zero bonds will
always be below par.

Practice problem: risk and return
You observe the following market prices and cash flows. Compute the
missing prices using the law of one price.

Market
price today
Recession Growth
Government bond 1000 1050 1050
Stock market 1200 960 1560
Shares of firm A 560 1060
Bond of firm A 400 500

Solution

Assume that the probability of a recession is 25%. Compute the expected

returns of each traded security. Also, outline the relationships between the
different expected returns of these securities.
Returns in each scenario
Expected
Recession Growth return
Government bond
Stock market
Shares of firm A
Bond of firm A

Solution

Practice problem: capital structure
Consider a firm with ordinary shares worth 200 million Euros and bank
debt of 100 million Euros. Investors expect a return on the shares of 15%
per year. The bank charges an interest rate of 6% per year. Furthermore,
assume that the capital market is perfect and free of arbitrage.
■ If the firm issues 100 million Euros worth of new shares to pay back
the bank debt, what is the equity holders’ expected return afterwards?
■ Alternatively, the firm considers to raise 50 million of additional debt to
buy back shares. If the risk of debt is not changing, what is the new
equity holders’ return after the share buyback?
■ How would the result to the previous question change qualitatively if
the risk of debt actually increases? Provide an economic explanation.

Practice problem: capital structure
Solution

Practice problem: bonds
You observe the following risk-free term structure of interest rates:

Year 1 2 3
Risk-free rate per year 2% 5% 7%
■ Compute the prices of zero bonds for each year with a notional
amount of 1 Euro.
■ Compute the price of a coupon bond with a notional amount of 1000
Euros and a coupon rate of 7%.
■ Suppose the above described coupon bond trades at 1000 Euros.
Does this price provide an arbitrage opportunity? If so, describe the
trades necessary to implement the strategy.
■ Consider another coupon bond with a coupon rate of 2%. Does it
trade above or below par?

Practice problem: bonds
Solution

Indices and funds
Wichtige Konzepte:
Index, Gewichtung, Deutscher Aktienindex (DAX), Prozess der
Kaptalanlage, Investmentfonds
Literatur:
Berk/DeMarzo Kapitel 22

Indexierung
Definition
■ Idee: Schaffung einer einfachen Kennzahl, welche die Entwicklung
eines Marktsegmentes widerspiegelt (z.B. Aktienmarkt)
■ Eigenschaften
■ Bezieht sich auf ein (virtuelles) Referenzportfolio, dessen
Zusammensetzung sich im Zeitablauf ändern kann
■ Notiert in Punkten ausgehend von beliebigem Startwert
■ Veränderung des Index entspricht Rendite des
Referenzportfolios

Indexierung
Beispiel 1
■ Indexberechnung basierend auf Einzelaktie
Index ohne Index mit
Tag Aktienkurs Dividende Dividende Dividende
0 76,0 1000 1000
1 72,0
2 72,0 4,0
3 78,0
4 83,0

Indexierung
Berechnung eines Index

■ Bestimmung der Rendite des Referenzportfolios vom letztem
Berechnungszeitpunkt bis zum Zeitpunkt
■ Gewichtung der Portfoliobestandteile

■ Wertgewichtung, z.B. anhand Marktkapitalisierung
■ Preisgewichtung
■ Gleichgewichtung
■ Berücksichtigung von Dividenden
■ Performance-Index bezieht Dividenden in Rendite mit ein
■ Kursindex berücksichtigt keine Dividenden
■ Fortschreibung des Indexstands

Indexierung
Beispiel 2
■ Referenzportfolio mit vorgegebenen Gewichten
■ Austausch von Aktie B gegen Aktie C zum Zeitpunkt
Aktie A Aktie B Aktie C
Zeit Kurs Gewicht Kurs Gewicht Kurs Gewicht
0 50,2 65% 77,0 35%
55,7 63,3
1
55,7 50% 433,5 50%
2 57,2 523,1

Indexierung
Fortsetzung Beispiel 2
■ Startwert für Index von 1000 in
■ Berechnung Rendite Referenzportfolio und Indexstand für
■ Berechnung Rendite Referenzportfolio und Indexstand für

Deutscher Aktienindex DAX
Referenzportfolio
■ Beinhaltet die 40 größten Unternehmen, welche an der Frankfurter
Wertpapierbörse notiert sind
■ Auswahl der Aktien nach Marktkapitalisierung und Börsenumsatz
■ Weitere Kriterien
■ Unternehmenssitz in Deutschland
■ Streubesitz von mindestens 10%
■ Mindestens 2 Jahre mit positivem EBITDA
■ Pünktliche quartalsweise Finanzberichterstattung
■ Notierung im Börsensegment „Prime Standard“ und
kontinuierlicher Handel über „Xetra“ für mindestens 30 Tage

Deutscher Aktienindex DAX
Berechnungsweise
■ Startwert von 1.000 am 30.12.1987
■ Jährliche Überprüfung der Zusammensetzung (mit Ausnahmen)
jeweils im September
■ Quartalsweise Neuberechnung der Portfoliogewichte
■ Gewichtung der Einzelaktien
■ Marktkapitalisierung als Gewicht
■ Nur Aktien in Streubesitz (nicht von dominierenden Aktionären
gehaltene Aktien)
■ Obergrenze von 10%
■ Üblicherweise Angabe als Performance-Index (aber auch weitere
Version als Kursindex verfügbar)
■ Berechnung während des Handels im Zeitintervall von 1 Sekunde

Weitere bekannte Indizes
Aktienindizes
■ Dow Jones Industrial Average: preisgewichteter Index der 30 größten
Aktien in den USA
■ S&P500: wertgewichteter Index der 500 größten börsennotierten
Unternehmen in den USA
■ Euro Stoxx 50: wertgewichteter Index der 50 größten in Euro
notierenden Aktien
■ Weitere: FTSE 100 (Großbritannien), CAC 40 (Frankreich), SMI
(Schweiz), ATX (Österreich), ISE 100 (Türkei), Nikkei 225 (Japan)
Andere Anlageklassen
■ Deutscher Rentenindex REX: Deutsche Staatsanleihen
■ S&P GSCI (früher: Goldman Sachs Commodity Index)

Portfoliomanagement
Prozess der Kapitalanlage

■ Festlegung der Rahmenbedingungen
■ Anlagehorizont
■ Risiko und Diversifikation
■ Verteilung des Kapitals auf Anlageklassen (Allokation)
■ Bargeld
■ Anleihen
■ Aktien
■ Sonstige (z.B. Rohstoffe, Währungen)
■ Auswahl der Investments in der jeweiligen Anlageklasse
■ Direktanlage
■ Investmentfonds
■ Umsetzung in Form einer Einmalanlage oder eines Sparplans

Investmentfonds
Anlageform Investmentfonds
■ Investmentfonds ist gemanagtes Portfolio für mehrere Anleger
■ Rechtliche Grundlage: Kapitalanlagegesetzbuch (KAGB)
■ Anleger erwerben Anteile an Sondervermögen, welches durch
Kapitalverwaltungsgesellschaft verwaltet wird
■ Anlagebedingungen: vorgegebene Benchmark-Strategie
■ Aktives Management: Fonds-Manager darf (in vorgegebenem
Rahmen) eigene Entscheidungen treffen
■ Passive Strategie: automatisierte Umsetzung
■ Dachfonds: investiert in weitere Fonds
■ Für Fondsanteile wird regelmäßig Wert errechnet, zu dem Anteile
i.d.R. täglich handelbar sind
■ Sonderform der Börsennotierung (exchange traded fund ETF)

Investmentfonds
Gebührenstruktur
■ Bei Kauf und Verkauf
■ Transaktionskosten
■ Vertriebsprovision als Ausgabeaufschlag (bis zu 5% bei
klassischen Fonds)
■ (Versteckte) laufende Kosten
■ Depotgebühren
■ Fixe Management Gebühr (zwischen 1% und 2% pro Jahr bei
klassischen Fonds und weniger als 0,5% bei ETF)
■ Erfolgsabhängige Management Gebühr
■ Handelskosten des Fonds
■ Kosten werden direkt vom verwalteten Vermögen abgezogen

Investmentfonds
Beispiel
■ Anlagebetrag von 10.000 Euro
■ Zwei Alternativen mit DAX als Benchmark
■ ETF mit 1% Transaktionskosten und 0,5% Gebühr pro Jahr
■ Aktiver Fonds mit 5% Ausgabeaufschlag und 1,5% Gebühr p.a.
■ Erwartete Rendite des DAX von 8% pro Jahr
■ Vergleich erwartetes Vermögen nach 20 Jahren

Derivatives
Konzepte:
Literatur: Berk/DeMarzo Kapitel 22

Derivate
Definitionen
■ Bei Geschäften im Kassamarkt erfolgen Vereinbarung, Zahlung und
Erfüllung zum selben Zeitpunkt (sofort)
■ Im Terminmarkt liegen Zeitpunkt der Vereinbarung (sofort) und
Erfüllung sowie Zahlung (in der Zukunft) auseinander
■ Finanzprodukte im Terminmarkt werden auch Derivate genannt, da
sich ihr Wert von den Preisen eines sogenannten Basiswertes im
Kassamarkt ableitet (oder genereller von beobachtbaren Variablen)
■ Beispiele für Basiswerte
■ Aktien oder Aktienindizes
■ Anleihen oder Zinssätze
■ Rohstoffe oder Agrarprodukte
■ Fremdwährungen
■ Wetter oder Umweltkatastrophen
Derivate
Notation und Annahmen
Bewertungs- Fälligkeits-
stichtag zeitpunkt
Zeit
~
𝑆𝑡 𝑆𝑇
■ Basiswert (z.B. Aktie)
■ Heutiger Preis im Kassamarkt
■ Zukünftiger (unbekannter) Preis
■ Basiswert kann ohne Beschränkung gekauft (Long-Position) oder
verkauft werden (Short-Position)
■ Keine Transaktionskosten oder Kosten für Wertpapierleihe
■ Investoren können sich ohne Einschränkung zum risikolosen Zinssatz
verschulden oder zu diesem Zinssatz Geld anlegen

Forwards
Forward Kontrakt (Terminkauf)

𝑡 𝑇
Zeit
Vereinbarung Lieferung des
des Preises, Basiswertes und
keine Zahlung Zahlung
■ Verpflichtende Vereinbarung zwischen zwei Parteien
■ zur Lieferung des Basiswertes
■ zum Fälligkeitszeitpunkt
■ zum Preis
■ welcher zum Zeitpunkt vereinbart wurde
■ Der Kauf eines Forward-Kontraktes wird Long-Position genannt,
während eine Short-Position dem Verkauf entspricht
■ Börsengehandelter Forward wird Futures genannt
Forwards
Beispiel
■ Forward-Geschäft über 1000 Barrel Rohöl in 1 Jahr zum Preis von
43,25 US-Dollar pro Barrel
■ Gewinn/Verlust zum Fälligkeitszeitpunkt

Forwards
Gewinn- und Verlust Diagramm
Kauf des Forwards Verkauf des Forwards
𝑆𝑇 𝑆𝑇

Forwards
Vergleich von zwei Strategien

■ Alternative 1
■ Kauf von Rohöl über Forward-Kontrakt zum Preis
■ Kein Zahlungsstrom zum Zeitpunkt
■ Alternative 2
■ Kauf von Rohöl zum Zeitpunkt im Kassamarkt zum Preis von
42,25 US-Dollar
■ Lagerung des Rohöls für 1 Jahr zum Preis von 0,57 US-Dollar
pro Barrel (Zahlung erfolgt in )
■ Finanzierung des Kaufpreises und der Lagerhaltungskosten
durch Kredit zum Zinssatz von 1%
■ Nach einem Jahr wird der Kredit zurück gezahlt

Forwards

■ Alternative 1
Forward
■ Alternative 2
Kauf im Kassamarkt
Lagerhaltung
Kredit

Forwards

■ Konsequenz für Terminpreis
■ Was wäre, wenn ein Terminpreis von beobachtet werden könnte?

Forwards
Verallgemeinerung (cost of carry Ansatz)

■ Der Terminkauf des Basiswertes kann repliziert werden durch den
Kauf und Einlagerung des Basiswertes im Kassamarkt, welcher durch
einen Kredit finanziert wird
■ Nach dem Gesetz des einen Preises müssen beide Alternativen
identische Kosten haben oder Arbitrage ist möglich
■ Allgemeine Gleichung für den Forward-Preis
■ Barwert der Lagerhaltungskosten:

■ Barwert der Dividenden/Einnahmen:
■ Anmerkung: die Zahlungsströme eine Verkaufs-Position können
ermittelt werden durch Multiplikation der Zahlungen der Kauf-Position
mit

Forwards
Wert eines Forwards

■ Wichtige Unterscheidung zwischen Preis und Wert
■ Der Forward-Preis ist der am Fälligkeitstag zu zahlende Preis,
welcher bei Vereinbarung des Forwards so festgelegt wird, dass der
Wert des Forward-Geschäftes im Vereinbarungszeitpunkt für beiden
Parteien gleich Null ist
■ Preis bleibt konstant, aber Wert kann sich im Zeitablauf ändern
■ Formel für Wertermittlung zum Zeitpunkt eines Forwards, welcher
zum Preis vereinbart wurde
■ Wenn der Forward-Preis steigt, gewinnt die Kaufposition an Wert,

während die Verkaufsposition an Wert verliert

Optionen
Kontraktbeschreibung
■ Kauf-Option (call option)
■ gibt dem Käufer das Recht (aber nicht die Pflicht)
■ den Basiswert (bis) zum Fälligkeitszeitpunkt
■ zum Basispreis von der Gegenpartei zu kaufen
■ Verkaufs-Option (put option)
■ gibt dem Käufer das Recht (aber nicht die Pflicht)
■ den Basiswert (bis) zum Fälligkeitszeitpunkt
■ zum Basispreis an die Gegenpartei zu verkaufen
■ Verkäufer von Optionen werden Stillhalter genannt
■ Optionen, welche nur am Fälligkeitszeitpunkt ausgeübt auswerden
können, werden Europäische Optionen genannt, während
Amerikanische Optionen jederzeit ausgeübt werden können

Optionen
Beispiel
Basispreis Call Put
■ EUREX Aktienoptionen
vom 17.12.2019 12,00 46,55 0,03
■ Basiswert ist Aktie der
20,00 38,58 0,10
Daimler AG
■ Aktienkurs von Daimler 30,00 28,68 0,27
betrug 58,54 Euro
40,00 19,04 0,79
■ Fälligkeitsdatum:
19.6.2021 (dritter Freitag 50,00 10,36 2,44
des Monats)
■ Typ: Amerikanisch 60,00 4,15 6,61
■ Physische Lieferung der 70,00 1,34 13,90
Aktie 2 Tage nach
Ausübung 80,00 0,41 23,02

Optionen
Beispiel
■ Sie befinden sich am Fälligkeitszeitpunkt und die Optionen wurden
bislang nicht ausgeübt
■ Für welche Aktienkurse würden Sie die Kaufoption mit Basispreis von
40 Euro ausüben? Welchen Gewinn machen Sie?
■ Wenn die Daimler Aktie zu 35,6 Euro notiert, welche Verkaufs-

optionen werden ausgeübt? Welchen Gewinn machen Sie?

Optionen
Beispiel
■ Daimler-Optionen mit Basispreis 50 Euro
■ Gewinn bei Ausübung zum Fälligkeitszeitpunkt (ohne Kaufpreise)

Optionen
Kaufoption Verkaufsoption
𝑆𝑇 𝑆𝑇

Optionen
Ausübung und Auszahlungen

■ Kaufoptionen werden nur ausgeübt, wenn der Preis des Basiswertes
oberhalb des Basispreises ist
■ Auszahlung einer Europäischen Kaufoption bei Fälligkeit
■ Verkaufsoptionen werden nur ausgeübt, wenn der Preis des

Basiswertes unterhalb des Basispreises liegt
■ Auszahlung einer Europäischen Kaufoption bei Fälligkeit

Optionen
Anlagestrategien mit Optionen

■ Annahme: Anleger befindet sich bereits im Besitz des Basiswertes
■ Covered Call: Verkauf von Call Optionen zu hohen Basispreis
■ Wenn Option nicht ausgeübt wird, so erhält man zusätzliche
Einnahme aus Optionsprämie
■ Wenn Option ausgeübt wird, so verkauft man die Aktien zu
einem hohen Kurs (Gewinnobergrenze)
■ Absicherungsgeschäft (hedge): Kauf von Put Optionen mit niedrigem
Basispreis (Absicherungsniveau)
■ Wird Option nicht ausgeübt, so verliert man die Optionsprämie
(Kosten der Absicherung)
■ Fällt der Aktienkurs, so sinkt der Wert des abgesicherten
Portfolios niemals unter Absicherungsniveau

Optionen
Covered Call Hedge
𝑆𝑇 𝑆𝑇

Derivate
Anwendungsgebiete und Nutzen

■ Risiko-Management von Unternehmen
■ Erhöhte Planungssicherheit von Landwirten durch Verkauf der
zukünftigen Produktion im Terminmarkt
■ Kauf von Energie und Treibstoff (z.B. durch Fluglinien) zur
Absicherung gegen Kursschwankungen
■ Management von Wechselkursrisiken innerhalb von international
tätigen Unternehmen
■ Absicherung von Zinsänderungsrisiken
■ Wertpapieranlage
■ Individualisierung von Anlagestrategien
■ Absicherung gegen Kursverluste oder Zinsänderungsrisiko

Derivate
Anwendungsgebiete (Fortsetzung)
■ Spekulation
■ Rein finanzieller Handel im Basiswert (z.B. Spekulation auf
Entwicklung des Ölpreises ohne physischen Besitz)
■ Typischerweise geringer oder gar kein Kapitaleinsatz ermöglicht
hohen Hebel, welcher aber mit hohem Risiko einhergeht
■ Auswirkung der Spekulation mit Derivaten umstritten
■ Vorteil: Erhöhtes Handelsvolumen
■ Nachteil: Gefahr von starken Preisschwankungen, welche
Finanzkrisen auslösen können
■ Zitat von Warren Buffett (Berkshire Hathaway, 2002): "In our view,
however, derivatives are financial weapons of mass destruction,
carrying dangers that, while now latent, are potentially lethal."

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Principles of Corporate Finance – winter semester 2022-23 Page 1

Principles of Corporate Finance

Winter semester 2022-23

Principles of Corporate Finance – winter semester 2022-23 Page 2

Time and location

Principles of Corporate Finance – winter semester 2022-23 Page 3

Materials provided on Moodle

Principles of Corporate Finance – winter semester 2022-23 Page 4

Principles of Corporate Finance – winter semester 2022-23 Page 5

Why is it important to study Finance?

Principles of Corporate Finance – winter semester 2022-23 Page 7

Why is it important to study Finance?

Financial decisions of corporations

Principles of Corporate Finance – winter semester 2022-23 Page 9

Financial decisions of corporations

Principles of Corporate Finance – winter semester 2022-23 Page 10

Financial decisions of private households

Principles of Corporate Finance – winter semester 2022-23 Page 11

Financial decisions of private households

Principles of Corporate Finance – winter semester 2022-23 Page 12

Principles of Corporate Finance – winter semester 2022-23 Page 13

■ Objective: documentation, information, payout policy

■ Objective: investment and financing decisions

Principles of Corporate Finance – winter semester 2022-23 Page 15

Principles of Corporate Finance – winter semester 2022-23 Page 16

Investments are always

Principles of Corporate Finance – winter semester 2022-23 Page 17

Principles of Corporate Finance – winter semester 2022-23 Page 18

Principles of Corporate Finance – winter semester 2022-23 Page 19

Bankruptcy code (in Germany: Deutsche Insolvenzordnung InsO)

Bankruptcy code (in Germany: Deutsche Insolvenzordnung InsO)

■ Owner and Manager are same person

Principles of Corporate Finance – winter semester 2022-23 Page 22

Principles of Corporate Finance – winter semester 2022-23 Page 23

Board of Chief Executive Officer

Controlling department Finance department

Accounting Capital budgeting

Taxation Loan department

Principles of Corporate Finance – winter semester 2022-23 Page 24

Data from Germany in 2016 (source: Bösch book)

Principles of Corporate Finance – winter semester 2022-23 Page 25

Principles of Corporate Finance – winter semester 2022-23 Page 26

Principles of Corporate Finance – winter semester 2022-23 Page 27

Advantages of going public

Advantages of private financing

Principles of Corporate Finance – winter semester 2022-23 Page 28

■ Regulated in Germany by the Aktiengesetz (AktG) as well as

■ Regulated in Germany by the Aktiengesetz (AktG) as well as

Principles of Corporate Finance – winter semester 2022-23 Page 31

Key properties of financing instruments

Principles of Corporate Finance – winter semester 2022-23 Page 32

Key properties of financing instruments

Principles of Corporate Finance – winter semester 2022-23 Page 33

Principles of Corporate Finance – winter semester 2022-23 Page 34

Principles of Corporate Finance – winter semester 2022-23 Page 35

Principles of Corporate Finance – winter semester 2022-23 Page 36

Principles of Corporate Finance – winter semester 2022-23 Page 37

Principles of Corporate Finance – winter semester 2022-23 Page 38

Principles of Corporate Finance – winter semester 2022-23 Page 39

Principles of Corporate Finance – winter semester 2022-23 Page 40

■ Simplified framework for analysis: perfect (or frictionless) market

Principles of Corporate Finance – winter semester 2022-23 Page 41

1005% + 1055%=110,25 EUR