NBS8001

INTERNATIONAL FINANCE AND CAPITAL MARKETS

FORMULA SHEET
1.

Portfolio Theory:
Portfolios of n shares
n

rp = i =1 wi ri

Expected return

Here, wi denotes the value weight associated with the i th asset, rp denotes the
expected return of the portfolio and ri , the expected return on the i th asset.
n

2p = i =1 j =1 wi w j ij

Variance

ij denotes the covariance between assets i, j,. i2 ( ii ) is the variance of the

i th asset and 2p denotes the variance of the portfolio p. Covariance ij and

correlation ij are related by the formula ij = ij i j .

The two asset case:
rp = w1r1 + w2 r2

2p = w12 12 + w22 22 + 2 w1w2 12

2.

Security market line (CAPM)

ri = rf + rm rf i
where i = im / 2m

rm , m2 denote the expected return and variance for the market as a whole.

Systematic risk and Unsystematic risk: i2 = i2 M2 + 2i

3.

Beta for a portfolio

n

p = i =1 wi i
4.

Annuity formulae
For per annum for T years at a rate of interest of r per annum;

b ge b g j

PV = / r 1 1 + r
For per annum forever;
PV = /r

5.

Share valuation models

P0 = i =1

LM Div OP
MN b1 + r g PQ
t

P0 is the current share price, Divt is the dividend per share in year t and rE is
the expected return on equity. With no growth in dividends ( Divt = Div , a
constant), then from the annuity formula;
P0 = Div / rE
With a constant growth rate in dividends such that
Divt = Divt 1 1 + g , then

b g
P = Div / br g g = Div b1 + g g / br g g .
0

6.

Bonds and Debentures:

T

P0 + t =1

(a) Redemption Yield;

Fr

b1 + ig b1 + ig
t

=0

Here P0 is the current bond market price, F its face value, r its coupon rate of
interest, and T the redemption date. The yield is the value of i which solves
this equation (i.e. it is the internal rate of return). For an irredeemable bond,
using the annuity formula, this collapses to:
P0 + Fr / i = 0 i = Fr / P0
(b) Modified Duration: Mod_D = MD (1 + y)
T

where MD = ( PV (CFt ) t ) P
t =1

P
CF t
PV
y
MD

=
=
=
=
=

price, i.e. present market value

cash flow paid at time t (t = 1,2,3,T)
present value
yield per-period
Macaulays duration

(c) Price-Convexity formula:

dP
P

1
(convexity ).(dy ) 2
2

7.

Weighted Average Cost of Capital (excluding corporate taxes)

g b

WACC = D / V rD + E / V rE
(where V = D+E is the value of the firm, D denotes the market value of the
debt, E, the market value of the equity, rD , rE are the expected returns on debt,
equity).

firm = D / V D + E / V E
In the MM model, firm is invariant to changes in capital structure.

Note: if D = 0 (riskless debt), then firm = E / V E =

F 1 I
GH 1 + b D / E gJK

This is a -degearing formula for deriving a firm- from an observed equity when debt is riskless.

8.

Capital Structure

(a) MM Second Proposition

gb

rE = rA + D / E rA rD

rA : WACC. In the MM model, in the absence of taxes, both rA (and

rD ) are invariant to changes in capital structure.
(b)

With Corporation taxes

VL = VU + c D
where VL denotes the value of the levered firm, VU , the value of the
unlevered firm, c is the corporate tax rate. Denoting Ru as expected
return on the unlevered firm,
rE = ru + ( D / E )( ru rD )(1 c )

rA = ru (1 D V c )
(c)

With corporation tax ( c ) and personal taxes on equity income ( e )

and on debt income ( d )
VL = VU + D
where

= 1

b1 gb1 g
b1 g
c

Here is the apparent gain in value arising out of the tax shield on
debt.

(d)

In the Miller Debt and Taxes model, equilibrium in the market for debt
as a whole implies that

b1 g = b1 gb1 g
d

That is, = 0 in (c) above.

9. Options and Futures

(a) F0 = S 0 e rT or F0 = ( S 0 I )e rT or F0 = S 0 e ( r q )T
(b) Bounds: S 0 Ke rT c S 0 and Ke rT S 0 p Ke rT
(c) Put-Call Parity theorem

c + Div + Ke

rf T

= p + S0

where rf denotes the risk free rate of interest, and S0 , p, c, Div, K denote
the current share, put and call prices, Dividend and Exercise price
respectively.
(d) Black-Scholes Option Pricing Formula

c = S0 N (d1 ) Ke rT N (d 2 ); p = Ke rT N ( d 2 ) S0 N ( d1 )
d1 =

ln( S 0 / K ) + (r + 2 / 2)T

(e) Hedging

N* = P / F
N = (* - ) P / F

; d2 =

ln( S0 / K ) + (r 2 / 2)T

= d1 T