Absence of Arbitrage Valuation (eBook)

Paskalis Glabadanidis is Senior Lecturer in Finance at the University of Adelaide.

Cover 1
Title 4
Copyright 5
Dedication 6
Contents 8
List of Figures 12
List of Tables 14
1 Asset Pricing Models 15
1.1 Future Value 15
1.2 Present Value 15
1.3 Perpetuities 16
1.4 Annuities 17
1.5 Capital Asset Pricing Model 18
1.5.1 The Case of Two Risky Securities 18
1.5.2 The Case of Multiple Risky Securities 20
1.6 Fama–French Three-Factor Model 23
1.7 Carhart Four-Factor Model 24
1.8 Arbitrage Pricing Theory 24
1.9 Macroeconomic Multifactor Models 26
Problems 26
2 Discounted Cash Flow Valuation 28
2.1 Dividend Growth Models 28
2.1.1 Single-Stage Models 28
2.1.2 Two-Stage Models 28
2.1.3 Three-Stage Models 31
2.2 Equity Free-Cash Flow 34
2.2.1 Single-Stage FCFE Model 34
2.2.2 Two-Stage FCFE Model 35
2.2.3 Three-Stage FCFE Model 36
2.3 Firm Free Cash Flow 37
2.3.1 Single-Stage FCFF Model 37
2.3.2 Two-Stage FCFF Model 38
2.3.3 Three-Stage FCFF Model 39
Problems 40
3 Relative Valuation with Equity and Value Multiples 41
3.1 Equity Multiples 41
3.1.1 Price–Dividend Ratio 41
3.1.2 Price–Earnings Ratio 42
3.1.3 Price-to-Book Ratio 43
3.1.4 Price–Sales Ratio 44
3.2 Value Multiples 44
3.2.1 Value-to-Income Ratio 45
3.2.2 Value-to-Book Ratio 45
3.2.3 Value-to-Sales Ratio 46
Problems 47
4 Financial Options 48
4.1 Equity Calls and Puts 48
4.2 Examples of Option Strategies 52
4.2.1 A Protective Put Strategy 52
4.2.2 A Straddle Example 52
4.2.3 A Butterfly Example 54
4.3 Option Valuation 56
4.3.1 Bounds on Option Values 57
4.4 Option Pricing 58
Problems 67
5 Real Options 69
5.1 Equity and Bond Pricing as Options on Assets 69
5.2 Pricing Convertible Bonds 70
5.3 Option to Wait 72
5.4 Option to Abandon 73
Problems 75
6 Fixed Income Securities 77
6.1 Bond Characteristics 77
6.2 Bond Pricing 83
6.2.1 Basics 83
6.2.2 Bond Pricing Example 85
6.2.3 Bond Prices at Different Times to Maturity and YTMs 86
6.2.4 Bond Yields 86
6.2.5 Bond Yields on Callable Bonds 87
6.2.6 Credit Risk 88
6.3 Spot and Forward Interest Rates 89
6.3.1 The Yield Curve 89
6.4 Term Structure of Interest Rates 90
6.4.1 Expectations Hypothesis 91
6.4.2 Liquidity Preference 91
6.4.3 Market Segmentation 91
6.4.4 Preferred Habitat Theories 92
6.4.5 Interpreting the Term Structure 92
6.4.6 Measuring the Term Structure 92
6.4.7 More Bonds than Time Periods 93
6.5 Fixed Income Arbitrage Strategies 93
6.6 Duration 100
6.7 Convexity 102
6.8 Bond Portfolios 105
Problems 108
7 Fixed Income Derivatives 110
7.1 Interest Rate Models 110
7.1.1 Traditional Term Structure Models 110
7.1.2 Term Structure Consistent Models 115
7.2 Binomial Term Structure Models 119
7.2.1 Pricing a Fixed-Coupon Risk-Free Bond 119
7.2.2 Pricing a Risk-Free FRN 120
7.2.3 An Interest Rate Swap 121
7.2.4 Adjustable-Rate Mortgages 121
7.2.5 Pricing an Interest Rate Cap/Caption 121
7.2.6 Pricing an Interest Rate Floor/Flotion 122
7.2.7 Pricing a Reverse Floater 124
Problems 124
8 Foreign Exchange 125
8.1 Spot and Forward Commodity Prices 125
8.1.1 Purchasing Power Parity 125
8.2 Spot and Forward Exchange Rates 126
8.2.1 Triangular Arbitrage with Bid-Ask Spread 127
8.2.2 Interest Rate Parity 127
8.3 Foreign Exchange Capital Budgeting 131
8.4 Currency Option Valuation 135
8.5 Currency Option Put–Call Parity 138
8.6 Pricing Currency Future Options 140
8.7 Currency Futures Option Put–Call Parity 141
Problems 142
9 What Next? 144
9.1 Contingent Convertible Securities 144
9.2 Longevity Swaps 146
9.3 Acts of God versus Acts of Man 147
Problems 147
Notes 149
Bibliography 151
Index 153