Some basic question

Why is the term expected value used for the Markowitz portfolio theory ?
The reason is "Convinence and Tradition". Since the term is often used people needed a label for it instead of calling it by the conventional name of "weighted average of possible outcomes with probability as the weights".

Why do we use only mean as the measure of return and why not mode or median ?
If we have the nomral distribution, then a portfolio is mean-standard deviation efficient if and only if it is
mode-probability loss efficient
mode-standard deviation efficient
mean-probability of loss efficient
median-probability of loss efficient
median-standard deviation efficient

The questionnaire was phrased in terms of mode "most likely return" for convinece of computation mode was translated into mean, for ease of interpretation mean was translated back into mode.

Median is insensitive to changes
Mode changes far more dramatically for even small changes in returns as long as it does not effect the midpoint of the distribution.

1)A distribution can never more than one mean but it can many modes and medians.
2) The arithmetic relationship between means of securities and means of portfolios are much simpler than the corresponding relationships for modes and medians


Why do we use only standard deviation as the measure of central tendency and not any other?

excel formulas

1) eomonth = end of month is a very useful formula and returns the date at the end of the month. This function is particularly useful for project financing where payments are made after every 6 months and at the end of the month or for quarterly projections.
The function requires just two parameters 1) The date 2)Months

2) It is always advisable to name parameters that would be used through out the excel sheet so that it is easy for the user to relate to the parameters.

3) Never hard code a number more than once.

4)Always have distinct areas in an excel sheet for different things. Like for rough work have a rough section, For assumptions have a separate sheet.

5)Index function is among the most widely used functions, if you can use this function correctly then there is no use to have functions like vlookup or hlookup.

Excise duty and duty free credit entitlement

Excise duty is levied on things produced within the country.Excise duty is a part of the p&L statement of most of the construction companies.

There is sometimes another term used known as the accruals under duty free credit entitlement
It is basically an entitlement to import capital goods duty free under the duty free credit entitlement certificate route.

"The only exception to the latest standpoint would be import of agriculture, dairy products, motorcars, sports utility vehicles and all-purpose vehicles. These products and items cannot be imported under the entitlement available in the DFCEC route.

Under the DFCEC route, service providers (other than hotels) are entitled to duty-free imports equivalent to 10 per cent of the average foreign exchange earned by them in preceding three licensing years. Hotels are entitled for duty-free imports equivalent to 5 per cent of the average foreign exchange earned by them in preceding three years.
This entitlement would be available only to those service providers, who have a total foreign exchange earning of over Rs 30 lakh in the preceding one/two/three licensing years."

Share Issue expenses

Share issue expenses are adjusted against the share premium account. and are not part of the expenses in profit and loss. So, according to the double entry book keeping one entry would go to the cash flow statement i.e. Decrease the asset size and the other would be part of the balance sheet i.e. Equity and would decrease it.

Therefore since Equity decreases and asset decreases the equation
A=E+L is balanced

Distributions

It is hard to compare distributions, so we use summary statistics to simplify the task and compare the data with each other.

4 ways to characterize the distribution
1) Central Tendency
1) Arithmetic Average
2) Median (Divides the sample of data in half)
3) Most frequently observed value
2) Dispersion from center (What is the average departure from the centre)
1) Range of deviation
2) Mean absolute deviation. (Average distance from the mean)
3) Variance: Average squared distance from the mean
3) Symmetry
1)Skewness: - am i more likely to see more observations above the mean or below the mean.
4) Pointiness: Kurtosis: Does my tail look fat to you. Relative measure of the pointedness of the distribution and tails. More kurtosis means that we can expect more extreme observations than we do in the normal distribution.

Real worlds is negative skewed and excess kurtosis
These summary statistics help us get the shape and the location of the distribution

Time Value of Money

Time value of money is similar to opportunity cost. I have some money that i can invest in some project, but what is my next best opportunity. If i can see the difference, then okay but if not then search for another opportunity given the resources that you have.

Value is relative, compare with next best investment, if it does then it generates value for you.
Every instrument can be thought of as a series of cash flows. The diagram that we draw is called the time line. Divide future in periods. Give them a time subscript. you make an investment at time=0 to buy something and after that you hope to operate this or get some positive returns from the business. Forever perhaps or for a limited time period. The ideas is to figure out when cash flows occur. Using this diagram is extremely simple. Do use the time line even if the problem looks trivial. Donot hesitate to use the time line in order to note the time value of money.

We talk about two values, present value and future value.what would my cash flows be worth, if i kept investing these cash flows in the next best opportunity. Cash flows earn interest on interest as cash flows are invested year after year or period after period.

How much of the next-best investment would i buy to get these cash flows

PV and FV are additive in nature, that i can break up.

For loans
PV of payments = principal that you borrow
At any time at balance = FV of principal - FV of payments made

Interest Rates
APR (Annual Percentage Return ) is Bull shit. It is less than informative.
We need information on the following things
Time period covered by the Rate
Compounding Frequency
Rate

THree ways to quote rates or return of rates
Periodic Rate, Rp. The r that we use in FV and PV is a periodic rate. so first figure out what the periodic rate is.

Second way) Stated annual rate RA.
THird way )Very Handy tool as it is very informative = 1 year periodic rate =simple annual rate =annual rate compounded 1 per year.

(1+annual rate ) = (1+rp)^n
rp=ra/m

Why is the depreciation added back ?

The depreciation is added back as it is a non-cash expense or in other words it can be understood as follows

When the company purchases an asset, it is spending the entire amount to buy it at a single point of time, but in accounting it only takes the depreciation into account, therefore while calculating the FCFE we subtract the capex of the company and also depreciation. In order to account for that depreciation which was subtracted above add it back.

Why are other non-cash expenses like bad debts not added back

They are not added back because they are already accounted for in the working capital. Whenever we have bad debts, we treat them as expenses and reduce an equivalent amount from the accounts recievable, thereby netting the whole thing. Therefore there is no need to add back these expenses.

Working

Operating Income	20 cr
Operating expenses(Inclusive of losses due to bad debts and depreciation):	16cr
Net operating Income (EBIT)	4cr
Interest expense	50lkh
PBT	3.5cr
Tax rate	40% (Marginal tax rate)
PAT	2.1cr
Less:Changes in working capital(Current assets - current liabilities) = Debtors+Inventory-Bad debts-current liabilites)	30lk
Less:Net Capex	50lkh (Capex-depreciation)
Therefore the FCFE becomes	1.3cr

There are two things that we must note here:

• Depreciation has not been added back explicitly because, it was present in the net capex already and when we subtracted net capex deprecation was effectively added back


• The same is the case with bad debts, when we subtracted working capital changes, the bad debt effectively was added back