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Foundational equations or concepts of Finance

Considering this is an Economics Stack Exchange site, I’m going to answer in the spectre of Financial Economics. These are the most foundational equations and ideas of Financial Economics to ...
Übel Yildmar's user avatar
7 votes
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How can a company run out of cash when its stock prices is dropping?

It appears to me that it is the other way round: The RBS was running out of cash which is why the stock price was dropping. Stocks usually don't affect the immediate operation of a company, since ...
kratom_sandwich's user avatar
5 votes
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Why do companies sit on cash while they have debt?

Debt is cheap. Flexibility is valuable. They hold debt + cash up to the point where the value of flexibility is still greater than the net cost of servicing the debt minus any interest earnt on the ...
410 gone's user avatar
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5 votes
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Why is having a big corporation keep its money in foreign countries a bad thing in the public's eye?

Firms can always shift their profits from one tax territory to another via various methods. Consider a simplistic example, let’s say we have firm ABC that has most of its business in Sweden. The ...
1muflon1's user avatar
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4 votes

How does the Fama and French 3-factor model explain stock covariance?

There are two ways I could think of to answer this question. First, and I think this is what you are asking, "what is the covariance structure of two assets under the Fama-French 3-factor model?&...
BKay's user avatar
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4 votes
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How to justify the treatment and control groups for Difference-In-Difference with staggered implementation of laws?

[W]hy do they need to write down "adopted a leniency law at some later point of time"? Because in Korea case, the word "our sample period" means "1995-2002" already. ...
Thomas Bilach's user avatar
4 votes
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Calculating Tobin's q from the financial statements of publicly listed companies

Tobin's q is defined as the ratio between the market value of the firm over the replacement cost of its assets. If you use WRDS, you can calculate it as follows: Tobin's q = (AT + (CSHO ∗ PRCC_F) − ...
BKay's user avatar
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4 votes
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Connection assets under management and net worth

Fidelity Investments is a corporation which manages investments on behalf of clients. It does not own "its" assets under management. Those assets belong to its clients. In order to manage ...
Adam Bailey's user avatar
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4 votes
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Modigliani & Miller with taxes: how is this equation derived?

Note that with taxes, the value of the company is { the value of the company as if it had no debt } + { the value of the tax shield }: $$ V_L=V_U+T_C D; $$ here, $V_L$ is the value of a levered ...
Richard Hardy's user avatar
3 votes

How can a company run out of cash when its stock prices is dropping?

From the answer to the question How does stock market drop affect the economy if it doesn't affect the corporations? I learned that "companies still routinely issue new stocks when they are in ...
Hans-Peter Stricker's user avatar
3 votes
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Adding a non-binding constraint to the objective function

To illustrate what Tirole has done, let's consider a simpler environment. Consider a utility maximisation problem over two goods, $x$ and $y$. The consumer has utility function $u(x,y) = f(x) + y$, ...
Theoretical Economist's user avatar
3 votes
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How are shell companies used for tax evasion?

Another key feature of those shell companies is that they hide the ultimate beneficiary of the transactions. Banks, insurance companies and most financial services firm must make enquiries as part of ...
Hector's user avatar
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3 votes
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Corporate Finance Book Recommendations

frequent Corporate Finance textbooks are MBA level - Berk and de Marzo (2017) - Corporate Finance, 4th ed. (Stanford) Advanced undergrad and corp theory-specific - Grinblatt and Titman - ...
develarist's user avatar
3 votes

Risk neutral probability for each of 3 states

I cannot really follow your formulas, what is the logic behind them? Seems to me there is no way to divine three state risk-neutral probabilities from 1 financial instrument's prices. The equation $$ ...
Giskard's user avatar
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3 votes

Bankruptcy Vs default

Declaring bankruptcy is a step taken by companies to get protection from creditors. (They cannot seize collateral unilaterally, etc.) The company can still operate, within the legal framework, and ...
Brian Romanchuk's user avatar
3 votes
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Shouldn't corporate tax be calculated based on EBIT instead of EBT?

Indeed the debt tax shield is distorting. Any policy that will essentially distort prices to favor A over B will lead to too much A and too little B. So such differentials are (almost) always ...
BB King's user avatar
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3 votes
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Shouldn't big tech want to split up?

This is going to be a hard find because it is not true. These companies have increasing returns to scale over the relevant range and for the foreseeable future. Many technologies, particularly ...
RegressForward's user avatar
3 votes
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How to prove the value of a European Call Option is convex on the underlying’s price?

I know nothing about finance so please do not be too harsh. Let's sell 1 call option with underlying price $\alpha S_a + (1-\alpha) S_b$ and strike price $K$. This means that I need to pay $$ \max\{\...
tdm's user avatar
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3 votes

How to prove the value of a European Call Option is convex on the underlying’s price?

Proposition. If $f:A\rightarrow\mathbb{R}$ and $g:A\rightarrow\mathbb{R}$ are convex functions defined on convex subset $A$ of $\mathbb{R}^n$, then $\max(f,g):A\rightarrow\mathbb{R}$, defined as $\max(...
Amit's user avatar
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2 votes

How are shell companies used for tax evasion?

A shell is simply an inactive company - there is a market for shell companies because it allows ordinary persons to buy a ready to go business - for example public traded shells with a stockmarket ...
Aurigae's user avatar
  • 192
2 votes
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Free Cash Flow to the Firm

Debt service cost is felt by equity owners and debt holders but neutral to the firm. Taxation does not care for cash flow, it is levied on tax law specific accounting profit, not even reporting profit,...
user110084's user avatar
2 votes

What happens to a company whose share price goes down to very little over dividend loss?

What happens is completely dependent on the owners. They're the ones whose income has been taken anyway. They may be the only ones with the legal power to do anything (depending on the jurisdiction: ...
410 gone's user avatar
  • 8,168
2 votes

Definition of market to book value?

They are not the same. Basic accounting equation: Assets = Liability + Shareholder Equity Assets refers to what the company actually owns: cash, property, ...
Kontorus's user avatar
  • 431
2 votes
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CAPM goodness of fit

$\beta$ is the measure of the sensitivity of stock returns to market returns. This has nothing to do with the value of $R^2$. Your results appear to be fine, you can get significant beta estimates ...
london's user avatar
  • 2,010
2 votes

Where are bank loans in balance sheet?

In the link one can very clearly see that the company has no contractually short term debt, and in the short-term (i.e. in the next 12 months) has to pay part of its long term debt. Also, that the ...
Alecos Papadopoulos's user avatar
2 votes

Where to learn financial modelling concepts and skills?

When I was studying for my bachelors we learned finance from textbook Corporate Finance by Jonathan Berk. I think thats good entry into learning some basic financial analysis.
csilvia's user avatar
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2 votes

Understanding Modigliani & Miller: different graphs in different textbooks

The indicators measured on the horizontal axes are different, $D/(D+E)$ vs $D/E$. Taking this into consideration we get consistent functional forms for $R_E$, but not for $R_D$. Let $D/(D+E) = x$. ...
Giskard's user avatar
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2 votes
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Does doing nothing produce negative net present value? How can we show that?

NPV just looks at actual cashflows so NPV of doing nothing is 0. What you are thinking about is the concept of opportunity cost from economics. Every action/inaction has a cost that you need to forgo ...
1muflon1's user avatar
  • 57k
1 vote
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Interpeting equivalent annual cash flows

You're missing the distinction between costs and benefits. In your first probem you have positive NPVs and therefore the equivalent annual value is the equivalent annual cashflows that comes in. In ...
Maarten Punt's user avatar
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