Session 2



Main textbook for the course : Brealey and Myers, Principles of corporate finance, McGraw-Hill


A. The practice of capital expenditure & performance evaluation

Capital budgets and projects authorizations

The criteria actually used

Problems and some solutions


Evalutating performance


The example of biases coming from ROI



B. Corporate financing and the six lessons of market efficiency

Examples of trade-offs

Always back to NPV

What is an efficient market

Efficient markets follows random walks

On average mutual funds don't do better than the market


The six lessons to remember about market efficiency :



  1. Markets have no memory : If from the past track of a security we could forecast a bit its future price everybody would do it and the price of the security would instantaneously reach that future price ; therefore at the price where a security is it is as likely next to up or down, and the mean is zero. It follows a random walk.

  2. Trust market prices : If the price of a security was too low everybody would know it and buy that security, therefore the price would go up. Same with an overvalued security. Therefore the prices of securities are fair.

  3. Security prices can tell us a lot about the future (the Viacom example) : If a firm issues a bond with an unusually high return that means it is in trouble and needs urgently money.

  4. There are no financial illusions : A stock split does not create any value. Stock prices are once in a while split only to facilitate purchases by small buyers, and for psychological reasons : to avoid too big figures.

  5. The do-it-yourself alternative : A corporation that "diversifies to reduce the risk taken by its stockholders" does not protect them any better than they could do it themselves, usually less well.

  6. Seen one stock, seen them all : If one stock was notoriously better than the others everybody would know it and its price would go up. Therefore all stocks are equivalent.

Where do positive NPVs come from ? From work and competitive advantages.

One contradiction of financial markets : when two market players exchange securities, there are no good reasons for that. (Note : Warren Buffet keeps its securities for years.)