SERVING THE QUANTITATIVE FINANCE COMMUNITY

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daveangel
Posts: 17031
Joined: October 20th, 2003, 4:05 pm

The most foolish theorem ever...

Quote Company 1:A << 0 - huge negative valueCompany 2:A > = 0 - non-negative value (zero or positive) How can A be < 0 ? A >= 0.if the Assets in company A are the same as company B then they will have the same value in the future.
knowledge comes, wisdom lingers

torontosimpleguy
Posts: 1011
Joined: July 12th, 2004, 5:51 pm

The most foolish theorem ever...

QuoteOriginally posted by: daveangelif debt has exponential nature then the asset side also has exponential nature. Assets (as earnings) can't have exponential value.Quotei dont why we have to take the argument into the future when we can with present values.Because present value is a 'convention.'QuoteHow about my CDO example ?Don't have time to analyze. Need to do smth before I leave.

torontosimpleguy
Posts: 1011
Joined: July 12th, 2004, 5:51 pm

The most foolish theorem ever...

QuoteOriginally posted by: daveangelHow can A be < 0 ? A >= 0.if the Assets in company A are the same as company B then they will have the same value in the future.It's after company A repays its huge debt. Company B has no debt.

hamster
Posts: 216
Joined: October 12th, 2008, 3:51 pm

QuoteOriginally posted by: torontosimpleguyQuoteOriginally posted by: hamsterQuoteOriginally posted by: torontosimpleguyThe point is that M&M don't talk about time horizon in debt financing.When we talk about 'infinite' time horizon then cash outflow to serve the debt will eventually exceed the cash inflow from the business activity.the going concern assumption makes life easier bcoz it allows to plug perpetual into a model. e.g. you cannot reason going concern for structured products, project financing, etc... common sense ...1. There is 'perpetual' debt; there is no 'perpetually going' concern.2. Exponential nature of debt can be seen from the following example. If your ancestor borrowed 2,000 years ago just $1 with 5% annual interest, then your debt today is 2.4 *10^42, at least according to Microsoft calculator 3. No business can provide exponential income. So, your debt will inevitably surpass your revenue.yep. that's the reason why indebted entities are condemned to grow, eg politicans worship economic growth (to serve public debt), a ceo of a mnc is pressured to enter new markets (to serve the mncs pension liabilities, and much more). of course there is no infinite growth possible. that is why a firm have to wipe competitors out => their default leaves some space for growth. after many M&As, bankcrupt competitors, an so forth, there are one or few huge survivor firms left. is there a guarantee for survival, or coverage for secured debt? no ... (solutions to let exp-growth run into nothing: investors become obsessed by the free-cash hypothesis and as a result liquidating the monster firms' assets - under the assumption of no additional monetary expansion) Last edited by hamster on February 3rd, 2010, 11:00 pm, edited 1 time in total. list Posts: 2041 Joined: October 26th, 2005, 2:08 pm The most foolish theorem ever... It is good that we begin to prove our opinion with numbers. Let me complete the above statement."For example no one will pay for the brand new car and the same car with break down$500 to fix the same price. If a buyer occurs be convinced to pay the same price it is only happened when he does not correctly interpret the notion piece"It actually how M&M probably interpret the essence of the Theorem. Indeed if a new car 30K = ( Equity + zero Debt ) is without 4 wheels which cost 1K (Debt) then we have 30K for new or 29 + 1 = ( E + D ) is a convenient illustration of the MMT from buyer point of view.Nevertheless, there does not exist a seller of the none zero debt car who thinks that without wheels he could sell the car for 30K because MMT states that his car price is E + D= 29 + 1. He thinks that the price is 29K = E based on common sense. And this is consistent with the buyer who also thinks that the price is the equity price and adding 1K he will get a brand new product. Thus the equation Price = E + D does not work for seller.This example does not perfect but it illustrates that the price 29K is the Equity and 1K does not actually the Debt. To present more accurate situation assume that seller fixed the problem but not paid yet. The E = 30 , D = 1. In contrast to above, buyer now disagrees to pay M&M price 31K = E + D and seller also understand that M&M is quite stupid price.

daveangel
Posts: 17031
Joined: October 20th, 2003, 4:05 pm

QuoteOriginally posted by: torontosimpleguyQuoteOriginally posted by: daveangelHow can A be < 0 ? A >= 0.if the Assets in company A are the same as company B then they will have the same value in the future.It's after company A repays its huge debt. Company B has no debt.look I think we are clearly talking about different things here. The asset value is the same for a and b. I am going to be as clear as possible. There are two companies that make widgets. they have the same product and same sales and their factories are identical. let say the asset (the factory) is worth $1000. Company A is financed purely by equity and company B is financed purely by debt. Let us also say that that there is an investor who wants to invest in either A or B. Do you think that an investor in a world where M&M conditions hold will pay more than$1000 for the equity in A or buy the debt issued by company B for less than $1000 ? Last edited by daveangel on February 4th, 2010, 11:00 pm, edited 1 time in total. knowledge comes, wisdom lingers list Posts: 2041 Joined: October 26th, 2005, 2:08 pm The most foolish theorem ever... daveangel: what does it formally mean "Company A / B is financed purely by equity /debt?". I have thought that "financing" formally means that company can issue bonds over any period they wish. Other might be rather theoretical interpretation of financing is go short on Treasuries for any amount and period. This option probably should be rejected as far as any company then should finance themselves by the equal low risk free interest. It looks like too strong assumption which might be admissible in a very simplify setting.It looks that saying "Company A or B are financed purely by equity or debt one need more accurately specify 'financing' notion, doesn't it? taneururer Posts: 16 Joined: October 4th, 2005, 4:07 pm The most foolish theorem ever... What does it mean to be purely financed by debt? Equity is the residual claim on the firm, but if there is no equity then debt now controls the residual claim on all assets and cash flows.In other words, in a corporate structure, debt cannot exist without equity (ignoring a firm that is in a bankruptcy state). torontosimpleguy Posts: 1011 Joined: July 12th, 2004, 5:51 pm The most foolish theorem ever... QuoteOriginally posted by: daveangelDo you think that an investor in a world where M&M conditions hold will pay more than$1000 for the equity in A or buy the debt issued by company B for less than $1000 ?"Smart" investor wouldn't invest in company with debt structure as I said (long-term zero-coupon bond). It's because equity of this company will evaporate. torontosimpleguy Posts: 1011 Joined: July 12th, 2004, 5:51 pm The most foolish theorem ever... QuoteOriginally posted by: taneururerIn other words, in a corporate structure, debt cannot exist without equity (ignoring a firm that is in a bankruptcy state).The point is different,E = A - DAnd debt grows faster since it has exponential nature. So equity will eventually vanish. torontosimpleguy Posts: 1011 Joined: July 12th, 2004, 5:51 pm The most foolish theorem ever... QuoteOriginally posted by: hamsteryep. that's the reason why indebted entities are condemned to grow, eg politicans worship economic growth (to serve public debt), a ceo of a mnc is pressured to enter new markets (to serve the mncs pension liabilities, and much more). of course there is no infinite growth possible. that is why a firm have to wipe competitors out => their default leaves some space for growth. after many M&As, bankcrupt competitors, an so forth, there are one or few huge survivor firms left. is there a guarantee for survival, or coverage for secured debt? no ... (solutions to let exp-growth run into nothing: investors become obsessed by the free-cash hypothesis and as a result liquidating the monster firms' assets - under the assumption of no additional monetary expansion)You are not quite right about "economic growth." Actually M&M "theory" is not only theoretically wrong. From practical point of view it is destructive. It sabotages "economic growth" by encouraging companies to load debt on their balance sheets. list Posts: 2041 Joined: October 26th, 2005, 2:08 pm The most foolish theorem ever... MMT does not deal with dynamics. It is an algebra relationship and any reference on growth or exponential are irrelevant. The question is whether or not : price of a company = E + D at any t or price of a company = Cost ( t , E , D ) and nothing else. torontosimpleguy Posts: 1011 Joined: July 12th, 2004, 5:51 pm The most foolish theorem ever... QuoteOriginally posted by: listMMT does not deal with dynamics. It is an algebra relationship and any reference on growth or exponential are irrelevant. The question is whether or not : price of a company = E + D at any t or price of a company = Cost ( t , E , D ) and nothing else.What is the company's value? It is determined through dynamics (a "going concern" concept). daveangel Posts: 17031 Joined: October 20th, 2003, 4:05 pm The most foolish theorem ever... QuoteOriginally posted by: torontosimpleguyQuoteOriginally posted by: daveangelDo you think that an investor in a world where M&M conditions hold will pay more than$1000 for the equity in A or buy the debt issued by company B for less than \$1000 ?"Smart" investor wouldn't invest in company with debt structure as I said (long-term zero-coupon bond). It's because equity of this company will evaporate.forget about the "smart" investor - we are talking about a world where M&M assumptions hold.
knowledge comes, wisdom lingers

torontosimpleguy
Posts: 1011
Joined: July 12th, 2004, 5:51 pm

The most foolish theorem ever...

QuoteOriginally posted by: daveangelforget about the "smart" investor - we are talking about a world where M&M assumptions hold.I think I explained myself clearly. Debt can't be equal to equity since they have different "mathematical properties."One is growing exponentially, another is not (actually much slower than an exponent).P.S. It is difficult to talk with non-mathematicians though they also want to create their own "theorems."