2. The Time Value of Money in Finance

Question 1

Cash flow additivity principle

Answer 1

The principle that dollar amounts indexed at the same point in time are additive.

Question 2

Dividend payout ratio

Answer 2

The ratio of cash dividends paid to earnings for a period.

Question 3

Forward price-to-earnings ratio

Answer 3

A P/E calculated on the basis of a forecast of EPS; a stock’s current price divided by next year’s expected earnings.

Question 4

Hedge ratio

Answer 4

The proportion of an underlying that will offset the risk associated with a derivative position.

Question 5

Perpetual bonds

Answer 5

Bonds with no stated maturity date.

Question 6

Perpetuity

Answer 6

A perpetual annuity, or a set of never-ending level sequential cash flows, with the first cash flow occurring one period from now.

Question 7

Premium

Answer 7

In the case of bonds, premium refers to the amount by which a bond is priced above its face (par) value. In the case of an option, the amount paid for the option contract.

Question 8

Price-to-earnings ratio (P/E)

Answer 8

The ratio of share price to earnings per share.

Question 9

Terminal value

Answer 9

The expected value of a share at the end of the investment horizon—in effect, the expected selling price.

Question 10

Zero-coupon bonds

Answer 10

Bonds that do not pay interest during their life. They are issued at a discount to par value and redeemed at par. Also called pure discount bond.