B2-M1 Capital structure p1 Flashcards
what are floating-rate bonds?
they automatically adjust the return on a financial instrument to produce a CONSTANT market value for that instrument.
what are zero-coupon bonds?
they have a fixed stated rate of return that would require assignment of a premium or discount to the underlying security to produce a market rate of interest if that market yield is different from stated rate
what are callable bonds?
fluctuate in value. The issuer of callable bonds is the ability to call or refinance the bonds if interest rates become favorable
what is commercial paper?
- maturity dates are less than 270 days
- short term debt which is used to pay for short term obligations
- has a secondary market available, but not an active secondary market.
Advantages:
- avoids the expense of maintaining a compensating balance with a commercial bank
- provides a broad distribution for borrowing
- accrues a benefit to the borrower because its name becomes more widely known
Disadvantages:
- there are restrictions as to the type of corporation that can enter into the commercial paper market for short term financing
what is the formula to calculate the net cost of debt?
effective interest rate * (1 - tax rate)
what is the formula to calculate the cost of preferred stock?
- preferred dividend / net proceeds from preferred stock
- net proceeds = selling price - floatation cost
- floatation cost is cost of issuing new stock
- Dividend paid = par value x issued %
what is weighted average cost of capital (WACC)?
- this is a hurdle rate for decision making
- (cost of PS * weight of PS) + (cost of CS * weight of CS) + (after tax cost of debt * weight of debt)
what is formula to calculate each interest payment?
- face amount * coupon rate
- then adjust for frequency of payment
what is formula for expected rate of return?
dividend PS/CS (annual) / current market price of PS/CS stock
what is beta coefficient?
- beta coefficient represents the measure (risk/volatility) of a particular stock’s % change compared to the % change in the market over the same period.
- % change in stock price / % change in market price
what is capital asset pricing model formula?
RR = RFR + b(RM - RFR)
RR: required return rate on equity
RFR: risk free rate earned on the US treasury bonds
b: beta coefficient
RM: expected market return (earnings)
what is market rate of interest on a one year US treasury bill?
it equals risk free rate of return + inflation premium
what is cost of debt measured?
actual interest rate minus tax savings
