Bonds 2 and Stock Valuation Flashcards
A Yield Curve shows the relationship between
Interest rate and Time
Bonds are traced by a
Serial Number
This type of bond can be called back at the discretion of the issuing company
Callable bond
If you expect interest rates to decrease in the near future, the economy is described by a ___ curve
Downward Yield
When a company makes a decision to call back a bond, they have to do 3 things:
- Predict a downward yield curve/future interest rates
- Hire and Investment Bank
- File Shelf Registration with the SEC 30 days in Advance
Interest in Arears is a ____ in a balance sheet
Current Liability
What 3 things does the bondholder receive if a company calls back a bond they’re holding?
- Par Value
- Call Premium
- Interest in Arears
Accrued interest on a bond is also called…
Interest in arears
Call Premium =
Callable Price - Par Value
This type of loan will likely be taken out by a company when calling in bonds
bridge loan
What is used for collateral of bridge loans?
The best parts of your liquid assets
Bridge loans have ____ maturity
Short, 3 to 9 months
Many companies promise bondholders they won’t call back loans within…
3-5 years
A convertible bond is a bond which can be converted to _____ at the discretion of ______
Common Stock
Bondholder
Conversion Ratio of a convertible bond =
Par Value / Conversion price
The conversion ratio reporesents….
how many shares of common stock a bondholder will receive if they elect to convert
If a convertible bond has a par value of $1000 and a conversion price of $50, how many shares could the bondholder recieve?
20
Convertible bonds are usually…
Debentures
What are 3 negative aspects of convertible bonds
- High Conversion price
- Usually Debentures
- Coupon Rate is relatively low compared to other bonds in the market
These types of companies usually hold convertible bonds
High volatility, like high tech
A zero coupon bond doesn’t have a par value it has a ….
Maturity value
Even though bondholders of zero-coupon bonds do not receive any interest payments and no payout until maturity, they must do what
report their interest income to the IRS as though they had actually received an annual payment
Companies issuing zero coupon bonds must inform bondholder of what rate?
Implied interest rate
Do company’s report interest they didn’t actually pay to zero-coupon bonds annually?
Yes, the interest owed using the implied interest rate must be reported on their income statment
Pharmaceutical companies are likely to issue what type of bond
Zero coupon bond
(issued by companies that will make a lot of money in the future once new technologies are patented and in serial production)
Sinking fund bonds are issued by companies with a ____ outlook
Poor
Not god guarantee you’ll get par value back at maturity
Interest on sinking fund bonds is relatively ____ compared to standard bonds and you’ll receive ____ annually as well
Higher
Portion or the principal
If a company issues $2billion of sinking fund bonds, $1000 par value each, 8% coupon rate, maturity of 20 years, how much will it pay out in the first year?
Coupon payment = $2 billion * 8% = $160 million
+
$2billion / 20 years = $100 million
= $260 million
A high yield bond is an example of a
Debenture
Interest on Muni bonds are exempt from what?
federal taxes
What are the 2 types of Muni bonds?
- General Obligation Bond
2. Revenue Bond
These types of muni bonds are used to finance a major public work
General Obligation bond
What is the collateral repayment mechanism backing a general obligation bond?
ability to increase income taxes
A revenue bond is used to finance
a profitable project (ex a turnpike)
Municipal bonds are more beneficial to individuals in ____ income brackets
higher
On a sinking fund bond, the amount of annual principal payment =
Amount borrowed (total amount of bonds) / maturity in years
Given a municipal bond rate, what is the formula for converting to an equivalent rate of a corporate bond
Interest rate of Muni Bond / (1 - marginal tax rate) = equivalent interest of Corporate bond
If you have a corporate bond with a 4.65% interest rate, and your marginal tax rate is 35%, what is the equivalent rate of a municipal bond?
4.65% * (1-35%) = 3.02%
Peak, Trough, Growth and ____ are phases of the _____
Contraction
Business Cycle
LBO stands for
Leverage Buyout
When market value is < book value, then the stock is
undervalued
7 conditions that should be met for a leverage buyout to happen. Company should:
- be well known with a well known product line
- be a mature business
- have a well known management team
- have small long term debt
- have a depressed stock price
- have multiple independent divisions
- have undervalued stock
The high yield bond was invented by
Michael Milton
What are some funding sources a company’s managers will use to prep for an LBO?
- pool their own money
- short term (ex 3 year) loan from bank syndication
- take out high yield bond
after an LBO the company will be
private
Perpetual bonds are typically issued by companies that…
don’t seem to have an expiration date on the horizon as far as the market is concerned
The bond value of a perpetual bond =
Amount of Yearly Interest / Rate of required return
What is the price of a perpetual bond with a par value of $1000, a coupon rate of 6%, when the the required rate of return of an investor is 8%?
Vb = $1000*6% / 8% = $750
Stock valuation of preferred stock is very similar to…
perpetual bonds
What is the value of a preferred stock (P0) with a dividend rate of 6%, when the investor requires a rate of return of 8% (K)?
Assume par = $100
P0 = D $/ K = $100*6% / 8% = 75
What are the 3 models of valuating common stock?
- zero growth dividend model
- constant growth dividend model
- super normal growth dividend model
The value of a common stock with a steady state annual dividend has this formula, the same as ____
Value of Stock = P0 = D / K = Amount of Annual Dividend / Required Rate of Return
Same as perpetual bond and preferred stock
What is the formula for stock value of a common stock with a constant growth dividend?
P0 = Di / (K - g)
If a common stock has a constant growth dividend, with a growth rate of 5%, and an initial dividend of $2, when market rate of return is 7%, what is the value?
Value = $2 / (7% - 5%) = $100
A common stock with an initial dividend growth rate that will change to a 2nd after X number of years should be modelled by:
super normal growth dividend model
ABC company currently pays a cash dividend of $2 (D0 = $2). This dividend will grow at an annual rate of g1 = 25% for the next 3 years. After which the dividend growth rate will be g2 = 8% forever. WHAT IS THE CURRENT VALUE of this stock (the PRICE) for an investor whose required rate of return is K = 10%
$165.45
Fixed costs are those costs which
Stay the same regardless of production level
rent, insurance, car registration fees, R&D, are examples of
fixed cost
Variable costs are those costs which
increase as production level increases
materials and labor are an example of
variable costs
Is payment of dividends tax deductible for a company?
NO
Owning common stock gives shareholders a ____ in the company
equity claim
Some of this type of share are retained by the company
issued shares
The average market beta =
1.0
Why do companies set conversion price very high?
it would increase qty of outstanding shares and would dilute their EPS
