Chapter 6 Bonds Flashcards
Zero-Coupon Bonds
A single payment at a fixed future date.
Maturity Date
The date when the issuer of the bond makes the last payment.
Face Value
The payment at maturity.
Coupon
Payments at fixed dates.
Clean Price
The quoted price.
Dirty Price
The price actually paid including accrued interest.
Consols
Bonds that never stop paying a coupon with no final maturity date.
Which government still commits to giving out consols even during hard times?
English Government
Discount
When the present value is less than face value.
Premium
When the present value is higher than face value.
Yield To Maturity
The rate of return that the holder is earning on the bond.
Holding Period Return
The total return received from holding an asset or portfolio.
Shares of Capital Stock
Residual claims to after-tax earnings or to the firm’s asset if there’s dissolution.
Preferred Shares
Priority in dividend payments and liquidation (over common shareholders) but no voting rights.
Common Shares
Dividends for an ongoing firm and control over firm’s decisions.
Dividends
A distribution of the company’s earnings.
Capital Gains
Share price appreciation.
Zero Growth Dividend Model
Assumes that the dividend will remain at the same level forever.
Constant Growth Dividend Model
Assumes that dividends will grow at a constant rate forever.
Differential Growth Dividend Model
Estimate the future dividends in the foreseeable future, estimate the future stock price and compute the total PV of estimated future dividends.
Growth Rate
Retention Ratio x Return on Earnings (Historical ROE)
Payout Ratio
Dividends/Earnings
Dividend Discount Model Concerns
- What if firms don’t pay dividends?
- The model is well-specified if r >g
- if g > r than assume differential growth
- Very hard to estimate
Cash Cow
EPS = DIV, a company with a level stream of earnings per share in perpetuity.
NPV of Growth Opportunities
The sum of the firm value given a 100% dividend payout ratio and net present value of growth opportunities (NPVGO)
Dividend Discount Model
Use TVM tools to value the firm’s equity as a function of its expected dividend distributions.
Relative Valuation: Price Earnings Ratio
- Values a company by comparing it with that of publicly traded companies in the same industry.
- Often the last 4 quarters’ earning are used.
Growth Stocks
Firms whose shares at high multiples and with value concentrated in NPVGO.
Value Stocks
Firms whose shares sell at low multiples and with value concentrated in cash cow.
Limitation of P/E
- Uninformative when companies have negative or very low, earnings
- One year’s earning can fall, but a stock price is a function of many years.
Price/Cash Flow
Cash Flow = Net Income + Depreciation
Price/Sales
Current stock price over annual sales per share.
Price/Book
Current price over book value of equity.
Book Value = Assets - Liabilities
Spot Interest Rate
The interest rate fixed today on a loan today.
Forward Interest Rate
A hypothetical interest rate that is specified now for a loan that will occur in the future.
Expectations Theory
Investors set interest rates so that the forward rate equals the spot rate expected at that time.
Liquidity Preference Theory (Risk Avoidance Theory)
Investors demand a “risk premium” to hold riskier longer-term debt instrument.
Market Segmentation Theory
- Separate markets exist for securities of different maturities.
- Each market determines a rate based on supply/demand forces
Upward Sloping Yield Curve
Long-Term Rates > Short-Term Rates
Downward Sloping Yield Curve
Short-Term Rates > Long-Term Rates
Flat Yield Curve
Short-Term Rates = Long-Term Rates
Humped Yield Curve
Medium-Term rates are higher than Short-Term and Long-Term rates
