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Corporate Finance > Corporate Finance > Flashcards

Corporate Finance Flashcards

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1
Q

Lessons from capital market history

A

There is a reward for bearing risk.
Greater the risk, Greater the reward.
It is called risk return trade-off

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2
Q

Total Dollar Return

A

Income from investment + Capital gain

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3
Q

Dividend Yield (PR)

A

Income / Beginning Price

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4
Q

Capital Gains Yield

A

(Ending p - Beginning p) - Beginning p

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5
Q

Total Percentage Returns

A

Dividend Yield - Capital Gains Yield

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6
Q

Importance of Financial Markets

A

Businesses have to go to financial markets and institutions for the financing they need to GROW.

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7
Q

5 Important Types of Financial Markets

A

Large Company Stocks, Small “, Long Term Corporate Bonds, Long Term US government bonds, US Treasury Bills

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8
Q

Best Guess About the size of the RETURN for a year selected Random

A

%11.8

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9
Q

Risk-free rate

A

the Rate of Return that can be earned with CERTAINTY.

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10
Q

Risk Premium

A

the excess return required from an investment in a risky asset over that required from a risk-free investment.

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11
Q

Variability Measured by Standard Deviation

A

It measure the uncertainty of asset returns, GREATER THE UNCERTAINTY, GREATER THE TOTAL RISK.

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12
Q

Standard Deviation

A

Square root of the VAR(R)

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13
Q

Variance

A

VAR(R)

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14
Q

Arithmetic Average

A

Return earned in an AVERAGE PERIOD over MULTIPLE PERIODS

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15
Q

Geometric Average

A

Average COMPOUND RETURN per period over MULTIPLE PERIODS

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16
Q

Arithemtic Average is

A

Overly optimistic for LONG HORIZONS

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17
Q

Geometric average is

A

Overly pessimisticfor SHORT HORIZONS

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18
Q

EFM (Efficent Market Hypothesis)

A

New info. is assimilated quickly & correctly into financial asset prices.

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19
Q

When Financial Markets are Efficent?

A

When new info becomes available, people buy and sell stocks and bonds try to incorporate new info into their estimates of the security.

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20
Q

According to EFM,

A

Stock prices are in equilibrium, Stocks are fairly priced informational efficiency.

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21
Q

What Makes Markets Efficent?

A

As new info comes to market it is being analyzed and trades are made based on this info. Prices should reflect all available public info. IF INVESTORS STOP researching stocks, then the market WONT be efficent.

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22
Q

Strong-Form Efficent Market

A

Info is Public or Private, INSIDE INFO IS BEING USED.

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23
Q

Semistrong-form Efficent Market

A

Info is publicly available. Fundamental ANALYSIS IS BEING USED.

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24
Q

Weak Form Efficent Market

A

Info is past prices and volume data. Technical ANALYSIS IS OF LITTLE USE.

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25
Q

Common Misconceptions about EMH

A

EM do not mean that you can’t make money, They do mean that: on average you will earn a return that is appropriate for the risk undertaken.
Market efficiency will not protect you from wrong choices if you do not diversify.

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26
Q

Portfolios

A

It is a collection of assets, An asset’s risk and return is how they effect the risk and return of a portfolio. The risk-return trade-off for a portfolio is measured by the portfolio expected return adn standard deviation, JUST AS WITH INDIVIDUAL ASSETS.

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27
Q

Expected Return on a Portfolio

A

Wealth-weighted average of the returns expected from the assets held in the portfolio.

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28
Q

Portfolio Variance

A

The combination of the WEALTH-WEIGHTED AVERAGE of the variances of the two assets and their covariance.

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29
Q

Systematic Risk

A

Component of total risk which is due to economy-wide factors.

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30
Q

Non-systematic Risk

A

Component of total risk which is unique to an asset or firm.

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31
Q

Diversification (Formula)

A

Total Risk = Systematic Risk + Nonsystematic Risk

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32
Q

Principle of Diversification

A

Spreading an investment across a number of assets will eliminate some, but not all of the risk.

33
Q

Measuring Systematic Risk

A

We use the BETA Coefficent.

34
Q

Security Market Line

A

Representation of Market Equilibrium

35
Q

Capital Asset Pricing Model (CAPM)

A

A Model that RELATES the REQUIRED RATE of return on a security to its systematic risk as measured by BETA

36
Q

Covariance and Correlation

A

Covarience term measures HOW returns change together

37
Q

Risk of Portfolio

A

Represents the amount of risk that the organization is currently exposed to.

38
Q

NPV

A

Net Present Value

39
Q

What is NPV?

A

NPV is the PV of future cash flows - the cost of the investment. If the NPV is ABOVE ZERO then it’s a GOOD INVESTMENT.

40
Q

Calculating NPV Steps

A

1- Estimate expected future cash flows

2- Estimate the required return

3- Find the present value of the cash flows

41
Q

What is PP? (Payback Period)

A

Amount of time required for an investment to generate CASH FLOWS SUFFICENT to RECOVER ITS INITIAL COST.

42
Q

Adv. Of PP

A

Easy to understand - Adjusts for uncertainty of later cash flows. Biased Towards Liquidity

43
Q

Disadv. Of PP

A

Time value of money and risk is ignored - Ignores cash flows beyond the cut-off trade. Biased against LONG-TERM and NEW PROJECTS.

44
Q

Disadv. Of PP

A

Time value of money and risk is ignored - Ignores cash flows beyond the cut-off trade. Biased against LONG-TERM and NEW PROJECTS.

45
Q

What is CUT-OFF Trade?

A

The daily cut-off is the time that forex dealers set that distinguishes the end of one trading day from the beginning of the next

46
Q

Discounted Payback Period

A

Takes into account as TIME VALUE OF MONEY. More difficult to Calculate - Length of time required for an investments discounted cash flows to EQUAL its INITIAL COST.

47
Q

What is Initial Cost?

A

Initial cost is the average cost of purchasing or manufacturing your stock on hand.

48
Q

Adv. of Discounted Payback

A

Includes time value of money.

Easy to understand.

Biased towards liquidity.

49
Q

Disadv. of Discounted Payback.

A

May reject positive NPV investments.

Biased against long-term and new products.

50
Q

Accounting Rate of Return

A

Measurement of an investments profitability.

51
Q

Adv. of ARR (Accounting Rate of Return)

A

Easy to calculate and understand, ALMOST Always available.

52
Q

Disadv.of ARR

A

Measure is not a true reflection of return. Time value is ignored

53
Q

Internal Rate of Return (IRR)

A

DISCOUNT RATE that makes the NPV of an investment zerov

54
Q

Adv. of IRR

A

Popular in practice, does not require a discount rate.

55
Q

Disadv. of IRR

A

More than one negative cash flow. Project is not INDEPENDENT.

56
Q

Present Value Index (PVI)

A

Expresses a projects benefits relative to its initial cost.

57
Q

Adv. of PVI

A

Closely Related to NPV, generally leading to identical decisions.

58
Q

Disadv. Of PVI

A

May lead to incorrect decisions in comparisons of mutually exclusive investment.

59
Q

Disadv. Of PVI

A

May lead to incorrect decisions in comparisons of mutually exclusive investment.

60
Q

Capital Budgeting in Practice (SUM OF THEM)

A

We should consider several investment criteria when making decisions: NPV and IRR are the most commonly used primary investment criteria. Payback is a commonly used secondary investment criteria.

61
Q

Capital Budgeting in Practice (SUM OF THEM)

A

We should consider several investment criteria when making decisions: NPV and IRR are the most commonly used primary investment criteria. Payback is a commonly used secondary investment criteria.

62
Q

Considerations in International Financial Management

A

Have to consider the effect of exchange rates when operating in more than one currency.

Have to consider the political risk associated with actions of foreign governments.

More financin opportunutiies when you consider the international capital markets and this may reduce the firm’s cost of capital.

63
Q

International Finance Terminology

A

Cross-rate

Eurobond

Eurocurrency

Foreign Bonds

Gilts

London Interbank Offer Rate

Swaps

64
Q

Global Capital Markets

A

Number of exchanges in foreign cuntries continues to increase, as does the liquidity on those exchanges.

65
Q

Exchange Rates

A

Price of one country’s currency in terms of another. All currencies are in some way quotes to U.S. Dollars.

66
Q

Exchange Rates

A

Price of one country’s currency in terms of another. All currencies are in some way quotes to U.S. Dollars.

67
Q

Transaction Terminology

A

Spot trade (Exchange currency immediately) exchange rate for an immedite trade.

Forward trade (Agree today to exchange currency at some future date.) exchange rate specified in the forward contract.

68
Q

Absolute Purchasing Power Parity

A

Transaction costs are zero.

No barriers to trade.

No difference in the commoditiy between locations.

69
Q

Relative Purchasing Power Parity

A

Provides information about what causes changes in exchange rates.

70
Q

Interest Rate Parity

A

There must be a forward rate that would prevent the arbitrage opportunity.

71
Q

Short Run Exposure

A

Risk from day to day fluctuations in exchange rates.

72
Q

Short Run Exposure

A

Risk from day to day fluctuations in exchange rates.

73
Q

Long Run Exposure

A

Fluctuations come from UN-ANTICIPATED CHANGES in relative economic governments.

74
Q

Translation Exposure

A

Income from foreign operations has to be translated back to domestic currency.

75
Q

Political Risk

A

Changes in value due to political actions in the foreign country.

76
Q

Overseas Production: Alternative Approaches

A

Home currency approach - foreign currency approach

77
Q

Home Currency Approach

A

Estimate Cash flows in foreign currency, estimate future exchange rates using UIP (Uncovered interest rate parity)

78
Q

Foreign Currency Approach.

A

Estimate cash flows in foreign currency. Use the IFE to convert domestic required return TO foreign required return.

Corporate Finance (1 decks)

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