Brainscape's Knowledge GenomeTM

Browse over 1 million classes created by top students, professors, publishers, and experts.


See full index

finance 2 > Debt > Flashcards

Debt Flashcards

You may prefer our related Brainscape-certified flashcards:
Series 65 flashcards Series 63 flashcards Series 66 flashcards Series 7 Top-off Exam flashcards SIE Exam flashcards CFA flashcards Series 79 Top-Off Exam flashcards
1
Q

What is capital structure?

A

Capital structure is the proportion of debt, equity and other securities that a firm uses to finance its operations

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

What is debt?

A

The cash flows that are capped to the promised amounts

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

What are debtholders entitled to?

A

interest payments and the principal at maturity

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

Who has seniority on the firm’s cash flows?

A

debtholders

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

True or false: debtholders have voting rights.

A

False

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

What is equity?

A

The rights to the cash flows after debtholders are paid

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

True or false: equityholders have voting rights.

A

True

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

Who has ownership over the firm: debt or equityholders?

A

equityholders

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

Who has residual claimants of the firm’s cash flows?

A

equityholders

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

Who has limited liability?

A

equityholders, since shareholders aren’t personally liable if the firm goes bankrupt

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

What other examples besides debt and equity can be part a firm’s capital structure?

A

Warrants, convertible debt, leasing, hybrid securities, etc.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

What does it mean when equity is unlevered?

A

There’s no debt D/E=0

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

What is the main conclusion of M&M?

A

Under perfect capital market conditions, the total value of a firm doesn’t depend on its capital structure.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

Why is is that under perfect capital market conditions, the total value of a firm doesn’t depend on its capital structure?

A

Because total cash flows to the investor of the firm are equal to the cash flows that the project will generate, and therefore have the same present value.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

What are the assumptions for M&M Proposition 1?

A
  1. investment policy is held constant
  2. no transaction costs
  3. capital markets are efficient
  4. managers maximise shareholder’s wealth
  5. no taxes
  6. no bankruptcy costs
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

What is the M&M Proposition 1?

A

Under perfect market condition a firm’s market value is independent of its capital structure.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
17
Q

What does “the size of the pie” depend on?

A
  1. operating policy by firm
  2. working capital policy
  3. investment policy
  4. business risk (and corresponding risk premium)
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
18
Q

What can’t exist in perfect capital market?

A

Arbitrage opportunities

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
19
Q

What is arbitrage?

A

Arbitrage consists of taking advantage of mispricing in the market and usually involves the simultaneous purchase and sale of securities that are supposed to have the same price to make a riskless profit. It has to have non-negative cash flows at all instances and at the very minimum, a non-zero probability of getting a positive cash-flow in at leat one moment in time.

20
Q

What will result from the actions of arbitrageurs?

A

Their actions result in the price of the cheapest one to rise and the most expensive to fall, making the arbitrage opportunity to disappear.

21
Q

What does leverage cause to equityholders?

A

It increases their risk and therefore the return they ask for increases to compensate for the extra risk.

22
Q

Dow we need risky debt for leverage to increase the risk on equity?

A

No

23
Q

Following M&M, what is the WACC equal to?

A

return on assets

24
Q

Following M&M, does the WACC depend on the mix of securities the firm has outstanding?

A

No, WACC only depends on its assets and operating activities.

25
Q

What does the M&M Proposition 2 tell us?

A

The return on equity is equal to the return on assets plus a premium to compensate for the financial risk caused by leverage.

26
Q

What happens when we apply the CAPM on Proposition 2?

A

We obtain an equivalent relation for betas.

27
Q

True or false: the higher the leverage, the risker the equity.

A

True

28
Q

Is holding excess cash part of the financing decision?

A

Yes.

29
Q

What is excessive cash?

A

Excessive cash is cash and short-term investments that aren’t used in the company’s operations.

30
Q

True or false: M&M Proposition 2 tells us that the systematic risk of equity increases with leverage.

A

True

31
Q

Why does systematic risk of equity increases with leverage?

A
  1. debt carries less systematic risk than equity
  2. fewer shareholders are carrying the same asset risk that would be shared by more equityholders if the firm was all-equity financed
32
Q

What is riskless debt?

A

cash flows are always higher than the promised payment on debt in all realisations of the future

33
Q

What is risky debt?

A

there is at least one realisation of the future where cash flows are lower than the promised payment on debt

34
Q

When we have risky debt, does the value of the assets and the opportunity cost of capital change?

A

Not under perfect market conditions

35
Q

If debt is risky, does the equity cost of capital increase?

A

Yes

36
Q

True or false: the WACC changes for alternative capital structures

A

False

37
Q

In perfect capital markets, is WACC equal to the asset cost of capital?

A

Yes

38
Q

What drives the riskiness of securites?

A

The riskiness of assets

39
Q

Does the riskiness of securities drive the riskiness of assets?

A

No, it’s the other way around.

40
Q

If the firm is all-equity financed is the beta from equity equal to the beta from assets?

A

Yes

41
Q

When does rA change?

A

taxes

42
Q

How do you calculate wealth?

A

wealth = P + DPS

43
Q

If debt is risk free what is the value of debt’s beta?

A

0

44
Q

Does P change when you repurchase stock?

A

no

45
Q
A

finance 2 (6 decks)

Brainscape helps you reach your goals faster, through stronger study habits.
© 2024 Bold Learning Solutions. Terms and Conditions