ESP Flashcards
What is the goal of a corporation?
Increase stock value by balancing between making profits and managing risk.
What is Capital Structure
Finding the optimal mix of bonds & stocks to finance the business
What is Capital Budgeting
Deciding on potential investments to increase the firm’s value.
What is an Efficient Market?
In the market where prices reflect all available information.
What is the Time Value of Money (TVM)?
The value of money when you receive it.
What is Intrinsic Value?
The real value of economics benefits to the investor.
Define Present Value (PV).
Cash received today
What is Future Value (FV)?
Cash received in the future.
What is Risk Aversion?
Choosing a lower risk, even if it means a lower return.
Define Risk Premium.
Extra return for an investor for taking a higher risk
Define Required Return.
Min. “profit” needed to attract an investor.
Define Bond.
A “loan” from the investor, with face value, coupon rate, and maturity.
What is Stock?
Investor becomes part owner with a principal, potential dividends and no maturity.
Define Bond Price.
PV of cash flows to the investor.
What is Face Value?
The amount repaid at maturity, usually a $1,000.
What is Coupon Rate?
The interest rate paid annually or semi-annually
What is Maturity?
Date when the bond is repaid.
Define Yield.
Investor % Profit per Year.
What is Uncertainty?
The inability to predict future events because of lack of information
What is the main difference between Finance and Accounting?
Accounting measures previous activity; Finance focuses on future transactions.
Explain the Inverse Relationship.
When bond prices go up, yields go down, and vice versa.
What is Yield to Maturity (YTM)?
Total return an investor earns if a bond is held to maturity.
Define APY (Annual Percentage Yield).
Annual interest rate, including compounding, APR is used to calculate APY
What is APR (Annual Percentage Rate)?
STATED or GIVEN Interest Rate
What is an Ordinary Bond?
Interest paid semi-annually, with principal at maturity.
Define Amortizing Bond.
Monthly payments, including interest and principal repayment.
List factors that affect a bond’s required yield.
Treasury yields, credit risk, market risk, collateral, and tax status.
What is an Ordinary Annuity?
Payments received at the end of each period.
What is an Annuity Due?
Payments received at the beginning of each period.
What is a Perpetuity?
An endless stream of payments.
Keyword: FOREVER
What is a Growth Perpetual Annuity?
An endless stream of increasing payments.
What is the Capital Asset Pricing Model (CAPM)?
calculates the required return on a specific stock.
Define Risk-Free Rate.
U.S. Treasury Bond yield
What is Market Risk?
Risk of investment losses due to overall market changes.
What is Market Risk Premium?
Difference on required return on stocks minus Risk-Free Rate.
What is Beta?
A stock’s market risk.
What is the Gordon Dividend Growth Model?
Assumes that Dividend Increase over Time Forever.
Growth Rate
Rate of increase in Dividend over time.
What is the Single Holding Period model used for?
Expected return of a stock over one period (usually a year).
What is Cost of Capital?
The required return to finance a firm’s operations or projects.
What is Expected Dividend?
Dividend expected to be paid at the end of the year.
What is Recent Dividend?
Dividends that has already been paid
What is WACC (Weighted Average Capital Cost)?
Average cost of a firm’s financing.
Define Leverage.
High levels of fixed expenses.
What is Operating Leverage (DOL)?
Reliance on fixed costs for production of the firm’s product.
What is Financial Leverage (DFL)?
Measure of a firm’s reliance on debt financing.
What is Initial Cash Outflow (ICF)
To invest in the project.
Differential Cashflow (DCF)
Yearly cash profit over the life of the project.
Terminal Cash Flow (TCF)
Salvage Value; the end-of-life profit of a project.
What is the Internal Rate of Return (IRR)?
Is the Annual Profitability of the firm.
What is Net Present Value (NPV)?
PV of Cash inflows minus initial cash outflow.
IRR & NPV is…
Potential Investments
What is a Hurdle Rate?
Minimum return required to accept a project or investment, typically set at the firm’s WACC.
Why is WACC the hurdle rate for Investment?
WACC is the minimum return needed for a project to add value and cover capital costs .
If Expected Return > Required Return:
Price will Rise - - increase in demand.
If Expected Return < Required Return:
Price will Fall - - decrease demand.
When should buy Stock:
If Market Price < Intrinsic Value:
Buy; Price expected to Rise
When should buy Stock:
If Market Price > Intrinsic Value:
Sell; Price expected to Fall.
Prudent Investor
Investor picks a risk-level they are comfortable with.
Diversification
Invest in different things.
Idiosyncratic Risk
Events that impact only a single firm
Systematic Risk
Events that impact all firms
Idiosyncratic Risk + Systematic Risk =
Total Risk
Why do diversification reduce Market Risk?
Diversified portfolios have less risk.
Correlation is
When prices rise and fall TOGETHER.
Perfect Correlation =
+1.0
Low Correlation improves…
Diversification
Max Return-To-Risk
Diversified portfolio on the efficient frontier.
Efficient Frontier
Maximizes expected return for a given level of risk
A fully diversified portfolio that has eliminated Idiosyncratic Risk.
Primary Market success is:
Optimal mix of stocks & bonds; and NPV > 0 Investment Projects.
Secondary Market Success:
Prudent risk exposure; Max Return-to-Risk ratio
Balance Sheet
a snapshot of the firm’s assets, liabilities, and equity over a specific period.
Income Statement (Profit & Loss Statement)
the scorecard of revenue minus expenses during last year.
Statement of Cash Flows
Shows Cash In & Out (operations, investments, financing) during a period.
Cash Flows from Operations (CFO)
Cash ‘earned’ by producing & selling the firms’s product.
Cash Flows from Investing (CFI)
Cash ‘invested’ by investment projects.
Cash Flows from Financing (CFF)
Cash ‘raised’ by selling bonds & stocks.
Cash Flows from Investment (CFI)
Cash ‘spent’ from investment projects
Net Working Capital (NWC)
current assets minus current liabilities
Financial Ratios
Measure the use of debt vs. equity.
Financial Ratios: Liquidity
Can the company pay its bills
Financial Ratios: Efficiency
How well are Assets being used
Financial Ratio: Financing
Reliance on Debt.
Financial Ratio: Profitabilty
Can a company make money (Net Income)
What is Financial Forecasting?
Predicting future finances to plan revenue, expenses, and funding needs.
Sustainable Growth Rate (SGR)
Sale growth rate w/ no need for external funding.
Discretionary Funding Needed (DFN)
Is to project the need for additional funding
What is the Pro Forma Balance Sheet?
Projection based on Sales forecast.
Discretionary Accounts
The decisions on financial accounts that can be Changed by management decision. For example: buying equipment
Working Capital Management
Managing Current Assets & Current Liabilities
Working Capital Management Decisions are
Cash, Accounts, Receivable, Inventory, & Accounts Payable
Securities Act of 1933 -
A prospectus with audited financials
Prospectus is..
Business & Financial Information that is required on the IPO
Securities Exchange Commission (SEC) -
regulates security markets and enforces 10 K Annual Reports
Sarbanes-Oxley Act (SOX) -
Ensures transparency and audit of internal controls
FINRA (Financial Industry Regulatory Authority)
A regulatory corporation that ensures honesty, ethical behavior, & transparency in the financial markets.
Rule 144A -
Sell private capital to accredited U.S. investors
Reg S -
allows non-U.S. investors to invest in a U.S. company through private capital markets.
Dodd-Frank Act -
addresses “too big to fail” banks
FSOC (Financial Stability Oversight Council)
Regulates “systemic” risks
Volker Rule -
Limits proprietary/hedge fund trading by banks
Global Financial Management Multi-National Corporation (MNC)
Corporations that have operations in many different countries.
Tariffs
A tax on imported goods
Initial Public Offering (IPO)
The first where stocks & bonds are sold to raise money in the primary market.
Market Rate > Coupon Rate
Bonds will sell at a discount
Market Rate < Coupon Rate
Bonds will sell at premium
