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FI 311 > Exam 2 > Flashcards

Exam 2 Flashcards

1
Q

Interest rate levels

A

Price of capital. Borrows are willing to pay and lenders are going to recieve

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2
Q

What are the four factors that affect interest rates?

A

Production opportunities, time preferences for consumption, risk, and expected inflation

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3
Q

Time preferences for consumption

A

Supply side. More in future high supply =lower interest rate

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4
Q

Risk

A

Higher risk=higher interest

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5
Q

Expected inflation

A

High inflation = high IR

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6
Q

R*

A

Real risk free rate of interest

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7
Q

Rrf

A

The nominal rate of interest on treasury securities

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8
Q

Rrf=

A

R*+IP

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9
Q

Interest rate equation

A

R*+IP+DRP+LP+MRP

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10
Q

R

A

Required return on a debt security

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11
Q

DRP

A

Default risk premium. Chance for borrower not to make payment

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12
Q

LP

A

Liquidity premium. Convertibility to cash at fair market value

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13
Q

MRP

A

Maturity risk premium. Price of long term bonds changes over time as interest rate changes. Risk of capital loss

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14
Q

Short term treasury

A

IP

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15
Q

Long term treasury

A

IP and MRP

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16
Q

Short term corporate

A

IP DRP LP

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17
Q

Long term corporate

A

IP MRP DRP LP

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18
Q

Term structure

A

Relationship between interest rates and maturities

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19
Q

Yeild curve step one

A

Find the average expected inflatiob rate over years

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20
Q

Yeild curve step two

A

Find the appropriate maturity risk premium. .1%(t-1)

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21
Q

Yeild curve step 3

A

Add the premiums to r*

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22
Q

Upward sloping yeild curve

A

Due to an increase in expected inflation and MRP

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23
Q

Corporate yeild curves

A

Are higher than that of treasury securities though not parallel to t-curve

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24
Q

The spread between corporate and treasury yeild curves

A

Widens as fhe corporate bond rating decreases

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25
Q

Since corporate yields include a DRP and LP the yield spread can be calculated as

A

Corporate bond yield-Treasury bond yield

DRP+LP

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26
Q

Investment grade bonds

A

BBB and higher. Investment companies can only invest in these

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27
Q

Junk bond

A

BB and lower

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28
Q

Pure expectations theory

A

Contends that the shape of the yield curve depends on investors expectations about future interest rates. IR increase LT rates will be higher than ST rates

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29
Q

Assumptions of pure expectations

A

MRP for T-securities is zero, LT rates are an average of current and future ST rates, use to guess future rates

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30
Q

Macro factors that influence IR

A

Federal reserve policy, federal budget deflicits or surpluses, international factors, level of business activity

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31
Q

Federal reserve policy

A

Short term: money increases IR decreases

Long term: inflation increases IR increases

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32
Q

Bonds are primarily traded in the

A

Over the counter market

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33
Q

Most bonds are owned by and teades among

A

Large financial institutions

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34
Q

Par value

A

Face amount paid at maturity

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35
Q

Coupon rate

A

Stated interest rate

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36
Q

Yield to maturity

A

Rate of return earned on a bond held until maturity

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37
Q

Call provision

A

Allows issuer to refund the bond if rates decline, bond premium, deferred call and declining call

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38
Q

Sinking fund

A

Provision to pay off a loan over its life rather than all at maturity. Reduces risk to investor. Investors have reinvestment risk

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39
Q

Convertable bond

A

May be exchanged for common stock of the firm at the holders option

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40
Q

Warrant

A

Long term option to buy a stated number of shares of common stock at a specific price

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41
Q

Putable bond

A

Allows holder to sell the bond back to the company prior to maturity

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42
Q

Income bond

A

Pays interest only when interest is earned by the firm

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43
Q

Indexed bond

A

Interest paid is based upon the rate of inflation CPI+%

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44
Q

Opportunity cost of debt capital

A

Discount rate. Rate that could be earned on alternative investments of equal risk

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45
Q

If Rd remains constant

A

The value of prmium bond will decrease, value of discount bond will increase, par value stays the same

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46
Q

Current yield

A

Annual coupon payment/ current price

47
Q

Capital gains yield

A

Change in price/ begining price

48
Q

Expected total return

A

YTM= expected CY+ expected CGY

49
Q

The longer the bond

A

The higher the price risn

50
Q

Reinvestment risk

A

The concern that the rd will fall and the future CFs will have to be reinvested at lower rates

51
Q

Short term/high coupon bonds

A

Low price risk, high reinvestment risk

52
Q

Long term/ low coupon

A

High price risk, low reinvestment risk

53
Q

Semiannual bonds

A

Period: 2N
Periodic rate: rd/2
PMT= annual rate/2

54
Q

Callable bonds YTM or YTC

A

If YTC

55
Q

When is a call more likely to occur?

A

Market

56
Q

Default risk

A

Influenced by the issuers finanacal strength and the terms of the bond contract

57
Q

Mortgage bonds

A

Backed by fixed assets

58
Q

Debenture bonds

A

Bond with no collateral

59
Q

Subordinated debenture

A

3rd tear

60
Q

Liquidation

A

Assets are auctioned off to obtain cash that is then distrubuted to creditors

61
Q

Priority claims of liquidation

A

Secured creditors, trustee costs, wages, taxes, unfunded pensions, unsecured creditors, preferred stock, common stock

62
Q

Reprganization

A

Emerges from bankruptcy with lower debts reduced interest and a chance for success. Unsecured creditors more willing to participate

63
Q

Investment risk

A

The chance that unfavorable events will occur from an investment. Probability that earn low or negative return

64
Q

Stand alone risk

A

Investing in one companys stock

65
Q

Portfolio risk

A

Investing in multiple companys stock

66
Q

Probability distributions

A

Narrower is lower risk. Wider is higher risk

67
Q

Stocks are said to provide

A

Relativly higher return with higher risk. Trade off

68
Q

High tech relative to economy

A

Moves with the economy and has positive correlation

69
Q

Collections relation to economy

A

Is countercyclical and has negative correlation

70
Q

Expected rate of return calculation

A

Weighted average of all probablities

71
Q

Standard deviation for each investment

A

Weighted average of expected returns minus actual returns

72
Q

Larger SD

A

The lower the prob that actual returns will be closer to expected returns. Associated with a wider prob distribution of returns

73
Q

Corfficient of variation

A

A standardized measure of dispersion about the expected value that shows the risk per unit of return. SD/expected return

74
Q

Risk aversion

A

Assumes investors dislike risk and require higher rates of return to encourage them to hold riskier securities

75
Q

Risk premium

A

The difference between the return on a risky asset and riskless asset which serves as compensation for investors to hold riskier securites

76
Q

A portfolios expected return is

A

A weighted average of the returns of the portfolios component assets

77
Q

Correlation

A

A tendency of 2 variables to move together

78
Q

SD for average stock

A

35%

79
Q

Most stocks are

A

Positivley correlated with the market

80
Q

Correlation that is very low or negative

A

Reduces risk

81
Q

Stand alone risk =

A

Market risk + diversifiable risk

82
Q

Market risk

A

Portion of a securitys stand alone risk that cannot be eliminated through diversification. Measured by beta

83
Q

Diversifiable risk

A

Portion of a securitys stand alone risk that can be eliminated through proper disverification

84
Q

Capital asset pricing model

A

Model linking risk and required returns

85
Q

CAPM suggests

A

That there is a security market line that states a stocks required return equals the risk free return plus a risk premium

86
Q

Primary conclustion for CAPM

A

The relevant riskiness of a stock is its contributiob to the riskibess of a well diversified portfolio. Not to the riskiness of added specific asset

87
Q

Beta

A

Measures a stocks market risk and shows voliatiliy relatice to the market. Indicates how risky a stock is if held in difersified

88
Q

Beta equation

A

Ri/rm

89
Q

Beta=1

A

The security is just as risky as the average stock

90
Q

Beta>1

A

Riskier than average

91
Q

Beta<1

A

Less risky than average

92
Q

SML equation

A

Ri= Rrf+ (Rm-Rrf) b

93
Q

Market risk premium

A

Additional return over risk free needed to compensate investors for assuming an average amount of risk (Rm-Rrf)

94
Q

Fed stimilates

A

R* decreases causing a decrease in Rrf and SMl decreases

95
Q

Facts about common stock

A

Represent ownership, implies control, elect directors, directs elect management, management max stock price

96
Q

Stocks with price below intrinsic value

A

Undervalued

97
Q

Discounted dividend model

A

Value of a stock is the present value of the future dividends expected to be generated

98
Q

Stock price equation DDM

A

D1/rs-g

99
Q

Growth factor is

A

Comes feom the RE and reinvestment. The increased % of RE means increased g

100
Q

Dividend yield

A

D1/Po (dividends/stock price)

101
Q

Capital gains yield stock

A

P1-po/po

%change in stock price

102
Q

Total return stock

A

Dividend yield-capital gains yield

103
Q

If g=0

A

Would be perpetuity. Pmt/r

104
Q

Negitive growth stock

A

Do(1+g)/(rs-g)

105
Q

Corporate valuation model

A

Free cash flow method. Suggest the value of the entire firm equals the present value of the firms free cash flows

106
Q

Free cash flows equation

A

(Ebit(1-T)+dep)-(capital expenditures+change in working captial)

107
Q

Applying CVM

A

1) find pv of FCF
2) subtract debt anf preferred stock
3) divide by # of shares

108
Q

Issues CVM

A

Used when firm doesnt pay dividends, assumes fcf growth constant, horizon value is point growth becomes constant

109
Q

Firm multiples method

A

Analysts often us the following multiples to value stocks:p/e, p/cf, p/sales. Multiply but expected earnings

110
Q

Economic value added approach

A

Find EVA, add future values to BV of equity, divide by # of shares

111
Q

EVA

A

Equaity capital(ROE-cost of equity)

112
Q

Preferred stock

A

Hybrid security, fixed dividends that must be paid before common stock, dont have to pay

113
Q

Preferred stock expected return

A

Dividends/selling price

FI 311 (3 decks)

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