EXAM 3 Finance

Question 1

debt

Answer 1

includes all borrowing incurred by a firm, including bonds, and is repaid according to a fixed schedule of payments.

Question 2

equity

Answer 2

consists of funds provided by the firm’s owners (investors or stockholders) that are repaid subject to the firm’s performance.

Question 3

Differences between debt and equity:

Answer 3

voice in management, voting rights, claims on income and assets

Question 4

equity holders claims on income and assets

Answer 4

secondary to claims of creditors, they are residual claimant, last to receive distributions

Question 5

maturity difference between debt and equity

Answer 5

Unlike debt, equity capital is a permanent form of financing, equity has no maturity date and never has to be repaid by firm

Question 6

tax treatment differences

Answer 6

Interest payments to a firm’s debtholders are treated as tax-deductible expenses by the issuing firm. Dividend payments to a firm’s stockholders are not tax-deductible

Question 7

common stock

Answer 7

true owners of the firm (also known as residual owners or residual claimants), receive what is left, limited liability, expect to be paid with adequate dividends and capital gains

Question 8

common stock ownership

Answer 8

can be privately owned by private investors to publicly owned by a broad group of investors. shares of private firms are generally not traded. large corps are publicly owned and actively traded in broker and dealer markets

Question 9

common stock voting rights

Answer 9

each share of stock to holder to one vote in election, generally assignable votes and may be cast at the annual stockholders meeting

Question 10

proxy statement

Answer 10

statement transferring the votes of a stockholder to another party

Question 11

common stock dividends

Answer 11

dividends may be paid in cash or stock, not guaranteed, but expected on basis of dividend patterns of the firm. any past due dividends must be paid first before paid to preferred stockholders

Question 12

preferred stock

Answer 12

gives holders certain privileges that make them senior to common stockholders, prior claim on earnings and assets compared to common stocks, fixed periodic dividend (%or$). most are cumulative

Question 13

basic rights of preferred stockholders

Answer 13

specifies a fixed periodic payment (dividend), not normally given a voting right, sometimes allowed to elect one member of BOD

Question 14

common stock valuation

Answer 14

art and science of determining what a security or asset is worth

Question 15

if you own a share you can receive cash by:

Answer 15

1. dividends
2. selling the share

Question 16

bonds and stocks

Answer 16

price of stock is present value of:
dividends-cash income
selling-capital gains

Question 17

zero dividend growth model

Answer 17

assumes stock will pay the same dividend each year after year, it is equal to perpetuity

Question 18

constant growth model

Answer 18

widely cited dividend valuation approach that assumes that dividends will grow at a constant rate every period

Question 19

gordon model

Answer 19

is a common name for the constant-growth model that is widely cited in dividend valuation.
Where 𝐷_1 = expected dividend at the end of the next period;
𝑟_𝑠 = required rate of return; g = the constant dividend growth rate

Question 20

variable growth model

Answer 20

is a dividend valuation approach that allows for a change in the dividend growth rate.

Question 21

The price/earnings multiple approach

Answer 21

is a popular technique used to estimate the firm’s share value; calculated by multiplying the firm’s expected earnings per share (EPS) by the average price/earnings (P/E) ratio for the industry.

Question 22

primary market

Answer 22

new-issue market (initial public offering (IPO): The first time shares are sold in the market.
From the firm’s perspective, IPO could be a bumpy ride:
It puts you under the spotlight.
It urges you to deliver the expected results as you advertised, or your stock price may drop)

Question 23

secondary market

Answer 23

existing shares traded among investors (Exchanges. E.g., NYSE, NASDAQ.
Over the counter (OTC). A network of brokers and dealers)

Question 24

dealer

Answer 24

maintains an inventory:
Ready to buy or sell at any time.
Think “Used car dealer”.

Question 25

broker

Answer 25

Brings buyers and sellers together, charging a commission.
(Think “Real estate broker”)