Fakta Flashcards
1
Q
What is the nominal interest rate?
A
The rate at which your money will grow if invested for a certain period.
2
Q
What is the real interest rate?
A
The rate of growth of your purchasing power?
3
Q
What is the yield curve?
A
A yield curve is a line that plots yields (interest rates) of bonds having equal credit quality but differing maturity dates. The slope of the yield curve gives an idea of future interest rate changes and economic activity. There are three main types of yield curve shapes: normal (upward sloping curve), inverted (downward sloping curve) and flat.
4
Q
What is cost of capital?
A
The best available expected return offered in the market on an investment of comparable risk and term to the cash flow being discounted.
5
Q
What stocks have the largest fluctuations in price and most return over time?
A
Small stocks
6
Q
What are two difficulties with using past return to predict the future?
A
- We’can’not’know’what’investors’expected’in’the’past,’we’can’only’ observe’the’actual’returns’that’were’realized’
- The’average’return’is’just’an’estimate’of’the’true’expected’return,’and’is’ subject’to’estimation’error’
7
Q
What is covariance?
A
The expected product of the deviation of two returns from their means.
8
Q
What is correlation?
A
A measure of the common risk shared by stocks that does not depend on their volatiloty.
9
Q
What is the efficient portfolio?
A
There is no way to reduce the volatility of the portfolio without lowering it’s E(R)
10
Q
How do we identify the tangent portfolio?
A
Find the portfolio that generates the steepest possible line when we combine with the risk-free investment
11
Q
What is the Sharpe ratio?
A
The Sharpe ratio measures the ratio of reward-to-volatility provided by a portfolio. The tangent portfolio has the highest Sharpe ratio of any portfolio.
12
Q
What does CAPM say?
A
All investors should choose a portfolio on the CML, by holding some combo of the risk-free security and the market portfolio.
13
Q
What is the difference between the SML and the CML?
A
CML - Bara optimala portföljer ligger på linjen, alla andra ligger under.
SML - Alla värdepapper på linjen, var de ligger beror på vilken risk de har.
14
Q
What is a value-weighted portfolio?
A
Equal ownership portfolio - each security is held in proportion to its market capitalization
15
Q
What is a passive portfolio?
A
A portfolio that is not rebalanced in response to price changes, only in changes of number of shares.
16
Q
What is a price-weighted portfolio?
A
Holds and equal number of shares of each stock, independent of their size.
17
Q
What is Yield To Maturity?
A
YTM is the IRR an investor will earn from holding the bond to maturity and receiving its promised payments.
18
Q
What happens to the cost of capital when the fixed costs are higher?
A
higher beta –> higher cost of capital
19
Q
What is alpha?
A
If the market portfolio is not efficient –> all stocks will not lie on the SML –> the distance of a stock above or below the SML = the stocks alpha. Regardless of how much information an investor has access to, he can guarantee himself a alpha=0 by holding the market portfolio.
20
Q
What are typical behavior of individual investors?
A
- Under diversification and portfolio biases
- Exessive trading and overconfidence
- Hanging on to losers and the disposition effect
21
Q
What are three strategies for selecting portfolios?
A
- Market capitalization strategies: buys small stocks and finances by short selling big stocks (SMB)
- Book-to-market ratio: Long position in the high M/B ratio portfolio and short position in the low. (HML)
- Past Return strategy: Past returns, buys 30 best and sells 30 worst past performing stocks. (PR1YR)
22
Q
What is the multifactor risk model?
A
More than one portfolio used to capture risk, FFC Factor specification most popular choice. Better than CAPM.
23
Q
What is M&M proposition 1?
A
The company’s capital structure does not impact it’s value. VL=VU
24
Q
What is M&M proposition 2?
A
The cost of capital of levered equity increases with the firm’s market value of debt-equity ratio. Se formel.
25
What is dilution?
If a firm issues new shares, the CF generated by the firm must be divided along a larger number of shares --> reducing the value of each individual share.
26
What is recapitalization?
When a firm makes a significant change to its capital structure
27
What is an optimal level of leverage from a tax savings perspective?
Interest expense = EBIT, more interest is called excess interest and does not reduce taxes.
28
Why are firms underleveraged?
Increasing the level of debt increases the profitability of bankruptcy.
29
Why do creditors agree on reorganization?
Value of cash and securities are generally less than the amount each creditor is owed, but more than the creditor would recieve if chapter 7 would be used.
30
What are two direct costs of bankrupcty
- Outside professionals are generally hired - costly
| - Creditors get costs, e.g. legal representation
31
What are indirect costs of financial distress?
- Loss of costumers
- Loss of suppliers
- Loss of employees
32
Who pays for the financial distress costs?
When securities are fiarly priced, the original shareholders of a firm pay the present value of the costs associated with bankruptcy and financial distress.
33
What does the trade-off theory say?
Combine benifits of leverage from the interest tax shield with the costs of financial distress to determine the amount of debt --> maximize value.
34
What are three factors that determine the PV of the financial distress costs?
1. Probability of financial distress
2. Magnitude of the costs
3. Firms market risk
35
What are agency costs of leverage?
Levered firm --> conflict of interest --> does the investment decision have different consequenses for the value of equity and the value of debt.
36
What is the debt overhang/under-investment problem?
When a company has a hard time attracting investors because profits are eaten up by the debt overhang --> can't invest.
37
What is the leverage ratchet effect?
When an unlevered firm issues new debt, equity holders bear any anticipated agency or bankruptcy costs. Once a firm already has debt, some of the agency or bankruptcy cost that result from taking on additional leverage will fall on existing debt holders. --> Shareholders may have incentive to increase debt, but not decrease.
38
What is a positve effect leverage can have on management?
Leverage --> managers run the firm more effectively.
39
Why does managers overspend on personal perks and make lage unprofitable investments?
- Empire building: want to run large firms
| - Free Cash Flow Hypothesis: Excess cash after investments
40
What is the declaration date?
The date on which the board authorizes an dividend
41
What is the record date?
Shareholders record by this date will receive the dividend
42
What is the ex-dividend date?
Two business days prior to the record date, will not receive dividend
43
How does a 4:1 stock split work?
Every share generates four more shares.
44
What are three types of repurchases?
- Oper market repurchase: Long period of time... (95%)
- Tender offer: Short time, price premium.
- Targeted repurchase: Firm buys from a major shareholder.
45
What does M&M say about payout policies?
In perfect capital markets, dividend or share repurchases does not matter. When a dividend is paid, the share price drops by the amount of the dividend.
46
When is it better to pay no dividend?
If taxes are the only important market imperfection, when the tax rate on dividend exceeds the tax rate on capital gains, the optimal dividend policy is for the firm to pay no dividend. --> share repurchase.
47
What are clientele effects when it comes to payout policy?
The dividend policy of a firm is optimized for the tax preference of its investor clientele.
48
What does M&M say about retention of cash and payout
In perfect capital markets, if a firm invests excess cash flows in the financial securities, the firm's choice of payout versus retention is irrelevant and does not affect the initial value of the firm.
49
What is true about retaining cash and taxes?
Corporate taxes make it costly for a firm to retain excess cash. A firm receives interest --> it owes taxes on interest. Also agency costs with retaining cash.
50
What are two reasons to retain cash?
- Avoid financial distress costs
| - Preserve financial slack for future growth opportunities.
51
What are two types of signaling with payout policy?
- Dividend smoothing
| - Dividend signaling
52
What is a spin-off?
E.g. 100 shares of Pharmacia stock --> receive 17 shares of Monsanto stock
53
What is APV?
Adjusted present value; a valuation method, add the value of the interest tax shield to the projects unlevered value
54
What is FTE?
Flow to equity; a valuation method, value of a firms equity based on the total payouts to shareholders.
55
When is the WACC method better than the APV method?
In general, the WACC method is the easiest to use when a firm has a target D/E ratio that it plans to maintain over the time of the investment. For other leverage policies, APV is better.
56
What do a firms credit rating depend on?
- Risk of bankruptcy
| - Bondholders ability to lay claim to the firms assets in the event of such a bankruptcy
57
What are three ways in which a firm can increase its dividend?
1. Increase its earnings
2. Increase its dividend payout
3. Decrease its shares outstanding
58
How can a firm increase its growth rate?
By retaining more of its earnings
59
What is the total payout model?
Allows us to ignore the firms choice between dividends and share repurchases. Total future dividend and share repurchase/R-g
60
What is the DCF model?
Focus on the CF to all of the firm's investors, allow us to avoid estimating the impact of the firms borrowing decisions on earning.
61
What does the DDM, Total payout and DCF model determine?
- Stock price
- Equity value
- Enterprise value
62
What does the efficient market hypothesis say?
The NPV of investing is 0. Securities with equivalent risk should have the same E(R).
63
What does at the money mean?
When the exercise price of an option is equal to the current price of a stock
64
What does in the money mean?
When the payoff from exercising an option immediately is positive.
65
What does out of the money mean?
The payoff is negative
66
What is straddle and strangle?
Common combos of options
Straddle: Long call option and long put option, same strike price.
Strangle: Long call option and long put option, put option is less than the call option strike price.
67
Can an American option be worth less than its European counterpart?
No
68
Can a put option be worth more than its strike price?
No
69
Can a call option be worth more than the stock itself?
No
70
Can an American option be worth less than its intrinsic value?
No
71
Is it ever optimal to exercise a call option on a non-dividend paying stock early?
No, you are always better off just selling the option.
72
does an American call option on a non dividend stock have the same price as its European counterpart?
Yes
73
Can an American put option be worth more than an identical European option?
Yes
74
What is cannibalization
When sales of a new product displace sales of an existing product
75
What is a break-even analysis?
For what value of IRR is will we still have a positive NPV
76
What is sensitivity analysis?
Shows how much the NPV varies as the underlying assumptions change, which are most important?
77
What is scenario analysis?
Consider the effect of NPV of changing multiple project parameters.
78
What sources of funding are there (equity)
- Angel investors, Venture Capital firms, Private equity firms, Investors
79
What is an Angel investor?
Individual investors who buy in small private firms
80
What is a Venture capital firm?
A limited partnership that specializes in raising money to invest in the private equity of young firms.
Exit in one of two ways:
- Acquisition
- Public offering
81
How does Venture capital firms raise their money?
Venture capital funds are investment funds that manage the money of investors who seek private equity stakes in startup and small- to medium-sized enterprises with strong growth potential. Typically institutional investors such as pension funds are limited partners.
82
What is private equity?
Like a venture capitalist firm, but it invest in the equity of existing privately held firms rather than start-up firms.
83
What are preferred stocks?
- Preferential dividend
- Seniority in any liquidation
- Special voting rights
84
What are some advantages of going public?
- Better access to capital
- Greater liquidity
- Equity investors get the ability to diversify
85
What are some disadvantages of going public?
- Investors diversify their holdings -> mindre påverkan på företagets styrsätt -> vill betala mindre pga loss of control
- Costly and time-consuming
86
What are some different types of IPOs?
- Best efforts IPO
- Firm commitment IPO
- Auction IPO
87
What is a Best efforts IPO?
The underwriter does not guarantee that the stock will be sold, but instead tries to sell the stock for the best possible price
88
What is a firm commitment IPO?
The underwriter guarantees that it will sell all of the stock at the offer price
89
What different types of auction IPOs are there?
Prisdiskriminerande auktion
| Dutch auction
90
What 4 characteristics of IPO Puzzle financial economists
1. On average, IPOs appear to be underpriced
2. The number of issues is highly cyclical
3. The cost of an IPO are very high, and it is unclear why firms willingly incur them
4. The long-run performance of a newly public companu is poor
91
What is the winners curse?
You "win" (get all the shares you requested) when demand for the shares by other is low and the IPO is more likely to perform poorly.
92
Vad är en nackdel med att köra IPO auction?
Försäljningspriset är känsligt för koalitionsbeteende bland köparna
93
Vad är en garant?
"Underwriter" - förutom att fungera som rådgivare och kvalitetssäkrare köper ofta garanten värdepappren från emmittenten till ett reducerat pris och tar därmed risken att inte kunna sälja dessa vidare till placerarna.
94
What is an ASB?
Asset-backed security - a security that is made up of other financial securities
95
What is a CDO?
Collateralized debt obligation, an ABS backed up by other ABS
96
Name 4 different synergies from an M&A
- Economies of scale & scope
- The control provided by vertical integration
- Gaining monopolistic power
- The expertise gained from the acquired company
97
Name 5 takeover defences
- Poison pill
- Staggered board
- White Knight
- Recapitalization
- Regulatory approval
98
Assume all firms have the same expected dividends. If they have different expected returns, how will their market values and expected returns be related? What about the relation between their dividend yields and expected returns?
Firms with higher expected returns will have lower market values, and firms with high dividend yields will have high expected returns.
99
If you can use past returns to construct a trading strategy that makes money (has a positive alpha), it is evidence that market portfolio is not efficient. Explain why.
If the market portfolio is efficient, then all stocks have zero alphas, and you could not construct any strategy that has a positive alpha.
100
Which type of firm is more likely to experience a loss of customers in the event of financial distress:
a. Campbell Soup Company or Intuit, Inc. (a maker of accounting software)?
b. Allstate Corporation (an insurance company) or Adidas AG (maker of athletic footwear, apparel, and sports equipment)?
a. Intuit Inc.—its customers will care about their ability to receive upgrades to their software.
b. Allstate Corporation—its customers rely on the firm being able to pay future claims.
101
Which of the following industries have low optimal debt levels according to the trade-off theory? Which have high optimal levels of debt?
a. Tobacco firms
b. Accounting firms
c. Mature restaurant chains
d. Lumber companies
e. Cell phone manufacturers
a. Tobacco firms—high optimal debt level—high free cash flow, low growth opportunities
b. Accounting firms—low optimal debt level—high distress costs
c. Mature restaurant chains—high optimal debt level—stable cash flows, low growth, low distress costs
d. Lumber companies—high optimal debt level—stable cash flows, low growth, low distress costs
e. Cell phone manufacturers—low optimal debt level—high growth opportunities, high distress costs
102
In 2015, Intel Corporation had a market capitalization of $134 billion, debt of $13.2 billion, cash of $13.8 billion, and EBIT of nearly $16 billion. If Intel were to increase its debt by $1 billion and use the cash for a share repurchase, which market imperfections would be most relevant for understanding the consequence for Intel’s value? Why?
Intel’s debt is a tiny fraction of its total value. Indeed, Intel has more cash than debt, so its net debt is negative. Intel is also very profitable; at an interest rate of 6%, interest on Intel’s debt is only $792 million per year, which is around 4.95% of its EBIT. Thus, the risk that Intel will default on its debt is extremely small. This risk will remain extremely small even if Intel borrows an additional $1 billion. Thus, adding debt will not really change the likelihood of financial distress for Intel (which is nearly zero), and thus will also not lead to agency conflicts. As a result, the most important financial friction for such a debt increase is the tax savings Intel would receive from the interest tax shield. A secondary issue may be the signaling impact of the transaction—borrowing to do a share repurchase is usually interpreted as a positive signal that management may view the shares to be underpriced.
103
At current tax rates, which of the following investors are most likely to hold a stock that has a high dividend yield:
a. Individual investors?
b. Pension funds?
c. Mutual funds?
d. Corporations?
d. Corporations: As discussed on Table 17.3, corporations enjoy a tax advantage of dividends. While the other investor either have no tax disadvantage (pension funds and mutual funds) or a tax disadvantage of dividends (individual investors).
104
Assume capital markets are perfect. Kay Industries currently has $100 million invested in short term Treasury securities paying 7%, and it pays out the interest payments on these securities each year as a dividend. The board is considering selling the Treasury securities and paying out the proceeds as a one-time dividend payment.
a. If the board went ahead with this plan, what would happen to the value of Kay stock upon the announcement of a change in policy?
b. What would happen to the value of Kay stock on the ex-dividend date of the one-time dividend?
c. Given these price reactions, will this decision benefit investors?
a. The value of Kay will remain the same.
b. The value of Kay will fall by $100 million.
c. It will neither benefit nor hurt investors.
105
Explain under which conditions an increase in the dividend payment can be interpreted as a signal of the following:
a. Good news
b. Bad news
a. By increasing dividends managers signal that they believe that future earnings will be high enough to maintain the new dividend payment.
b. Raising dividends signals that the firm does not have any positive NPV investment opportunities, which is bad news.
106
What is IPO underpricing? If you decide to try to buy shares in every IPO, will you necessarily make money from the underpricing?
Underpricing refers to the fact that, on average, underwriters pick the IPO issue price so that the average first-day return is positive. If you followed a strategy of placing an order for a fixed number of shares on every IPO, your order will be completely filled when the stock price goes down, but you will be rationed when it goes up. In effect you only get substantial amounts of stock when you do not want it. The winners’ curse is substantial enough so that the strategy of investing in every IPO does not yield above market returns.
107
What are the advantages to a company of selling stock in an SEO using a cash offer? What are the advantages of a rights offer?
A cash offer is when a company offers the new shares to investors at large. A rights offer is when the new shares are only offered to existing shareholders. Rights offers protect existing shareholders from underpricing. However, with a rights offer, only existing shareholders are offered stock to purchase. Demand may be lower, because existing shareholders are only a subset of all possible investors, and because they may not want to increase the percentage weight of this stock in their portfolios. If demand is lower, firms may receive a lower price from rights offers
108
Explain some of the differences between a public debt offering and a private debt offering.
In a public debt offering, a prospectus is created with details of the offering and a formal contract between the bond issuer and the trust company is signed. The trust company makes sure the terms of the contract are enforced. In a private offering there is no need for a prospectus or a formal contract. Instead, a promissory note can be enough. Moreover, the contract in a private placement does not have to be standard.
109
Why do bonds with lower seniority have higher yields than equivalent bonds with higher seniority?
Requiring coupon payments protects the bondholders from waiting a long time in case the debtor defaults. Without coupon payments, default only happens when the bond matures, but by then the corporation might have depleted all of its assets. In contrast, with coupon payments the debtor would be in default the moment it misses one of the coupon payments, and the bondholders can then force the firm into bankruptcy. At this stage, they might be able to get a larger fraction of the value of the original debt than if they waited until maturity.
110
Explain the difference between a secured corporate bond and an unsecured corporate bond.
A secured corporate bond gives the bondholder the right over particular assets that serve as collateral in case of default. An unsecured corporate bond does not offer such protection to the bondholder. Thus, with an unsecured corporate bond, the bondholders are residual claimants in the case of bankruptcy after the secured assets have been given to the corresponding bondholders.
111
What is the difference between a foreign bond and a Eurobond?
A foreign bond is a bond issued by a foreign company in a local market. Eurobonds, on the other hand, are bonds denominated in a different currency than the country in which they are issued.
112
Explain why bond issuers might voluntarily choose to put restrictive covenants into a new bond issue.
Bond issuers benefit from placing restricting covenants because by doing so they can obtain a lower interest rate.
113
Explain why the yield on a convertible bond is lower than the yield on an otherwise identical bond without a conversion feature.
The option to convert the bond into stock is valuable, hence its price will be higher and its yield lower.
114
What is Mezzanine debt?
Mezzanine debt occurs when a hybrid debt issue is subordinated to another debt issue from the same issuer.
115
Vad är nackdelarna med Venture Capital ur företagets perspektiv?
Entrepreneurs experience several major problems in negotiating with a VC at various stages of the ventures development.The first, and perhaps most difficult, problem is the severe trade-off the entrepreneur faces between obtaining adequate financing for the next stage, on the one hand, and accepting substantial ownership dilution on the other.A second problem is that a VC may want protection built into the securities they purchase. The third problem is that entrepreneurs are often frustrated by:(a) the discipline that a VC imposes on them; (b) the VC’s periodic demands for information as part of the VC’s monitoring efforts; and (c) the influence that the VC wishes to have on the development of the venture.
116
What is the market feedback hypothesis?
The Market Feedback Hypothesis suggests underwriters underprice offerings for which favorable information is revealed in order to get investors to reveal that favorable information, which still benefits the underwriter since a partial upward price revision is better than none.
117
What is the bandwagon hypothesis?
The bandwagon effect is a psychological phenomenon in which people do something primarily because other people are doing it, regardless of their own beliefs, which they may ignore or override.
118
What is the investment banker's monopsony hypothesis?
Investment banker’s monopsony power: According to Ritter, the investment bankers intentionally under price the securities and ration them to their large customers who regularly buy a variety of investment services from them
119
What is the lawsuit avoidance hypothesis?
The basic notion of the lawsuit avoidance hypothesis is that issuers deliberately sell their IPOs at a discount to reduce the possibility of future legal liability claims from investors.
120
What is the signaling hypothesis suggests?
The signaling hypothesis suggests that firms have incentives to underprice their initial public offerings (IPOs) to signal their quality to the outside investors and to issue seasoned equity (SEO) at more favorable terms.
121
What is the ownership dispersion hypothesis?
The ownership dispersion hypothesis: Underpricing increases demand → increases liquidity by having a large number of small shareholders. Reduces ability for outside blockholders to challenge management.
122
Excess Capital Hypothesis: Repurchases and Distribution Policy
When a firm’s capital exceeds its investment opportunities, the firm can either retain the excess cash or distribute it to shareholders. Stock repurchases may also be preferred over dividends as a means of distribution due to the personal-tax-rate advantage of capital gains.
123
Undervaluation Hypothesis: Repurchases and Investment Policy
Stock repurchases offer flexibility not only in the choice to distribute excess funds but also when to distribute these funds. This flexibility in timing is beneficial because firms can wait to repurchase until the stock price is undervalued
124
Optimal Leverage Ratio Hypothesis: Repurchases and Capital Structure Policy
A firm is, therefore, more likely to repurchase stock if it’s leverage ratio is below its target leverage ratio. Thus, a firm’s capital structure will affect its decision to repurchase.
125
Management Incentive Hypothesis: Repurchasesand Compensation Policy
Thus, stock options encourage managers to substitute re-purchases for dividends since repurchases do not dilute the per-share value of the firm.
126
Takeover Deterrence Hypothesis: Repurchases and Corporate Control
Thus, a repurchase can be used as a takeover defence because a repurchase can increase the lowest price for which the stock is available
127
Tredje vågen: 1955-1969
Conglomerate mergers
Determinants: Booming economy, expansion in management science, the possibility of accounting manipulations
Characteristics: Period of conglomerate mergers, little increase in industrial concentration...
Effects: Fail of conglomerates, non-core activities divested in the following years
Inhibitors: Tax reform that ended accounting manipulations (största skattereformen någonsin), stock market crash 1969.
128
Fjärde vågen: 1980-1989
Corporate raiders and hostile takeovers
Determinants: Existance of raiders and arbitragers, agresive role of investment bankers
Characteristics: PEriod of mega mergers and histce takeovers, junk financing largely used, increased volue and size of leveraged buyouts. use of politial and legal stragedies ato avoid takovers, dereguation
Effects: negative impact on shareholder value.
Inhibitors: collapse of junk bond market and relatively mild recession in 1989-1990.
129
Första vågen: 1893-1904
Horizontal mergers
Determinants: Man reorganiserade transportsystem, järnvägen kom
Man kunde då satsa på mer storskalig producering
Characteristics: Little and inneffective legislation.
Effect: Adoption of new antitrust legislation
Inhibitors: weak banking system, the stock market crash from 1904.
130
Andra vågen: 1919-1929
Vertical mergers
Determinants: Man hade haft ett krig så man hade organiserat sig lite annorlunda, man hade radio osv.
Characteristics: Mycket vertikal integration, monopol fick man inte ha med man byggde oligopolistiska strukturer
Effects: Adoption of tougher antitrust legislation
Inhibitors: the stock market crash from 29 October 1929 and the recession that followed.
131
Femte vågen:1993-2000
Globaliseringsvåg
Determinants: 1990’s US economy exansion, increasing aggregate demad
Characteristics: Internationa wave, hostile takeover activity dishminished, period of mergers of equals.
Effects: transactions at the beginning of the fifth merger wave are value creating, but between 1998 – 2001 striking losses occurred, tighter lending standards.
Inhibitors: bursting of the Dot-com Bubble, large M&A failures.
132
Sjätte vågen: 2003-2007
Strategic M&A’s
Determinants: globalization, government encouragement to create strong national companies, availability of low interest financing, existence of hedge funds, private equity firms, shareholder activism.
Characteristics: focus on strategic fit and attention to post merger integration issues, bigger portion of deals paid in cash, EU brought a focus on building stronger pan-European competitive position, raise in activity of financial buyers.
Effects: value creation or value destruction?
Inhibitors: current financial crisis.
