Final Flashcards
Income Statement steps
net sales cogs gross income ops exp ebit interest ebt income tax net profit
How long are short term interest rates
security rates less than one year
How long are long term interest rates
security rates greater than one year
Who sets short term interest rates
The Fed
Who sets long term interest rates
by the bond market based on expectations of inflation
define interest
the cost of borrowing money
define spread
difference between 2 interest rates
define basis point
one hundredth of a percentage point (bips)
define money market securities
debt securities maturing in less than one year
define risk
uncertainty about the outcome
define inflation
an increase in prices over time
define real
value adjusted for inflation
what is the length of time for interest accrual payment
standard is a year
do interest rates change over time?
yes
define bonds
debt securities with an original maturity greater than one year
define common stock
equity securities
what is the CPI and who releases it
consumer price index measures inflation at the store / the government
what is PPI and who releases it
product price index measures inflation at the middleman level - between manufacturers and sellers eludes to what consumer price will be / the government
how does demand increase interest rates
more demand, less supply, rates goes up
what is core CPI and who releases it
CPI minus food and energy / the government
what is a debt security
bonds
what is an equity security
stocks
positive real interest rate
interest rate is greater than inflation rate
negative real interest rate
interest rate is less than inflation rate
risk return trade off
the greater the risk the greater the potential return
what are investors to risk
risk averse, must be compensated for them to invest
3 types of yield curves
short, intermediate, long
flattening of yield curve
a decrease in the difference between maturity rates
steepening of yield curve
an increase in the difference between maturity rates
what does a negative yield curve signify
a recession
alt name for yield curve
term structure of interest rates
what is a flat yield curve
interest rates remaining the same regardless of maturity length
what is a negative yield curve
when short term interest rates are higher than long term
what is nominal rate
total rate, with inflation, doesn’t differentiate what you’re earning compared to inflation
positive real interest rate
interest rate is greater than inflation
negative real interest rate
interest rate is lower than inflation
difference between nominal and real risk free rate
US Treasuries use nominal risk free, meaning that it is a risk free investment but without adjustment for inflation
Types of US debt securities
bills - less than 1 year
notes - 2-10 years
bonds - 10+ years
examples of default risk
a borrower failing to pay, an institution going bankrupt
alternate name of default risk
credit risk
default risk
possibility that the borrower may not be able to make scheduled interest or principal payments
why are US securities the safest
can just increase taxes to pay for it and never go bankrupt
inflation premium
average projected annual inflation rate over the life of the investment.
liquidity risk
how easily something is able to be converted to cash, greater the longer it has until maturity
maturity risk behavior
bond price fluctuation due to interest rates is weaker the closer it gets to maturity
interest rate risk
the amount prices change due to interest rates
do risk premiums remain constant over time
no, can change
risk premium
measures the minimum amount of return required for investors
what do bond ratings measure
measure of the borrowers ability to repay creditors
2 bond ratings agencies, are they government
Moodys
Standard and Poors
no
can bond ratings change over time
yes
cut off of investment vs junk bond ratings
BBB- is the lowest investment grade
alternate names for junk bonds
high yield / speculative
what does S&P mean
Standard and Poors
what kind of securities are bonds
debt, long term
difference between debt and equity securities
debt is an instrument to get money, equity a claim of ownership,
which financial statement tells if bonds have been issued
balance sheet
par value corporate bond
1000
can par value change over time
no
coupon rate
rate of interest that a bond pays on its par value
par value
the amount issuers agree to repay upon maturity
alt name for par value
principal value / maturity value / face value
how do interest rate changes relate to value
market value is inversely related to interest rates
type of capital bond holders provide to issuer
debt
two reasons why bond market value changes
bond rating and coupon rate
what component of total return is interest
income
what is total return
combination of income and growth for investments
municipal bond differences
interest they pay is federal income tax-free to investors
secured bond
bond back with collateral (mortgage)
unsecured bond (name)
debentures
zero-coupon bonds
pay no interest but are issued at a significant discount
convertible bonds
may be exchanged for the issuer’s common stock, at the bondholder’s option
when can a callable bond be called since issue
may be redeemed at the issuer’s option prior to maturity
refunding operation
paying off old high interest bonds with new lower interest rate bonds
borrowing money to pay off a debt that has a higher interest rate
who does the call feature favor
borrowers, allows ability to pay less interest on low new bonds
who does call protection period favor
investor
reinvestment rate and risk
putting money from one investment to another is riskier, but generally pay higher interest
call premium
an amount above the par value that is paid to the bondholders if called
alt names for fundamental value
intrinsic / theoretical
required rate of return
minimum amount of return required for investors to invest
yield to maturity
compound annual total return you would earn if you hold the bond until it matures
what components does YTM measure
income and growth, covers all of total return
what does YTM reflect/indicate
current market rate of interest of similar rated bonds
indicates investors’ required rate of return for the bond
what variable is YTM for Vbond
i
discounted cashflow analysis
calculates present value of expected future cashflows
do you use YTM or coupon rate to determine interest payment of a bond
coupon rate
do you use YTM or the coupon rate for interest rate when calculating Vbond
YTM
interpretations of the results of Vbond
interpret Vbond
if you invest x today and recieve i yearly with an end result of v you must invest y today
current yield of a bond formula
annual coupon interest in $ / current market price of the bond
how to calculate Vbond with semi annual payments
divide total Vbond by half
what does it mean to interpret
write out sentences explaining what happened
Yield to call (YTC)
compound annual total return assuming the bond is called on the next call date
2 things that YTC reflects
current market rate of interest for the callable bond
the required return for the callable bond
both also include similarly rated bonds
what variable is YTC used for for V callable bond
i
call premium formula
call price - par value
yield to maturity formula
1
when should an investor expect to earn YTC or YTM
1
if coupon rate is lower than market rate,
1
when are callable bonds called
when interest rates drop
Corporate Charter / Articles of Incorp.
Registered with the secretary of state, establish the existence of a corp in the US outlining objectives
Authorized Stock
max shares a corp is allowed to issue, stated in articles of incorp
Issued Stock
The amount of shares registered and either held in treasury or sold
Treasury Stock
Stock not sold or sold stock bought back
Pre-emptive Right
Clause to buy new shares first to maintain percentage owned
formula for shares outstanding
issued shares - treasury shares
Corporation
a legally incorporated business entity, owners are shareholders
Incorporation
the process of becoming a business entity
Company
a business whose owners are members of the business, not legal entity
what type of capital is common stock
equity
dividend
distribution of earnings to shareholders
how often are stock dividends paid
quarterly
which shares do not receive dividends
treasury
what rate is Tbill
nominal risk free
how is market risk affected when there is higher perceived risk
goes up
Beta
how risky an investment is
Beta of a portfolio
multiply percentage owned times beta then add together
TTM
trailing 12 months
proceeds
the amount you receive from selling something
Dividend discount model variables
Present future value of all dividends
P0 = D1/rs-g
P0 = V at time 0
D1 = dividend at end of year 1
(dollar amount + growth rate ^ # terms)
rs = required rate of return on the stock (expected return)
g = annual growth rate
goal of financial management steps
max present value of companys expected future free cashflows
max value of common stock
max wealth of business owners
alt names for shareholder wealth
shareholder value /
alt names for EBIT
earnings before interest and tax / operating profit
2 variables that impact free cashflow
EBIT and Tax Rate
Value of a firm
PV of expected future cashflows
V Firm Formula
Freecashflow 1 / (1+WACC)^1 + FCF 2 / (1+WACC)^2 + etc
WACC
Weighted Average Cost of Capital
WACC meaning
weighted average of the required returns on the corps securities
2 variables that impact Vfirm
freecashflow / WACC
how do variables impact value of the firm
if FCF goes up V goes up
if WACC goes up V goes down
which security is riskiest to invest in
common stock
which security is least risky to invest in
bonds
capital budget
used to determine which long term investments are worth pursuing
optimal capital budget
amount of investment toward goals that optimizes shareholder investment
capital rationing
placing a limit on the amount of new projects undertaken by a company
independent project
funding of one project does not affect another
NPV formula
Cash Flow / (1+i)^t - initial investment
i = rate
t = periods
accept or reject a project based on IRR
internal rate of return
MIRR
Modified internal rate of return
2 types of equity capital
shareholder equity
paid in capital
role of board of directors
protects the interests of the shareholders
consists of execs, large shareholders, officers
3 uses for free cashflow
Distribute dividends
Buy back stock
pay off debt
expenditure
a cash outflow, but not an expense
goal of financial management
maximize wealth of stockholders
max value of stock/company
benchmark
ratios used for industry standards
gross margin
gross profit/net sales
net profit margin
net income/net sales
leverage
potential increase on investment returns
decreases amount owners must invest
increases risk
common equity
the amount that all the investors have put into the company
calculate interest
Principle * interest * fraction of a year
calculate return in dollars
amount received - amount invested
calculate return in %
Return in $ / amount invested
ordinary annuity
payments at the end of each period
annuity due
payments at the beginning of each period
