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FI 311 > Final Exam > Flashcards

Final Exam Flashcards

1
Q

Three major forms of business in the United States:

A
  • Sole Proprietorship
  • Partnership
  • Corporation
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2
Q

Sole Proprietorship Advantages (4):

A
  • Easiest to start
  • Least regulated
  • Single owner keeps all the profits
  • Taxed once as personal income
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3
Q

Sole Proprietorship Disadvantages (4):

A
  • Limited to life of the owner
  • Unlimited liability
  • Equity capital limited to owner’s personal wealth
  • Difficult to sell ownership interest
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4
Q

What is the goal of financial management?

A

The goal of financial management is to maximize the current market value of the existing stock

Maximize the value of the owner’s equity/stake of the company

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5
Q

Money that is leaving the company because of an agency problem

A

Direct Agency Cost

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6
Q

Money that should’ve been coming in to the company but did not

A

Indirect Agency Cost

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7
Q

What is a way to alleviate an agency problem?

A
  • Pay sales people on commission

- Issue stock

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8
Q

Features of Common Stock (4):

A

-Voting Rights
-Proxy Voting
-Classes of stock
-Other Rights
Share proportionally in dividends paid
Share proportionally in remaining assets after liquidation
The right to vote on stockholder matters of great importance, such as a merger. Voting is usually done at the annual meeting or a special meeting
Preemptive right - first shot at new stock issue to maintain proportional ownership if desired

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9
Q

A contract between a borrower and investor

A

Bond

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10
Q

Interest payments made by the company are _____

A

Tax deductible

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11
Q

T/F

Bond holders have part ownership in the company

A

False

They are just lenders and not owners

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12
Q

T/F

Bonds can be traded between investors the same way as stocks

A

True

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13
Q

Lowest rating to be an investment grade bond

A

BBB-

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14
Q

Highest rating to be a noninvestment grade bond

A

BB+

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15
Q

Future value interest factor

A

(1+r)^t

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16
Q

T/F

The longer the time period, the higher the present value

A

False

The longer the time period, the lower the present value

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17
Q

PV formula

A

FV/(1+r)^t

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18
Q

For interest rates

If you are looking at annual periods, you need a ___ rate

If you are looking at monthly periods, you need ___ rate

A

annual

monthly

ALWAYS make sure they match

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19
Q

Debt security, usually an interest-only loan

A

Bond

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20
Q

Face value (par value) of a bond

A

Typically $1,000

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21
Q

Stated interest payment made on the bond

A

Coupon Payment (PMT)

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22
Q

State in the indenture (contract). Equals ( Annual Coupon Payments / Face Value of the bond )

A

Coupon Rate

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23
Q

Coupon Payment calculation

A

(Coupon Rate)*(Face Value)/(# of payments per year)

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24
Q

Specified date on which the principal amount of the bond will be repaid

A

Maturity

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25
Q

the rate of total return (return based on purchase-vs-par value of the bond, plus coupon [interest payments] received) that a purchaser of a bond will receive if he/she holds the bond until maturity

A

Yield to Maturity (YTM)

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26
Q

T/F

If a bond sells at face value, its YTM is equal to its coupon rate

A

True

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27
Q

What relationship does bond prices/values and interest rates have?

A

Inverse relationship

They always move in opposite directions

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28
Q

As bond prices rise, the YTM ____

A

decreases/falls

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29
Q

o The following factors typically affect the risk-level, and therefore the required rate of return (and YTM), of bonds (5):

A 
 Bond Rating
 Seniority	
 Financial health of the issuer (this should be reflected in the bond rating)
 Callable vs Non-Callable
 Secured vs Unsecured
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30
Q

___ = pay less

A

Callable

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31
Q

___ = price will fall, yield will rise

A

Unfavorable

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32
Q

If the NPV is positive ____ the project

A

Accept

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33
Q

NPV is a direct measure of how well this project will

A

meet our goal

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34
Q

IRR is the return that makes the NPV =

A

0

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35
Q

IRR Decision Rule:

Accept the project if the IRR is…

A

greater than the required return

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36
Q

Two exceptions to NPV and IRR giving the same decision:

A
  • Nonconventional cash flows

- Mutually exclusive projects

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37
Q

Common Types of Cash Flows:

A

o Sunk costs – costs that have occurred in the past
o Opportunity costs – costs of lost options
o Side effects
o Positive side effects – benefits to other projects
o Negative side effects – costs to other projects
o Changes in net working capital
o Financing costs
o Taxes

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38
Q

Sunk costs are always ____ in cash flows, as well as anything in the past

A

Excluded

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39
Q

Opportunity costs are ___ in cash flows

40
Q

Depreciation itself is a ________

A

Non-cash expense

41
Q

T/F

Depreciation does not affect taxes

A

False

Depreciation affects taxes.

42
Q

If the salvage value is different from the book value of the asset, then there is a ___

A

tax effect

43
Q

Book value =

A

Initial cost - accumulated depreciation

44
Q

After-tax salvage =

A

salvage - (salvage - book value)

45
Q

When is the only time bottom-up approach works?

A

Only when there is no interest expense

46
Q

How do you find Bottom-Up Approach

A

Start with the bottom line (NI) and add back non-cash deductions

OCF = NI + Depreciation

47
Q

Top-Down Approach

A

OCF = Sales - Cash Expenses - Taxes

48
Q

We can examine returns in the financial markets to help us determine the ______

A

appropriate returns on non-financial assets

49
Q

Lessons from the capital market history (3):

A
  • There is a reward for bearing risk
  • The greater the potential reward, the greater the risk
  • This is called the risk-return trade-off
50
Q

Stocks or bonds

Higher risk?

A

Stocks

Also means higher returns

51
Q

Small or large cap

Higher return?

52
Q

Government or corporate

Riskier?

53
Q

Highest return

A

Small cap stock

54
Q

Lowest return

A

Government bonds

55
Q

Risk Premium =

A

Average return, risk free rate

56
Q

Return earned in an average period over multiple periods

A

Arithmetic average

57
Q

Average compound return per period over multiple periods

A

Geometric average

58
Q

The ___ average will be less than the ___ average unless all the returns are equal

A

Geometric

Arithmetic

59
Q

Implications of Market Efficiency (4):

A
  1. Stock prices respond very rapidly to new information
  2. Future prices are very difficult to predict based on publicly available information (financial statements, disclosures, etc.)
  3. It is very difficult for the average investor to identify and exploit mispriced stocks.
  4. Financial managers cannot time stock and bond sales.
60
Q

Expected returns are based on the …

A

Probabilities of possible outcomes

61
Q

In expected returns context, “expected” means ___

62
Q

The “excepted return does not even have to be a …

A

possible return

63
Q

___ returns are generally not equal to ___ returns

A

Realized

Expected

64
Q

At any point in time, the unexpected return can be _____

Over time, the average of the unexpected component is ___

A

Positive or negative

Zero

65
Q

Announcements and news contain both ___ and ___ components

A

Expected

Surprise

66
Q

Price of the stock is driven by …

A

unexpected component

67
Q

Total return =

A

Expected return + unexpected returns

68
Q

Unexpected returns =

A

Systematic portion + unsystematic portion

69
Q

Risk factors that affect a large number of assets

A

Systematic Risk

70
Q

Systematic risk is also known as __ or __ risk

A

non-diversifiable or market

71
Q

Systematic risk includes such things as changes in … (3)

A

GDP, inflation, interest rates

72
Q

T/F

Systematic risk only affects select stocks

A

False

Systematic risk affects most stocks in the market

73
Q

Risk factors that affect a limited number of assets

A

Unsystematic Risk

74
Q

Unsystematic risk is also known as __ and __ risk

A

unique and asset-specific

75
Q

Unsystematic risk includes such things as .. (2)

A

Labor strikes, part shortages

76
Q

Examples of unsystematic risks (2)

A

Price of oil rising

CEO’s plane crashing

77
Q

Investment in several different asset classes or sectors

A

Portfolio Diversification

78
Q

Are you diversified if you own 50 technology stocks?

A

No, but if you own 50 stocks that span 20 different industries then you are

79
Q

Diversification can substantially reduce the _____ without an equivalent reduction in ___

A

variability of returns

expected returns

80
Q

Reduction in risk arises because ___ than expected returns from one asset are offset by ___ than expected returns from another

A

worse

better

81
Q

There is a minimum level of risk that cannot be diversified away and that is the _____

A

systematic portion

82
Q

T/F

Diversification reduces risk without a corresponding reduction in return which brings down the risk level much moe

83
Q

The standard deviation of returns is a measure of

A

total risk

84
Q

For well-diversified portfolios, _______ is very small

A

unsystematic risk

85
Q

The total risk for a diversified portfolio is essentially equivalent to

A

systematic risk

86
Q

The expected return on a risky asset depends only on that asset’s…

A

systematic risk since unsystematic risk can be diversified away

87
Q

How do we measure systematic risk?

A

We use the beta coefficient

88
Q

What does beta tell us?

A beta of 1 implies..
A beta < 1 implies..
A beta > 1 implies..

A

of 1 implies the asset has the same systematic risk as the overall market

<1 implies the asset has less systematic risk than the overall market

> 1 implies the asset has more systematic risk than the overall market

89
Q

Systematic Risk

Less than 1 =
More than 1 =

A

Less risky

More risky

90
Q

Security with higher total risk has higher

A

standard deviation

91
Q

Higher beta is higher

A

systematic risk, expected return

92
Q

The Capital Asset Pricing Model defines the relationship between __ and __

A

risk and return

93
Q

If we know an asset’s systematic risk, we can use the capital asset pricing model (CAPM) to determine its

A

expected return

94
Q

The Pure Play Approach (5):

A

o Find one or more companies that specialize in the product or service that we are considering
o Compute the beta for each company
o Take an average
o Use that beta along with the CAPM to find the appropriate return for a project of that risk
o Often difficult to find pure play companies

95
Q

Subjective Approach (4):

A

o Consider the project’s risk relative to the firm overall
o If the project has more risk than the firm, use a discount rate greater than the WACC
o If the project has less risk than the firm, use a discount rate less than the WACC
o You may still accept projects that you shouldn’t and reject projects you should accept, but your error rate should be lower than not considering differential risk at all

96
Q

Subjective Approach

Less risk =
High risk =

A

subtract

add

FI 311 (3 decks)

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