Final Review Flashcards
Four Types of Firms
Sole Proprietorship
Partnership
Limited Liability Companies
Corporation
Corporation pays tax on its profits and shareholders pay their own personal income taxes
C Corporation
Firm’s profits/losses are not subject to corporate taxes
S Corporation
Financial Management Tasks
- Investment decisions
- Financing decisions
- Manage cash flow from operating activities
Holding the time period constant while decreasing the interest rate _______ present values.
Increases
Equally-spaced cash flows that increase in size at a constant rate forever
Growing Perpetuity
Equally-spaced cash flows that increase in size at a constant rate for a finite number of periods
Growing Annuity
Does not account for the number of compounding periods or adjust the annualized interest rate for the time value of money
APR
Accounts for the number of compounding periods and adjusts the annualized interest rate for the time value of money
EAR
More accurate measure of rates involved in lending and investing
EAR
Real rate of interest
Interest rate that would exist in the absence of inflation
Nominal rate of interest
Interest rate adjusted for inflation
Interest rates tend to follow
the business cycles
Interest rates tend to decrease during an
economic contraction
Interest rates tend to increase during an
economic expansion
Slopes upward from left to right and imply higher interest rates are likely
Ascending Yield Curve
Slopes downward from left to right and implies lower interest rates are likely
Descending Yield Curve
Implies interest rates are unlikely to change
Flat
Three factors that influence the shape of the yield curve:
Real rate of interest
Expected rate of inflation
Interest rate risk
The longer the maturity of a security, the _______ its interest rate risk.
greater
The interest rate risk premium adds _______ _____ to the slope of the yield curve
Upward bias
Treasury notes
Original maturities from one to ten years
Treasury bonds
Original maturities of more than ten years
If coupon rate is equal to the yield, the bond is sold at?
par
If coupon rate is less than its yield, the bond is sold at?
A discount
If coupon rate is greater than its yield, the bond is sold at?
A premium
Bonds with higher coupon rates are _____ sensitive to interest rate changes because they pay higher cash flows up-front
less
Four features of debt instruments responsible for the differences in corporate borrowing costs and determine the level and structure of interest rates:
Marketability
Call feature
Default risk
Term-to-maturity
Yield to maturity of a defaultable bond is not equal to what?
the expected return of investing in the bond
Risks affecting individual companies or industries are called ________ risk
Unsystematic or Private
Risks affecting the entire market are called _________ risk
Systematic
________ risk can be diversified away in a large portfolio
Unsystematic
Risk premium of a security is only determined by its __________ risk
Systematic
The total risk of a portfolio is the _____
volatility
Small firms and value firms do better than big firms and growth firms according to what model
Fama-French
WACC Assumptions
Average Risk
Constant Debt-Equity Ratio
Limited Leverage Effects
A private company can seek funding from several potential sources:
Angel investors
Venture capital firms
Institutional investors
Corporate Investors
Advantages of going public:
Greater liquidity
Better access to capital
Disadvantages:
Equity holders more dispersed
Must satisfy requirements of public companies
Investment banking firm that manages the IPO and designs its structure
Underwriter
Syndicate
other underwriters that help market and sell the issue
Underwriter Tasks
SEC Filings
Valuation
Underwriter guarantees that it will sell all of the stock at the offer price
Firm Commitment Arrangement
Underwriter does not guarantee that the stock will be sold
Best-efforts basis
Company or its investment bankers auction off the shares directly to the public
Auction IPO
Private Debt
Bank Loans
Private Placements
Bank Loans
Term Loan
Syndicated Bank Loan
Revolving Line of Credit
Asset-Backed Line of Credit
Public Debt
Notes
Debentures
Mortgage Bonds
Asset-backed Bonds
Subordinated Debenture
debenture issue that has a lower priority claim to the firm’s assets than other outstanding debt
Tranches
different classes of securities that comprise a single bond issuance
Debt that involves foreign investors:
Domestic bonds
Foreign Bonds
International Bonds
Issued by a local entity and traded in a local market, but purchased by foreigners
Domestic Bonds
Issued by a foreign company in a local market and are intended for local investors
Foreign Bonds
International bonds that are NOT denominated in the local currency of the country in which they are issued
Eurobonds
Combines the features of domestic, foreign, and Eurobonds and are offered for sale in several different markets simultaneously
Global bonds
Limits the issuer in a bond contract from taking actions that might hinder its ability to pay bondholders
Covenants
Advantages of Covenants
May reduce a firm’s cost of borrowing, and the reduction might more than outweigh the cost of the loss of flexibility associated with covenants
Yield of a callable bond assuming that the bond will be called on the earliest call date
Yield to Call
When coupon rate is above current market yield, YTC is less than YTM what will the firm do?
call the bond
When coupon rate is below current market yield, YTC is greater than YTM what will the firm do?
NOT call the bond
A perfect capital market is a market in which:
Securities are fairly priced
No tax consequences or transaction costs
Investment cash flows are independent of financing choices
MM Prop I:
In perfect capital market, the total value of a firm is equal to the market value of the free cash flows generated by its assets and is not affected by its choice of capital structure
Indirect costs of financial distress:
Loss of customers
Loss of suppliers
Loss of employees
Fire sale of assets
As debt increases, tax benefits increase until ______ _______ exceeds EBIT
interest expense
Costs that arise when there are conflicts of interest between stakeholders
agency costs
Pecking order hypothesis
Managers have a preference to fund investment using retained earnings, followed by debt, and will only choose to issue equity as a last resort
Share repurchases to distribute cash to shareholders:
Open Market Repurchases
Tender offer
Targeted Repurchase
A firm must _______ the tax costs of holding cash with the potential benefits of not having to raise external funds in the future
balance
Paying out excess cash through dividends or share repurchases can ______ the stock price by reducing managers’ ability and temptation to waste resources
boost
Asymmetric information
when managers have better information than investors regarding the future prospects of the firm, their payout decisions may signal this information
The practice of maintaining relatively constant dividents
dividend smoothing
Dividend signaling
the idea that dividend changes reflect managers views about a firm’s future earnings prospects
Consequences of Stock Dividends
- Firm doesn’t pay out any cash to shareholders
- Increase in the number of shares outstanding (stock price will fall)
- Stock dividends are not taxed
Why issue a stock dividend?
Typical motivation for a stock split is to keep the share price in a range thought to be attractive to small investors
When a firm sells a subsidiary by selling shares as a non-cash special dividend in the subsidiary alone
Spin-offs
Advantages of a spin-off
- avoids the transaction costs associated with such a sale
- special dividend is not taxed as a cash distribution
What is the financial managers most important job?
Making investment decisions
What strategies are available to shareholders to help ensure managers are motivated to act in the shareholders interests?
- Ensure that employees are paid with company stock and/or stock options
- Mount hostile takeovers
- Ensure that underperforming managers are fired
- Write contracts that ensure the interests of the managers and shareholders are closely aligned
What is an example of a physical market?
New York Stock Exchange (NYSE)
What is an example of an over-the-counter market?
NASDAQ
