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CIA PT 3 > Finance > Flashcards

Finance Flashcards

1
Q

Return on investment equals

A

Amounts received - Amounts invested

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2
Q

Rate of return equals

A

Return on investment divided by Amount invested

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3
Q

Residual income equals

A

Operating income - Target return on invested capital

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4
Q

Quantifies the expected return on an equity security by relating the security’s level of risk to the average return available in the market.

A

Capital asset pricing model (CAPM)

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5
Q

The CAPM Formula:

Required rate of return equals

A

Rf + B (Rm -Rf)

Rf = Risk-free return
Rm = Market return
B (Beta) = Measure of eh systematic risk or volatility of the individual security in comparison to the market (diversified portfolio)

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6
Q

Is the risk faced by all firms. The risk cannot be offset through diversification.

A

Systematic risk

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7
Q

Is the risk inherent in a particular investment. This risk can be offset through diversification.

A

Unsystematic risk

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8
Q

When choosing a portfolio of investments, an investor wants to

A

Maximize return and minimize risk

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9
Q

Is the weighted average of the returns on the individual securities in the portfolio.

A

Portfolio return

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10
Q

Is less than a simple average of the risks of the securities in the portfolio

A

Portfolio risk

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11
Q

Is an investment transaction in which the parties’ gain or loss is derived from some other economic event.

A

A derivative instrument

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12
Q

Has bought the right to demand that the counterparty buy or sell an underlying asset on or before a specified future date.

A

A party who buys an option

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13
Q

Gives the buyer the right to purchase the underlying asset at a fixed price.

A

A call option

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14
Q

Gives the buyer the right to sell the underlying asset at a fixed price

A

A put option

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15
Q

The price of an option (the option premium) consists of two components:

A

1) Intrinsic value and

2) the time premium

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16
Q

Equals Intrinsic value + Time premium

A

Option premium

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17
Q

Is the price at which the holder can purchase (in the case of a call option) or sell (in the case of a put option) the asset underlying the option contract.

A

The exercise price

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18
Q

Of a call (put) option is the amount by which the exercise price is less (greater) than the current price of the underlying asset.

A

The intrinsic value

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19
Q

Is an agreement that, at a set future date, one party will perform and the other will pay a specified amount for the performance.

A

A forward contract

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20
Q

Is a commitment to buy or sell an asset at a fixed price during a specific future period.

A

A futures contract

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21
Q

Is an exchange of one party’s stream of payments for another party’s stream of payments with a different pattern.

A

A swap transaction

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22
Q

Is the process of using offsetting commitments to minimize or avoid the effects of adverse price movements.

A

Hedging

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23
Q

Are futures contracts that are purchased to protect against price increase (declines)

A

Long (short) position hedges

24
Q

Are the principal form of long-term debt financing for corporations and governmental entities.

A

Bonds

25
Q

In general, the longer the term of a bond is,

A

The higher the return demanded by investor to compensate for increased risk will be.

26
Q

Are the owners of a corporation, and their rights as owners, although reasonably uniform, depend on the laws where it is incorporated.

A

The common shareholders

27
Q

Common stock valuation based on

A

Dividend yield models

28
Q

When the dividend per share of common stock is constant and expected to be paid continuously, the price per share

A

Po = D divided by r

Po = Price per share now
D = Dividend per share (constant)
r = Required rate of return (cost of common stock)
29
Q

Assumes that dividend per share and price per share grow at the same constant rate.

A

The constant growth model (dividend discount model)

30
Q

Has features of debt and equity. It has a fixed charge, but payment of dividends is not an obligation.

A

Preferred stock

31
Q

The future cash flows from the preferred stock are assumed to consist only of the

A

Estimated future annual dividends (Dp)

32
Q

Estimated future annual dividends (Dp) equals

A

Par value of preferred stock x Preferred dividend rate

33
Q

A firm’s financing structure consists of three components:

A

1) Long-term debt,
2) Preferred equity, and
3) Common equity

34
Q

A firm’s weighted-average cost of capital (WACC) is a single, composite rate of return on its

A

Combined components of capital

35
Q

Is the process of planning and controlling investments for long-term projects.

A

Capital budgeting

36
Q

The first step in assessing the desirability of a potential capital project is to

A

Identify the relevant cash flows (do not include sunk costs)

37
Q

Is the difference between the present values of the net cash savings or inflows expected over the life of the project and the required dollar investment.

A

A capital project’s net present value (NPV)

38
Q

The internal rate of return (IRR) of a project is the

A

Discount rate at which the investment’s net present value equals zero.

39
Q

If the internal rate of return is higher than the company’s hurdle rate,

A

The investment is desirable

40
Q

If the internal rate of return is lower,

A

The project should be rejected

41
Q

Is the number of years required for the net cash savings or inflows to equal the original investment. No consideration is made for the time value of money under this method

A

The payback period

42
Q

Payback period equals

A

Initial investment divided by (Annual after-tax cash savings divided by Inflows)

43
Q

Is a technique for assessing potential capital projects that ignores the time value of money.

A

The accounting rate of return

44
Q

Is the formula for residual income adjusted for the opportunity cost of capital.

A

Economic value added (EVA)

45
Q

The goal of cash management is to

A

Determine and maintain the firm’s optimal cash balance.

46
Q

Is a minimum amount that the bank requires the firm to keep in its demand (checking) account

A

A compensating balance

47
Q

Companies use various strategies to

A

Speed up cash collections while slowing cash disbursements

48
Q

Is the single most important strategy for expediting the receipt of funds.

A

A lockbox system

49
Q

Is the amount of current liabilities, such as trade payables and accruals, that arises naturally in the ordinary course of business without the firm’s financial managers needing to take deliberate action.

A

Spontaneous financing

50
Q

The annualized cost of not taking the discount is

A

Discount % divided by (100% - Discount %) x (Days in year) divided by (Total payment period - Discount period)

51
Q

Is one in which the interest is paid at the end of the loan terms.

A

A simple interest loan

52
Q

The amount of interest to be paid is based on

A

The nominal (stated) rate and the principal of the loan (amount needed)

53
Q

Interest expense equals

A

Principal of loan x Stated rate

54
Q

The effective rate on any financing arrangement is

A

The ratio of the amount the company must pay to the amount the company gets use of.

55
Q

Effective interest rate equals

A

Interest expense divided by Usable funds

56
Q

Is one in which the interest and finance charges are paid at the beginning of the loan term.

A

Discounted loan

57
Q

Total borrowings equals

A

Amount needed divided by (1.0 - Stated rate)

CIA PT 3 (28 decks)

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