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Finance and investment Flashcards

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1
Q

Four types of firms

A

1) sole proprietorship
2) Partnership
3) Limited liability company
4) Corporations

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2
Q

Sole proprietorship

A

Business is owned and run by one person. It typically has few, if any, employees

Advantage: easy to set up

Disadvantages: No separation between firm and owener, Unlimited personal liability and a limited life

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3
Q

Partnership

A

Like sole proprietorship but with more than one owner. All partners are personally liable for all the firms debts and the partnership ends with the death or withdrawal of any single partner

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4
Q

General partners

A

liable for the firms debt obligation

Run day to day business

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5
Q

Limited partners

A

Have limited liablility (their investment or less), are transferable (in case of death or withdrawl) and have no management authority and no legal involvement in the managerial decision makeing for the business

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6
Q

Corporation

A

Legal entity separate from its owner, can enter in contracts, own assets and borrow money

Corporation is soley responsible for its own obligations its owners are not liable for any obligation the corporation enters into

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7
Q

Formation (Corporation)

A

Corporation ust be legally formed. The corporation files a charter with the state it wishes to incorporate in. The state then charters the corporation, formally giving its consent in the incorporation

▪ Due to its attractive legal environment for corporations,
Delaware is a popular choice for incorporation

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8
Q

Ownership

A

Represented by a share of stock

shareholder, stockholder or equityholder

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9
Q

Equity

A

Sum of all ownership value

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10
Q

What happens if a firm fails to repay its debt

A

Corporate bankrptcy –> Reogranization &liquidation

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11
Q

Primary markets

A

When a corporation itself issues new shares of stock and sells them to investors

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12
Q

Secondary markets

A

After the initial transaction in the primary market, the s hares continue to trade in a secondary market between investors

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13
Q

Bid price

A

The price at which they (market managers) are willing to buy the stock

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14
Q

Ask price

A

The price at which market makers are willing to sell the stock

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15
Q

Limit order

A

An order to buy or sell a set amount at a fixed price

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16
Q

Limit order book

A

The collection of all limit orders

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17
Q

Market orders

A

Orders that trade imediatly at the best outstanding limit order

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18
Q

High frequency traders

A

A class of traders who with the aid of computers execute trades many times per second in response to new information

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19
Q

Negatives of corporations

A

Costly to set up

Corporate charter specifies the initial rules that govern how the corporation is run

Double taxation

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20
Q

Cash management

A

Financial manager must ensure that the firm has enough cash on hand to meet its day to day demands

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21
Q

Dark pools

A

An alternative to buying stock (limit order not visible)

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22
Q

Corporate management team

In a corporation ownership and direct control are separate (2 elements)

A

Board of directors have ultimate decision making

CEO delegates day to day decision making

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23
Q

Hostile takeover

A

Low stock prices may entice a corporate raider who gets control by buying stocks and replaces current management

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24
Q

Marketing

A

To forecast the increase in revenues resulting from an adverising capaigne

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25
Q

Valuation principle

A

The value of an asset to the firm or its investors is determined by its competitive market price. The benefits and costs of a decision should be evaluated using these market prices, and when the value of the benefits exceeds the value of the costs, the decision will increase the market value of the firm.

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26
Q

Risk free interest rate (rf)

A

For a given period as the interest rate at which money can be borrowed or lent without risk over that period

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27
Q

Value of investment in one year formula

A

Cost = origional value times interest rate in one year

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28
Q

NPV (net present value)

A

NPV = PV(benefits)-PV(costs)

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29
Q

NPV decision rule

A

When making an investment decision take the alternative with the highest NPV. Choosing this alternative is equivalent to receiving its NPV in cash today

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30
Q

Accept or reject a project (NPV) ?

A

Accept those projects with positive NPV because accepting them is equivalent to receiving their NPV in cash today, Reject thos eprojects with negative NPV

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31
Q

Arbitrage

A

The practice of buying and selling equivalent goods in different markets to take advantage of a price difference

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32
Q

Law of one price

A

If equivalent investment opportunities trade simultaneously in different competetive markets, the nthey must trade for the same price in all markets

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33
Q

Separation principle

A

We can evaluate the NPV of an investment decision separately from the decision the firm makes regarding how to finance the investment or any other security transaction the firm is considering

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34
Q

Three rules of time travel

A

1) Comparing and combining values
2) Moving cash flows forward in time
3) Moving cash flows back in time

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35
Q

Annuities

A

When a constand cash flow will occur at regular intervals for a finite number of N periods it is called annuity

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36
Q

Growing annuity PV formula

A

PV = C x 1/(r-g) x (1-((1+g)/(1+r))^N

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37
Q

annuity

A

A stream of N equal cash flows paid at regular invtervals. The difference between an annuity and a perpetuity is that an annuity ends after some fixed number of payments

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38
Q

PV annuity

A

PV = C x 1/r x(1- (1/(1+r)^N))

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39
Q

FV annuity Formula

A

FV = PV x (1+r)^N = C/r((1+r)^N-1)

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40
Q

Growing perpetuity

A

A steam of cash flows that occur at regular intervals and grow at a constant rate

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41
Q

EAR

A

The total amount of interest that will be earned at the end of the year

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42
Q

Annual percentage rate (APR)

A

Indicates the amount of simple interest earned in one year

Typically less than EAR

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43
Q

Simple interest

A

The amount of interest earned without the effect of compounding

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44
Q

EAR to APR

A

(1+APR/k)^k = 1 + EAR

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45
Q

Fischer formula

A

(1+nom) = (1 + inf) x (1+ real)

46
Q

Term structure

A

The relationship between the investment term and the interest rate

47
Q

Yield curve

A

A graph of the term structure

48
Q

After tax interest rates + formula

A

Taxes reduce the amount of interest an investor can keep, and we refer to this reduced amount as the after tax income rate

𝑟−(𝜏 × r) = 𝑟 (1 − 𝜏)

49
Q

Effective annual rate (EAR)

A

The actual amount of interest that will be earned at the end of ONE year

50
Q

Annual percentage rate (APR)

A

Indicates the amount of simple interest earned in one year, that is, the amount of interest earned without the effect of compounding

51
Q

Interest rate per compounding period

A

APR / k periods

52
Q

Converting APR to EAR

A

1 + EAR = (1+APR/k)^k

53
Q

Amortizing loans

A

Each month you pay interest on the loan plus some part of the loan balance

54
Q

Computing the outstanding loan balance

A

The outstanding balance on a loan, also called the outstanding principal, is equal to the present value of the remaining future loan payments, again evaluated using the loan interest rate

55
Q

Nominal interest rate

A

Indicates the rate at which your money will grow if invested for a certain period

56
Q

Real interest rate

A

The growth of your purcahsing power after adjusting for inflation

57
Q

Opportunity 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

58
Q

Market risk premium

A

Expected return % - Risk free interest rate %

59
Q

Yield to maturity formula zero coupon bond

A

ytm= (FV/P)^1/n -1

60
Q

Origional price of a bond

A

P = C x 1/r x (1-1/(1+r)^N) + FV/(1+r^n)

61
Q

Forward rate formula

A

fn = ((1 + YTMn)^n)/ ((1 + YTMn-1)^n-1)

62
Q

IRR rule

A

When the IRR is higher than the cost of capital you should take it

63
Q

Effective annual interest rate Formula

A

(1 + (nominal rate / number of compounding periods)) ^ (number of compounding periods) - 1.

64
Q

Internal rate of return

A

the interest rate that sets the net present value of

the cash flows equal to zero

65
Q

Amount of coupon payment formula

A

Coupon rate x face value / Number of payments per year

66
Q

Zero coupon bond

A

Bond that makes no coupon payments

Always sells at a discount (a price lower than face
value), so they are also called pure discount bonds

Treasury Bills are U.S. government zero-coupon
bonds with a maturity of up to one year.

67
Q

Yield to maturity definition

A

The yield to maturity of a bond is the discount rate that sets the present value of the promised
bond payments equal to the current market price of the bond.

Anticipated return if you hold the bond until maturity

68
Q

Price of a bond formula

A

Face value / (1+YTM)^N

69
Q

Yield to Maturity of a coupon bond:

A

P = CPN/y x (1/(1+y)^N) + FV/(1+y)^N (y=interest rate y)

70
Q

Default spread (Credit spread)

A

the difference between the yields of the corporate bonds and the Treasury yields

71
Q

Yield to maturity formula

A

nth root of FV/PV - 1

72
Q

Forward rate definition

A

A forward rate is an interest rate applicable to a financial transaction that will take place in the future.

73
Q

Examples of partnerships

A

1) Law firm
2) Group of doctors
3) Accounting firms

74
Q

What is good about corporations in practice

A

No limitation on who can own its stock! This
allows free trade in the share of
corporation.

Corporations can raise capital because they can
sell ownership shares to anonymous outside
investors.

75
Q

financial managers Responsibilities

A

1) Investment decision
2) How to raise money
3) Cash management Management,→meet day-to-day
operations + managing working capital

76
Q

Moral hazard (definition)

A

In economics, a moral hazard is a situation where an economic actor has an incentive to increase its exposure to risk because it does not bear the full costs of that risk. For example, when a corporation is insured, it may take on higher risk knowing that its insurance will pay the associated costs.

77
Q

Liquid investment

A

any investment that can be easily converted into cash without having a significant impact on its value.

78
Q

Bid ask spread

A

Ask price - Bid price

–> Transaction cost investors have to pay

79
Q

Competetive market

A

A market in which goods can be bought and sold at the same price

80
Q

Discount factor formula

A

1/1+rf

81
Q

Interest rate factor

A

1 +rf

82
Q

Normal market

A

Market with no arbitrage opportunities

83
Q

Price of a security

A

PV (all cash flows paid by the security)

84
Q

Moving cashflows backward in time: What is the present value of a bond that pays x in y years

A

PV = C/1+r^n

85
Q

Internal rate of return how it works

A 
PV(growingperpetuity) = C/(r − g)
Thus, the
NPV of this investment would equal zero if
1,000,000=1000,000/r−0.04 
We can solve this equation for r
r= 1000,000/1,000,000+0.04=0.14
86
Q

Interest rate for non annual payments

A

rn =(1 + ryear)^1/n -1

87
Q

Real interest rate formula

A

nominal interest rate - inflation rate

88
Q

nominal interest rate formula

A

1+nom = (1+inf) x (1+real)

89
Q

The yield curve is influenced by

A

Interest rates

Inverted yield curve = interest rates are expected to decline in the future

90
Q

Three reasons bonds are important

A

1 The price of risk free government bonds can be used to determine risk free interest rates that produce the yield curve.

  1. Firms often issue bonds to fund their own investment.
  2. Bond’s return will help us to determine a firms cost of capital.
91
Q

bond certificate

A

states the terms of the bond

92
Q

Maturity date

A

Final repayment date

93
Q

Term

A

Time remaining until maturity date

94
Q

Coupon

A

Promised interest payments

95
Q

Face value

A

Notional amount used to calculate the interest payments

96
Q

Coupon rate

A

Determines the amount of each coupon payment expressed in apr

97
Q

Coupon payment formula

A

Coupon rate x face value /Number of payments per year

98
Q

Price of a zero coupon bond

A

P = FV/(1+YTM)^n

99
Q

YTM of a zero coupon bond

A

YTM = (FV/Price)^1/n -1

100
Q

Discount (bond)

A

A bond is selling at a discount if the price is less than the face value.

Coupon Rate < YTM

101
Q

Premium (bond)

A

▪ A bond is selling at a premium if the price greater than the face value.
▪ Coupon Rate >YTM

102
Q

As interest rates and bond yields rise bond prices

A

Fall

103
Q

Bonds with high durations are sensitive to

A

Changes in interest rates

104
Q

On-the-Run Bonds

A

Most recently issued bonds

105
Q

YTM corporate bond

A

YTM gov bond + Credit spread

106
Q

forward rate

A

an interest rate that we can guarantee today for a loan or investment that will occur in the future.

107
Q

Forward interest rate formula

A

fn = ( 1 + YTMn)^n/(1+YTMn-1)^n-1 -1

108
Q

Expected Future Spot Interest Rate formula

A

Forward Interest Rate + Risk Premium

109
Q

IRR rule

A

Accept any project if IRR> Cost of capital

110
Q

When does IRR rule and NPV rule may be in

conflict ?

A

1) Delayed Investment (When the benefits of an investment occur before the costs, the N P V is an increasing function of the discount rate.)
2) Non-existent IRR
3) Multiple IRRs

111
Q

Payback period

A

Time it takes to pay back initial investment

If the payback period is less than a pre-
specified length of time, you accept the
project.

112
Q

ProfitabilityIndex formula

A

Value Created/ ResourceConsumed = NPV/Resource Consumed

Finance & investment (2 decks)

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