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finance revision Flashcards

1
Q

investments

A

financial assets like stocks and bonds
price and risk

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2
Q

financial institutions

A

financial matters
banks and insurance

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3
Q

international finance

A

specialisation of assets and financial matters

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4
Q

capital budgeting

A

managing a long term investment

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5
Q

capital structure

A

mixture of debt and equity to finance operations

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6
Q

working capital

A

short term assets and liabilities

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7
Q

sole proprietorship

A

owned by one person
unlimited liability
all income taxed as personal

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8
Q

partnership

A

general - share gains and losses, unlimited liability
limited - liability limited to shares in business, not active in decisions

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9
Q

disadvantages of sole propietorship and partnership

A

unlimited liability for debts
limited life of business
difficult to transfer ownership

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10
Q

corporation

A

distinct legal entity
formed from articles of incorporation and bylaws

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11
Q

advantages of corporation

A

ownership easily transferred
life not limited
stockholders have limited liability

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12
Q

disadvantages of corporation

A

double taxation - corporation pays tax and stockholders pay income tax
more expensive/difficult to form

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13
Q

goal of financial management

A

maximise shareholders equity
profit maximisation is too vague
managers make decisions for shareholders, act in their best interest by increasing value

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14
Q

agency relationship

A

relationship between management and shareholders

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15
Q

agency problem

A

conflict of interest between managers and shareholders

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16
Q

why should managers act in shareholders interest

A

managerial compensation - job performance tied to rewards to increase share value
management control - threat of management replacement and takeover

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17
Q

primary market

A

original sale of securities occurs
public offerings or private placements

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18
Q

secondary market

A

owner sells to another, corporation not involved
dealer markets - dealers buy and sell at their own risk
auction market - brokers and agents match buyers and sellers

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19
Q

two lessons from market history

A

risky assets on average earn a risk premium as reward for bearing risk
greater the risk, the greater the potential reward

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20
Q

total dollar return

A

dividend income + capital gain/loss

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21
Q

return on investment

A

gain or loss from investment
income component - cash you receive from investment
capital gain/loss - change in value of asset

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22
Q

dividend yield

A

Dt+1 / Pt

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23
Q

capital gains yield

A

(Pt+1 - Pt)/Pt

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24
Q

risk-free return

A

return on gov bonds

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25
Q

risk premium

A

difference between stock returns and treasury bills
reward for bearing risk

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26
Q

arithmetic return

A

(R1 + R2 + … + Rt)/t

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27
Q

arithmetic vs geometric return

A

geometric < arithmetic if returns are not equal
arithmetic for short periods
geometric for long periods

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28
Q

efficiency

A

prices adjust quickly and correctly to new info

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29
Q

efficient capital market

A

market prices fully reflect all info, and adjust accordingly

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30
Q

inefficient market

A

overreaction or delayed reaction to events, gives investors the opportunity to make profit on announcements

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31
Q

efficient market response

A

the price instantaneously adjusts to fully reflects new info, there is no tendency for subsequent increase and decrease

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32
Q

slow response

A

the price adjusts slowly to the new info, 30 days elapse before price reflects new info

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33
Q

overreaction

A

the price over adjusts to the new info, there is a bubble in the price sequence

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34
Q

efficient market hypothesis

A

argues that actual capital markets are efficient
all investments in an efficient market are zero NPV investments

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35
Q

strong form efficient

A

all information of every kind is reflected in stock prices, there exist no such thing as inside info

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36
Q

semi strong efficient

A

all public info is reflected in the stock price

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37
Q

weak for efficient

A

at a minimum, the current price of a stock reflects its own past prices

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38
Q

future value

A

amount of money an investment will grow over some period of time at some given interest rate

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39
Q

compound interest

A

interest on interest

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40
Q

simple interest

A

interest only earned on principal amount

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41
Q

present value

A

current value of future cash flow discounted at appropriate rate

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42
Q

what do the letters represent in PV and FV equations

A

r - discount rate
t - life of investment

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43
Q

ordinary annuity

A

stream of cash flows for a fixed period of time

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44
Q

annuity due

A

a variation on ordinary annuity, an annuity for which cash flows occur at the beginning of each period

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45
Q

perpetuity

A

stream of cash flows continues forever
C - cash flow
r - discount rate

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46
Q

quoted rate vs effective annual rate

A

quoted rate - interest rate implied by advertising
EAR - interest you will actually earn

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47
Q

annual percentage rate vs EAR

A

APR is not EAR as it is equal to interest rate per period multiplied by the number of periods per year

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48
Q

pure-discount loan

A

borrower receives money today and repays a single lump sum some time in the future
usually short period of time

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49
Q

interest-only loan

A

borrower pays interest each period and repay entire principal at some point in the future

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50
Q

amortised loan

A

lender requires borrower to repay parts of the loan over time
paying it off called amortisation
the total payment declines each year because the beginning balance reduces

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51
Q

bond coupons

A

regular interest payments on a bond

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52
Q

securities

A

traded in financial markets
distributed subject to some legal requirements

53
Q

financial market

A

a market where securities are traded
enable the exchange of previously issued securities
facilitate capital raising

54
Q

common stock

A

securities represent an ownership stake in a firm
share of common stock gives right to put a vote at the firms annual meeting

55
Q

stock market index

A

performance measure of a group of stocks in the market

56
Q

preferred stocks

A

have several important differences to common stocks

57
Q

priority in dividend payments

A

firms pay dividends firstly to the holders of PS before paying the holders of CS

58
Q

no voting rights

A

PS do not convey the right to vote at the firms annual meetings

59
Q

initial public offering

A

a companys first equity issue made available to the public
IPOs occurs when a privately held compnay decides to go public for the first time

60
Q

secondary equity offering

A

an already publicly traded company issues additional equity
seasoned offerings may involve shares sold by existing shareholders, new shares or both

61
Q

secured bonds

A

supported by collateral in the event of bankruptcy

62
Q

unsecured bonds

A

no collateral

63
Q

callable bonds

A

gives the issuing firm the right to repurchase at a set price

64
Q

convertible bonds

A

investor can convert bonds into a set amount of equity shares

65
Q

face value or par value

A

the amount of money repaid at the end of the loan

66
Q

yield to maturity

A

total rate of return that will have been earned by a bond when it makes all interest payments and repays the original principle

67
Q

total bond value

A

present value of single cash flow + present value of annuity

68
Q

discount bond

A

when market interest rate is higher than the coupon rate, the bond sells for less than face value

69
Q

premium bond

A

if market interest rate is lower than the coupon rate on the bond

70
Q

interest rate risk

A

risk from fluctuating interest rates, sensitivity of a bond to this risk depends on time to maturity and coupon rate
longer time to maturity, greater the risk
lower coupon rate, greater the risk

71
Q

debt

A

repaid by the debtor/borrower to the creditor/lender

72
Q

debt vs equity

A

debt is not an ownership of the firm
payment of interest is tax deductible, dividends are not
unpaid debt is a liability, if not paid creditors can claim assets of the firm

73
Q

unfunded debt

A

short term debt security
maturity is less than a year

74
Q

debentures

A

long term debt security
maturity is more than a year

75
Q

indenture

A

written agreement between the corporation and creditors, also called a deed of trust
bond agreement

76
Q

features of indentures

A
  1. basic terms of bond
  2. total amounts of bonds issued
  3. description of property used as security
  4. repayment arrangement
  5. call provisions
  6. details of protective covenants
77
Q

basic terms of bonds (indentures)

A

registration of the principal value
registered form - registrar who records bond ownership
bearer form - certificate is evidence of ownership and corporation will pay the bearer, bonds are difficult to recover if paper is lost or stolen

78
Q

colleteral

A

term for securities pledged as a payment of debt

79
Q

seniority

A

order in which repayment to lenders occurs in bankruptcy

80
Q

sinking fund

A

account managed by a bond trustee for the purpose of repaying bonds

81
Q

call provisions

A

allows companies to repurchase or call some or all of the bonds at stated prices over a specific period
can have deferred call provision - not active at beginning of bonds life, making the bond call protected

82
Q

protective covenant

A

limits certain actions a company may take during the term of the loan
negative covenants - prohibiting actions
positive covenants - obligate actions

83
Q

bond ratings

A

concerned with the possibility of default, made from info supplied by corporation
debt rated by either Moody’s, standard and poor or fitch

84
Q

treasury notes and bonds

A

gov issued bonds, usually ordinary coupon bonds
no default risk and are exempt from state income taxes

85
Q

zero coupon bond

A

pays no coupons at all and is usually offered at a price much lower than its stated value
deduct interest every year for tax purposes even though no interest is paid

86
Q

floating rate bond

A

coupon payments are adjustable
adjustments tied to an interest rate
usually the holder can redeem the note on coupon payment date after a specified amount of time
coupon rate has a floor and a ceiling

87
Q

inflation-linked bond

A

coupons adjust to the rate of inflation

88
Q

income bonds

A

coupon payments depend on company income

89
Q

convertible bonds

A

bonds can be swapped for a fixed number of shares anytime before maturity

90
Q

put bonds

A

allow the holder to force the issuer to buy bonds back at a stated price

91
Q

over the counter

A

most bonds are traded over the counter rather than in bond markets
lacks transparency and ability to see trading price and volume

92
Q

bid price

A

price a dealer is willing to pay for a security

93
Q

bid-ask spread

A

dealers profit

94
Q

clean price

A

price of a bond not including accrued interest payments

95
Q

dirty price

A

price including accrued interest payments
also called full/invoice price

96
Q

nominal interest rate

A

percentage change in the number of dollars you have

97
Q

real interest rate

A

percentage change in how much you can buy with your dollar, the percentage change in buying power

98
Q

fisher effect

A

relationship between nominal and real interest rates and inflation
1+R=(1+r)(1+h)
R - nominal rate
r - real rate
h - inflation rate

approximation formula - R = r+h

99
Q

term structure of interest rates

A

relationship between short and long term interest rates
long term > short term, term structure is upward sloping
short term > long term, downward sloping

100
Q

determinants of term structure curve

A

real rate of interest rate - real rate is high, interest rate is high
inflation - prospect of future inflation makes investors demand compensation for their loss in return which is inflation premium
interest rate risk - long term bongs have greater risk of loss from changing interest rates, compensation as interest rate risk premium

101
Q

treasury yield curve

A

yield on treasury bonds relative to their maturity
the shape of the curve is a reflection of the term structure of interest rates

102
Q

taxability premium

A

extra yield demanded as a result of the unfavourable tax treatment

103
Q

liquidity premium

A

result of illiquidity of many corporate bonds

104
Q

zero growth rate

A

P0 = D/R

105
Q

growth is constant

A

D1= D0(1+g)

106
Q

growing perpetuity

A

asset that shows constant growth rate forever

107
Q

common stock

A

equity without priority for dividends or in bankruptcy

108
Q

cumulative voting

A

total number of votes that each shareholder may cast is determined first, usually number of share owners x number of directors elected
1/(N+1)

109
Q

straight voting

A

directors are elected one at a time, each shareholder can cast all of his votes for each member of board, free out minority shareholders

110
Q

staggered elections

A

are applied, only a fraction of the directorships are up for election at a particular time

111
Q

proxy

A

grant authority by a shareholder to someone else to vote the shareholders shares

112
Q

proxy fight

A

management tries to get as many proxies transferred as possible but sometimes an outside group can try to obtain votes via proxy

113
Q

rights of directors

A

right to share proportionally in dividends paid
right to share proportionally in assets remaining after liabilities have been paid in liquidation
right to vote on stockholder matters of great importance such as a merger

114
Q

pre-emptive right

A

the right to share proportionally in any new stock sold

115
Q

dividend characteristics

A

unless declared by the board of directors, dividends are no liability, a company cannot default on a undeclared dividend
the payment of dividends is not a business expense, it is paid out of the corporations after tax profits
dividends received by shareholders are taxable

116
Q

dividend

A

cash paid out of earnings, if payment is made from sources other than retained earnings it is called distribution

117
Q

declaration date

A

the date the board passes a resolution to pay dividend

118
Q

ex-dividend date

A

two days before the date of records, establishing those individuals entitled to a dividend
if you buy on or after this date the previous owner receives the dividend

119
Q

date of record

A

the holder of records are identified, those who are entitled to receive the dividends

120
Q

date of payment

A

the date that the dividend checks are mailed

121
Q

share repurchases

A
  1. open market - firm does not reveal themselves to buyer
  2. tender offer - firm announces all of its stockholders that it is willing to buy a fixed number of shares at a specific price
  3. targeted repurchase - firm may repurchase shares from specific individual stockholders
122
Q

net present value

A

difference between the market value of an asset or project and its cost
how much value is added by undertaking an investment

123
Q

discounted cash flow valuation

A

determine value of investment by prospecting and discounting future cash flow to todays value
we can estimate the NPV by comparing this to cost of the investment

124
Q

net present value rule

A

states that an investment should be accepted if the net present value is positive and rejected if it is negative
challenge process of discounting but coming up with the cash flows
resulting NPV is only an estimate, reality can be higher or lower

125
Q

payback period

A

the amount of time required for an investment to generate cash flows sufficient to cover its initial cost

126
Q

disadvantages of payback

A

ignores the time value of money as it is calculated by adding up future cash flows
need the right cut off, may reject long term projects if you ignore cash flows beyond cut off

127
Q

advantages of average accounting return

A

easy to calculate
needed info will usually be available

128
Q

disadvantages of average accounting return

A

not a true rate of return, time value of money is ignored
uses a benchmark cut-off rate
based on accounting net income and book values, not cash flows and market values

129
Q

internal rate of return

A

closely related to NPV and specifies the discount rate that makes NPV of an investment 0
investment is acceptable if IRR > required return

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