Finance Test 4 Flashcards
Credit Policy
Generically, a business’s rules and regulations regarding granting credit and collecting from buyers that take credit; for healthcare providers, the business’s policy regarding self pay and indigent patients
Free Trade Credti
the amount of credit received from a supplier that has no explicit cost attached; in other words, credit received during the discount period
Costly trade credit
the credit taken by a company from a vendor in excess of the free trade credit
Compensating Balance
a minimum checking account balance that a business must maintain to compensate that bank for other services or loans
Line of credit
a loan arrangement in which a bank agrees to lend some maximum amount to a business over some designated period
What are accruals? What is their role in short term Financing?
accruals increase automatically as a firm’s operations expand. this type of short term debt is free in the sense that no explicit interest is paid on funds raised through accruals
What is the “price” of debt capital?
The price takes the form of dividends and capital gains (or losses)
What four factors affect the cost of money?
investment opportunities, time preferences for consumption, risk and inflation
Term Loan
long term debt financing obtained directly from a financial institution, often a commercial bank
Bond
long term debt issues by a business or government unit and generally sold in $1,000 or $5,000 increments to a large number of individual investors
Corporate Bond
debt issued (sold) by for profit businesses, as opposed to government or tax exempt bonds
zero coupon bonds
a bond that pays no interest. it is bought as a discount from par value, so its return comes solely from price appreciation
Mortgage bond
a bond issued by a business that pledges real property as collateral
Debenture
an unsecured bond, meaning one that has no assets pledged as security (collateral)
Municipal Bond
a tax exempt bond issues by a govt entity, such as a state, city, or healthcare financing authority
Private Placement
the sale of newly issues securities to a single investor or small group of investors
Junior Mortgage
second mortgages are sometimes called junior mortgages because they are junior in priority to claims of senior mortgages, or first mortgage bonds.
Key Difference between a private placement and a public issue?
Interest rate on private placements is generally higher that the interest rate on public issues. the administrative costs of placing an issue are less for private placements
What is the purpose of a bond pool?
raise funds by issuing municipal bonds that are then loaned to not for profit hospitals that are too small to ‘tap’ the muni market directly
Indenture
a legal document that spells out the rights and obligations of both bondholders and the issuing corporations; the loan agreement for a bond
Promissory Note
a doc that specifies the terms and conditions of a loan; also called loan agreement or in the case of bonds, indenture
Restrictive Covenant
a provision in a bond indenture or loan agreement that protects the interests of lenders by restricting the actions of management
Trustee
an individual or institution, typically a commercial bank, that represents the interests of bondholders
call Provision
a provision in a bond indenture (contract) that gives the issuing company the right to redeem (call) the bond prior to maturity
What is the diff between technical default and ‘regular’ default?
by allowing its current ratio to drop below 2.0 it is said to be technical default. Reg default occurs when an interest or principal payment is not made on time, which is called a missed payment
What impact does a call provision have on an issue’s interest rate?
it is valuable to the issuer but potentially detrimental to bondholders, especially if the bond is issues during a period when interest rates are cyclically high.
investment grade bond
a bond with a BBB or higher rating
junk bond
a bond with a BB or lower rating
What are the three major rating agencies?
Fitch Ratings, Moody’s Investors Service, and Standard & Poor’s
What are some criteria that the rating agencies use when assigning ratings?
quality or management and business’s financial strength
How do bond ratings affect the cost of debt to the issuing firms?
a bond’s rating is an indicator of its default risk, so the rating has a direct, measurable influence on the interest rate required by lenders and hence on the firm’s cost of debt capital
Real Risk Free Rate
RRF; the rate of interest on the riskiness investment in the absence of inflation
Inflation Premium
IP; the premium that debt investors add to the real risk free interest rate to compensate for inflation
Risk Free Rate
RF; the rate of interest on the riskiness investment when inflation effects are considered
Default risk premium
DRP; the premium that creditors demand for bearing default risk. the greater the default risk, the higher the default risk premium.
Liquid asset
an asset that can be quickly converted to cash at its fair market value
liquidity premium
LP; the premium that debt investors add to the base interest rate to compensate for lack of liquidity
Price Risk
the risk that rising interest rates will lower the values of outstanding debt
Price Risk Premium
PRP; the prem that debt investors add to the base rate to compensate for bearing price risk
Call Risk Premium
the premium that debt investors add to the case rate to compensate for bearing call risk
Equation for the require interest rate on a debt security
RRF + IP + DRP + LP + PRP + CRP
What do the interest rates on treasury securities include?
liquidity premium and price risk premium
Why are callable bonds riskier for investors than similar bonds without a call provision?
their is a lot of uncertainty about holding periods
Par Value
The stated (face) values of a bond; the principal amount that must be repaid to the issuer
Maturity Date
the date on which the principal amount of a loan must be repaid
Coupon (interest) rate
the stated annual rate of interest on a bond, which is equal to the coupon payment divided by the par value
coupon payment
the dollar amount of annual interest on a bond
interest (current) yield
the annual interest return on a bond, defined as the interest payment divided by the beginning of the year price
capital gains yield
the percentage capital gain (loss) over some period, defined as the price appreciation divided by the beginning of period price
Yield to Maturity
the expected rate of return on a debt security assuming it is held until maturity
Yield to Call
the expected rate of return on a debt security assuming it is held until it is called
Interest Rate Risk
the risk to current debtholders that stems from interest rate changes. interest rate risk has two components; price risk and reinvestment rate risk
reinvestment rate risk
the risk that falling interest rates will lower the returns on cash flows from bond investments that are reinvested during the life of the bond (or investment horizon)
What is the general valuation model?
its a four step process.
- Estimate the expected cash flow stream
- Assess the riskiness of the stream
- Set the required rate of return
- Discount and sum the expected cash flows
How are bonds valued?
a bond represents an annuity plus a lump sum, and its value is calculated as the present value of this cash flow stream
