Financial Management - Concepts/Tools

Question 1

Frequency of Compounding

Answer 1

The frequency of compounding explains the difference between the stated rate and the effective rate.

Question 2

Normal Yield Curve

Answer 2

A normal yield curve is one in which short-term rates are lower than intermediate-term rates which are lower than long-term rates.

Therefore, the curve is upward sloping.

Question 3

Beta (β) value significance

Answer 3

The beta focuses on systematic risk.

• a. β = 1, then an investment price (value) moves in line with the asset class benchmark for that investment; the investment has average systematic risk.
• b. β > 1, then an investment price (value) moves greater than the asset class benchmark for that investment; the investment has higher systematic risk—the investment is more volatile than the benchmark for the asset class. i. In the example, above, β = 2 says that the assumed asset is more volatile (more risky) than the benchmark for its asset class; therefore, the required rate of return (17%) is significantly more than the benchmark rate (10%).
• c. β < 1, then an investment price (value) moves less than the asset class benchmark for that investment; the investment has lower systematic risk—the investment is less volatile than the benchmark for the asset class

Question 4

Cost of Additional Capital

Answer 4

• Common stock is the most expensive form of financing and because of floatation costs new common stock is more expensive than retained earnings.
• Retained earnings are an inexpensive form of capital.

Question 5

Beta Coefficient

Answer 5

• . Beta is the covariance of the asset’s returns with the returns of the overall portfolio. Therefore, it measures the systematic risk of the investment.
• A measure that describes the risk of an investment project relative to other investments in general is the beta coefficient
• The beta coefficient of an individual stock is the correlation between the stock’s price and the price of the overall market.
• As an example, if the market goes up 5% and the individual stock’s price, on average, goes up 10%, the stock’s beta coefficient is 2.0.

Question 6

Annuity Due

Answer 6

An annuity due is a series of equal payments the first of which is due at the inception of the agreement.

Question 7

Ordinary Annuity

Answer 7

An ordinary annuity would mean payments are due at the end of each period.

Question 8

Short Term Interest Rates

Answer 8

There is less risk involved in the short run and investors are willing to accept lower rates on short-term investments because of their liquidity.

Short-term rates have ordinarily been lower than long-term rates.

Question 9

Optimal Capital Structure

Answer 9

The optimal capital structure for an organization is when it minimizes its weighted-average cost of capital.

Question 10

Competetive Market

Answer 10

In a competitive market, the market will always clear at the equilibrium price. If there is an equal increase in both demand and supply, the equilibrium price may increase, decrease, or remain the same. However, there will be more units sold.