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BEC > Financial Risk Management and Capital Budgeting > Flashcards

Financial Risk Management and Capital Budgeting Flashcards

1
Q

Avoidable costs

A

costs that will not continue to be incurred if a particular course of action is taken

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2
Q

Cash flow hedge

A

a hedge of the variability in the cash flows of a recognized asset or liability or of a forecasted transaction that is attributable to a particular risk

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3
Q

Committed costs

A

costs related to the company’s basic commitment to open its doors (ie depreciation, property taxes, management salaries, etc)

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4
Q

Credit (default) risk

A

the risk that a firm will default on a payment of interest or principal of a debt

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5
Q

Currency swaps

A

forward-based contracts in which two parties agree to exchange an obligation to pay cash flows in one currency for an obligation to pay in another currency

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6
Q

Differential (incremental) costs

A

the difference in cost between two alternative courses of action

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7
Q

Discretionary costs

A

fixed costs whose level is set by current management decisions (eg, advertising research and development)

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8
Q

Fair value hedge

A

a hedge of the changes in fair value of a recognized asset or liability, or of an unrecognized firm commitment

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9
Q

Forwards

A

negotiated contracts to purchase and sell a specific quantity of a financial instrument, foreign currency or commodity at a price specified at the origination of the contract with delivery and payment at a specified future date.

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10
Q

Futures

A

Forward-based standardized contracts to take delivery of a specified financial instrument, foreign currency or commodity at a specified future date or during a specified period generally at the then market price.

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11
Q

Interest rate risk

A

the risk that the value of a debt instrument will decline due to an increase in prevailing interest rates

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12
Q

Interest rate swaps

A

forward-based contracts in which two parties agree to swap streams of payments over a specified period of time. These contracts are often used to trade variable-rate instruments for fixed-rate instruments

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13
Q

Internal rate of return method

A

uses the rate of return that equates investment with future cash flows to evaluate investment alternatives

  • TVMF = PV (investment today)/Cash flows
  • discount rate is the end result of the calculation
  • also called the time-adjusted rate of return
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14
Q

Market risk

A

the risk that the value of a debt instrument will decline due to a decline in the aggregate value of all assets in the economy

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15
Q

net present value method

A

uses the present value of future cash flows to evaluate investment alternatives

  • NPV = (PV future cash flows) - Investments
  • assumes the projects cash flows are reinvested at the NPV discount rate (usually the cost of capital)
  • discount rate also called the hurdle rate
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16
Q

Opportunity cost

A

the maximum income or savings (benefit) foregone by rejecting an alternative

17
Q

Options

A

an instrument that allows, but does not require, the holder to buy (call) or sell (put) a specific or standard commodity or financial instrument, at a specified price during a specified period of time or at a specified date

18
Q

Outlay cost

A

the case disbursement associated with a specific project

19
Q

Payback method

A

evaluates investment alternatives based on the length of time until the investment is recaptured

  • considers tax savings from depreciation
  • does not consider TVMF
20
Q

Relevant costs

A

future costs that will change as a result of a specific decision

21
Q

Sensitivity analysis

A

exploring the importance of various assumptions to forecasted results

22
Q

Sunk (unavoidable) costs

A

committed costs that are not avoidable and are therefore irrelevant to future decisions

23
Q

Swaption

A

an option of a sap that provides the holder with the right to enter into a swap at a specified future date with specified terms

24
Q

Systematic risk

A

the risk related to market factors which cannot be diversified away

25
Q

Unsystematic risk

A

the risk that exists for one particular investment or a group of like investments. This risk can be diversified away

26
Q

Accounting Rate of Return

A

= annual net income / average (or initial) investment

27
Q

Profitability Index

A

net present value of future cash flows / amount of initial investment

  • if greater than 1, NPV is positive
28
Q

Cost of capital

A

the rate management must pay to obtain funds

29
Q

NPV vs IRR

A

NPV > 0 then IRR > Discount Rate
NPV = 0 then IRR = Discount Rate
NPV < 0 then IRR < Discount Rate

30
Q

Depreciation tax shield

A

benefit of depreciation in cash flow analysis = resulting tax savings

31
Q

Coefficient of Variation

A

= standard deviation / expected return

32
Q

Diversified company / Portfolio risk

A

= weighted average of project risk

BEC (8 decks)

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