Midterm Exam 2 Pt. I Flashcards
True or False: FV is how much money you want to have left at the end of the period.
True
What should the FV be set at if you’re paying off a loan? And why?
0, because that’s how much you want to owe at the end of the period.
What does BP stand for?
Basis point
What is a basis point?
Unit of measurement similar to percentage
How do you convert percentage to BP?
You multiply it by 100. For example, 5% would be 500 BP, 10% would be 1000 BP, 0.083% would be 8.3 BP
When calculating bond prices, what is the PV?
The bond price or bond value (could also be called the PRESENT value or TVM).
When calculating bond prices, what is the FV?
Face value, par value, or maturity value
When calculating bonds, what is n?
How much time is left in the life of the bond (the maturity)
OR
N= the number of periods left in the life of the bond.
When calculating bonds, what is i/y?
Yield to maturity, required rate of return, discount rate. Always calculated annually unless you specify a different number of periods (divisible by the year).
True or False: The coupon rate is company specific
True
True or False: The YTM is affected by the global market and is NOT company specific.
True
Do most consumers buy bonds from the primary market or secondary market?
The secondary market
What is the difference between the primary market and secondary market?
Primary market is where big corporations/big investors spend money. They buy bonds for less and sell for more. These are the people “flipping” the bonds to the secondary market, where ordinary consumers typically buy from.
Is the price of the bond “set” in the primary or secondary market?
Secondary market. That’s where the bond is being bought for REAL, and it’s the price that matters to the company, even though they don’t get any of that money (they got paid by primary market).
What does it mean if a bond is on Premium?
That the PV is greater than the FV.
PV > FV
What does it mean if a bond is on Discount?
That the PV is less than the FV.
PV < FV
What is the Inverse price/yield relationship?
As the YTM decreases, the price of the bond goes UP. As the YTM increases, the price of the bond goes DOWN.
What does it mean to call a bond?
To buy it back
What are the two strategies for investing in bonds?
- Buy and hold
- Time the market
What is the “buy and hold” strategy for investing in bonds?
You keep the bond no matter how the YTM changes. You are seeking yield, not worried about businesses going out of business or trying to get the best deal.
Typically people doing this strategy are buying government bonds.
What is the “Time the market” strategy for investing in bonds?
Buy low, sell high. You buy when the rates are going up, hoping to sell it for more later.
I think it’s also called Fixed Income? Not sure how?
True or False: If the YTM is less than the coupon rate, the market price has gone down.
TRUE. That would mean that the price went up from par, and will be over $1000.
True or False: The CPN percentage is usually set at par, meaning that when it was issued, it was set the same as the TYM.
True
What is another name for a zero coupon bond?
Deep discount bond.
What is another name for discount rate?
YTM
How do you find the Current Yield?
It is the Annual Coupon Payment (not percentage) divided by the Market price
What is another name for yield?
Rate
What are the three types of yields for bonds?
- YTM - Actual annual rate of return if held to maturity.
- CPN rate - Will not change, fixed PMT by the firm to whoever holds the bond
- Current Yield - Estimate of YTM
Is the current yield formula accurate?
No, it’s just an estimate (before there were calculators).
What does it mean to be in “default?”
You missed a payment and can’t pay your debts
Creditors
Can drive you into bankruptcy because you owe them and can’t pay. You owe them money.
What are the two types of bankruptcy?
- Reorganize - Keep operating as a business, government forgives some of your debts
- Liquidation - Shut down, sell off all your assets
What is another name for credit score?
FICO score. FICO is just one of the models used to determine credit. Used by the main 3 companies.
Which companies rate other company’s credit scores?
S&P, Moody’s, and Fitch. They evaluate companies based on debt.
What is the debt scoring/FICO scoring system used to evaluate companies?
It uses AAA, AA, A, BBB, BB, B, etc.
Triple A is the best, it gets worst from there.
What does it mean to be “investment grade?”
You must have a score of BBB or better. That lets investors know you’re a reliable company that’s worth investing in.
What is a junk bond?
Double B or below
What are other names for junk bonds?
High yield bonds, speculative bonds. The risk is high so the return is high.
True or False: Lowest risk = lowest yields
True
Securitization
Bundling bonds
What is a NINJA loan?
No income, no job or assets
Municipal Bond
Issued by local governments
National Bond
Federal government/treasury
Corporate bond
Issued by private company
TIP
Treasury Inflation Protected security
True or False: If the return required by shareholders increases, then the price of a stock will decrease.
True
True or False: According to the Gordon Growth Model, if the growth rate of dividends increases, the price of a stock will decrease.
False
True or False: The price of preferred stock usually varies more than the price of common stock.
False
True or False: Common shareholders have the right to vote while preferred shareholders do not.
True
True or False: Suppose a company, which fell on hard times and withheld the payment of dividends to both preferred and common shareholders for the past year, decided to reinstitute the payment of dividends. The company cannot pay a dividend to common shareholders without paying dividends to preferred shareholders.
True
True or False: Common stock represents a hybrid security while preferred stock represents ownership in the company.
False
True or False: Both common stock and preferred stock allow shareholders a claim to the assets of the company.
True
True or False: Suppose a company, which fell on hard times and withheld the payment of dividends to preferred shareholders for the past year, decided to reinstitute the payment of dividends. The company must pay all the dividends owed to preferred shareholders.
True
True or False: Common shareholders have preferences to dividends while preferred shareholders have preferences to ownership in the firm.
False
True or False: The cash flows that common shareholders receive are referred to as coupons.
False
A firm just issued new shares of preferred stock that will pay a dividend of $4.60. If the return required by shareholders is 10%, then the price of the preferred stock is ____________.
$46
A share of preferred stock for company XYZ pays a dividend of $5.60. The price per share of preferred stock is $49.75. Given this information, the return required by preferred shareholders is _______________.
11.26%
A share of preferred stock for company STO pays a dividend of $2.50. The price per share of preferred stock is $19. A share of preferred stock for company GHI pays a dividend of $3.50. The price per share of preferred stock is $28. Given this information, the return required by preferred shareholders of STO is _____________ while the return required by preferred shareholders of GHI is ________________.
13.16%; 12.50%
A company recently paid a dividend of $5 and anticipates decreasing the dividend at a constant rate of 2% per year, indefinitely. The current share price of the stock is $32. According to the Gordon Model, what is the return required by shareholders?
13.31%
A company anticipates paying a dividend of $4 one year from today. Further, analysts predict that the price of the stock is expected to be $100 at the end of the year. According to the Holding Period Return Model, if the return required by shareholders is 12%, then the price of the stock should be ________________.
$92.86
A company anticipates paying a dividend of $4 one year from today and a dividend of $6 two years from today. Further, analysts predict that the price of the stock is expected to be $100 at the end of the second year. According to the Holding Period Return Model, if the return required by shareholders is 15%, then the price of the stock should be ________________.
83.63
A company is planning to pay a dividend of $5 and grow the dividend at a constant rate of 3% per year, indefinitely. The current share price of the stock is $44. According to the Gordon Model, what is the return required by share holders?
14.36
Firm A has preferred stock outstanding that pays a dividend of $9.50. Firm B has preferred stock outstanding that pays a dividend of $4.50. Given this information, the price of Firm A is _________________.
Cannot be determined with this information
A company is planning to pay a dividend of $3.20 and grow the dividend at a constant rate of 3% per year, indefinitely. Further, the return required by share holders is 14%. According to the Gordon Model, what is the price of this firm’s common stock?
29.09
A company just paid a dividend of $4 and anticipates increasing its dividend at a constant rate of 5% per year, indefinitely. Further, the return required by share holders is 17%. According to the Gordon Model, what is the price of this firm’s common stock?
$35
A company is planning to pay a dividend of $5 and keep the dividend payment of $5 per year indefinitely. The return required by share holders is 14%. According to the Gordon Model, what is the price of this stock?
35.71
Company RTZ has a unique dividend policy. The company anticipates paying a dividend of $5 one year from today, $6 two years from today, and $7 three years from today. After the third year, the company anticipates increasing the dividend at a rate of 3% per year, indefinitely. If the return required by shareholders is 15%, then the price of the stock should be ________________.
$53
Company RTZ has a unique dividend policy. The company anticipates paying a dividend of $4 in each of the next three years. After the third year, the company anticipates increasing the dividend at a rate of 5% per year, indefinitely. If the return required by shareholders is 14%, then the price of the stock should be ________________.
$40.79
