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2021 - Financial Mgmt > Module 6 > Flashcards

Module 6 Flashcards

1
Q

examples of security markets?

A

bond and stock markets

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2
Q

what 3 things do security markets do?

A
  • bring buyers and sellers together
  • reduce the cost of b&s (helps operational efficiency)
  • provides a trading location
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3
Q

what is market equilibrium price?

A

the price that balances the overall demand and supply for a security

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4
Q

what is the intrinsic price?

A

PV of the CF an investor can expect to receive in future

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5
Q

what is the market price?

A

consensus price of all traders

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6
Q

characteristics of an efficient market?

A
  • information efficiency
  • low cost, easy to transact (operational)
  • market price = intrinsic price
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7
Q

characteristics of an inefficient market?

A
  • opposite of efficient

- market prices deviate from intrinsic prices by a huge margin

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8
Q

what is a bond?

A

it is a long-term security issued by comps, govs, municipalities, in order to borrow from the public.

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9
Q

two parties to a bond?

A
  • borrower / issuer / seller

- lender / investor / buyer

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10
Q

what is a coupon payment?

A

the periodic interest the borrow is obligated to pay to the bondholder

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11
Q

what obligations do bond issuers have?

A
  • to pay bondholders fixed interest amounts / coupons

- to pay the principle sum on maturity

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12
Q

advantages of bonds?

A

safer and less risky than shares

int and capital sum are guaranteed

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13
Q

disadvantages of bonds?

A

lower returns than shares

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14
Q

types of corp bonds?

A
  • vanilla/straight bonds
  • zero-coupon bonds
  • convertible bonds
  • callable/puttable and perpetual bonds
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15
Q

what is a vanilla/straight bond?

A
  • coupon payments are fixed for bond life

- entire original principle paid at maturity

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16
Q

what is a zero-coupon bond?

A
  • single pmt at maturity

- int paid to the bondholder is the difference between the principle amt and current amount received @ maturity

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17
Q

what is a convertible bond?

A

converted into ordinary shares at some predetermined ratio

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18
Q

what is a non-redeemable bond?

A
  • bond in perpetuity
  • no redemption date, pays coupons indefinitely
  • principle not paid back
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19
Q

what is a redeemable bond?

A
  • fixed lifespan, pays coupons up to maturity date

- full principle paid back at maturity

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20
Q

what is the face value of the bond?

A

paid / rec when the bond matures

21
Q

what is the yield to maturity?

A
  • represents the return required by investors on a particular bond
  • used as a discount rate
  • fluctuates with market conditions/int rates
22
Q

how is the YTM derived?

A
  • from the yields of similar instruments in the market

- when int rates inc, they inc

23
Q

what is the process of valuation?

A
  • process of determining how much an asset is worth

- we get fair value and intrinsic value from it

24
Q

why do we value bonds?

A
  • to determine its intrinsic value

- to discount all future coupons using the YTM as the discount rate

25
Q

what techniques do we use to value financial assets?

A

discounted CF techniques = finding the PV of the future benefits (CF) of an asset

26
Q

when should we trade financial assets?

A
  • intrinsic value > market price = buy (underpriced)
  • market price > intrinsic value = sell (overpriced)
  • market price = intrinsic value (hold)
27
Q

what is the relationship between bond price and YTM?

A

there is a negative relationship to ensure that existing bonds continue to offer the return demanded by investors/equal to similar bonds

28
Q

what will a change in YTM without a corresponding price change mean?

A

a return different from what shareholders want

29
Q

what does an inc in YTM mean?

A

investors want a higher return = less demand = price drops till YTM is equal to the higher yield wanted

30
Q

what does a dec in YTM mean?

A

investors expect a lower return = huge demand = price increases till YTM is equal to lower yield wanted

31
Q

what is interest rate risk?

A

relates to uncertainty about future bond values that is caused by the volatility of int rates

32
Q

what is the default risk?

A

the probability that the borrower can fail to meet a condition of the contract which results in default

33
Q

what causes markets to be efficient?

A

market prices of securities traded reflect all available info relevant to the security

34
Q

types of secondary markets?

A
  • direct search
  • brokers
  • dealers
35
Q

what is a direct search?

A

individuals bear the full cost of locating and negotiating. it is very costly. infrequent b&s.

36
Q

what is a broker?

A

brings b&s together and charges a commission fee less than direct search cost. increases market efficiency.

37
Q

what is a preference share regarded as?

A

a fixed income security because div is fixed

38
Q

general characteristics of a preference share?

A
  • receive divs before OSH
  • have pref on sharing of surplus assets on liquidation before OSH
  • do not have voting rights
39
Q

preference shares as equity?

A
  • equity position
  • fixed dividend
  • ranked second priority
  • div payment can be postponed or forgone
40
Q

bonds as debt?

A
  • debt position
  • fixed int / coupon
  • first priority
  • coupon has to be paid at stipulated date or default
41
Q

types of pref shares?

A

nonredeemable (cumul, non-cumulative)

redeemable

42
Q

general characteristics of an ordinary share?

A
  • represent ownership int in the comp
  • voting rights
  • divs when declared
  • share surplus on assets @ liquidation
43
Q

advantages of OS?

A
  • outperform bonds and long term instruments
  • easy to buy and sell
  • info is easily available
  • variety of firms
44
Q

disadv of OS?

A
  • higher risk

- divs not guaranteed

45
Q

ordinary shares as equity?

A
  • equity position
  • rank last
  • no fixed CF
  • no fixed lifespan
46
Q

three versions of the DDM?

A
  • zero growth model
  • constant growth model
  • non-constant growth model
47
Q

limits of the constant growth model

A
  • assumption is unrealistic
  • only applies to comps paying divs
  • if g > R, shares get negative value
48
Q

when would a non-constant growth model be suitable?

A

for firms currently experiencing high div growth which is followed by a lower but stable growth rate in divs later

2021 - Financial Mgmt (11 decks)

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