MT1 Flashcards
In a competitive market, what 3 assumptions do we make? What is the one rule regarding interest rates?
- costless trading
- information available to everybody
- there are a lot of traders/no market manipulation
- no arb opps - only one equilibrium rate
What are 4 bond concepts from chapter 6?
- B(y) inversely related to y
- if c>y = premium, if c than high coupon bonds (think zeroes)
Why is NPV a good way to evaluate projects? (3)
- uses all cash flows
- discounts all cash flows
- uses cash flows (some don’t)
What is the payback period and what are three problems associated with it?
Shows how quickly project will “pay back” original investment
- cash flow timing
- cf discounting
- arbitrary standard for pb period
What are 2 components of business risk?
- revenue cyclicality
- operational leverage
What are 2 risks associated with a company’s beta?
Business risk and Financial risk
What are 3 problems associated with beta estimation and their solutions?
(1 - beta changes over time, 2 - data available may not be sufficient) - fixed by using advanced stats techniques
3 - betas influenced by change in financial leverage and business risk - adjust beta for changes
Beta is generally stable if firm stays in same industry - what are 4 possible causes of changes to beta?
- different product line
- different technology
- deregulation
- change to financial leverage
Why aren’t variance and cyclicality the same?
Stocks with high variance don’t necessarily have high betas (business not necessarily linked to business cycle)
What is financial leverage? What is financial risk?
Leverage - use of FC’s (bonds - interest payments)
Risk - additional risk shareholders take as firm leverages
Should we use a discount rate from the firm or project when evaluating projects?
Project - might be same as firm but we want to discount risky cash flows according to appropriate risk (cf’s)
