Session 18: DCF Flashcards
The DCF determines the
Value of an investment
The markets determine the
Price of an investment
If value is greater than price the investment is
Undervalued and you should buy
If price is greater than value the investment is
Overvalued and you should sell
The value of an investment equals the
Present value of its expected cash flows discounted for risk and timing
The most likely cash payments that you can expect to receive
Expected cash flows
Principle payment equals
Annual Payment - Interest Payment
Primary factors in discounting an investments expected cash flows
Time and risk
If interest rates decline, the value of a bond will
Increase even though future cash flows don’t change
The interest of a bond is paid how often
Semiannually
Interest rate and cash flows associated with loaned mortgages and annuities are
Fixed (level cash flows); don’t change
An obligation under which a person borrows money from a lender
Loan
Terms of the loan state
An interest rate and repayment or amortization schedule
Level payments over a long time periods usually 20 to 30 years
Amortization schedule
Contract sold by pensions funds and life insurance companies; pays a specified amount of money per year to owner
Life annuity
Three steps to DCF
Develop a set of expected cash flows
Estimate the discount rate and calculate the discount factors
Multiply the cash flows by the discount factors and add them to determine the value of the asset
Project stocks and bonds have what kind of cash flow
Uneven
Debt instrument
Bond
Bond repayment of principal is due at
Maturity
Ownership interest in a corporation
Stock
Cash inflow: dividend and increase in stock price
The life of a stock is
Infinite
Bonds and mortgages have cash flows that are known with
Certainty
Discounted Cash Flow analysis is used to determine the value of an investment based on the
Present value of future cash flows, discounted for risk and timing
