SU5: Financial Instruments & Cost of Capital

Question 0

Serial Bond

Answer 0

Matures in stated amounts at regular intervals

Question 1

Term Bond

Answer 1

Has a single maturity date at the end of it’s term

Question 2

Callable Bonds

Answer 2

May be purchased by the issuer at a specified price before maturity

Question 3

Convertible Bonds

Answer 3

May be converted into equity securities of the issuer at the option of the holder under certain conditions

Question 4

Mortgage Bonds

Answer 4

Backed by specific assets, usually real estate

Question 5

Debentures

Answer 5

Backed by the borrower’s general credit but not by specific collateral

Question 7

Income Bonds

Answer 7

Pay interest contingent on the issuer’s profitability

Question 13

The Dividend Discount Model

Answer 13

Dividend per share/Cost of capital - dividend growth rate

Question 14

Preferred Stock Valuation

Answer 14

Dividend per share/Cost of capital

Question 15

Book Value per Share

Answer 15

Shareholders’ equity/Shares outstanding

Question 16

Price-Sales Ratio

Answer 16

Market price per share/Sales per share

Question 17

Long Position - Hedging

Answer 17

A person who would like to sell an asset in the future. They benefit if the value of the asset rises

Question 18

Short Position - Hedging

Answer 18

A person who would like to buy an asset in the future. They benefit if the value of the asset falls

Question 19

Call Option

Answer 19

Gives the buyer the right to purchase the underlying asset at a fixed price. They benefit if the price rises.

Question 20

Put Options

Answer 20

Gives the buyer the right to sell the underlying asset at a fixed price. They benefit if the price falls

Question 21

Put-Call Parity

Answer 21

Value of call + PV of exercise price = Value of put + Value of underlying

Question 22

Naked Option

Answer 22

A call option that does not have the backing of stock.

Question 23

American Option

Answer 23

Contractual arrangement that gives the owner the right to buy or sell an asset at a fixed price at any moment in time before or on a specified date

Question 24

Forward Contracts

Answer 24

The two parties agree that, at a set future date, one of them will perform and the other will pay a specified amount for the performance

Question 25

Futures Conteacts

Answer 25

A commitment to buy or sell an asset at a fixed price during a specific future month; unlike with a forward contract the counterparts is unknown

Question 26

Interest Rate Swaps

Answer 26

Agreements to exchange interest payments based on one interest structure for payments based on another structure

Question 27

Currency Swaps

Answer 27

Agreements to exchange cash flows denominated in one currency for cash flows denominated in another

Question 28

Credit Default Swaps

Answer 28

Agreements whereby one of the parties indemnifies the other against default by a third party

Question 29

Cost of Capital - Debt

Answer 29

Effective rate x (1 - Marginal tax rate)

Question 30

Cost of Capital - Preferred Stock

Answer 30

Dividend Yield= Cash dividend on preferred stock/Market price of preferred stock

Question 31

Cost of Capital - Common Stock/ RE

Answer 31

Dividend Yield= Cash dividend on common stock/Market price of common stock

Question 32

Cost of New Debt

Answer 32

Annual interest/Net issue proceeds

Question 33

Cost of New Preferred Stock

Answer 33

Next dividend/Net issue proceeds

Question 34

Cost of New Common Stock

Answer 34

(Next dividend/Net issue proceeds) + Dividend growth rate

Question 35

Required Rate of Return

Answer 35

Risk free rate + Beta(Market rate - Risk free rate)

Question 36

Marginal Cost of Capital

Answer 36

Is a weighted average of the investors’ required returns on debt and equity