Finance #2

  1. The ... earned by an investor can be divided into two categories:
    1. income paid by the issuer of the financial asset (either ... on debt or ... from equity)
    2. The change in value of the financial asset in the financial market (capital gains) over some time period
    • Dollar Return
    • Interest or Dividends
  2. is the dollar return stated as a percentage of the dollar amount that was originally invested
  3. What do we call the price or cost of debt capital?
    Interest Rate
  4. What do we call the price or cost of equity capital?
    Return on Equity = Dividends + Capital Gains
  5. The returns available within an economy from an investment in productive (cash generating) assets
    Production Opportunities
  6. The preferences of consumers for current consumption as opposed to saving for future consumption
    (want money now or buy bond for the future)
    Time preferences for consumption
  7. In a financial market context, the chance that a financial asset will not earn the return promised (chance of default)
  8. The tendency of prices to increase over time
  9. A premium for expected inflation that investors add to the real risk-free rate of return
    Inflation Premium - IP
  10. The return on ... is often used as the risk free rate because they represent Short term debt of the U.S. government that is very liquid and free of most risks
    U.S. Treasury Bills
  11. DRP+LP+MRP - The return that ... the risk-free rate of return, and thus represents payment for the risk associated with an investment
    Risk Premium or RP - exceeds
  12. The difference between the interest rate on a U.S. Treasury bond and a ... bond of eual maturity and marketability.
    Reflects the chance that the borrower (the issuer of the sevurity) will not pay the debt's interest or principal on time.
    DRP Default Risk Premium - Corporate
  13. A premium added to hte rate on a security if the security cannot be converted to cash on short notice at a price that is close to the original cost
    Reflects the fact that some investments are more easily converted into cash on short notice at a "reasonable price" than are other securities
    Liquidity Premium - LP
  14. A premium that reflects ... rate risk
    Bonds with longer maturities have greater interest rate risk
    Maturity Risk Premium - MRP - interest
  15. the risk of capital losses to which investors are exposed because of changing interest rates (part of MRP) - Long Term Bonds
    Interest Rate Risk
  16. The risk that a decline in interest rates will lead to lower income when bonds mature and funds are reinvested
    Although Long Term bonds are heavily exposed to interest rate risk, short term investments are more vulnerable to this
    Reinvestment Rate Risk
  17. r* = ... risk free rate The rate of interest that would exist on default free U.S. Treasury secutities if no ... were expected
    t-bill rate is example
    fluctuates between ...% to ...% normally in the U.S.
    real - inflation - 2 - 4
  18. changes over time depending on economic conditions especially:
    On the rate of return corporations and other borrowers are willing to pay to borrow funds
    On people's time preferences for current versus future consumption
    r*= real risk free rate
  19. r = any ... rate aka quoted or stated
  20. rRF= rate on T-securities: risk free
    r* + IP
  21. The relationship between interest rates ( or yields) and maturities of securities
    Term Structure of Interest Rates
  22. A graph of the term structure showing the relationship between yields and maturities of securities is called the
    yield curve
  23. An upward slopind yield curve
    Normal yield curve
  24. A downward sloping yield curve
    Inverted ("abnormal") yield curve
  25. Equation for Short Term Treasury Bonds
    r* + IP
  26. Equation for Long Term Treasury Bonds
    r* + IP + MRP
  27. Equation for Short Term Corporate Bonds
    r* + IP + DRP + LP
  28. Equation for Long Term Corporate Bonds
    r* + IP + DRP + MRP + LP
  29. All else equal lenders prefer to make ... loands rather than ... loans because they are less subject to interest rate risk and are thus more easily bought or sold in the market.
    Liquidity Preference Theory - Short Term - Long Term

    Thus Short term rates should be low and the yield curve should be sloped upward
  30. -Every borrower and lender has a prefered maturity
    -The slope of the yield curve depends on the supply of and demand for funds in the Long Term market relative to the Short Term markety (yield curve should be flat, upward, or downward sloping)
    Market Segmentation Theory
  31. Explanation for the shape of the yield curve
    -Shape of the yield curve depends on investors' expectations about future inflation rates
    -If inflation is expected to increate, short term rates will be ... Long term rates ... and vice versa, thus the yield curve can slope up or down
    • Expectations Theory
    • low high
  32. Operations in which the fderal reserve buys or sells treasury securities to expand or contract the U.S. money supply
    -Distorts the ...
    -contract -
    - expand -
    • Open Market Operations
    • yield curve
    • fed buys
    • fed sells
  33. The larger the federal deficit the ... the level of interest rates
  34. When trade deficits occur, they must be financed, and the main source of financing is debt. This has the effect of ... interest rates
    driving up
  35. Inflationary peridos vs. Recessionary periods
    as business booms rates jump, recession rates drop encourage business
    Business Activity
  36. The higher the rate of interest the ... a firms profit PV= FV/(1+r)^t
  37. affect the level of economic acticity, and economic activity affects coporate profits
    Interest rates
  38. Interest rates influence stock prices because of competition in the market place between stocks and bonds:
    -If interest rates rise shaprly, investors can obtain ... returns in the bond market which induces them to sell stocks and transfer funds from the stock market to the bond market. A massive sale of stocks in repsonse to rising interest rate obviously would depress stock prices.
    -As interest rates decline, the ... market generally is the "hot" investment
    • highter
    • stock
  39. The value of an asset is a function of:
    -the ... it is expected to generate in the future and
    -the ... at which investors are willing to provide funds to purchase the investment
    --when the cost of money increases the value of an asset ...
    • cash flows
    • rate of return
    • decreases
  40. The interest rate lenders charge borrowers.
    Cost of Money
  41. Determined by the supply of funds and the demand for those funds
    How the cost of money is determined
  42. production opportunities, time preferences for consumption, risk, inflation
    factors that affect interest rates
  43. A snapshot of relaitonship between short and long term interest rates at a particular time
    Yield Curve
  44. Government borrowing exerts pressure on the demand for fudns and may inflate interest rates
    How governement actions and business activity affect interest rates
  45. When rates increase value of assets decrease which would you prefer if they both decrease
    How does the level of interest rates affect the calues of stocks and bonds
  46. A loan to a firm, government, or individual
    ex. home mortgages, commercial paper, term loans, bonds, secured and unsecured notes, marketable and nonmarketable debt
  47. The amount owed to the lender, which must be repaid at some point during the life of the debt
    Principal Value, Face Value, Maturity Value, and Par Value
  48. Securitites selling for less than PAr Value, usually occurs on debt instruments which do not offer interest payments
    Discounted Securities
  49. The date on which the principal amount of debt is due
    Maturity Date
  50. Interest on debt is paid before stock dividedns are distributed, and any outstanding debt must be repaid before stockholders can receive any proceeds from liquidation of the company
    Priority to Assets and Earninds
  51. Voting rights are not offered with debt, therefore debtholders cannot attain this
    Control of the firm
  52. Discounted short term debt instruments issued by the U.S. government to finance operations
    Treasury Bills
  53. An arrangement in which one firm sells some of its financial assets to another firm with a promise to repurchase the securities at a higher price at a later date
    Repurchase Agreement
  54. Overnight loans from one bank to another
    Federal Funds
  55. Aninstrument issued by a bank that obligates the bank to pay a specified amount at some future date( a postdated check)
    Banker's Acceptance
  56. A type of promissory note or legal IOU issued by large financially sound firms at a discount
    Commercial Paper
Card Set
Finance #2
chapter 5-8