Finance #2

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

is the dollar return stated as a percentage of the dollar amount that was originally invested

What do we call the price or cost of debt capital?

What do we call the price or cost of equity capital?

The returns available within an economy from an investment in productive (cash generating) assets

The preferences of consumers for current consumption as opposed to saving for future consumption
(want money now or buy bond for the future)

In a financial market context, the chance that a financial asset will not earn the return promised (chance of default)

The tendency of prices to increase over time

A premium for expected inflation that investors add to the real risk-free rate of return

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

DRP+LP+MRP - The return that ... the risk-free rate of return, and thus represents payment for the risk associated with an investment

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.

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

A premium that reflects ... rate risk
Bonds with longer maturities have greater interest rate risk

the risk of capital losses to which investors are exposed because of changing interest rates (part of MRP) - Long Term Bonds

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

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.

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 = any ... rate aka quoted or stated

rRF= rate on T-securities: risk free

The relationship between interest rates ( or yields) and maturities of securities

A graph of the term structure showing the relationship between yields and maturities of securities is called the

An upward slopind yield curve

A downward sloping yield curve

Equation for Short Term Treasury Bonds

Equation for Long Term Treasury Bonds

Equation for Short Term Corporate Bonds

Equation for Long Term Corporate Bonds

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.

-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)

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

Operations in which the fderal reserve buys or sells treasury securities to expand or contract the U.S. money supply
-Distorts the ...
-contract -
- expand -

The larger the federal deficit the ... the level of interest rates

When trade deficits occur, they must be financed, and the main source of financing is debt. This has the effect of ... interest rates

Inflationary peridos vs. Recessionary periods
as business booms rates jump, recession rates drop encourage business

The higher the rate of interest the ... a firms profit PV= FV/(1+r)^t

affect the level of economic acticity, and economic activity affects coporate profits

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

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 ...

The interest rate lenders charge borrowers.

Determined by the supply of funds and the demand for those funds

production opportunities, time preferences for consumption, risk, inflation

A snapshot of relaitonship between short and long term interest rates at a particular time

Government borrowing exerts pressure on the demand for fudns and may inflate interest rates

When rates increase value of assets decrease which would you prefer if they both decrease

A loan to a firm, government, or individual
ex. home mortgages, commercial paper, term loans, bonds, secured and unsecured notes, marketable and nonmarketable debt

The amount owed to the lender, which must be repaid at some point during the life of the debt

Securitites selling for less than PAr Value, usually occurs on debt instruments which do not offer interest payments

The date on which the principal amount of debt is due

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

Voting rights are not offered with debt, therefore debtholders cannot attain this

Discounted short term debt instruments issued by the U.S. government to finance operations

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

Overnight loans from one bank to another

Aninstrument issued by a bank that obligates the bank to pay a specified amount at some future date( a postdated check)

A type of promissory note or legal IOU issued by large financially sound firms at a discount

An interest-earning time deposit at a bank or other financial intermediary

Certificate of deposit that can be traded to other investors prior to maturity; redemption is made by the investor who owns the CD at maturity

A deposit in a foreign bank that is denominated in U.S. dollars

Investment funds pooled and managed by investment companies that are primarily invested in short term financial assets

A loan generally obtained from a bank or insurance company on which the borrower agrees to make a series of payments consisting of interest and principal on specific dates to the lender - principal is paid back throughout the life of the loan

A long term contract under which a borrower agrees to make payments of interest and principal on spevific dates to the bondholder (investor)
Principal is paid back at the end of the loan
Coupon rate used

Interest paid on a bond or other debt instrument stated as a percentage of it face or maturity value; represents the total interest paid each year

Debt Issued by federal state or local governments -- treasury notes or bonds

Bonds issued by state or local governments including revenue bonds and general obligation bonds

A municipal bond that generates revenue, which in turn can be used to make interest payments and repay the principal

A municipal bond backed by the local government's ability to impose taxes

Long term debt instruments issued by corporations

A bond backed by fixed assets. First motgage bonds are senior in priority to claims of second mortgage bond

A long term bond that is not secured by a mortgage on specific property

A bond that has a claim on assets olny after the senior debt has been paid off in the event of liquidation

A bond that pays interest to the holder only if the interest is earned by the firm

A bond that can be redeemed at the bondholder's option when certain circumstances exist

A bond that has interest payments based on an inflation index to protect the holder from inflation

A bond whose interest rate fluctuates with shifts in the general level of interest rates

A bond that pays no aannual interest but is sold at a discount below par, thus providing compensation to investors in the form of capital appreciation

A high-risk high-yiled bond used to finance mergers, leveraged buyouts, and troubled companies

A formal agreement or contract between the issuer of a bond and the bondholders

an official who ensures that the bondholders' interests are protected and that the terms of the indenture are carried out

A provision in debt contract that constrains the actions of the borrower

A provision in a bond contract that gives the issuer the right to redeem the bond uner specified terms prior to the normal maturity date

Retiring an existing bond issue with the proceeds of a newly issued bond

A required annual payment designed to amortize a bond issue
may handle by
-call in for redemption a certain percentage of the bonds each year or
-buy the required amount of bonds on the open market

Permits bondholders to exchange their investments for a fixed number of shares of common stock, cannot be reversed

A bond rated A or triple B - the lowest rated bonds that many banks and other institutional investors may hold by law

A bond's rating is an indicator of its default risk
Most bonds are purchased by institutional investors who are legally restricted to investment grade securities
Changes in ratings affect a firm's ability to borrow long term capital and the cost of that capital

Restructuring to reduce the financial charges to a level that the firm's cash flows can support

If bankruptcy court orders a liquidation, proceeds are distributed in this order

Refunding Questions:
Would it be profitable to call an outstanding issue now and to replace it with a new issue?
Even if refunding is profitable, would it be better to call now or to postpone the refunding to a later date?

Debt issued by a foreign borrower but denominated in the currency of the country in which it is sold

Debt issued in a country other than the one in whose currency the debt is denominated: Eurocredits, euro-commercial paper, Euronoes

the interest rate offered by the best london banks on deposits of other large very creditworthy banks

The average rate of return earned on a bond if it is held to maturity

The average rate of return earned on a bond if it is held until the first call date

The price a frim has a pay to recall a bond; generally equal to the principal amount plus some interest

Because the cash flows associated with the bond-- that is interst payments and principal repayment -- remain constant, the value of a bond will ... when interest rates...

A bond that sells below its par value. This occurs whenever the going rate of interest rises above the coupon rate

A bond that sells above its par value. This occurs whenever the going rate of interest falls below the coupon rate

The risk of changes in bond prices to which investors are exposed due to changing interest rates

The risk that income from a bond portfolio will vary because cash flows must be reinvested at current market rates

Interest rate risk is ... for bonds that have longer maturities and lower coupon rates

Reinvestment risk is ... for bonds that pay high coupon rates- or for bonds with shorter maturities

What is debt?

What are bond ratings?

How are bond prices determined?

What is the relationship between bond prices and interest rates?

The nominal or face value of a stock or bond
-establishes the amount due to preferred stockholders in the event of ...
-the preferred dividend generally is stated as a perventage of the this

any preferred dividends not paid in previous peridos must e paid before common dividends can be distributed(dividedns in arrears)q

Dividends must be paid on preferred stock before they can be paid on common stock, and in the even of bankruptcy, the claims of preferred stockholders must be satisfied boefre the common stockholders receive anything

Almost all preferred stock is

Most stock can be converted to...

gives the issuing corporation the right to call in the preferred stock for redemption

The amount in excess of par value that a company must pay when it calls a security

call for the repurchase and retirement of a given percentage of the stock each year- plan for calling- making sure they have enough money to buy it

... with the common stock in sharing firms earnings - typically occurs when the dividend declared for common stock exceeds that which is paid to the preferred stockholders

legally represents a stockholder's minimum financial obligation in the event the corporation is liquidated - not required and does not determine the market value of common stock or vice versa

The firm has ... to pay common stock dividends

stocks of firms that traditionally pay little or no dividedns so as to retain earnings to help fund growth opportunities

common stockholders have the ... to elect the firms directors and to vote on shareholder's proposals. mergers, and changes in the firms charter

a document giving one person the authority to act for another typically the power to vote shares of common stock

an attempt by a person or group of peopld to gain control of a firm by getting its stockholders to grant that person or group the authority to vote their shares so as to change the management team

an action whereby a person or group succeeds in ousting a firms managememnt and taking control of the company

a provision in the coproate charter or bylaws that gives existing common stockhodlers the right to purchase on a pro rata basis any additional shares of stock sold by the firm

common stock that is given a special designation to meet special needs of the company

a class of stock owned by the firm's founders who have sole voting rights

certificates created by banks that represent ownership in stocks of foriegn countries

stock issued by foreign companies and traded in the united states

stock traded in countries other than the "home" country of the company not including the U.S.

Growth that is expected to continue into the forseeable future

the part of the life cycle of a firm in which its growth is either much faster or much slower than that of the economy as a whole

the ... the p/e ratio the more investors are willign to pay for each dollar earned by the firm- gives an indication of a stock's payback period

the ... the EVA the better management is making decisions to beneift of the stockholders

prices move ... to changes in rates of return

prices move in the ... as changes in cash flows expected from the stock in the future

the value of assets that are owned minus the amount of debt that is owed

...change because ivestors change their expectations about the returns the firm will generate in the future

the stock price is equal to the ... of the dividend stockholders expect to reveive during the company's life

are based on the dividend the company pays and the change in the market value of the stock during hte year

what techniques do investors use to value stocks

the chance that an unexpected outcome will occur

a listing of all possible outcomes with a probability (chance of occurence) assigned to each outcome

In a continuous probability distribution the number of possible outcomes is

in a discrete probability distribution - number of possible outcomes is

-a standardized measure of the risk per unit of return
-useful where investments differ in risk and expected returns
-calculated as the standard deviation divided by the expected return

risk adverse investors require higher rates of return to invest in

The portion of the expected return that can be attributed to an investment's risk beyond a riskless investment
equals the difference between the expected rate of return on a given risky asset and that on a less risky asset

-the return that is actually earned

-measures the degree of relationship between two variables

Perfectly or positvely correlated stocks have rates of return that move in the ... direction roe=1

negatively correlated stocks have rates of return that move in ... directions roe=-1

combining stocks that are not perfectly correlated will reduce the portfolio risk through
-the riskiness of a portfolio is reduced as the number of stocks in the portfolio increases
-the smaller the positive corelation the lower the risk

that part of a security's risk associated with random outcomes generated by events, or behaviors, specific to the firm
-can be eliminated through proper diversivication

that part of a security's risk that cannot be eliminated through diversification because it is associated with economic, or market factors that systematically affect all firms
-relevant risk is the risk of a security that cannot be diversified away, or its mrket risk-

the risk of a security that cannot be diversified away or its market risk
reflects a security's contribution to a portfolio's total risk

A measure of the extent to which the returns on a given stock move with the stock market

The beta of any set of securities is the .... average of the individual securities betas

a theoretical model used to determine the required return on an asset which is based on the proposition that any asset's return should be equal to the risk free return plus a risk premium that reflects the asset's nondiversifiable risk

The addicitional return over the risk free rate needed to compensate investors for assuming an average amount of risk

The line that shows the relationship between risk as measured by beta and the required rate of return for individual securities - result of CAPM

In increase in expected inflation would ... the nominal risk free rate

The slope of the SML reflects the extent to which investors are

An increase in risk aversion ... the risk premium and ... the slope

the condition under which the expected return on security is equal to its required return

Riskiness of corporate assets is only relevant in terms of its ... on the stock's risk