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81 Cards in this Set
- Front
- Back
Bond
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A formal contractual obligation to pay an amount of money to the holder at a certain date, plus a series of cash interest payments based on a specified percentage.
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The longer term of a bond the ______ will be the return demanded (yield) by investors to compensate for increased risk
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higher
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Advantages of Bonds to the issuer
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Interest paid on debt is tax deductible.
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Disadvantages of Bonds to the issuer
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1. YOU HAVE TO PAY BACK INTEREST AND PRINCIPLE.
2. Because it is a legal obligation to pay back, it raises risk. 3. Long term nature makes it risky. 4. Specific ratios must be kept avove a certain level (dso/dsi) 5. Debt to equity ratio can limit how many bonds can be issued. |
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Term Bond
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SIngle maturity date at the end of its term.
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Serial bond
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matures in stated amounts at regular intervals
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Variable rate bonds
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pay interest that is dependent on market conditions.
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Zero-coupon
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No stated interest rate
No periodic cash payments Interest component consists entirely of the bonds discount. |
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Commodity backed bond
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Payable at prices related to a commodity such as gold.
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Callable bonds
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may be repurchased by the issuer at a specified price before maturity
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Convertible bonds
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may be converted into equity securities of the issuer at the option of the holder under certain conditions.
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Mortgage bonds
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Backed by specific assets, usually real estate.
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Debentures
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Backed by the borrowers general credit but not by specific collateral.
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Registered bonds
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issued in the name of the holder. Only the registered holder may receive interest and principal payments.
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Bearer bonds
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not individually registered. Interest and principle are paid to whomever presents the bond.
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Subordinated debentures
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Junior security with claims inferior to those of senior bonds.
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Second mortgage bonds
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Junior security with claims inferior to those of senior bonds.
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Income bonds
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pay interest contingent on the issuers profitability
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Revenue bonds
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issued by governmental units and are payable from specific revenue sources
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Bond Ratings
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The higher the rating, the more likely the firm is to make good its commitment to pay interest and principle
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Investment grade bonds
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considered safe investments and thus have the lowest yeields
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Triple-A rated bonds
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the highest rated bond
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Non-Investment grade bonds
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Speculative-grade bonds, high-yield bonds, or junk bonds, carry high risk.
Exploit the tax deductibility of large interest payments. |
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Whats the most important concern to the bond issuer
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the amount of cash that he will receive from investors on the day the bonds are sold.
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If the bonds stated rate is higher than the market rate
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Investors are willing to pay more for the bonds, since their periodic interest payments are higher than those currently available in the market.
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common stockholders
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owners of the corporation, and their rights as owners, although reasonably uniform, depend on the laws of the state. where the the firm is incorporated.
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Advantages to issuing common stock
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1. Doesn't require fixed dividend
2.No fixed maturity date for repayment of capital 3. Proving equity improves creditworthyness 4. more attractive to investors than debt because it grows in value with the success of the firm. |
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Disadvantages to issuing common stock
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1.Cash dividends on common stock are not tax-deductible, so its comes from after tax profits.
2. Control is usually diluted as more common stock issued 3. New common stock sales dilute EPS 4. Under writing cots are high 5. too much equity may raise the avg cost of capital of the firm above optimal level. |
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Preemptive rights
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give common shareholders the right to purchase any additional stock issuances in proportion to their current ownership percentages.
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A stock's Par Value
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Represents legal capital.
Arbitrary value assigned before the stock is issued. it represents the maximum liability of a shareholder. |
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Preferred stock
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hybrid of debt and equity.
It has a fixed charge and increases leverage, but payment of dividents is not an obligation. |
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Advantages to issuing preferred stock
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It is a form of equity and therefore builds the creditworthiness of the firm.
Control is still held by common shareholders Superior earnings of the firm are usually still reserved for the common shareholders |
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Disadvantages to issuing preferred stock
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1.Cash dividends on preferred stock are not deductible as a tax expense and are paid with taxable income. The result is a substantially greater cost relative to bonds.
2. In periods of economic difficulty, dividends in arears create major financial and managerial problems. |
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If the firm goes bankrupt, who has priority (common vs preferred)
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preferred stockholders.
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Par value of a preferred stock
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liquidation value, and percentage of par equals preferred dividend.
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Options
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right to demand some action in a future date.
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exercise of an option
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performing the action. Always at the discretion of theoption holder.
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European option
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An option that can be exercised only on its expiration date
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American option
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An option that grants the buyer the right to exercise anytime on or before expiration.
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exercise price
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price at which the owner can purchase or sell the asset underlying the option contract.
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option price
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amount the buyer pays to the seller to aquire an option.
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covered option
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on in which the seller already has possession of the underlying
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Naked option
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speculative. The writer does not hold the underlying. he may have to aquire it at an unknown price to satisfy obligation.
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Index option
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an option whose underlying asset is a market index. If exercised settlement is made by cash since dilivery is impossible.
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Long-Term equity anticipation securities
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examples of long term stock options or index options, with expiration dates up to 3 years away
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Foreign currency options
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give the holder the right to buy a specific foreign currency at a designated exchange rate.
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in the money
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if the price of the underlying rises above the exercise price.
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out of the money
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if the value of the underlying is less than the exercise price of the option.
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at the money
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if the value of the underlying is equal to the exercise price of the option.
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put option
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gives the buyer the right to sell the underlying asset at a fixed price.
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in the money for a put option
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when the price of the underlying falls below the exercise price. This way you get people to buy the underlying at a price higher than that prevailing in the market.
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out of the money for a put option
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if the value of the underlying is higher than the exercise price of the option, the option is "out-of-the-money" or not worth exercising.
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At the money
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if the value of the underlying is equal to the exercise price of the option, the option is said to be "at the money"
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put-call parity theorem
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mathematically depicts the combinations of investment strategies that can be devised using European options (i.e. Those with a single exercise date).
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What are 2 methods for valuing options
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1. The Black-Scholes formula for call options
2. The Binomial method |
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What does the buyer of a call option benefit from
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A low exercise price.
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What does the user of a put option benefit from
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a high exercise price
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An increase in the exercise price of an option results in a _______ in the value of a call option and a _________ i the value of a put option.
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a decrease in the value of a call option and an increase in the value of a put option.
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As the price of the underlying increases the value of the _________ also increases.
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call option
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The value of a put option will _______ as the price of the unerlying increases.
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decrease, since there is no advantage in selling at a lower than market price
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A rise in interest rates will therefore result in a ______ in the value of a call option and a _______ in the value of a put option.
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fall in the value of a call option and a rise in the value of a put option.
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The more time passes the
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riskier any investment is.
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An increase in the term of an option ( both calls and puts)
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will result in an increase in the value of the option.
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An increase in the volatility of the price of the underlying
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will result in an increase in the value of the option.
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simple forward contract
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two parties agree that, at a set future date, one of them will perform and one will pay a specified amount for the performance.
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The party that has contracted to buy the underlying at a future date
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Has taken the long position
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The party that has contracted to deliver the underlying at a future date
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has taken a short position.
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INterest rate swaps
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agreements to exchange interest payments based on one interest structure for payments based on another structure
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Currency swaps
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agreements to exchange cash flows denominated in one currency for cash flows denominated in another.
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Credit default swaps
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Agreements whereby one of the parties indemnifies the other against default by a third party.
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Lease
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long term contractual agreement in which the owner of property allows another party the right to use the property for a stated period in exchange for a stated payment.
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Capital Lease
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Purchase and financing arrangement.
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operating lease
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Long term rental contract
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Convertible securities
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Debt or preferred stock securities that contain a provision allowing the holder to convert the securities into some specified number of common shares after a specified time has elapsed
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Stock purchase warrant
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a call option on the corporations common stock. After a specified time has elapsed, the holder of the warrant can exchange the warrant plus a specified amount of awash for some number of shares of common stoke.
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Retained earnings
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cumulative accrual basis income of the corporation minus amounts paid out in cash dividends minus amounts reclassified as additional paid-in capital from stock dividends
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Marginal cost of capital
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cost to the firm of the next dollar of new capital raised after existing internal sources are exhausted.
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Cost of new capital
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the ratio of what the firm must pay to what the firm gets.
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Cost of new debt (ratio)
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Annual Interest / Net issue proceeds
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Cost of new preferred stock
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Next Dividend / Net issue proceeds
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Cost of new common stock
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(Next dividend / Net issue proceeds) + dividend growth rate.
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