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145 Cards in this Set
- Front
- Back
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the process of leaving the money in the financial market and lending it for another year
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compounding
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each interest payment is reinvested
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compound interest
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the process of calculating the present value of a future cash flow
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discounting
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the factor used to calculate the present value of a future cash flow
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present value factor
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the annual interest rate without consideration of compounding
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stated annual interest rate
annual percentage rate (APR) |
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the annual rate of return
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effective annual rate (EAR)
effective annual yield (EAY) |
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compounding every infinitesimal instant
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continuous compounding
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the constant stream of cash flows without end
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perpetuity
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rise in cash flows indefinitely
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growing perpetuity
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end of year 0 is the present, the end of year 1 occurs one period hence
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end-of-the-year convention
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date 0 represents the present time, date 1 etc.
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dates convention
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a level stream of regular payments that lasts for a fixed number of periods
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annuity
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the term we use to compute the present value of the stream of level payments for T years
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annuity factor
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a finite number of growing cash flows
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growing annuity
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simplest form of loan
the borrower receives money today and repays a single lump sum at some time in the future |
pure discount loan
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the borrower pays interest each period and repays the entire principal at some point in the future
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interest-only loans
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the lender may require the borrower to repay parts of the loan amount over time
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amortized loan
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process of providing for a loan to be paid off by making regular principal reductions
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amortizing the loan
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interest earned on the original principal
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simple interest
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interest is earned on the accumulated interest added to the principal each period
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compound interest
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an infinite regular cash flow stream
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perpetuity
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a finite regular cash flow stream
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annuity
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cash flows occur at end of each period
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ordinary annuity
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cash flows occur at beginning of each period
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annuity due
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the interest rate stated on an annual basis
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stated annual interest rate
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an interest rate that reflects the effect of compounding within an annual period
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effective annual interest rate
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regular interest payments a bond promises to make
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coupons
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type of bond where the coupon is constant and paid every year
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level coupon bond
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the amount that will be repaid at the end of the loan for a bond
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bond's face value, par value
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a bond that sells for its par value
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par value bond
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the annual coupon divided by the face value
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coupon rate on the bond
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the number of years until the face value is paid
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bond's time to maturity
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the interest rate required int he market on a bond
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bond's yield to maturity (YTM)
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bond sells for less than face value
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discount bond
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bond sells for more than face value
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premium bond
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the risk that arises for bond owners from fluctuating interest rates
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interest rate risk
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a bond's annual coupon divided by its price
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current yield
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short-term debt
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unfunded debt
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issues with an original maturity of 10 years or less
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notes
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issues with an original maturity of more than 10 years
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bonds
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the written agreement between the corporation and its creditors
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indenture, deed of trust
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makes sure the terms of the indenture are obeyed
manages the sinking fund represents the bondholders in default |
trustee, trust company
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face value of bond
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principal value
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initial accounting value of bond
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par value of bond
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the company has a registrar who will record the ownership of each bond and record any changes in ownership
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registered form
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the certificate is the basic evidence of ownership and the corporation will pay the bearer
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bearer form
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securities that are pledged as security for payment of debt
any asset pledged on a debt |
collateral
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securities secured by a mortgage on the real property of the borrower
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mortgage securities
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the legal document that describes the mortgage for mortgage securities
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mortgage trust indenture, trust deed
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unsecured bond, for which no specific pledge of property is made
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debenture
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preference in position over other lenders
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seniority, senior or junior, subordinated
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an account managed by the bond trustee for the purpose of repaying the bonds
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sinking fund
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allows the company to repurchase or "call" part or all of the bond issue at stated prices over a specific period
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call provision
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the difference between the call price and the stated value
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call premium
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call provisions that are not operative during the first part of a bond's life
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deferred call provision
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period of prohibition
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call protected
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the part of the indenture or loan agreement that limits certain actions a company might otherwise wish to take during the term of the loan
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protective covenant
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it limits or prohibits actions that the company might take
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negative covenant
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it specifies an action that the company agrees to take or a condition the company must abide by
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positive covenant
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a bond that pays no coupons at all
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zero coupon bonds, zeroes
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coupon payments are adjustable
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floating-rate bonds (floaters)
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allows the holder to force the issuer to buy the bond back at a stated price
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put bond
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coupon is subject to a minimum and a maximum
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collar
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bonds that have coupons that are adjusted according to the rate of inflation
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inflation-linked bond
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similar to conventional bonds except that coupon payments are dependent on company income
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income bonds
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can be swapped for a fixed number of shares of stock anytime before maturity at the holder's option
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convertible bond
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whether it is possible to easily observe its prices and trading volume
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transparency
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represents what a dealer is willing to pay for a security
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bid price
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what a dealer is willing to take for it
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asked price
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difference between bid and ask price, dealer's profit
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bid-ask spread
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quoted price where accrued interest is deducted
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clean price
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price you actually pay, includes accrued interest
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dirty price, full or invoice price
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rates not adjusted for inflation
the percentage change in the number of dollars you have |
nominal rates
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rates that have been adjusted for inflation
the percentage change in how much you can buy with your dollars, in other words, the percentage change in your buying power |
real rates
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the relationship between nominal rates, real rates, and inflation can be written as
1+R = (1+r)(1+h) where h is the inflation rate |
the Fisher Effect
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the relationship between short- and long-term interest rates
tells us what nominal interest rates are on default-free, pure discount bonds of all maturities |
term structure of interest rates
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extra compensation demanded by investors for the loss of higher nominal rates
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inflation premium
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extra compensation for bearing risk of loss resulting from changes in interest rates
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interest rate risk premium
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plot of Treasury yields relative to maturity
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Treasury yield curve
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extra compensation demanded for possibility of default
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default risk premium
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extra yield on taxable bond as compensation for unfavorable tax treatment
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taxability premium
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extra compensation for varying degrees of liquidity
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liquidity premium
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a long-term promissory note
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bond
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the principal amount of the bond
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par value
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the stated life of the bond, upon which the principal must be repaid by the firm
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maturity
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the amount of interest paid
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coupon payment
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the interest rate promised by the bond
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coupon rate
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the opportunity cost; the rate that current bonds of equivalent risk are offering
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yield
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a measure of bond performance; the rate of return you would earn if you bought the bond today and held it to maturity
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yield-to-maturity
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the value of the bond is inversely related to discount rates. if market rates increase, the bond value will decrease; if market rates decrease, the bond value will increase
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interest rate risk
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the bond involves a legal obligation to pay specified cash flows and perform other obligations relating to the security of these payments
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default risk
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the use of fixed interest expense costs to increase net performance
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financial leverage
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the ratio of retained earnings to earnings
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retention ratio
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the return on the cumulation of all the firm's past projects
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return on equity (ROE)
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expected cash dividend divided by the current price
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dividend yield
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the rate at which the value of the investment grows
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capital gains yield
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the ratio of dividends/earnings
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payout ratio
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the company pays all of their earnings out to stockholders as dividends
EPS=Div |
cash cow
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using the growing perpetuity formula to price a stock with a steady growth in dividends
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dividend growth model
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stock that has no special preference either in receiving dividends or in bankruptcy
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common stock
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the directors are elected all at once
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cumulative voting
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the directors are elected one at a time
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straight voting
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the grant of authority by a shareholder to someone else to vote his/her shares
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proxy
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the right to share proportionally in any new stock sold
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preemptive right
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a return on the capital directly or indirectly contributed to the corporation by the shareholders
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dividends
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has preference over common stock in the payment of dividends and in the distribution of corporation assets in the event of liquidation
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preferred stock
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only that the holders of the preferred shares must receive a divided before holders of common shares are entitled to anything
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preference
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if preferred dividends are not paid in a particular year, they will be carried forward as an arrearage
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cumulative
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shares of stock are first brought to the market and sold to investors
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primary market; new-issue market
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existing shares are traded among investors
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secondary market
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maintains an inventory and stands ready to buy and sell at any time
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dealer
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brings buyers and sellers together, but does not maintain an inventory
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broker
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own "seats" on the exchange; owners of exchange
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members
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execute customer orders to buy and sell stocks
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commission brokers
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acts as an assigned dealer for a small set of securities
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specialists; market makers
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used by commission brokers who are too busy to handle certain orders themselves
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floor brokers
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allows orders to be transmitted electronically directly to the specialist
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SuperDOT system
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independently trade for their own accounts
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floor traders
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the flow of customer orders to buy and sell stocks
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order flow
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each of the counters at a figure-eight-shaped station
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specialist's post
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a securities market largely characterized by dealers who buy and sell securities for their own inventories
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over-the-counter (OTC) market
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Web sites that allow investors to trade directly with one another
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electronic communications networks (ECNs)
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companies will attract a certain type of investor and manage their business to keep these investors happy
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the clientele effect
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produces a stable cash flow stream in the form of dividends
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income stock
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may not produce a safe dividend stream, but offers potential for price appreciation-capital gains
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growth stock
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firms kept cash and promised investors greater capital gains
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a reduced payout ratio
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investors wanted higher capital gains and not income from dividends
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a reduced dividend yield
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dividend yield
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dividend next year/current price
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capital gain yield
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percentage increase in stock price
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the decision-making process for accepting or rejecting projects
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capital budgeting
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the difference between the sum of the present values of the project's future cash flows and the initial cost of the project
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net present value
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accept a project if the NPV is greater than zero; reject a project if the NPV is less than zero
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NPV rule
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the value of the firm is merely the sum of the values of the different projects, divisions, or other entities within the firm
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value additivity
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alternative to NPV where you calculate the time it takes for the firm to recover its investment
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payback
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all investment projects that have payback periods of shorter than the cutoff date are accepted
all investment projects that pay off in more than the cutoff date are rejected |
payback period rule
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first discount the cash flows and then see how long it takes for the discounted cash flows to equal the initial investment
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discounted payback period method
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the average project earnings after taxes and depreciation, divided by the average book value of the investment during its life
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average accounting return
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the rate that causes the NPV of the project to be zero
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internal rate of return
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accept the project if IRR is greater than the discount rate; reject the project if IRR is less than the discount rate
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basic IRR rule
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a project whose acceptance or rejection is independent of the acceptance or rejection of other projects
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independent project
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you can accept A or you can accept B or you can reject both of them, but you cannot accept both of them
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mutually exclusive investments
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combines cash flows until only one change in sign remains
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modified IRR
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the IRR on the incremental investment from choosing the large project instead of the small project
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incremental IRR
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the ratio of the present value of the future expected cash flows after initial investment divided by the amount of the initial investment
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profitability index
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when the firm does not have enough capital to fund all positive NPV projects
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capital rationing
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