Finance 301 Exam 2

Front 1

Required rate of return (r)

Back 1

r = (r* + IP) + DRP + LP + MRP
r* - real risk-free rate of interesst
IP - inflation premium
DRP - default risk premium
LP - liquidity risk premium
MRP - maturity risk premium

Front 2

Risk free rate (rf)

Back 2

rf = (r* + IP)
- usually 3-month T-bills
r* - real risk-free rate of interesst
IP - inflation premium

Front 3

Nominal (=)

Back 3

nominal = r* + IP + [(r*)(IP)]

Front 4

Pure Expectations Hypothesis (PEH)

Back 4

yield curve depends on investors expecations about future interest rates
- if interest rates are expected to increase: L-T rates will be higher than S-T rates

Front 5

Treasury Securities MRP

Back 5

MRP = 0

Front 6

Risks associated with overseas investing

Back 6

- exchange rate risk
- country risk

Front 7

bond

Back 7

long term debt instrument in which a borrower agrees to make payments of principle and interest to holders of bond (> 12 months)

Front 8

Par value (of a bond)

Back 8

face amount of the bond which paid at maturity

Front 9

coupon interest rate

Back 9

nominal stated contract rate (annual) - what you'll get for year based on payment incraments

Front 10

maturity date

Back 10

years until bond must be repaid

Front 11

issue date

Back 11

date when the bond was issued

Front 12

yield to maturity

Back 12

rate of return earned on bond held until maturity

Front 13

accrued interest

Back 13

interest owed of due from the last interest payment due (based on last paid)

Front 14

callable bond

Back 14

company can buy it back (call it back)

Front 15

sinking fund

Back 15

forces trustee to pay off a percentage of bonds per year (reduces risk of default)

Front 16

convertible bond

Back 16

when stock goes up owners buy stock -> automatically move from debt to equity

Front 17

warrant

Back 17

L-T option to buy stated # of shares at specified price (sweeten to buy debt)

Front 18

putable bond

Back 18

allows holder to sell the bond back to the company prior to maturity (low quality company)

Front 19

income bond

Back 19

only pays interest if the company earns interest

Front 20

indexed bond

Back 20

interest rate paid based upon a specific index

Front 21

catastrophic bond (cat bond)

Back 21

amount paid at maturity is a function of some defined contingency

Front 22

zero coupon bond

Back 22

no interest and at end of bond like get back principle (really high rate of return)

Front 23

discount rate (rd)

Back 23

the rate that could be earned on alternative investments of equal risk

Front 24

value of financial assets

Back 24

value paid based on expected return

Front 25

value bond with calculator

Back 25

par value - FV
coupon - PMT
_______ - PV
t - I/YR
time held - N

Front 26

bond values over time (if rd remains constant)

Back 26

- value of a premium bond would decrease until par value
- value of a discount bond would increase until par value
- value of par bond remains consistant

Front 27

Expected total return - Yield to maturity (YTM)

Back 27

YTM = [expected CY] + [expected CGY]

Front 28

YTM on calc

Back 28

N - time held
I/YR - __________
PV - sells for (neg)
PMT - par value (coupon)
FV - par value

Front 29

Current Yield (CY)

Back 29

Front 30

Capital gains yield (CGY)

Back 30

Front 31

Semiannual bonds

Back 31

- multiply years by 2 # of pds = 2N
- divide nominal rate by 2: periodic rate (I/YR) = rd/2
- divide annual coupon by 2: PMT = annual coupon/2

Front 32

Semiannual bond's effective rate

Back 32

Front 33

rate of return on investment

Back 33

- number is a percentage
- rate that you are earning money

Front 34

Investment risk

Back 34

degree of variability of possible outcomes (greater variability - greater risk)

Front 35

Expected rate of return (ȓ)

Back 35

Front 36

standard deviation (σ)

Back 36

Front 37

coefficient of variation (cv)

Back 37

high CV - in order to get high rate of return you are taking on a high level of risk

Front 38

risk aversion

Back 38

investors dislike risk (require higher rates of return for risks)

Front 39

risk premium

Back 39

the difference between return on a risky asset and a riskless asset

Front 40

weight average (ȓp)

Back 40

Front 41

CVp

Back 41

σp - decreases as stocks added

Front 42

market risk

Back 42

part of the total risk you can't get rid of

Front 43

diversifible risk

Back 43

part of the total risk you can get rid of

Front 44

capital asset pricing model (CAPM)
& security market line

Back 44

draws a line (security market line that describes rate of return you should get (risk after diversification)

Front 45

beta

Back 45

measures of securities reaction
- beta = 1, security just as risky as market
- beta > 1, security riskier than market
- beta < 1, security is less risky than market

Front 46

common stockk

Back 46

represents ownership; source of money to supply cash

Front 47

intrinsic value

Back 47

estimate of what it is worth vs. the marketplace

Front 48

dividend growth model

Back 48

Front 49

constant dividend growth stock

Back 49

stock whose dividends are expected to grow forever at a constant rate

Front 50

if growth is constant

Back 50

Front 51

Constant growth rate model can only be used if...

Back 51

- rs > g
- g is expected to be constant forever

Front 52

dividend yield

Back 52

Front 53

capital gains yield

Back 53

Front 54

total return (rs)

Back 54

Front 55

growth is zero

Back 55

Front 56

price

Back 56

Front 57

Corporate Value Model (CVM) - MV of equity

Back 57

MV of equity = MV of firm - MV of debt - MV of preferred

Front 58

Corporate Value Model (CVM) - value per share

Back 58

MV of equity / # of shares

Front 59

Preferred stock

Back 59

hybrid security