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41 Cards in this Set
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Differences Between Bond and Equity

Stockes don't have to pay dividend, bonds are debt, stocks are ownership

Par Value

Face Value: principal amount to be repaid at the end of the term, typically 1,000

Coupon Rate

The annual coupon divided by the face value of the bond

Coupon Payment

States interest payment made on the bond

YTM

Yield to Maturity the calculated return on the bond that investors will earn if they hold the bond till maturity

Maturity Date

specified date on which the principal amount of a bond is paid

Discount Bond

bond selling less than par value

Premium Bond

Sold over par value, 1000

Reinvestment Rate Risk

Uncertainty concerning rates at which cash flows can be reinvested. Short term bonds have more reinvestment rate risk than long term bonds. High coupon rate bonds have more reinvestment rate risk that low coupon rate bonds

Interest rate risk

Interest rate risk mis the risk that arises for bond owners from fluctuating interest rates. It depends on time to maturity and coupon rate: longterm bonds have more price risk than shortterm bonds, low coupon rate bonds have more risk than high coupon rate bonds.

Bond Classification: Senior vs subordinate

Senior gets payed first, then subordinate

Floating Rate Bond:

coupon rate floats depending on some index valu.e There is less price risk, the coupon floats so its less likely to differ substantially from the YTM

Municipal Securities

Debt of state and local government. Varying degrees of default risk, rated similar to corporate debt. Interest received is TAXEXEMPT at the federal level.

Zero Coupon Bonds

Make no periodic interest payments, cannot sell for more than par value

Disaster Bonds

Insurance company if something happens then interest is voided

Income Bonds

Corporate income level: no longer liable for payment is corporate income level isnt reached

Convertible Bonds

Change bond to stocks

Put Bonds

You have the right to sell bonds ack to the company

The fisher Effect

(1+Nominal Rate)=(1+real rate)+(1+expected inflation rate)

Term Structure of Interest Rates

The relationship between time to maturity and interest rate. Yield Curve: Nominal (Upward sloping), Inverted (DownwardSloping)

Constant Dividend

Perpetuity=Dividend/Rate. The firm will pay constant dividend forever, this is like preferred stock, the price is computed using perpetuity formula.

Constant Dividend Growth

The firm will increase the dividend by a constant PERCENT every period.
Po=D0(1+G)/RG OR Po=D1/(RG) 
Zero Growth

If dividends are expected at regular intervals forever, then this perpetuity: Paid amount/Required Rate

NonConstant Growth

Combination

Dividend Characteristics

Dividends are not a liability of the firm until a dividend has been declared by board. A firm cant go bankrupt for not declaring dividends. Dividends and Taxes: dividend payments are not considered a business expense and are not tax deductible, taxation of dividends received by individuals depend on the holding period, dividends received by corporations have a minimum 70% exclusion from taxable income. *companies DONT have to pay dividends.

Exchanges

Dealers execute trades and exchanges are places where dealers operate.

What do exchanges do?

Trading Services: Exchange and pay for it. Listing: get credited following ceratin rules. Info: price and other stats. Regulation: what companies can and can't do.

NPV

Estimate the expected future cash flows, estimate the required return for projects of this risk level, find the pv of the cash flows and subtract the initial investment

Payback Period

ADVANTAGE: Easy to understand. DISADVANTAGE: ignores the time value of money, requires and arbitrary cutoff point, ignores cash flows beyond the cutoff date, biased against longterm projects

Discounted Payback

ADVANTAGE: includes the time value of money, easy to understand. DISADVANTAGE: may reject positive NPV investments, requires an arbitrary cutoff point, ignores cash flows beyond the cutoff point, biased against longterm projects

Average Accounting Return (AAR)

ADVANTAGES: easy to calculate, needed information will usually be available. DISADVANTAGES: not a true rate of return time value of money is ignored, Uses arbitrary bench,mark cutoff rate, based on accounting NI and book values, not cash flows and market values

Internal Rate of Return (IRR)

Advantages: knowing a return is intuitively appealing, and it is a simple way to communicate the value of a project.

Profitability Index

ADVANTAGES: closely related to NPV generally leading to identical decisions, easy to understand and communicate, may be useful when funds are limited. DISADVANTAGES: may lead to incorrect decision in comparisons of mutually exclusive investments.

NonConventional Cash Flows (NPV vs. IRR)

cash flow signs change more than once, there is more than one IRR.

Mutually Exclusive Projects (NPV vs. IRR)

if you choose one, you can't choose the other.

NPV vs. IRR conflicts

NPV directly measures the increase in value to the firm, whenever there is a conflict between NPV and another decision rule, you should always use NP. IRR is unreliable in the following situations: Nonconventional cash flows and mutually exclusive projects

Sunk Costs (Cash Flows)

costs that have accrued in the past

Opportunity Costs (cash flow)

costs of lost options (ex. college for four years

Side effects/Externalities

One action having impact on other. Positive Side effects (benefit to other projects), Negative Side Effects (costs to other projects)

StraightLine Depreciation:

Depreciation=(Initial CostSalvage Value)/Number of Years

After Tax Salvage Value

[Book Value=Initial CostDepreciation] AfterTax Salve=Salvage%(SalvageBook Value)
