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118 Cards in this Set
- Front
- Back
- 3rd side (hint)
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primary goal of financial manager
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maximize firm (stock) value
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most financial decisions involve
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benefits and costs spread over time
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time value creates
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relationship between cash flows occurring at different points in time
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future value of a single sum
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FV=PV (1+R)^N
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term (1+r)^n is know as
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the future value interest factor
FV=PV (FVIFr, n) |
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FVIF factors
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-Assume end of period cash flows
-Are always > 1 |
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As r increases, FVIF...
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Increases
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As n increases, FVIF
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increases
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Present value of a single sum
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PVn=FV (PVIFr, n)
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formula
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PVIF factors
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-Assume end of period cash flows
-PVIF is always <1 |
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As r increases, PVIF
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decreases
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As n increases, PVIF
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decreases
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Annuity
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equal, evenly spaced cash flows
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Future value of an annuity formula
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FVAn=PMT (FVIFAr, n)
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Present value of an annuity formula
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PVAn=PMT(PVIFA r, n)
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Annuity due means
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payments at beginning of period
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Future value of annuity due
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FVAn=PMT X (FVIFAr,n) X (1+r)
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Present value of annuity due formula
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PVAn=PMT X (PVIFAr, n) X (1+r)
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Present value of perpetuity
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PVA=PMT ÷ r
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Compounding more frequently than annually
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1. divide r by m and
2. multiply n times m |
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mixed cash flow streams
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treat each cash flow as a single payment (learn how to do the formula)
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effective annual rate (EAR)
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(1+r/m)^m -1
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goal of financial manager (risk&return)
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share price maximization
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2 key determinants of share price
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risk and return
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What is risk?
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-a chance of loss
-variability in returns -uncertainty |
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What is return
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-total gain or loss experienced by an owner over time
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total return (formula)
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rt=ct+pt-pt-1/pt-1
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What are risk preferences?
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behaviors
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risk averse
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require more return as risk increases
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risk neutral
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No change in return is needed when risk changes
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risk seeking
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return can even decrease as risk increases
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expected return
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most likely return
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What does risk equal?
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standard deviation
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coefficient of variation
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measures relative risk when assets have different expected returns
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risk increases with
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time
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non-diversifiable risk
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-risk in the system (or market) due to the market factors that impact all firms
-recession, political, wars, interest rates, unemployment |
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diversifiable risk
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-associated with random causes that are firm specific
-lawsuits, industry regulations |
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You will not get compensated for taking
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diversifiable risk
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relevant risk
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non-diversifiable risk
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capital risk pricing model
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-links non-diversifiable risk and return for all assets
-asset pricing theory which derives required return based on market return |
What does it do?
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CAPM required return formula
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rj=Rf+b (rm-Rf)
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market has a beta of
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1
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if the beta is higher than 1...
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it is riskier than the market
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if a beta is less than 1...
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it is less risky than the market
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beta is
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-relative measure of non-diversifiable risk
-an index of change in an assets return in response to a change in the market return |
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security market line
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reflects required return for every level of non-diversifiable risk
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interest rates
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-cost of money
-determine economic activity and value of securities |
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real rate of interest
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r*
real growth rate in the economy |
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risk free rate
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Rf
risk free rate on government securities |
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inflation premium
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IP
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nominal rate
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r1
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term structure of rates
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relationship between rates and maturity (due dates) at a given time for same security
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as maturity increases, interest rates...
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increase
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What is a yield curve for?
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to forecast rates
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3 theories of term structure
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1. expectations theory
2. liquidity preference theory 3. market segmentation theory |
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expectations theory
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yield curve reflects expectations (or forecast) of inflation
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liquidity preference theory
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investors demand higher returns for longer maturity
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market segmentation theory
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different forces of supply and demand in different maturity markets
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risk premium
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-default
-maturity -contractual provisions |
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corporate bonds
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long term loans
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indenture has
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-standard covenants(promises)
ex. promising to pay taxes or provide financial information -restrictive covenants(protection) ex. maintaining business, current ratio IT IS A LOAN AGREEMENT |
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cost of bonds
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-longer maturity, higher cost
-larger issue, higher cost -higher risk, higher cost |
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some bond features
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-conversion to stock: rate is lower--not all bonds are convertible
-call feature: allows borrower to repay early--penalize borrower with a premium |
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bond yields
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-current yield=interest payment/current price
-yield to maturity=total return on the bond--> annually |
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bond rating
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-AAA, lower rate
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valuation
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process linking risk and return, with time value considered
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value
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sum of present values of cash flows returned by asset; discount rate is required return
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Must know 3 things(valuation)
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1. size and number of cash flows
2. timing of cash flows 3. required return for risk |
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basic valuation model formula
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Vo=CF1 (PVOFr,1)+CF2 (PVOFr,2)....CFn (PVIFr, n)
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Par value
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stated principle of each note (typically $1000)
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coupon rate
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rate of interest paid on par value
(interest on the note) |
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price
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quotes as % of par
-discount -premium |
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discount
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trades below par
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premium
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traded above par
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bond valuation formula
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Bo=$ interest (PVIFAr, n)+M (PVIFr, n)
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higher rates today means (bond valuation)
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lower present value
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today's level of return determine...
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the bond value
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What does value equal
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par, when discount rate equals coupon
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comments on bond value
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-they change over time (because the level of rates in the economy changes)
-as it nears maturity, value approaches par (borrower credit quality can change) |
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yield to maturity
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-rate of return investors will earn if they buy at specific price and hold to maturity
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approximation formula (yield to maturity)
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I+[(M-Bo)/n]
÷(M+Bo)/2 |
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stock
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equity capital of firm; common and preferred
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voice in management (debt and equity)
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debt - none
equity- shares have vote |
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claim on income/assets(debt and equity)
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debt-senior to equity
equity - subordinate to debt |
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maturity (debt and equity)
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debt - stated
equity- none |
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tax treatment (debt and equity)
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debt - interest deduction
equity- no deduction |
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common stock holders are
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-residual owners
-last ones to get money -taking a big risk |
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ownership (common stock)
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private (solely and closely held) companies vs. public (many unrelated owners) companies
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par value (common stock)
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has nothing to do with market value or terminal value
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preemptive rights (common stock)
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Right to buy shares in future offerings to maintain percentage ownership
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authorized stock (common stock)
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number of shares permitted to be issued under the charter
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outstanding stock (common stock)
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number of shares held by owners
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charter (common stock)
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articles of incorporation; establishes company
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issued stock (common stock)
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number of shares put into circulation
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treasury stock (common stock)
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repurchased shares
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voting rights (common stock)
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-regular, supervoting, non-voting
-1 vote per share |
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dividends (common stock)
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returns to shareholders
-cash -stock |
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international stock issues (common stock)
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American depository receipts are claims issued by US banks =shares of a foreign company held by bank in a foreign market
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preferred stock
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-hybrid (has traits of debt and equity)
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debt (preferred stock)
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fixed dividend at 0 growth; sits above common equity
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equity (preferred stock)
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at times, has vote; sits below debt; 95% of the time - no maturity date
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venture capital
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private equity with high returns
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investment banking
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-best efforts
-underwriting (acts as intermediary) |
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market efficiency
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rational buyers and sellers create equilibrium price
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efficient market hypothesis
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1. securities are fairly priced
2. prices reflect all public information 3. market price is best price **no chronic overvalued or undervalued |
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behavioral finance
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peoples hesitation to react rationally to the information
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stock valuation is harder than
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bond valuation
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stock valuation
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-more difficult: no maturity date
-no par value -no set cash flows |
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value=
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PV of all future dividends
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zero growth stock valuation formula
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Po=D/r
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constant growth stock valuation formula
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Po=D1/r-g
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variable growth stock valuation model
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a-find PV of dividends during initial growth period
b-find PV of stock at end of initial growth period -add a and b |
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free cash flow to the firm stock valuation formula
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Vs=Vc-Vd-Vp
a - determine PV of FCF for initial growth period b.- calculate PV of the firm at the end of the initial growth period c.- add and and b to get Vc; subtract debt and preferred equity to get Vs. |
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other valuation methods
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1. book value per share
2. liquidation value per share 3. P/E multiple |
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investor hold period is...
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irrelevant
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if risk increases, you pay
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less
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risk and price (increase/decrease)
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R increases, P decreases (risk increases, you pay less)
R decreases, P increases (risk decreases, you are willing to pay more) |
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the lower the dividend you expect,
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the less you are willing to pay
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