Finance Final Exam

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Common Stock

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Security representing ownership in a corporation; Common stock owners have a final claim on the firm's assets and earnings after the firm has met its obligations to creditors and preferred stockholders; In case of liquidation, the common stock holder receives whatever is left after all other obligations have been met

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Board of Directors

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Body elected by and responsible to stockholders to set policy and hire management to run a corporation

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Cumulative Voting

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Voting system that encourages minority representation by permitting stockholders to cast all their shares for one candidate for the firm's board of directors; Minority groups could elect a board member or two even though they don't have a majority - not an all-or-nothing system

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Preemptive Rights

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Right of current stockholders to maintain their proportionate ownership in the firm

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Rights Offering

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Sale of new shares to stockholders by offering them the option to purchase some of those new shares, presumably enough to maintain their proportionate ownership in the firm

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Cash Dividends

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Distribution of earnings paid in the form of cash; Recorded as a cash outflow

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Payout Ratio

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Ratio of cash dividends to earnings

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Date of Record

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Day on which an investor must own stock in order to receive the dividend payment

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Ex Dividend

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Stock purchased exclusive of any dividend payment

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Pay Date; Distribution Date

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Day on which a dividend is paid to stockholders

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Declaration Date

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One month before the Date of Record (29 days before the Ex Dividend Date), when the company announces that a dividend will be paid and what it will be

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Stock Dividends

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Distribution from earnings paid in additional shares of stock

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Dilution

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Reduction in earnings per share as the result of issuing additional shares

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Stock Split

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Recapitalization achieved by changing the number of shares outstanding

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Dividend Reinvestment Plans

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Plans that permit stockholders to have cash dividends reinvested in additional shares instead of receiving the cash

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Repurchase of Stock

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May be used as an alternative to paying dividends, offered because the firm doesn't want to pay the dividend

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Dividend Growth Model (Constant Growth DDM Model)

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Valuation model for common stock that discounts future dividends; Used when you can assume that the dividend will grow indefinitely at the same rate

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Security Market Line

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Line specifying the required return for different levels of risk

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P/E Ratio

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The ratio of a stock's Price to Earnings Per Share

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Bond

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Long-term debt instrument that specifies (1) the principal [amount owed], (2) the interest, and (3) the maturity date [when the bond must be repaid]

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Yield

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Return on the bond expressed as (1) a current yield [interest divided by the current price of the bond], or (2) the yield to maturity [return earned from holding the bond until maturity]

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Principal

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The amount owed on a bond; The amount loaned

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Maturity Date

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When the bond is to be collected

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Current Yield

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Interest divided by the current price of the bond

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Yield to Maturity

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The return earned by holding the bond until maturity

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Indenture

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Documents specifying the terms of a debt issue (bond)

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Default

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Failure to meet the terms specified in the indenture of a debt issue

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Trustee

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Representative of the rights of bondholders who enforces the terms of the indenture; If the firm defaults on the bond, it would be the trustee who takes the firm to court on behalf of all bondholders

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Credit Ratings

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Classification schemes designed to indicate the risks associated with a particular debt instrument

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Mortgage Bonds

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Bonds secured by a claim on real estate

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Collateral

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Assets used to secure a loan or debt instrument

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Equipment Trust Certificates

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Serial bonds issued by transportation companies that are secured by the equipment purchased with the proceeds of the loan

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Income Bonds

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Bonds whose interest is paid only if it is earned by the firm

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Revenue Bonds

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Bonds supported by the assets the bonds financed; Income bonds issued by state and local governments

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Convertible Bonds

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Bonds that may be converted into stock at the option of the bondholder

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Variable Interest Rate Bonds

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Long-term debt instruments whose interest payments vary with changes in short-term interest rates or the Consumer Price Index

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Zero Coupon Bonds

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Bonds that are initially sold at a discount and on which interest accrues and is paid at maturity

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High-Yield Bonds

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Also called Junk Bonds; Poor-quality debt with high yields and high probability of default

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Eurobond

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Bond sold in a foreign country but denominated in the currency of the issuing firm

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Serial Bonds

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Debt issued in a series so that some of the bonds periodically mature

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Sinking Fund

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Series of periodic payments to retire a bond issue

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Call Feature

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Right of a debtor to retire a bond prior to maturity; Obviously hurts the bondholder, so there's usually a Call Penalty factored in

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Municipal Bonds

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Issued by state and local governments; Special because they are exempt from federal tax, but the base price is usually inflated because the issuing government knows they're saving bond-buyers the price of federal tax

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A bond quoted at 98 means

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It's $980 for a $1,000 bond

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Bond price depends on (1), (2), (3)

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1) Interest paid by the bond

2) Interest rate earned on competing bonds

3) Maturity date

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Bond PMT is

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The annual coupon payment

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Bond FV is

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The principal

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Bond INT is

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The current (coupon) rate

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When bonds state the principal, you solve for

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Present value; the principal is the FV

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Bond prices and changes in the market are...

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Inversely related; When interest rates rise, bond prices decline

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Current Yield

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The percentage that you earn annually; Annual Interest divided by Bond Price (NOT Necessarily Par Value)

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Yield to Maturity

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Calculated as a percent return; It is i in the calculator

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If the bond sells at a discount...

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the yield to maturity exceeds the current yield

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If the bond sells at a premium...

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the current yield exceeds the yield to maturity

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Holding Period Returns

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Total return (income plus price appreciation during a specified time) divided by the cost of the investment

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HPR =

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(Sale Price + Dividends - Buy Price) / Buy Price ** (P1-P0+D)/P0; (P1-P0)/P0 <-- If there's no dividend

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HPR PV

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Price paid

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HPR FV

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Sale price

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Internal Rate of Return

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Percentage return that equates the present value of an investment's cash inflows with its cost; Determining whether or not the investment is a moneymaker

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HPR PMT

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Stated annual dividends

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HPR n

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How many years the security was held for

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IRR assumes

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That cash flows are reinvested each year; Translation: No money in your pocket until the term of the investment ends

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Closed-End Investment Company

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Investment company with a fixed number of outstanding shares that are bought and sold through secondary markets

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Investment Companies and Mutual Funds

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Mutual funds are a specific kind of investment company; "Investment Company" is just as broad as it sounds

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Open-End Investment Company

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Mutual fund that issues new shares and agrees to redeem the shares on the demand of the shareholder

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Mutual Fund

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Open-end investment company that stands to issue and redeem its shares on demand

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Net Asset Value

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Asset value of a share in an investment company; Investment company's assets minus liabilities divided by the number of shares outstanding

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NAV is important because

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Changes in the net asset value alter the value of the investment company's shares.

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Discount

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Extent to which the price of a close-end investment company's stock is less than the share's net asset value

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Premium

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Extent to which the price of a close-end investment company's stock exceeds the share's net asset value

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Costs of closed-end investment companies

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1) Brokerage commission
2) Asset management fees

3) Brokerage fees for purchasing and selling securities

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Ways of earning returns on closed-end investment companies

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1) Dividends from an individual stock, then distributed across the IC's shareholders

2) Selling assets to realize profits, then distributing those earnings to shareholders

3) NAV increases

4) The market price of the IC shares increases

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Relationship between open-end funds and mutual funds

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Mutual funds ARE open-end funds; Anyone can buy in, and the MF just uses the new money to buy more stock to keep its holders' proportionate ownership the same

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No-Load Fund

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Mutual fund that does not charge a commission when individuals purchase shares from the fund

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Load Fund

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Mutual fund that charges commissions when individuals purchase shares from the fund

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Differences between Open- and Closed-End ICs

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1) MF shares aren't traded; Bought directly

2) Load funds are strictly a MF concept

3) No premium or discount pricing in MF

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MF Offering Prices

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Should equal NAV/(1-Load Percentage); Useful for when you're given the NAV and the load and asked to calculate what you paid

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Capital Appreciation MF

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A mutual fund that attempts to increase asset value primarily through investments in growth stocks. The heavy investment in growth stocks increases the risk associated with these types of funds.

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Growth MF

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A diversified portfolio of stocks that has capital appreciation as its primary goal, with little or no dividend payouts. Portfolio companies would mainly consist of companies with above-average growth in earnings that reinvest their earnings into expansion, acquisitions, and/or research and development.

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Growth and Income MF

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A mutual fund or ETF that has a dual strategy of capital appreciation (growth) and current income generation through dividends or interest payments. A growth and income fund may invest only in equities or in a combination of stocks, bonds, REITS and other securities.

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Equity Income MF

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1. Dividend income that is earned through an investment in stocks (equity).

2. A type of mutual fund that invests in high-quality companies with a reliable history of dividend payments and growth in the dividend rate.

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Small-Cap MF

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Refers to stocks with a relatively small market capitalization. The definition of small cap can vary among brokerages, but generally it is a company with a market capitalization of between $300 million and $2 billion.

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Mid-Cap MF

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A company with a market capitalization between $2 and $10 billion, which is calculated by multiplying the number of a company''''s shares outstanding by its stock price. Mid cap is an abbreviation for the term "middle capitalization".

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Large-Cap MF

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companies with a market capitalization value of more than $10 billion. Large cap is an abbreviation of the term "large market capitalization". Market capitalization is calculated by multiplying the number of a company's shares outstanding by its stock price per share.

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Global MF

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A type of mutual fund, closed-end fund or exchange-traded fund that can invest in companies located anywhere in the world, including the investor's own country. These funds provide more global opportunities for diversification and act as a hedge against inflation and currency risks.

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International MF

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International and global stock funds invest primarily in stocks of companies located in different countries around the world; may help reduce the impact of an economic slowdown in any one country while providing currency diversification.

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Regional MF

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Regional or single country funds offer targeted exposure for investors looking to add the potential for growth or further geographical diversification to an already well-diversified international portfolio; "China Fund; Europe Fund; Pacific Basin Fund"

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Emerging Markets MF

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Diversified emerging-markets portfolios tend to divide their assets among 20 or more nations, although they tend to focus on the emerging markets of Asia and Latin America rather than on those of the Middle East, Africa, or Europe. These portfolios invest at least 70% of total assets in equities and invest at least 50% of stock assets in emerging markets.

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Index MF

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Index funds attempt to track the performance of a particular stock or bond index, such as the S&P 500® Index or the Barclays U.S. Aggregate Bond Index, by holding most or all of the securities that are included in that index.

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Social Conscience MF

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Green technologies, etc

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Sin/Vice MF

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Fund related to gambling, tobacco, etc.

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Tax-Managed MF

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dedicated to limiting shareholders' tax burdens

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When you need to value a stock with constant growth...

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Constant Growth DDM Model (Middle Formula)

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Determining the required return on a given stock, use...

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CAPM; "Beta" is a strong indicator that you need this formula

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CAPM Formula Components

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RF = "risk-free"

Rm = "Return on the market"

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Par Values and Principals in Bonds

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The face value (also known as the par value or principal) is the amount of money a holder will get back once a bond matures. A newly issued bond usually sells at the par value. Corporate bonds normally have a par value of $1,000, but this amount can be much greater for government bonds.

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If a bond's interest rate is higher than the running average...

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It will sell for above par value

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If a bond's interest rate is lower than the running average...

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It will sell for below par value

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"Comparable Debt" means

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Similar bonds

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When a bond problem has a semiannual payment...

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Recalculate the payment so that it's annual, but the years (n) stay as stated

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Solving Coupon Rate

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Payment/1000(or Par Value) ; Written as a percentage

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TI-83 instructions for Yield to Maturity

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Plug in all the info given, clear out the i, and Alpha-Solve

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HPR P1

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Sale Price

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HPR P0

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Purchase Price

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"Annualized Compounded Return" means

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IRR ; Also synonymous with "Anticipated Return" ; For TI-83: Still use the TVMSolver, plug in zeros where there's no information, and ALPHA-SOLVE for i

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HPR compared to IRR

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HPR is the return on an investment without considering time or compounding; IRR factors in time, and simply states what you earn per year