Finance Midterm 1

Front 1

financial derivatives

Back 1

financial security that derives its value from some other financial security ie: linked to currency rate

Front 2

investors/savers/lenders

Back 2

have surplus income and they let someone else use their money

Front 3

borrower

Back 3

any person that uses someone elses money

Front 4

primary securities

Back 4

created by the direct user of the money

Front 5

secondary securities

Back 5

created by someone that is not the direct user of the money

Front 6

issuer of contract

Back 6

whoever receives the money EX: individual of a home loan contract

Front 7

I- Bank:

Broker? Dealer?

Back 7

broker: matches up buyer and seller, charges a fee, never takes legal possession of the security, less risky

dealer: buys from one party and attempts to resell for a high price to another party, takes on risk

Front 8

hedge fund

Back 8

1. investment funds that are not open to general public
2. not very tightly regulated
3. lots of latitude as to what to invest in
4. collect money from investors, pools (co mingles) invest money into any fund
5. limited number of investors, takes percent of profits and a fee, does not stick to objective

Front 9

mutual fund

Back 9

1. open to general public
2. tightly regulated
a. managers cannot take % of profits
b. clearly stated objective as to what they will invest in, cannot deviate

Front 10

private money management

Back 10

1. manager investing money on behalf of a single investor
2. clients money not co mingled, separate account for each

Front 11

private equity/VC

Back 11

1. fund buys ownership in privately owned companies

Front 12

depository institutions

Back 12

commercial banks, credit unions
1. receive money from deposits, collect money, give financial contracts to depositors then invest

Front 13

non-bank financing

Back 13

1. do same thing as banks but get money from other sources than deposits, get money from markets
2. willing to break even because they usually offer other products and services, banks do not because it is their only business

Front 14

money market fund

Back 14

1. type of mutual fund
2. invests in only short term, high quality debt. (low possibility of default)
3. money continually reinvested, variable interest rate depending upon market conditions
4. greater RoR than checking acct

Front 15

pension funds

Back 15

collect money today > pool together > invest to pay people when you retire.

defined benefit:contract defines benefits explicitly

defined contribution: specified contribution that is made but no defined benefits EX: IRA and 401(k) (each individual has sep. account)

a) employer makes a contribution
1. fixed: each month put percent of income
2. match: same percentage as employee
b. employee contributes with upper limit since its tax free now

Front 16

financial security

Back 16

legally binding contract: stocks and bonds (financial investment = financial contract)

Front 17

par value

Back 17

total amount you owe/are owed at end of a contract

Front 18

bonds vs. loans

Back 18

1. loans obtained from financial institution, not traded daily on market
2. bonds: issued by govt or company, traded daily on market
(more old bonds then new bonds issued)

Front 19

corporate loan

Back 19

1. set interest rate, have to pay set rate of interest each period
2. when maturity comes, must pay entire par value.

Front 20

secondary trading

Back 20

1. trading and selling bonds back and forth
2. any given day, much more secondary trading than new issues

Front 21

relationship between price and yield

Back 21

move in opposite directions because cash flows are the same

Front 22

Future Value

Back 22

FV= PV(1 + im)^n

n= number of years

im= relevant interest rate

Front 23

Present Value

Back 23

FV/(1 + im)^n

process is called discounting

Front 24

% RoR

Back 24

r= (FV/PV)^(1/n) - 1

for a single cash flow

Front 25

value/price

Back 25

present discounted value oif all future cash flows

value= FCF (free cash flows)

FCFt/(1 + wacc)^t

wacc= weighted average cost of c

Front 26

balance sheet

Back 26

1.tells you financial position of a firm on a given date (stock concept)
2. items ordered in decreasing order of liquidity (how quickly an asset can be sold off and turned into cash)
3. for total assets 1. cash equivlants, short term investments 2. acct receivable 3. inventory

Front 27

assets and liabilities

Back 27

assets: stuff firm owns
liabilities: stuff owed by firm

total assets= total liabilities

Front 28

accounts receivables

Back 28

-products sold on credit

Front 29

inventories

Back 29

raw materials, works in progress, finished goods that did not sell (in coming year)

Front 30

total current assets

Back 30

1.cash and equivalents (easily converted short term investments)
2. short term investments
3. accounts receivables
4. inventories

Front 31

long term assets

Back 31

1. plant and equipment
2. net plant and equipment accounts for depriciation

Front 32

total current liabilities

Back 32

1. accounts payable: materials bought on credit.
2. notes payable: short term loans
3. accruals: regular expenses of business which you havent paid this year

Front 33

total liabilites

Back 33

1. accounts payable, notes payable and accruals
2. + long termbonds (unlimited libility)
3. preferred stock (immediate rights to dividends)
4. common stock
5.retained earnings (profits that aren't part of dividends)

Front 34

total common equity

Back 34

retained earnings + common stock= net worth (if sell assets and pay off liabilites)

Front 35

income statement

Back 35

financial position of a company during a certain period of time

Front 36

net income

Back 36

EBIT- interest- taxes

profits after tax, goes to pay shareholders

Front 37

earnings per share

Back 37

(EPS)

net income/total shares outstanding

Front 38

net cash flow

Back 38

net income- non cash revenues + non cash charges

NCF= NI + depreciation + amortization

Front 39

FCF

Back 39

cash flow that is available and distributed to shareholders

FCF= NOPAT- net investment in operating capital

Front 40

NOPAT

Back 40

EBIT(1-tax rate) - net operating profit after tax

Front 41

net investment in operating capital

Back 41

net operating capital at end of year - net operating capital at start of year

Front 42

net operating capital

net operating working capital

Back 42

1. = net operating working capital + operating long term assets
2. = operating current assets - operating current liabilites

operating long term assets= plan t and equipment

Front 43

ROIC

Back 43

NOPAT/ operating capital

-how efficiently invested capital turns to profits

Front 44

MVA

Back 44

market value added

1. market value of stock- total common equity
2. (shares outstanding X share price) - total common equity

Front 45

EVA

Back 45

economic value added

= NOPAT- (total net operating capital)(wacc)

Front 46

periodic i

Back 46

iper= i nom/ m

m= periods per year

Front 47

FV for iper

Back 47

FV= PV( 1 + inom/m) ^(m X n)

Front 48

effective annual rate

Back 48

= (1 + inom/m)^m - 1

1. for periodic interest, actual interest is compounded so more than nominal interest, have to adjust by using EAR
2. recognizes interest on interest

Front 49

relevant

Back 49

next best opportunity with exactly the same risk

Front 50

Pb= PVb, why

Back 50

a) everyone agrees it is worth its PV
b)
1. if we had the value of the bond greater than cost of bond, everyone wants to buy and the demand would cause the price to increase
2. if the value of the bond was less than price of bond no one would buy it

Front 51

Pb=

Back 51

n(sigma)t=1

coupon/(1 + im)^t + par/(1+im)^n

Front 52

ytm= im, why

Back 52

a) look at the Pb + ytm algebra
b)
1. suppose ytm>im, everyone will buy the bond, then the price of the bond will increase, which will decrease the ytm
2. suppose that the ytm is less than the im which means no one will buy which will decrease the price, people will then buy
C) if 2 investments have the same risk they must have the same return

Front 53

premium bond

Back 53

1.Price of the bond is greater than the par value. however the coupon is greater than the market interest rate
2. however we know that ytm= im, we pay more at the initial than par

Front 54

discount bond

Back 54

the price of the bond is less than the par. however the coupon is less than the market interest rate. but we still know that ytm=im

Front 55

ytm

Back 55

1. average annual RoR if you buy the bond today and hold it until maturity.
a) average not same every year
b) number depends on price you pay today
c) get avg RoR only if you hold until maturity

Front 56

interest rate risk/bond price sensitivity

-bond trader

Back 56

- single most important thing in bond market
-%Pb/%im < 0= interest rate risk = bond price sensitivity

bond trader a) forecast interest rate decreasing, want more sensitivity because price of the bond will skyrocket up

b) forecast interest rate going up, want less sensitivity so price does not shoot down

sensitivity increases as maturity increases

Front 57

CY

Back 57

Coupon/Pb

Front 58

realized return

Back 58

realized returns=

CY + CGY

CGY= (selling price- buying price)/buying price

Front 59

periodic PV

Back 59

m X n (sigma) Periodic CFt/ (1 + im/m)^t

Front 60

IRR

Back 60

1. internal rate of return
2. interest rate you get when NPV= 0

decision rate > cost of capital > IRR

but when comparing 2 projects, compare NPV, IRR can be conflicting

Front 61

perpetuity

Back 61

n= infinity

PVperpetuity= PMT(annual)/I

Front 62

nominal interest rate

Back 62

inom= real interest rate + inflation