Finance Terms Chpter 7,8,9

Front 1

Perpetuity

Back 1

An annuity stream of cash flow where the payments occur forever.

Front 2

Coupon

Back 2

The stated interest payment, in dollars, made on a bond each period. (note: coupon rate)

Front 3

Face Value

Back 3

The principal amount of a bond that is repaid at the end of the loan term. (note: unless otherwise indicated, the face value of a bond is $1000.00

Front 4

Maturity

Back 4

The specified date on which the principal amount of a bond is repaid.

Front 5

Yield to Maturity

Back 5

The rate of return required by investor in the market for owning a bond.

Front 6

Current Yield

Back 6

The annual coupon payment of a bond divided by its market price (note the difference of this from coupon rate and YTM)

Front 7

Par Bond

Back 7

A bond with a face value equal to the price of the bond.

Front 8

Discount Bonds

Back 8

A bond with a price less that face value

Front 9

Premium Bond

Back 9

A bond with a price that is greater that the face value. (note the relationship between coupon rate and yield to maturity rate and price of the bond).

Front 10

Bond Indenture

Back 10

The written, legally binding agreement between the corporate borrower and the lender detailing the terms of bond issue.

Front 11

Bearer Bonds

Back 11

A bond issued without record of the owner's name, with relevant payments made directly to whomever physically holds the bond.

Front 12

Debentures

Back 12

Unsecured debts of a firm with maturities less than 10 years.

Front 13

Notes

Back 13

Unsecured debts of a firm with maturities of less that 10 years.

Front 14

Sinking Funds

Back 14

A fund, paid into by the borrowing firm but managed by the bond trustee for the retirement of the bond.

Front 15

Call Provision

Back 15

An agreement giving bond issuer the option to repurchase (or call) the bond at a specified price prior to maturity.

Front 16

Treasury Bonds

Back 16

Long-Term bonds issued by the U.S. Government

Front 17

Municipal Bonds

Back 17

Long term bonds issued by state or local government in the U.S.

Front 18

Zero Coupons Bonds (or Deep Discount Bonds)

Back 18

Bonds that do not make coupon payments (Zero Coupon Rate).

Front 19

Convertible bonds

Back 19

Bonds, at the election of the holder, can be swapped for a fixed number of shares of common stock at any time prior to the bond's maturity.

Front 20

Real rate of interest

Back 20

The interest rate that has been adjusted for the effects of inflation.

Front 21

Fisher Effect

Back 21

The relationship between nominal interest rates, real interest rates, and expected inflation. In approximate form, nominal interest rate equals real interest rate plus expected inflation.

Front 22

Term Structure of interest rates

Back 22

The relationship between nominal interest rates on default-free, pure discount securities and the time to maturity.

Front 23

Inflation Premium

Back 23

The portion of nominal interest rate or bond yield to maturity that represents compensation for expected future inflation.

Front 24

Interest rate risk premium

Back 24

The portion of nominal interest rate or bond yield to maturity that represents compensation for expected future inflation.

Front 25

Default risk premium

Back 25

The portion of nominal interest rate or bond yield to maturity that represents compensation for the possibility of nonpayment by the bond issuer.

Front 26

Liquidity Premium

Back 26

The portion of nominal interest rate or bond yield to maturity that represents compensation for the lack of liquidity.

Front 27

Pre-emptive rights

Back 27

Refers to the right of shareholders in the forms of either cash, stock or payments in kind.

Front 28

Dividends

Back 28

Payments made by a corporation to its shareholders in the form of either cash, stock or payments in kind.

Front 29

Securities Dealer

Back 29

An agent who buys and sells securites from inventory.

Front 30

Securities Broker

Back 30

An agent who arranges security transactions among investors.

Front 31

Specialist

Back 31

A NYSE member acting as a dealer in one or more securities on the exchange floor.

Front 32

Cumulative Voting

Back 32

The voting procedure where shareholders may cast all of their votes for one member of the board.

Front 33

Primary Market

Back 33

The market in which new securities are originally sold to investors.

Front 34

Secondary Market

Back 34

The market in which previously issued securities are traded among investors.

Front 35

Dividend Yield

Back 35

A stock's next expected dividend divided by the current stock price.

Front 36

Capital Gains Yield

Back 36

The rate at which the stock price is expected to appreciated or depreciate .

Front 37

Dividend Growth Model

Back 37

The stock valuation model that determines the current stock price as the next dividend divided by the required rate of return for a common stock minus the dividend growth rate.

Front 38

NPV (Net Present Value)

Back 38

The Net Present Value of an investment is the difference between its market value and its cost. The NPV rule is to take a project if the NPV is positive. NPV is frequently estimated by calculation the present value of the future cash flows (to estimate market value) and then subtracting the cost. NPV has no serious flaws; it is the preferred decision criterion.

Front 39

Internal Rate of Returm (IRR)

Back 39

The IRR is the discount rate that makes the estimated NPV of an investment equal to zero; it is sometimes called the discounted cash flow (DCF) return. The IRR rule is to take the project when its IRR exceeds the required rate of return. IRR is closely related to NPV, and it leads to exactly the same decisions as NPV for conventional, independent projects. When project cash flows are not conventional, there may be no IRR or there may be more than one. More seriously, the IRR cannot be used to rank mutually exclusive projects; the project with the highest IRR is not necessarily the preferred investment.

Front 40

Modified IRR (MIRR)

Back 40

The MIRR is a modification to the IRR. A project's cash flows are modified by (1) discounting the negative cash flows back to the present; (2) compounding all cash flows to the end of the product life, or (3) combining (1) and (2). An IRR is then computed on the modified cash flows. MIRRs are guaranteed to avoid the multiple rate of return problem, but it is unclear how to interpret them; and they are not truly "internal" because they depend on externally supplies discounting or compounding rates.

Front 41

Profitability Index (PI)

Back 41

The PI also called the benefit costs ratio, is the ratio of present value to cost. The PI rule is to take an investment if the index exceeds 1. The PI measures the present value of an investment per dollar invested. It is quite similar to NPV; but, like IRR, it cannot be used to rank mutually exclusive projects. However, it is sometimes used to rank when a firms has more positive NPV investments than it can currently finance.

Front 42

Payback Period

Back 42

The payback period it the length of time until the sum of an investment's cash flows equals it cost. The payback period rule is to take a project if its payback it less than some cutoff.

Front 43

Discounted Payback Period

Back 43

The discounted payback period is the length of time until the sum of an investments discounted cash flows equal its costs. The discounted payback period rule is to take an investment if the discounted payback is less than some cutoff. The discounted payback rule is flawed, primarily because it ignores cash flows after the cutoff.

Front 44

Average Accounting Return (AAR)

Back 44

The AAR is a measure of accounting profit relative to book value. It is not related to IRR, but it is similar to the accounting rate of return on assest (ROA) measure in Chapter 3. The AAR rule is to take an investment if its AAR exceeds a benchmark AAR. The AAR is seriously flawed for a variety of reasons, and it has little to recommend it.