Financial Management Ch 4 - 11

Front 1

TVM

Back 1

Time Value Money

Front 2

Opportunity cost rate

Back 2

Rate of return on best available alternative investment of equal risk.

Front 3

Annuity

Back 3

Series of payments of an equal amount at fixed, equal intervals for a specified number of periods.

Front 4

Ordinary Annuity

Back 4

Annuity whose payment occurs at the end of each period.

Front 5

Annuity Due

Back 5

Annuity whose payment occurs at the beginning of each period

Front 6

Future Value (FV)

Back 6

The amount to which a cash flow or series of cash flows will grow over a given period of time when compounded at a given interest rate

Front 7

Compounding

Back 7

Process of determining the value to which an amount or series of cash flows will grow when compound interest is applied.

Front 8

Terminal value

Back 8

Future value of cash flow stream

Front 9

Present Value

Back 9

Current value of a future cash flow.

Front 10

Perpetuities

Back 10

Streams of equal payments expected to continue, forever.

Front 11

Simple (quoted) interest rate

Back 11

Annual, non-compounded rate. Used to determine rate earned per compounding period.

AKA: APR

Front 12

APR

Back 12

Simple interest rate

Front 13

Effective (equivalent) annual rate

Back 13

Annual rate of interest actually being earned, as opposed to the quoted rate; considers the compounding of interest.

Front 14

Amortized Loan

Back 14

Loan that requires equal payments over its life. Payments include interest and principal.

Front 15

Amortization schedule

Back 15

Schedule showing precisely how a loan will be repaid. Shows percentage of payment applied to interest and principal.

Front 16

Production opportunity

Back 16

Return available from investment in a productive asset.

Front 17

Time preference for consumption

Back 17

The preference of a consumer for current consumption as opposed to saving for future consumption.

Front 18

Nominal (quoted) risk-free rate

Back 18

Rate of interest that is free of all risk. Proxied by T-bill rate and includes inflation premium.

Front 19

Real risk-free rate of interest

Back 19

Rate of interest on a default-free U.S. treasury security if no inflation were expected.

Front 20

Default risk premium (DRP)

Back 20

compensation for the risk a company will not meet its debt obligations.

Front 21

Liquidity premium (LP)

Back 21

Premium added to rate on a security if security cannot be quickly converted to cash at a cost that is close to original cost.

Front 22

Maturity risk premium (MRP)

Back 22

Premium that reflects interest rate risk; bonds with longer maturities have greater interest rate risk.

Front 23

Yield curve

Back 23

Graph showing relationship between yields and maturities on a particular date.

Front 24

Normal yield curve

Back 24

Upward-sloping

Front 25

Inverted (abnormal) yield curve

Back 25

Downward-sloping

Front 26

Expectations theory

Back 26

Theory that shape of the tield curve depends on investor's expectations on future inflation rates.

Front 27

Open market operations

Back 27

Federal Reserve buys or sells treasury securities to expand or contract U.S. money supply.

Front 28

Discounted securities

Back 28

Securities selling for less than par value.

Front 29

Repurchase agreement

Back 29

Arrangement where one firm sells some of its financial assets to another firm with a promise to repurchase the securities at a later date.

Front 30

Federal Funds

Back 30

Overnight loans from one bank to another.

Front 31

Banker's acceptance

Back 31

Instrument issued by bank that obligates the bank to pay a specified amount at some future date.

Front 32

Commercial paper

Back 32

Discounted instrument that is a type of promissory note, or "legal" IOU. Issued by large, financially sound firms.

Front 33

Certificate of deposit

Back 33

Interest-earning time deposit at a bank or other financial intermediary.

Front 34

Eurodollar deposit

Back 34

Deposit in a foreign bank that is denominated by U.S. Dollars.

Front 35

Money Market Mutual Funds

Back 35

Pools of funds managed by investment companies that are primarily invested in short-term financial assets.

Front 36

Term loan

Back 36

Loan, paid back using a series of payments consisting of interest and principal.

Front 37

Coupon rate

Back 37

Interest paid on a bond or other debt instrument. Stated as a percentage of its face (maturity) value.

Front 38

Face Value

Back 38

Value a bond will have at maturity.

Front 39

Municipal bonds

Back 39

Bonds issued by a state or local government.

Front 40

Corporate bonds

Back 40

Bonds issued by corporations

Front 41

Mortgage bond

Back 41

Bond backed by tangible assets.

Front 42

Debenture

Back 42

Long-term bond that is not secured by a mortgage on a specific piece of property.

Front 43

Subordinated debenture

Back 43

Bond that, in the event of liquidation, has a claim, only after the "senior" debt has been paid off.

Front 44

Income bond

Back 44

Bond that pays interest, only if interest is earned by the firm.

Front 45

Putable bond

Back 45

Bond that can be redeemed at the bondholder's option when certain circumstances exist.

Front 46

Indexed (purchasing-power) bond

Back 46

Bond that has interest payments based on inflation index. Done to protect investor from loss of purchasing power.

Front 47

Floating-rate bond

Back 47

Bond whose interest rate fluctuates with shifts in the general level of interest rates.

Front 48

Zero coupon bond

Back 48

Bond that pays no annual interest, but sells at a discount below par. Compensation comes in form of capital appreciation.

Front 49

Junk bond

Back 49

High-risk, high-yield bond. Used to finance mergers, leveraged buyouts and troubled companies.

Front 50

Indenture

Back 50

Formal agreement between issuer of bond and bondholders.

Front 51

Call provision

Back 51

Provision in bond contract that allows bondholder to redeem bond, prior to maturity date, but only if certain, specified conditions exist.

Front 52

Sinking fund

Back 52

Required annual payment designed to amortize a bond issue.

Front 53

Conversion feature

Back 53

Permits bondholders to convert bonds into a fixed number of shares of stock.

Front 54

Foreign Debt

Back 54

Debt sold by foreign borrower but denominated in currency of country where it is sold.

Front 55

Eurodebt

Back 55

Debt sold in a country other than the one whose currency is denominated.

Front 56

LIBOR

Back 56

London Interbank Offered Rate. interest rate offered by the best London banks on deposits of large, creditworthy banks.

Front 57

What are Moody's and S&P's "high quality" ratings?

Back 57

Moody's: Aaa, Aa

S&P: AAA, AA

Front 58

What are Moody's and S&P's "Investment grade" ratings?

Back 58

Moody's: A, Baa

S&P: A, BBB

Front 59

What are Moody's and S&P's "substandard" ratings?

Back 59

Moody's: Ba, B

S&P: BB, B

Front 60

What are Moody's and S&P's "Speculative" ratings?

Back 60

Moody's: Caa, C

S&P: CCC, D

Front 61

What are the ratings that "Junk bonds" refer to?

Back 61

Substandard and Speculative

Front 62

Yield to maturity

Back 62

Average rate of return earned on bond if held to maturity.

Front 63

Yield to call

Back 63

Average rate of return earned ona bond if it is held until first call date.

Front 64

Current (interest) yield

Back 64

Interest payment divided by market price of bond.

Front 65

Capital gains yield

Back 65

% change in market price of a bond over some period of time.

Front 66

Interest rate price risk

Back 66

Risk of changes in bond prices investors are exposed to as a result of interest rates changing.

Front 67

Interest rate reinvestment risk

Back 67

Risk that income from a bond portfolio will vary because cash flows must be reinvested at current market rates.

Front 68

Cumulative dividends

Back 68

Protective feature on preferred stock. Requires unpaid preferred stock dividends to be paid before common stock dividends.

Front 69

Call premium

Back 69

The amount in excess of par value that must be paid when a security is called.

Front 70

Income stocks

Back 70

Stocks that traditionally pay large, relatively constant dividends, each year.

Front 71

Growth stocks

Back 71

Stocks that pay little to no dividends in order to retain earnings to help fund growth opportunities.

Front 72

Proxy

Back 72

Document giving one person the authority to act for another. Typically gives them the power to vote their shares.

Front 73

Preemptive right

Back 73

Provision giving existing common stockholders right to purchase new issues of common stock on a pro rata basis, before shares are offered to other investors.

Front 74

Classified stock

Back 74

Common stock that is given a special designation, to meet special needs of the company.

Front 75

Founders' shares

Back 75

Stock, owned by firm's founders, has sole voting rights, but only pays out restricted dividends for a specified number of years.

Front 76

ADR

Back 76

American Depository Receipts

Front 77

What are American Depository Receipts?

Back 77

Certificates created by organizations (banks, mainly) to represent ownership in stocks of foreign companies that are held in trust by a bank in the country where the stock is traded.

Front 78

Yankee stock

Back 78

Stock issued by foreign companies and traded in United States.

Front 79

Market price (value)

Back 79

Price at which stock is sold in the market.

Front 80

Intrinsic (theoretical) value

Back 80

Value of an asset that, in the mind of the investor, is justified by the facts. Market price can be different from asset's current market price, book value or both.

Front 81

Growth rate

Back 81

Expected rate of change in dividends per share

Front 82

Required rate of return

Back 82

Minimum rate of return that stockholders consider acceptable on a common stock.

Front 83

Dividend yield

Back 83

Next expected dividend, divided by the current price of a share of stock.

Front 84

Capital gains yield.

Back 84

Change in price during a given year, divided by price at beginning of year.

Front 85

Expected rate of return

Back 85

Rate of return a stockholder expects on a common stock.

(Expected dividend yield) + (Expected capital gains yield)

Front 86

Constant growth model (Gordon model)

Back 86

Used to find value of a stock that is expected to experience constant growth.

Front 87

Nonconstant growth

Back 87

Part in lifecycle of firm where growth is either much faster, or much slower than that of the economy as a whole.

Front 88

P/E ratio

Back 88

Current market price of a stock, divided by earnings per share.

Front 89

Probability distribution

Back 89

Listing of all possible outcomes or events with a probability assigned to each outcome.

Front 90

Standard deviation

Back 90

Measure of variability of a set of outcomes.

Front 91

Coefficient variation

Back 91

Standard measure of the risk per unit of return. calculated by dividing the standard deviation by expected return.

Front 92

Risk aversion

Back 92

Risk-averse investors require higher return for higher risk.

Front 93

Risk premium

Back 93

Portion of the expected return that can be attributed to additional risk of an investment.

(Expected rate of return on risky asset) - (expected rate of return on less risky asset)

Front 94

Realized rate of return

Back 94

Return that is actually returned. Usually differs from expected rate of return.

Front 95

Diversification

Back 95

Reduction of risk on a single investment by combining it with other investments in a portfolio

Front 96

Correlation coefficient

Back 96

A measure of the degree of relationship between two variables.

Front 97

Firm-specific risk

Back 97

Part of a security's risk associated with outcomes generated by events or behaviors specific to the firm. Can be eliminated through diversification.

Front 98

Market risk

Back 98

Part of a security's risk associated with economic or market factors. Cannot be diversified.

Front 99

Relevant risk

Back 99

Portion of a security's risk that cannot be diversified away.

Front 100

Beta coefficient

Back 100

Measure of extent to which the returns on a stock move with the stock market.

Front 101

Capital Asset Pricing Model (CAPM)

Back 101

Model used to determine required return on an asset which is based on the proposition that an asset's return should be equal to risk-free return plus risk premium that reflects firm's nondiversifiable risk.

Front 102

Security market line (SML)

Back 102

The line that shows the relationship betweenrisk as measured by beta and required rate of return for individual securities.

Front 103

Market risk premium

Back 103

Additional return over the risk-free rate needed to compensate investors for assuming an average amount of risk.

Front 104

Equilibrium

Back 104

Expected return is equal to required return.

Front 105

Capital budgeting

Back 105

Process of planning and evaluating expenditures based on assets whose cash flows are expected to extend beyond one year.

Front 106

Replacement decisions

Back 106

Decisions on whether to purchase capital assets to take the place of existing assets to maintain or improve current operations.

Front 107

Expansion decisions

Back 107

Decisions whether to purchase capital projects and add them to existing assets to increase existing operations

Front 108

Independent projects

Back 108

Projects whose cash flows are not affected by decisions made about other projects.

Front 109

Mutually exclusive projects

Back 109

Set of projects where acceptance of one means the others cannot be accepted.

Front 110

Post-audit

Back 110

Comparison of actual and expected results for a given capital project.

Front 111

Net Present Value (NPV)

Back 111

Present value of an asset's future cash flows, minus its purchase price.

Front 112

Internal rate of return

Back 112

Discount rate that forces PV of a project's expected cash flows to equal its initial cost. Similar to a bond's YTM.

Front 113

YTM

Back 113

Yield To Maturity. Applies to bonds.

Front 114

Required Rate of Return (Hurdle Rate)

Back 114

Discount rate that IRR must exceed for a project to be considered acceptable.

Front 115

Net Present Value (NPV) profile

Back 115

Graph that shows the NPVs for a project at various discount rates.

Front 116

Reinvestment rate assumption

Back 116

Assumption that cash flows from a project can be reinvested:

(1) at the cost of capital, if using NPV method

(2) at the IRR, if using the IRR method

Front 117

Multiple IRRs

Back 117

Situation in which a project has two or more IRRs

Front 118

Modified IRR

Back 118

Discount rate where present value of project's cash outflows is equal to its terminal value.

Front 119

Traditional payback period (PB)

Back 119

Length of time it takes to recover original cost of an investment from its unadjusted (raw) cash flows.

Front 120

Discounted payback period

Back 120

Length of time it takes fora project's discounted cash flows to repay the cost of the investment.

Front 121

Relevant cash flows

Back 121

Specific cash flows that should be considered in a capital budgeting decision.

Front 122

Incremental cash flow

Back 122

Change in a firm's net cash flow attributable to an investment project.

Front 123

Sunk cost

Back 123

Cash outlay that has already been incurred and that cannot be recovered, regardless of whether the project is accepted or rejected.

Front 124

Opportunity cost

Back 124

Return on best alternative use of an asset. The highest return that will not be earned if funds are invested in a particular project.

Front 125

Externalities

Back 125

Effect accepting a project will have on the cash flows in other parts(areas) of the firm.

Front 126

Initial investment outlay

Back 126

Incremental cash flows associated with a project that will occur only at the start of a project's life

Front 127

Supplemental operating cash flows

Back 127

Changes in day-to-day cash flows that resultfrom purchase of a capital project and continue until asset is disposed.

Front 128

Terminal cash flow

Back 128

Net cash flow that occurs at the end of the life of a project.

Front 129

Expansion project

Back 129

Project that is intended to increase sales.

Front 130

Replacement analysis

Back 130

Analysis involving the decision whether or not to replace an existing asset with a new asset.

Front 131

Stand-alone risk

Back 131

Risk an asset would have if it were the firm's only asset.

Front 132

Sensitivity analysis

Back 132

Risk analysis technique in which key variables are changed in order to observe the changes to NPV and IRR

Front 133

Scenario Analysis

Back 133

Risk analysis technique that compares "bad" and "good" sets of financial circumstances with the most likely situation.

Front 134

Worst-case scenario

Back 134

Analysis in which all of the variables are set to their worst reasonably forecasted values.

Front 135

Best-case scenario

Back 135

Analysis in which all of the variables are set to their best reasonably forecasted variables.

Front 136

Base (most likely) scenario

Back 136

Analysis in which all of the variables are set to their most likely values.

Front 137

Monte Carlo simulation

Back 137

Risk analysis technique in which probable future events are simulated on a computer, generating a probability distribution that includes the most likely outcomes.

Front 138

Corporate (within-firm) risk

Back 138

Risk that does not take into consideration the effects of stockholders' diversification.

Front 139

Beta (market) risk

Back 139

Part of a project's risk that cannot be eliminated by diversification

Front 140

Project required rate of return

Back 140

The risk-adjusted required rate of return for an individual project.

Front 141

Pure play method

Back 141

An approach used for estimating the beta of a project. A firm identifies companies whose only business is in the product in question, determines the beta for each firm, and then averages the beta to find an approximation of its own project beta.

Front 142

Risk-adjusted discount rate

Back 142

Discount rate that applies to a particular risky stream of income. Equal to risk-free rate plus risk premium.

Front 143

Repatriation of earnings

Back 143

Process of sending cash flows from a foreign subsidiary back to parent company.

Front 144

Exchange rate risk

Back 144

Risk associated with foreign currency exchange rate fluctuation.

Front 145

Political risk

Back 145

Risk of seizure of a foreign subsidiary's assets by the host government, or of unanticipated restrictions on cash flows to parent company.

Front 146

Another name for required rate of return

Back 146

Opportunity cost rate

Front 147

Cost of capital

Back 147

Firm's average cost of funds, which is the average return required by that firm's investors, a firm must pay to attract investors.

Front 148

Capital components

Back 148

Particular types of capital used by the firm. (Debt, preferred stock, common equity)

Front 149

After-tax cost of debt

Back 149

Relevant cost of new debt, taking into account the tax deductability of interest.

Front 150

Cost of preferred stock

Back 150

Rate of return investors require on the firm's preferred stock. Calculated as preferred dividend divided by preferred stock's net issuing price (NIP)

Front 151

Cost of retained earnings

Back 151

Rate of return required by stockholders on a firm's existing common stock.

Front 152

Cost of new common equity

Back 152

Cost of external equity; based on cost of retained earnings, but increased for flotation costs.

Front 153

Flotation costs

Back 153

Expenses incurred when selling new issues of securities.

Front 154

Target (optimal) cash structure

Back 154

Combination of debt, preferred stock and common equity that will maximize the price of a firm's stock.

Front 155

Weighted average cost of capital

Back 155

Weighted average of the component costs of debt, preferred stock, and common equity.

Front 156

Marginal cost of capital (MCC)

Back 156

Cost of obtaining another dollar of new capital

Front 157

MCC schedule

Back 157

Graph showing the firm's weighted average cost of each dollar of capital to the total amount of new capital raised.

Front 158

Break point

Back 158

Dollar value of new capital that can be raised before an increase in the firm's weighted average cost of capital occurs.

Front 159

Investment opportunity schedule

Back 159

Graph of the firm's investment opportunities ranked in order of the project's internal rates of return.