Reading...
Play button
Play button
Use LEFT and RIGHT arrow keys to navigate between flashcards;
Use UP and DOWN arrow keys to flip the card;
H to show hint;
A reads text to speech;
46 Cards in this Set
- Front
- Back
|
What are the strengths and weakness of the dividend discount model?
|
Strengths: Easy to use
Weaknesses: Only applies to dividend paying companies, assumes constant growth, doesn't explicitly consider risk |
|
|
What are the strengths and weaknesses of the CAPM model?
|
Strengths: Adjusts for risk, Applies to companies that do not pay dividends
Weaknesses: Beta and risk premium are still estimates, relies on past data to predict future |
|
|
What is par value and how is it calculated?
|
Par value= Accounting value, not market value, stated value on stock certificate, = total # of SHS* stated par value
|
|
|
Where does it state the # of shares a corporation is allowed to issue?
|
Articles of Incorporation
|
|
|
What are the advantages and disadvantages of authorizing a large number of shares to be issued?
|
Advantages: Flexibility to raise capital quickly
Disadvantages: Dilution because issue of new shares can be approved by board of directors only |
|
|
What is Capital Surplus?`
|
Amount of contributed capital in excess of par value, ex. if stock par value is $10 and issued at $12, Capital Surplus= $2
|
|
|
What are the plowback and dividend payout ratios?
|
Ratio of earnings/yr to actual dividend payout/Retained earnings
Plowback= b= Chng RE/Earnings Dividend payout = 1-b |
|
|
How is market value/market capitalization calculated?
|
=# shs outstanding* mkt trade value
|
|
|
How is book value calculated, what is the difference between directly and indirectly contributed equity?
|
Book value= TPV+CS+ARE= total par value + capital surplus + accumulated retained earnings, direct= TPV+ CS, indirect= ARE
|
|
|
What are the two basic shareholder rights?
|
1) Voting Rights
2) Cash Flow Rights |
|
|
What is the difference between cumulative and straight voting?
|
Cumulative voting: Includes minorities, = shs* positions, positions elected all at once, votes can be positioned so to guarantee at least a certain vote if minority
Straight= Each position elected seperately, tends to freeze out minorities b/c majority rules in each individual election, 1sh=1 vote |
|
|
What is proxy voting?
|
Proxy: legal grant of authority by a shareholder to someone else to vote her shares.
actual voting in large public corporations is usually done by proxy. |
|
|
What are the two most important nuances about dividends?
|
Unless & until dividend is declared by board of directors, it is not a liability.
A corporation cannot default for failure to pay a dividend. Payment of dividends is not business expense. (consider income stmnt.) Thus, dividends are not tax-deductible. Disadvantage of dividends (equity) vs. interest (debt): DOUBLE TAXATION of dividends! Consider what the investor receives: Debtholders: ($1 of Interest) x (1-TPI) Vs. Equityholders: ($1 of EBT) x (1-TPE) x (1-TC) |
|
|
What is the difference between dividends received by an individual shareholder and a corporation?
|
Individual: Dividends considered income by the IRS, fully taxable
Other Corporations: Dividends 70% deductible |
|
|
Why might a firm issue different classes of stock?
|
Raise equity while maintaining controlling interest in firm
|
|
|
What is the main difference between an interest payment on debt and a dividend declared for a corporation in terms of the government?
|
Debt is seen as a business expense, and thus fully tax deductible, paid with before tax dollars
|
|
|
What are the two main different kinds of debt?
|
Debenture: Unsecured, except for companies word
Bond: Usually backed by mortgage on corporate property |
|
|
What are positive and negative covenants on bonds?
|
Positive (Must be upheld): Minimum working capital requirements, Timely and regular financial statement disclosures
Negative (Cannot do): Issuance of new debt, size of dividend issuance, asset sales and mergers |
|
|
What is a security in corporate long term debt?
|
Property which is sold in event of default in order to satisfy the liability for which the security is given.
A mortgage is used for security in tangible property. |
|
|
What is an indenture in terms of corporate long term debt?
|
written agreement/contract b/n corporate debt issuer and lender.
Sets forth the terms of loan: (See slide # 10 for list of terms.) |
|
|
Preferred stock has preference over common stock in terms of...
|
1) Payment of dividends
2) Assets of corporation in case of bankruptcy |
|
|
With preferred shares, capital is raised without...
|
1) Dilution of control
2) Fear of financial distress |
|
|
What is the difference between cumulative and non cumulative preferred share dividends?
|
Cumulative: unpaid PS div’ds are carried forward; paid in full before CS div’ds are paid.
Non-cumulative: unpaid PS div’ds are NOT carried forward. |
|
|
How are preferred shares like and unlike debt?
|
Like Debt:
1) Receive fixed dividend (similar to interest payment) 2) In event of liquidation PS holders are entitled to fixed claim Unlike Debt: 1) Dividend cannot be tax deducted as business expense 2) Double taxation of PS dividends, paid with after tax $ |
|
|
What is the preferred stock puzzle?
|
Advantages of PS v. Debt do not offset disadvantages, 70% tax deduction for corporate tax investors, but dividends not tax deductible for issuing corp.
|
|
|
Based on the preferred stock puzzle, what type of corporation would issue preferred stock and why?
|
Smaller/Less profit corps
1) Cannot commit to interest payments 2) Cannot take advantage of debt tax shield |
|
|
What are the six recent patterns of financing?
|
Internally generated cash flow dominates as a source of financing, typically between 70 and 90%.
Firms usually spend more than they generate internally—the deficit is financed by new sales of debt and equity. Net new issues of equity are dwarfed by new sales of debt. This is consistent with the pecking order hypothesis. Firms in other countries rely to a greater extent than U.S. firms on external equity. Recent trend (last dozen years): Rising D/E ratios. |
|
|
Define Option
|
An option gives the holder the right, but not the obligation, to buy or sell a given quantity of an asset on (or perhaps before) a given date, at prices agreed upon today.
|
|
|
What is the basic difference between call and put options?
|
Call options gives the holder the right, but not the obligation, to buy a given quantity of some asset at some time in the future, at prices agreed upon today. When exercising a call option, you “call in” the asset.
Put options gives the holder the right, but not the obligation, to sell a given quantity of an asset at some time in the future, at prices agreed upon today. When exercising a put, you “put” the asset to someone. |
|
|
What is the difference between European and American Options?
|
European options can only be exercised at expiry, American options can be exercised at any point up to or at expiry, at expiry an American option is worth the same as a European option with the same payoffs
|
|
|
Define In-the-Money, At-the-Money, and Out-of-the-Money for both calls and puts
|
Call Option:
In-the-Money: Strike Price< Stock Price At-the-Money: Strike Price= Stock Price Out-of-the-Money: Strike Price> Stock Price Put: In-the-Money: Strike Price>Stock Price At-the-Money: Strike Price= Stock Price Out-of-the-Money: Strike Price<Stock Price |
|
|
What are the payoffs and profits for buyer and seller for a call option?
|
Payoff
Buyer: Max(ST-E,0) Seller: Min(E-ST,0) Profit Buyer: Max(ST-E,0)-C0 Seller: Min (E-ST,0)+C0 |
|
|
What are the payoffs and profits for buyer and seller for a put option?
|
Payoff
Buyer: Max(E-ST,0) Seller: Min(ST-E,0) Profit Buyer: Max(E-ST,0)-P0 Seller: Min(ST-E,0)+P0 |
|
|
What is a protective put?
|
Combination of options, go long on a put and buy the underlying stock. Why? Because if the price of the stock goes below the strike price, you still get the put, therefor receiving positive profit
|
|
|
What is a covered call?
|
Combination of options, buy a stock and write a call. Exchange future benefit for current income (call premium).
|
|
|
What is a long straddle?
|
Combination of options. Go long on call and put. When you think stock will make a major movement.
|
|
|
What is a short straddle?
|
Combination of options. Short a call and short a put. When you think stock will not move much, only nets a loss when price goes above or below strike price by combination of premiums
|
|
|
What does no arbitrage mean?
|
If two portfolios have the exact same payoffs, they must be worth the same value today: C0+ E/(1+r)^t= P0+S0
|
|
|
Value of a firm is equal to..
|
V= B + (CS+ PS)
|
|
|
Why is there no conflict between debt and equity owners typically?
|
Maximizing V means Maximizing S
|
|
|
What does the milk example show in terms of MM proposition I?
|
Debtholders(fat) pay more for $ of Interest (accept less Rd) b/c first in line
Equity holders (skim) pay less for $ of N.I. (demand more Re) b/c last in line |
|
|
What are the assumptions of the MM model?
|
1) Homogeneous Expectations
2) Homogeneous Business Risk Classes 3) Perpetual Cash Flows 4) Perfect Capital Markets A) Perfect Competition (Everybody is a taker) B) Firms and investors can lend/borrow at same rate C) Equal access to all relevant information D) No transaction costs E) No taxes |
|
|
What is a key insight of the MM model?
|
Since an investor can exactly offset whatever the firm does (or does NOT do) with respect to leverage, then the firm is not creating value for the investor! Only if the firm can do something that the investor can not otherwise do is the firm potentially adding value!
|
|
|
How is homemade leverage defined?
|
The process of an investor picking his own target level of leverage
|
|
|
More Volatile ROE is associated with a _____ firm while less volatile ROA is associated with a _______ firm
|
levered, unlevered
|
|
|
What does MM Proposition I fundamentally say?
|
The firm creates no value for the shareholder by altering its capital structure, therefor, firm value is unaffected by capital structure
|
