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112 Cards in this Set

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capital budgeting
the process of planning and managing a firm's long-term investments
capital structure
the mixture of debt and equity maintained by a firm
working capital
a firm's short-term assets and liabilities
sole proprietorship
business owned by one person
adv: easiest to start, least regulated, owner keeps all profit, taxed once as personal income
disadv: ltd to life of owner, equity capital ltd to owner's personal wealth, unltd liab, difficult to sell ownership interest
a business formed by 2 or more individuals or entities
adv: 2 or more owners, more capital available, relatively easy to start, income taxed once as personal income
disadv: unltd liab, partnership dissolves when one partner dies or wishes to sell, difficult to transfer ownership
a business created as a distinct legal entity composed of one or more individuals or entities
adv: ltd liab, unltd life, separation of ownership and mgmt, easy to transfer ownership, easier to raise capital (not ltd to owners' wealth
disadv: sep. of ownership and mgmt, double tax
agency problems
the possibility of conflict of interest between the stockholders and the management of a firm
someone other than a stockholder or creditor who has a claim on the cash flows of the firm
future value (FV)
the amount an investment is worth after one or more periods
the process of accumulating interest on an investment over time to earn more interest
interest on interest
interest earned on the reinvestment of previous interest payments
compound interest
interest earned on both the initial principal and the interest reinvested from other periods
simple interest
interest earned only on the original principal amount invested
future value equation
future value interest factor (FVIF)
present value (PV)
the current value of future cash flows discounted at the appropriate discount rate
calculate the PV of some future amount
discount factor/discount rate/present value interest factor (PVIF)
discount rate
the rate used to calculate the PV of future cash flows
discounted cash flow (DCF) valuation
calculating the present value of a future cash flow to determine its value today
PV equation
important relationship 1
r is constant
FV is constant
increase t
increase in FVIF
decrease in PVIF
decrese in PV
important relationship 2
t is constant
FV is constant
increase r
increase in FVIF
decrease in PVIF
decrease in PV
a level stream of cash flows for a fixed period of time
ordinary annuity
annuities that occur at the end of a period
annuity due
an annuity for which the cash flows occur at the beginning of the period
an annuity in which the cash flows continue forever
a type of perpetuity
stated interest rate (quoted interest rate)
the interest rate expressed in terms of the interest payment made each period
effective annual rate (EAR)
the interest rate expressed as if it were compounded once per year
annual percentage rate (APR)
the interest rate charged per period multiplied by the number of periods per year
the stated interest payment made on a bond
face value (par value)
the principal amount of a bond that is repaid at the end of the term
coupon rate
the annual coupon divided by the face value of a bond
the specified date on which the principal amount of a bond is paid
yield to maturity (YTM)
the rate required in the market on a bond
What increases interest rate risk?
Longer time to maturity and low coupon rate
current yield
a bond's annual coupon divided by it's price
the written agreement between the corporation and the lender detailing the terms of the debt issue
registered form
the form of bond issue in which the registrar of the company records ownership of each bond; payment is made directly to the owner of record
bearer form
the form of bond issue in which the bond is issued without record of the owner's name; payment is made to whomever holds the bond
an unsecured debt, usually with a maturity of 10 years or more
an unsecured debt, usually with a maturity under 10 years
call provision
an agreement giving the corporation the option to repurchase a bond at a specified price prior to maturity
deferred call provision
a call provision prohibiting the company from redeeming a bond prior to a certain date
call-protected bond
a bond that, during a certain period, cannot be redeemed by the issuer
protective covenant
a part of the indenture limiting certain actions that might be taken during the term of a loan, usually to protect the lender's interest
zero coupon bond
a bond that makes no coupon payments and is thus initially priced at a deep discount
bid price
the price a dealer is willing to pay for a security
ask price
the price a dealer is willing to take for a security
bid-ask spread
the difference between the bid price and the ask price, represents dealer's profit
clean price
the price of a bond net of accrued interest; this is the price that is typically quoted
dirty price
the price of a bond including accrued interest, aka the full or invoice price; this is the price the buyer actually pays
real rates
interest rates or rates of return that have been adjusted for inflation
nominal rates
interest rates or rates of return that have not been adjusted for inflation
Fisher effect
the relationship between nominal returns, real returns, and inflation
term structure of interest rates
the relationship between nominal interest rates on default-free, pure discount securities and time to maturity; that is, the pure time value of money
inflation premium
the portion of a nominal interest rate that represents compensation for expected future inflation
interest rate risk premium
the compensation investors demand for bearing interest rate risk
Treasury yield curve
a plot of the yields on Treasury notes and bonds relative to maturity
default risk premium
the portion of a nominal interest rate or bond yield that represents compensation for the possibility of default
taxability premium
the portion of a nominal interest rate or bond yield that represents compensation for unfavorable tax status
liquidity premium
the portion of a nominal interest rate or bond yield that represents compensation for lack of liquidity
dividend growth model
a model that determines the current price of a stock as it's dividend next period divided by the discount rate less the dividend growth rate
dividend yield
a stock's expected cash dividend divided by it's current price
capital gains yield
the dividend growth rate, or the rate at which the value of an investment grows
common stock
equity without priority for dividends or in bankruptcy
straight voting
a procedure in which a shareholder may cast all votes for each member of the board of directors
a grant of authority by a shareholder allowing another individual to vote his or her shares
payments by a corporation to shareholders, made in either cash or stock
preferred stock
stock with dividend priority over common stock, normally with a fixed dividend rate, sometimes without voting rights
primary market
the market in which new securities are originally sold to investors
secondary market
the market in which previously issued securities are traded among investors
an agent who buys and sells securities from inventory
an agent who arranges security transactions among investors
as of 2006, a member is the owner of a trading license on the NYSE
commission brokers
NYSE members who execute customer orders to buy and sell stock transmitted to the exchange floor
a NYSE member acting as a dealer in a small number of securities on the exchange floor; often called a market maker
floor brokers
NYSE members who execute orders for commission brokers on a fee basis; sometimes called $2 brokers
SuperDOT system
an electronic NYSE system allowing orders to be transmitted directly to the specialist
floor traders
NYSE members who trade for their own accounts, trying to anticipate temporary price fluctuations
order flow
the flow of customer orders to buy and sell securities
specialist's post
a fixed place on the exchange floor where the specialist operates
over-the-counter (OTC) market
securities market in which trading is almost exclusively done through dealers who buy and sell for their own inventories
electronic communications network (ECN)
a web site that allows investors to trade directly with each other
net present value (NPV)
the difference between an investment's market value and it's cost
discounted cash flow (DCF) valuation
the process of valuing an investment by discounting it's future cash flows
NPV rule
an investment should be accepted if the NPV is positive and rejected if it is negative
payback period
the amount of time required for an investment to generate cash flows sufficient to recover it's initial cost
payback period rule
an investment is acceptable if it's calculated payback period is less than some prespecified number of years
discounted payback period
the length of time required for an investment's discounted cash flows to equal it's initial cost
discounted payback rule
an investment is acceptable if it's discounted payback is less than some prespecified number of years
average accounting return (AAR)
an investment's average net income divided by it's average book value
AAR rule
a project is acceptable if it's AAR exceeds a target AAR
internal rate of return (IRR)
the discount rate that makes the NPV of an investment zero
IRR rule
an investment is acceptable if the IRR exceeds the required return; should be rejected otherwise
net present value profile
a graphical representation of the relationship between an investment's NPV and various discount rates
multiple rates of return
the possibility that more than one discount rate will make the NPV of an investment zero
mutually exclusive investment decisions
a situation in which taking one investment prevents the taking of another
profitability index (PI)
the PV of an investment's future cash flows divided by it's initial cost; aka benefit-cost ratio
incremental cash flows
the difference between a firm's future cash flows with a project and those without the project; The ICF for project evaluation consist of any and all changes in the firm's future cash flows that are a direct consequence of taking the project
stand-alone principle
the assumption that evaluation of a project may be based on the project's ICF
sunk cost
a cost that has already been incurred and cannot be removed an therefore should not be considered in an investment decision
opportunity costs
the most valuable alternative that is given up if a particular investment is undertaken
the cash flows of a new project that come at the expense of a firm's existing projects
pro forma financial statements
financial statements projecting future years' operation
accelerated cost recovery system (ACRS)
a depreciation method under U.S. tax law allowing for the accelerated write-off of property under various classifications
bottom-up approach
OCF = net income + depreciation
no interest expense
top-down approach
OCF = sales - costs - taxes
tax shield approach
OCF = (sales - costs) * (1 - T) + depreciation * T
depreciation tax shield
the tax saving that results from the depreciation deduction, calculated as depreciation multiplied by the corporate tax rate
equivalent annual cost (EAC)
the PV of a project's cost calculated on an annual basis