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112 Cards in this Set
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capital budgeting

the process of planning and managing a firm's longterm investments



capital structure

the mixture of debt and equity maintained by a firm



working capital

a firm's shortterm 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 

partnership

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 

corporation

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



stakeholders

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



compounding

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

FV=PV(1+r)^t



future value interest factor (FVIF)

(1+r)^t



present value (PV)

the current value of future cash flows discounted at the appropriate discount rate



discount

calculate the PV of some future amount



discount factor/discount rate/present value interest factor (PVIF)

1/((1+R)^t)



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

PV=FV[1/((1+r)^t)]



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 

annuity

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



perpetuity

an annuity in which the cash flows continue forever



consol

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



coupon

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



maturity

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



indenture

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



debenture

an unsecured debt, usually with a maturity of 10 years or more



note

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



callprotected 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



bidask 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 defaultfree, 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



proxy

a grant of authority by a shareholder allowing another individual to vote his or her shares



dividends

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



dealer

an agent who buys and sells securities from inventory



broker

an agent who arranges security transactions among investors



member

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



specialist

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



overthecounter (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 benefitcost 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



standalone 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



erosion

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 writeoff of property under various classifications



bottomup approach

OCF = net income + depreciation
no interest expense 


topdown 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

