Term
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Definition
Inflation Risk Premium
Maturity Risk Premium
Default Risk Premium
Seniority Risk Premium
Liquidity Risk Premium |
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Term
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Definition
| compensates the investor for risk that future purchasing power will be lower due to expected inflation |
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Term
| Maturity (Interest Rate) Risk Premium |
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Definition
compensates the investor for greater risk that results from longer term investment
value of longer term securities more sensitive to changes in interest rates |
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Term
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Definition
| compensates the investor for the risk that expected payments will not be made |
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Term
| Seniority (Priority) Risk Premium |
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Definition
| compensates the investor for risk from a lower ranking position in a claimant structure (bonds are first in line, stocks are last in line to be paid, receive residual cashflows) |
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Term
| Liquidity (Marketability) Risk Premium |
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Definition
| compensates the investor for risk that asset might not be quickly and easily sold |
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Term
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Definition
| collection of assets held by a firm or investor |
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Term
| Effect of portfolio diversification |
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Definition
| portfolio risk is reduced by combining assets that are less than perfectly positively correlated |
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Term
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Definition
a risk that influences a large number of assets
overall, market risk |
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Term
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Definition
a risk that influences a singe asset or small group of assets
unique, specific risk |
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Term
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Definition
indicates how the return on an asset moves relative to return for the entire market
measures systematic risk of an investment |
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Term
| Capital Asset Pricing Model |
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Definition
| expresses relation between asset's required return and its systematic risk |
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Term
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Definition
| a promise by a borrower to pay specified interest payments and/or specified principal amount at maturity |
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Term
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Definition
market-based required rate of return
AKA Cost of Debt |
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Term
| Tax Treatment of Interest on Corporate Debt |
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Definition
tax deductible to issuer,
taxable to all investors |
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Term
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Definition
default risk
interest-rate (maturity) risk
reinvestment rate risk
liquidity risk
expropriation (agency) risk |
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Term
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Definition
sensitivity of bond prices to changes in market interest rates
Affected by
1. Time to maturity
2. Coupon rate |
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Term
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Definition
Macaulay Duration and Modified Duration
measures rate of change in bond price caused by change in interest rates |
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Term
| Expropriation (Agency) risk |
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Definition
based on conflict of interest between stockholders and bondholders.
managers (agents of stockholders) may take actions that benefit stockholders at expense of bondholders |
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Term
| Contractual Characteristics of Long Term Bonds |
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Definition
coupon and maturity date
conversion option
seniority (priority)
security (collateral)
call option
sinking fund
put option
protective covenants |
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Term
| Discounted Cashflow (DCF) Valuation |
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Definition
dividend discount models
-zero growth
-constant growth
-non-constant growth |
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Term
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Definition
| assets end up in the hands of those who can use them most productively |
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Term
| market (informational) efficiency |
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Definition
| security prices quickly and accurately reflect all relevant information |
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Term
| short-term financial modeling process (cash budgeting) |
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Definition
1. estimate cash receipts
2. estimate cash disbursements
3. specify desired cash balance
4. identify cash deficits/surpluses
5. specify needed financing (if deficit) or short-term investment (if surplus) |
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Term
| one major outcome of financial modeling |
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Definition
identification of
1. how much financing a firm will need,
2. when it will be needed,
3. where it will come from |
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Term
| broad sources of financial information |
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Definition
1. accounting-based (book values)
2. market-based (market values) |
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Term
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Definition
psychological biases affect financial markets
markets are driven by fear and greed
consider cognitive biases |
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Term
| adaptive markets hypothesis |
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Definition
reconciles efficient markets and behavioral theories
applies principles of evolution to financial markets |
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Term
| ratios that combine book values and market values |
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Definition
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Term
| long term financial modeling process |
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Definition
1. forecast sales
2. define relation between sales and other account balances
3. specify dividend policy
4. estimate external financing needed (EFN)
5. select method of raising EFN
6. produce pro forma financial statements |
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