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Fin exam 2
Buz Finance
57
Economics
Undergraduate 3
02/07/2011

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Term
The more variable or wider the distribution of possible returns, whats the risk
Definition
Lower the risk due to diversification
Term
The most commonly used indicator of an assets risk
Definition
is standard deviation
Term
if 2 return series move in the same direction
Definition
they are positively correlated
Term
theoretically risk can be reduced to 0 if 2 securities have
Definition
perfect negative correlation

because if one to go down the other would up but this means you make no money
Term
War, inflation, interest rates and market pyschology are all examples of
Definition
nondiversifiable risk, market risk

You can bet against them or for them
Term
in the capital asset pricing model, the ____ is a measure of nondiversifiable risk
Definition
Beta,
Term
what are the ranges of beta, such as beta of 1
Definition
beta of 1, would mean that it moves perfectly with the market

2 means that if the market went up 3 point it would go up by double 6

negative means that it does the opposite of the market

zero means it has no correlation with the market

positive means that it moves in the same direction as the market
Term
How to determine a stock
Definition
Quanatative, cash flow, dividends etc

Beauty contest, like the company, like where its going

feeling- have a good feeling about the company
Term
CAPM
Definition
Capital Asset Pricing Model
Term
Rj = Rf + [Bj x (Rm – Rf)]

What is Rj
Definition
Rj - required return of on the asset
Term
Rj = Rf + [Bj x (Rm – Rf)]

What is Rf
Definition
Rf - Risk free rate of return, commonly measured by the return of a treasury bill

this is lowest rate of return that you can get with no risk
Term
Rj = Rf + [Bj x (Rm – Rf)]

what is Bj
Definition
beta cofficient
Term
Rj = Rf + [Bj x (Rm – Rf)]

what is Rm
Definition
Rm- market return, return on the market portolio of assets. Risk involved
Term
Rj = Rf + [Bj x (Rm – Rf)]

Rm – Rf)
Definition
Rm – Rf)- is consider the risk premium that one must obtain for the amount of risk they are taking
Term
Rj = Rf + [Bj x (Rm – Rf)]

what is Rm
Definition
Rm- market return, return on the market portolio of assets. the oppertunity cost
Term
Bond Indentures
Definition
the legal doc that determines the legal rights of the bondholders and the duties of the bond issuer, such as return, callable or not, restritive convants, and so forth
Term
restrictive convents
Definition
commitments that the bond issuers agrees it will follow during the life of the bond to ensure the safty of the bond, this in turn makes the bond safer
Term
Convertible bonds
Definition
bondholder could exchange its bonds into stocks at any time at a set amount, such as 30 shares for 1 bond
Term
sinking fund
Definition
money set aside by the company to buy back shares or bonds, this in turn causes the bond to be safer
Term
how does risk effect interest rate
Definition
lower the risk the lower the interest rate
Term
Call feature, callable
Definition
the firm can call back the bond at anytime, this in turn causes more risk in the bond since they probably will call back the loan when interest rates are very low
Term
Bond rating
Definition
All bonds are rated by a rating firm, this determines the rates it will charge. this is done by looking at the company and its ability to repay the bond

A's are good investment rating bonds used for hedge funds and other funds

B's is non investment level and are risky but in turn pay out more
Term
Bond advantages over stocks, from the firms side
Advantages
Definition
Advantages-
lock in interest rates, know the rates
call features, gives repayment flexibility
debt is tax deductible
less dilution of earnings
less dilution of control- no voting rights
lower selling cost
Term
Bond advantages over stocks, from the firms side
disadvantages
Definition
Fixed interest rate
legal obligation to pay interest and principal
increased risk, debt/equity ratio
maturing bonds must be repaid
restrictive convents
Term
Factors in determining the use of debt **
Definition
Asset structure/ maturing of debt- at the moment
current and forcasted interest rates
desire to maintain control
industry comparsion
cash flow situation- can you handle payments
interest payments- tax dedutible
lender and rating agency impact
management towards debt
what are you going to do with the money
Term
determing interest rate and required return
Definition
the rating of the bond
Maturity- how long
inflation
real rate
risk
Term
real rate
Definition
is the equil between the demand for funds and funds supplied, the us is very stable and stays around 1 this level determines real rate of interest
Term
Nominal interest rate
Definition
(real rate + inflation premium) + risk premium
Term
risk free rate
Definition
real rate of interest + inflation premium
Term
risk of a bond
Definition
default risk- the risk of the firm defaulting
maturity risk- how long the bond is
conditional risk- callable or not, etcc
Term
risk of a bond
Definition
default risk- the risk of the firm defaulting
maturity risk- how long the bond is
conditional risk- callable or not, etcc
Term
yield return graph
Definition
shows the return of different lengths of bonds

increase in slope- shows expected increase in inflation

upward sloping since risk goes up as time increase, unless it is a very high time of interest and expected interest rates will go down
Term
Basis spread,
Definition
difference in the nominal rates and the default rate of junk bonds
so if treasury bond is 10 and junk is 15, the spread is 5

in good times this spread is low, since people think all companies will be able to repay

in bad time, this is high since there is a higher chance they wont be able to

bond buyers tend to look out, so this spread is a good indicator what the future economy is going.
Term
types of bonds
Definition
junk bonds-
zero coupon bonds
secure bonds
unsecured bonds
Term
junk bonds
Definition
bonds that are rated in the b's
Term
zero coupon bond
Definition
bonds that have no interest rate, they are sold at a discount.

ad
you dont have payments. good if cash flow is hard

dis
ballon payment at the end
only raise half the capital
Term
secure bonds
Definition
bonds that are secured by an asset, for firms that are deemed high risk
Term
unsecured bonds
Definition
most big respectable companies use this because they dont need to secure it due to its low risk
Term
stock compared to debt/bond from the investor side
Definition
-voice in managment
-last in line for debt
can make the biggest gains as well as the biggest loss
-maturity, there is no maturity firms can buy back
Term
common stock advantages from the firms side
Definition
-no fixed charges
-no maturity
-increase credit standin/ borrowing power
-reduce cost of late debt
Term
common stock advantages from the firms side
Definition
-no fixed charges
-no maturity
-increase credit standin/ borrowing power
-reduce cost of late debt
Term
common stock disadvantages from the firms side
Definition
-high cost of underwriting
-dividends are not tax deductible
-dilution of earnings, ownership and control
key part
Term
common stock disadvantages from the firms side
Definition
-high cost of underwriting
-dividends are not tax deductible
-dilution of earnings, ownership and control
key part
Term
advising role of the investment bank

what does the investment bank do
Definition
-choosing of financing vehicle
-when and how much
- prepares the prospectus, to gain SEC approval
this describes everything about the company
-full disclosure and jury proof
so that they can not be sued if investor doesnt like something after the sale
-set the offering price
Term
problem with the IPO and the investment bank with the firm
Definition
investment bank wants a lower offering price because they will make money on the spread of the IPO and the first day of trading, while the firm wants the most capital possible
Term
6 different valuation models for stock
Definition
zero growth
variable growth
book value
constant value
free cash flow
price/ earnings multiples
Term
6 different valuation models for stock
Definition
zero growth
variable growth
book value
constant value
free cash flow
price/ earnings multiples
Term
efficent market
Definition
the idea that the stock market moves very fast therefore there is only a small window for there to be an undervalued stock
Term
price of stocks are determine largely by
Definition
EPS
cash flow
and sometimes dividends
Term
zero growth dividend
Definition
the idea that the stock will pay dividends of the same price forever
Term
constant growth model
Definition
cash flow (maybe EPS) / discount rate - growth rate = price

no companies growth at the same rate, some big cap firms do
Term
variable growth model
Definition
requries you to have different growth rates for each year

best way to do it but it is impossible to know
Term
free cash flow model
Definition
uses the varaible growth model for the short term then use constant for the long term and add them together
Term
wieghted cost of capital
Definition
is the same thing as discount of capital, cost of raising money
Term
discount rate
Definition
is the cost of capital, cost to get something, interest, min return one must get
Term
Pe ratio
Definition
earnings x PE

if the company is thought to grow the higher the PE
Term
stock value
Definition
is the present value of its future worth

the problem is knowing the future worth
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