Term
| Why is the present value of an annuity due larger? |
|
Definition
| Because each payment is discounted back one less year |
|
|
Term
| What is an annuity with an extended life called? |
|
Definition
|
|
Term
| What denotes uneven cash flows? |
|
Definition
|
|
Term
| What denotes even cash flows? |
|
Definition
|
|
Term
| What are the two major examples of uneven cash flows? |
|
Definition
1) Bonds
2) Stocks and Capital Investments
|
|
|
Term
| How is the value of all financial assets found? |
|
Definition
| Present value of their expected future cash flows |
|
|
Term
| (Annual percentage rate, or quoted or stated rate) contracted interest rate |
|
Definition
|
|
Term
| rate that would produce the same future value under annual compounding as would more frequent compounding at a given nominal rate. |
|
Definition
|
|
Term
| If a loan or investment uses annual compounding, the nominal rate =________ |
|
Definition
|
|
Term
| If compounding occurs more than once a year, what is the relationship between EAR and the nominal rate? |
|
Definition
|
|
Term
| loan that is to be repaid in equal payments over its life. |
|
Definition
|
|
Term
| What is the formula for an effective annual rate? |
|
Definition
|
|
Term
| What do the payments of an amortized loan consist of? |
|
Definition
Interest payments
Repayment of Principal |
|
|
Term
| What market does the present value price of a bond consider? |
|
Definition
|
|
Term
| what is forecasting future short term rates called? |
|
Definition
|
|
Term
| How should Inom be expressed in the EAR formula. |
|
Definition
|
|
Term
| Look at starred page in notes at determining unknown interest rates over a series of years |
|
Definition
|
|
Term
| If you are going from a PV to an FV what is this called? |
|
Definition
|
|
Term
| If you are going from an FV to a PV what is this called? |
|
Definition
|
|
Term
| What is the formula for a present value? |
|
Definition
|
|
Term
| What is the formula for a future value? |
|
Definition
|
|
Term
| What is the relationship between PV and K? |
|
Definition
|
|
Term
| What is the relationship between PV and N? |
|
Definition
|
|
Term
| What is the relationship between PV and Cash Flows? |
|
Definition
|
|
Term
| What is the relationship between FV and K? |
|
Definition
|
|
Term
| What is the relationship between FV and N? |
|
Definition
|
|
Term
| What is the relationship between FV and Cash Flows |
|
Definition
|
|
Term
| What are bonds quoted as? |
|
Definition
|
|
Term
| How do you calculate current yield? |
|
Definition
|
|
Term
| discount rate that makes present value of cash flows equal to the current market value |
|
Definition
|
|
Term
| What are the components of a bond quote? |
|
Definition
Issuer
Maturity date
Price Ex. (89.125%)
Current yield
Maturity yield
Coupon rate |
|
|
Term
| 0 coupon bonds always trade at a ______ |
|
Definition
|
|
Term
| Is the PV for a bond positive or negative? |
|
Definition
|
|
Term
| Low coupon bonds are ______ sensitive to rate changes than are high coupon bonds. |
|
Definition
|
|
Term
| Bond prices go up _____ than its going down in symmetrical rate changes |
|
Definition
|
|
Term
| Discount rate of return comes from the _____ |
|
Definition
| market (supply and demand forces) |
|
|
Term
| What two things does the nominal risk free rate include? |
|
Definition
| Nominal risk free rate includes expected inflation and real rate of return. |
|
|
Term
| shows relationship between short and long term yields. |
|
Definition
|
|
Term
| Describe the liquidity premium theory? |
|
Definition
| Long term bonds have more interest rate risk than Short Term bonds and deserve a higher rate of return. (Predicts an upward sloping yield curve) |
|
|
Term
| Describe the segmented market theory. |
|
Definition
| just supply and demand of maturity preferences that shape the curve.Only short term or long term investor. No switching between the two whatsoever. |
|
|
Term
| Describe the pure expectations theory |
|
Definition
| the curve tells us where we think rates are going to go in the future. We can predict future rates using current rates. Long term rates are the average of current and future short term rates. |
|
|
Term
| What is the most common type of yield curve? |
|
Definition
|
|
Term
| Why is the long term more risky than the short term? What is an often assumed, yet incorrect, reason for this? |
|
Definition
| Riskiness of Long term is due to fluctuation of rates, NOT default risk. |
|
|
Term
| very unique opportunity to take financial advantage of |
|
Definition
|
|
Term
| States that prices reflect information. |
|
Definition
| Efficient Market Hypothesis |
|
|
Term
| Difference between treasury yields and other yields. |
|
Definition
|
|
Term
| What type of risk does a yield curve look at? |
|
Definition
|
|
Term
|
Definition
|
|
Term
| what bond investor receives at maturity. |
|
Definition
|
|
Term
| fixed interest rate that the company promises over the life of the bond. |
|
Definition
|
|
Term
| allows company to call bond away from you. |
|
Definition
|
|
Term
| Is an option that you have a price to pay for. |
|
Definition
|
|
Term
| When are bonds typically called? |
|
Definition
|
|
Term
| Review figure 6.6 pg 202 in textbook |
|
Definition
|
|
Term
| What are the three types of risk premiums? |
|
Definition
Default
Maturity
Liquidity |
|
|
Term
| What is the y axis for a yield curve? What is the x axis for a yield curve? |
|
Definition
Y= interest rate
X= Years to maturity |
|
|
Term
| What are the investment grade bonds for the default risk ratings? |
|
Definition
|
|
Term
| What are the junk bonds for the default risk rating system? |
|
Definition
|
|
Term
| Which have higher return rates on average investment grade or junk bonds? |
|
Definition
|
|
Term
| Located at the K where we expect the bond issue to be called. |
|
Definition
| Price ceiling for a callable bond |
|
|
Term
| has no embedded options like callable, convertible, etc. |
|
Definition
|
|
Term
| move to safer bonds from riskier bonds |
|
Definition
|
|
Term
| return over 1 year investment or less horizon) |
|
Definition
| HPR (Holding Period Return) |
|
|
Term
| What is the formula for HPR? |
|
Definition
|
|
Term
| Why do we talk about returns as %s rather than in dollars? |
|
Definition
| due to relative amount of price. |
|
|
Term
| measure of variability around an average or expected return. |
|
Definition
| Standard deviation of returns |
|
|
Term
| Why might bond rating agencies have a conflict of interest? |
|
Definition
| Bond rating agencies are hired by companies they rate so there can be a conflict of interest. |
|
|
Term
Describe a risk-return curve for risk averse investors.
|
|
Definition
|
|
Term
| Describe a risk-return curve for risky investors. |
|
Definition
|
|
Term
| What is on the x and y axis for a risk-return curve? |
|
Definition
Return-Y axis
Risk-X axis |
|
|
Term
| Anytime you solve for I or Y, we must have cash flow as _______ |
|
Definition
|
|
Term
| In an amortizing loan, does the payment ever change? Describe the relationship between interest payment and principal repayment |
|
Definition
| No, but interest payment declines and principal repayment increases. |
|
|
Term
| What are the four most fundamental factors affecting the cost of money? |
|
Definition
Production opportunities
Time preferences for consumption
Risk
Inflation |
|
|
Term
| Which are more volatile, short term or long term interest rates? |
|
Definition
|
|
Term
| Current interest rate- Current Inflation Rate= _______ |
|
Definition
| Current real rate of interest |
|
|
Term
| What are the two main things that determine risk free rate of interest? |
|
Definition
1) Rate of return that corporations and other borrowers expect to earn on productive assets
2) People's time preferences for current vs future consumption |
|
|
Term
| Describe how the inflation rate is built into interest rates. |
|
Definition
| Based on the inflation rate expected in the future, not experienced in the past. |
|
|
Term
| Assets with ____ trading volume are generally easier to sell, and are therefore more liquid. |
|
Definition
|
|
Term
| risk of capital losses to which investors are exposed because of changing interest rates |
|
Definition
|
|
Term
| Premium that reflects interest rate risk. |
|
Definition
|
|
Term
| risk that a decline in interest rates will lead to lower income when bonds mature and funds are reinvested. |
|
Definition
|
|
Term
| Describes the relationship between bond yields and maturities? |
|
Definition
| Term structure of interest rates |
|
|
Term
| What does humped yield curve represent? |
|
Definition
| That intermediate rates are higher than long or short term rates. |
|
|
Term
| The riskier the corporation the _____ its yield curve. |
|
Definition
|
|
Term
| Why do yield curves normally slope upwards? |
|
Definition
| The maturity risk premium |
|
|
Term
| What is the formula for rrf? |
|
Definition
|
|
Term
| What is the formula for a treasury bond yield? |
|
Definition
|
|
Term
| How can one calculate the Corporate Bond Yield Spread? |
|
Definition
Corporate Bond Yield-Treasury Bond Yield
or
DRPt+LPt |
|
|
Term
| Which have lower liquidity premiums, short term or long term bonds? |
|
Definition
|
|
Term
| What are the four main factors that affect interest rates? |
|
Definition
Federal reserve policy
Federal budget deficit or surplus
International Factors
Level of Business Activity |
|
|
Term
| Are long term rates affected much by FED interevention? |
|
Definition
|
|
Term
| How can deficits be covered? |
|
Definition
Selling more treasury bonds
Print money |
|
|
Term
| The larger the federal deficit, the _____ the level of interest rates. |
|
Definition
|
|
Term
| Situation that exists when a country imports more than it exports. |
|
Definition
|
|
Term
| Desribe the relationship between ability to sell assets and debts |
|
Definition
| Greater ability to sell assets, more likely to use short term debt |
|
|
Term
| bonds issued by the federal government |
|
Definition
|
|
Term
| Bonds issued by state and local governments |
|
Definition
|
|
Term
| What's the main advantage of munis? |
|
Definition
| Exempt from federal taxes and from state taxes if the holder is a resident of the issuing state. |
|
|
Term
| Stated face value of the bond |
|
Definition
|
|
Term
| specified number of dollars of interest paid each year |
|
Definition
|
|
Term
| stated annual interest rate on a bond |
|
Definition
|
|
Term
| bonds whose interest rate remains the same for their entire life |
|
Definition
|
|
Term
| bonds whose interet rate fluctuates with shifts in the general level of interest rates |
|
Definition
|
|
Term
| Bonds that pay no annual interest but are sold at a discount below par, thus compensating investors in the form of capital appreciation. |
|
Definition
|
|
Term
| Any bond originally offered at a price below its par value |
|
Definition
| Original issue discount bond |
|
|
Term
| date on which the par value must be paid |
|
Definition
|
|
Term
| number of years to maturity at the time a bond is issued |
|
Definition
|
|
Term
provision in a bond contract that gives the issuer the right to redeem the bonds under specified terms prior to the normal maturity date
|
|
Definition
|
|
Term
| Typically equal to one years interest |
|
Definition
|
|
Term
| A deferred call is said to have _____ ______ |
|
Definition
|
|
Term
| Companies reduce their interest expense when rates fall due to this operation. |
|
Definition
|
|
Term
| A provision in a bond contract that requires the issuer to retire a portion of the bond issue each year |
|
Definition
|
|
Term
| When are sinking fund provisions bad for investors? |
|
Definition
| When coupon rate>market rate |
|
|
Term
| bonds that are exchangeable at the option of the holder for the issuing firm's common stock |
|
Definition
|
|
Term
| long term options to buy a stated number of shares of common stock at a specified price |
|
Definition
|
|
Term
| bonds with a provision that allows investors to sell them back to the company prior to maturity at a prearranged price |
|
Definition
|
|
Term
| pays interest only if the issuer has earned enough money to pay the interest |
|
Definition
|
|
Term
| bond that has interest payments based on an inflation index so as to protect the holder from inflation |
|
Definition
| Indexed (Purchasing power) bond |
|
|
Term
| What does M represent on a bond? |
|
Definition
| Maturity or par value of a bond |
|
|
Term
| bond that sells below its par value; occurs whenever the going rate of interest is above the coupon rate. |
|
Definition
|
|
Term
| bond that sells above its par value; occurs whenever the going rate of interest is below the coupon rate |
|
Definition
|
|
Term
| rate of return earned on a bond if it is held to maturity |
|
Definition
|
|
Term
| return that investors will receive if all of the promised payments are made |
|
Definition
|
|
Term
| What are the two situations in which yield to maturity equals the expected rate of return? |
|
Definition
1) Probability of default is 0
2) Bond cannot be called
|
|
|
Term
| rate of return earned on a bond when it is called before its maturity date |
|
Definition
|
|
Term
| A bond that has just been issued is known as a ___ _____. |
|
Definition
|
|
Term
| Once a bond has been issued it is called an ____________ ________ or a ________ _______ |
|
Definition
| outstanding bond, seasoned issue |
|
|
Term
| How do you calculate capital gains yield? |
|
Definition
| bonds annual change in price divided by the beginning of the year price |
|
|
Term
| How do you calculate a bonds total return? |
|
Definition
| Current yield + Capital Gains Yield |
|
|
Term
| Describe current yield and capital loss/gain for discount and premium bonds. |
|
Definition
Discount bounds have a low current yield and a capital gain
Premium bonds have a high current yield and a capital loss |
|
|
Term
| How are the vast majority of bond payments made? |
|
Definition
|
|
Term
| What are the three adjustments to be made for semiannual calculations? |
|
Definition
Divide coupon payment by 2
Multiply N by 2
Divide nominal rate by 2 |
|
|
Term
| risk of a decline in a bond's price due to an increase in interest rates |
|
Definition
| price (interest rate) risk |
|
|
Term
Which bonds have greater price risk, long or short term bonds?
|
|
Definition
|
|
Term
| Why can a decrease in interest rates hurt bondholders? |
|
Definition
| Long term investors will suffer a reduction in income |
|
|
Term
| risk that a decline in interest rates will lead to a decline in income from a bond portfolio |
|
Definition
|
|
Term
| Price risk relates to the _______ _____ _____ of the bond portfolio, while the reinvestment risk relates to the ______ the portfolio produces |
|
Definition
| current market value, income |
|
|
Term
| Short term bonds can have _______ price risk and _____ reinvestment risks |
|
Definition
|
|
Term
| long term bonds can have _____ price risk and ____ reinvestment risk |
|
Definition
|
|
Term
| period of time an investor plans to hold a particular investment |
|
Definition
|
|
Term
| weighted average of the time it takes to receive each of the bond's cash flows |
|
Definition
|
|
Term
| What's a way to manage both price and reinvestment risk? |
|
Definition
| Buy a zero coupon bond with a duration equal to the investor's investment horizon. |
|
|
Term
| If default risk increases, price ____ and YTM _____ |
|
Definition
|
|
Term
| bond backed by fixed assets. |
|
Definition
|
|
Term
| formal agreement between the issuer and the bondholders |
|
Definition
|
|
Term
| long term bond that is not secured by a morgage on specific property |
|
Definition
|
|
Term
| bonds having a claim on assets only after the senior debt has been paid in full in the event of liquidation |
|
Definition
|
|
Term
| are junior in priority to claims of senior mortgages |
|
Definition
|
|
Term
| means that new bonds can be issued from time to time under the same indenture |
|
Definition
|
|
Term
| What limits amount of new bonds that can be issued by a firm? |
|
Definition
| A firm's bondable property (P,P,E) |
|
|
Term
| requirements of a bond agreement (ex. the firm must not let its debt ratio exceed a stated level) |
|
Definition
|
|
Term
| What are two reasons bond ratings are important? |
|
Definition
They are an indicator of default risk
Most bonds are issued to institutional investors that are only allowed to invest in investment grade bonds |
|
|
Term
| Changes in a firms bond rating affect its ability to ________________________. |
|
Definition
| borrow funds and its cost of that capital. |
|
|
Term
| Why do many worry that rating agencies don't have the proper incentives to measure risk? |
|
Definition
| Because they are paid by the issuing firms. |
|
|
Term
When a business becomes _______, it doesn't have enough cash to meet its interest and principal payments.
|
|
Definition
|
|
Term
| What are the two results of insolvency? |
|
Definition
| Liquidation or reorginization |
|
|
Term
| What governs reorginization and liquidation? |
|
Definition
| Federal bankruptcy statutes |
|
|
Term
| How often do bankruptcies occur? |
|
Definition
|
|
Term
| ________ generally receive little in reorginizations and nothing in liquidations because the assets are usually worth less than the amount of debt outstanding. |
|
Definition
|
|
Term
| Corporate bonds are traded primarily in which market? |
|
Definition
|
|
Term
| chance that some unfavorable event will occur |
|
Definition
|
|
Term
The risk an investor would face if he or she held only one asset.
|
|
Definition
|
|
Term
| Listing of possible outcomes or events with a probability (chance of occurence) assigned to each outcome |
|
Definition
| Probability Distributions |
|
|
Term
| rate of return expected to be realized from an investment; the weighted average of the probabilty distribution |
|
Definition
|
|
Term
| How do you denote expected rate of return? |
|
Definition
|
|
Term
| The ______ the probability distribution, the lower the risk |
|
Definition
|
|
Term
| statistical measure of the variability of a set of observations |
|
Definition
|
|
Term
| What is the formula for coefficient of variation? |
|
Definition
| Standard Deviation/Expected return |
|
|
Term
| What does the coefficient of variation show? |
|
Definition
| risk per unit of return and it provides a more meaningful risk measure when the expected returns on two alternatives are not the same |
|
|
Term
| How do you calculate expected rate of return? |
|
Definition
| Expected Ending Value-Cost/Cost |
|
|
Term
| difference between the expected rate of return on a given risky asset and that on a less risky asset. |
|
Definition
|
|
Term
| model based on the proposition that any stock's required rate of return is equal to the risk free rate of return plus a risk premium that reflects only the risk remaining after diversification |
|
Definition
| Capital Asset Pricing Model |
|
|
Term
| What denotes expected return on a portfolio? |
|
Definition
|
|
Term
| weighted average of the expected returns on the assets held in the portfolio |
|
Definition
| Expected return on a portfolio |
|
|
Term
| How do you calculate expected return on a portfolio? |
|
Definition
| Summation of each stocks percentage in the portfolio times its expected return |
|
|
Term
| returns that were actually earned during some past period |
|
Definition
|
|
Term
| tendency of two variables to move together |
|
Definition
|
|
Term
| measure of the degree of relationship between two variables |
|
Definition
|
|
Term
diversification is completely useless for reducing risk if the stocks in the portfolio are perfectly _________ correlated.
|
|
Definition
|
|
Term
| _________ correlated stocks move in the opposite direction |
|
Definition
|
|
Term
| if returns are not related to one another at all, they are said to be _________. |
|
Definition
|
|
Term
| part of a security's risk associated with random events; can be eliminated by proper diversification. |
|
Definition
|
|
Term
| risk that remains in a portfolio after diversification has eliminated all company specific risk. |
|
Definition
|
|
Term
| Diversifiable risk deals with _____ events. Market risk stems from factors that ________ affect most firms. |
|
Definition
|
|
Term
| portfolio consisting of all stocks |
|
Definition
|
|
Term
| What are 4 reasons people choose not to have a market portfolio? |
|
Definition
1) High administrative costs and commissions
2) Index funds can be used in place
3) Some stocks may beat the market
4) Some people think they can beat the market through superior analysis |
|
|
Term
| risk that remains once a stock is in a diversified portfolio is its contribution to the portfolio's market risk. It is measured by the extent to which the stock moves up or down with the market. |
|
Definition
|
|
Term
| metric that shows the extent to which a given stock's returns move up and down with the stock market. (Measures market risk) |
|
Definition
|
|
Term
| What graphically represents a stock's beta? |
|
Definition
| Slope of a line relating the return on stocks to the return on market |
|
|
Term
| What is the average stock's beta? |
|
Definition
|
|
Term
| ____ is the theoretically correct measure of the stock's riskiness/ |
|
Definition
|
|
Term
| _____ risk is the only risk that should matter to a rational, diversified investor |
|
Definition
|
|
Term
| Look at variables on page 281 |
|
Definition
|
|
Term
| additional return over the risk free rate needed to compensate investors for assuming an average amount of risk |
|
Definition
|
|
Term
What is the security market line equation?
|
|
Definition
| Required return on stock=risk-free return + Market risk premium* Stock's beta |
|
|
Term
| How do you calculate the risk premium for a stock? |
|
Definition
| Market risk premium* beta |
|
|
Term
| How do you calculate the required return on a stock? |
|
Definition
| Risk-free return+ premium for the stock's risk |
|
|
Term
| What represents the price of money to a riskless borrower? |
|
Definition
|
|
Term
| How can a firm influence its market risk? |
|
Definition
Changes in the composition of its assets
Changes in the amount of debt it uses |
|
|
Term
| What are two ways a firm's market risk can be influenced by external factors? |
|
Definition
Increased competion in its industry
Expiration of basic patents |
|
|
Term
| stocks are ____ risky when held as part of a long-term portfolio |
|
Definition
|
|
Term
| stockholders are also called ______ |
|
Definition
|
|
Term
| document giving one person the authority to act for another, typically the power to vote shares of common stock. |
|
Definition
|
|
Term
| attempt by a person or group to gain control of a firm by getting its stockholders to grant that person or group the authority to vote its shares to replace the current management. |
|
Definition
|
|
Term
| action whereby a person or group succeeds in ousting a firm's management and taking control of the company |
|
Definition
|
|
Term
| What are the three main conditions companies often make shareholders agree to? |
|
Definition
1) Elect only one-third of the directors each year
2) Require 75% of the stockholders to approve a merger
3) Vote in a poison pill provision |
|
|
Term
| provision in the corporate charter or bylaws that gives common stockholders the right to purchase on a pro rata basis new issues of common stock (or convertible securities) |
|
Definition
|
|
Term
| What are the two main purposes of the preemptive right? |
|
Definition
1) Prevents management of a corporation from issuing a large number of additional shares and purchasing those shares itself.
2) Protect stockholders from a dilution of value |
|
|
Term
| common stock that is given a special designation to meet special needs of the company. |
|
Definition
|
|
Term
| stock owned by the firm's founders that enables them to maintain control over the company without having to own a majority of stock |
|
Definition
|
|
Term
| value of a share of common stock depends on the cash flows it is expected to provide |
|
Definition
| Discounted dividend model |
|
|
Term
| What are the two cash flows a stock provides? |
|
Definition
1) Dividends each year
2) Price received when stock is sold |
|
|
Term
| representative investor whose actions reflect the beliefs of those people who are currently trading a stock. It is the marginal investor who determines a stock's price. |
|
Definition
|
|
Term
| price at which a stock sells in the market |
|
Definition
|
|
Term
| expected rate of growth in dividends per share |
|
Definition
|
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Term
| minimum rate of return on a common stock that a stockholder considers acceptable |
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Definition
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Term
| rate of return on a common stock that a stockholder expects to receive in the future. |
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Definition
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Term
| rate of return on a common stock actually received by stockholders in some past period |
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Definition
| actual (realized) rate of return |
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Term
| Expected dividend divided by the current price of a share of stock |
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Definition
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Term
| capital gain during a given year divided by the beginning price |
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Definition
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Term
| sum of the expected dividend yield and the expected capital gains yield |
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Definition
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Term
| What is the formula for expected rate of return? |
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Definition
| Expected dividend yield + Expected growth rate, or capital gains yield |
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Term
| Growth in dividends requires growth in _______ |
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Definition
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Term
| Primarily, why does earnings growth in the long run occur? |
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Definition
| Firms retain earnings and reinvest them in the business |
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Term
| a common stock whose future dividends are not expected to grow at all |
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Definition
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Term
| What does beta represent? |
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Definition
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Term
| What does standard deviation represent? |
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Definition
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Term
| What type of risk is not diversifiable? |
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Definition
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Term
| What does a smaller CV imply? |
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Definition
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Term
| Does beta drop with diversification? |
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Definition
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Term
| What does a beta greater than 1 represent? |
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Definition
| You are taking on more risk than the market |
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Term
| What is the formula for holding period return? |
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Definition
| Dividend+ Ending Value-Beginning Value/Beginning Value |
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Term
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Definition
| Measure of risk per unit of return |
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Term
| What kind of correlation is recommended to reduce risk? |
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Definition
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Term
| theory that states that you deserve premiums for random risks that can't be determined |
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Definition
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Term
| What is the formula for holding period return? |
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Definition
Dividend+Ending Value-Beginning Value
Beginning |
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