FIN 3104- Exam 1

In early​ 2013, typical terms on a payday loan involved a $15 charge for a two​-week payday loan of $100. Assuming there are 26 14​-day periods in a​ year, what is the effective annual rate on such a​ loan?

(1 +( (15/100)* 26 )/ (26) ) ^ 26 -1 x100

Acid-Test (Quick Ratio)

(Current Assets - Inventory) / Current Liabilities

Gross Profit Margin

(Sales - COGS)/ Sales

APY (annual percentage yield) or EAR (equivalent annual rate)

-

Mutual Funds

- Classified as load or no load - shares must be bought from or sold to the Fund by investors -NAV = value of stock held/ number of shares -index fund is NOT fund with highest expenses payable

Interest Expense

- Deducted before taxes -When you pay interest, you lower taxes

Why prefer a dollar today?

- Earn interest - Opportunity cost of passing up the earning potential of a dollar

PE ratio increase (go up)

- Expect future earnings to go up - Less risk - Less inflation (earnings are worth more)

When you buy a bond you get...

- Interest paid semi-annually - At maturity, return of its par value

Long-term debt for borrower

- Interest rate are locked - Has a tax advantage

Dividend Payments

- Made from after tax money

Lower corporate tax rate means...

- More cash available to corporations for reinvesting/ paying dividends - US corporations are more competitive - Will cause an inc. in after-tax cost of borrowing

Call option

- Option to buy stock at a set price over set time period - Want price to go up -Gives the holder the right to buy a stated number of shares at a specified price for a limited time

Put option

- Option to sell something at a set price over set time period - Want price to go down

Russell 2000

- Rank companies by size (market cap= number of shares x price per share) - Stocks ranked 1000 to 3000 (looks at middle size companies)

Long-term debt for investor

- Used to generate income - Less risky than common stock

don't know**You have been offered a credit card with an interest rate of​ 1.5% per month. This is equivalent to and effective annual rate​ (EAR) of

---19.56

**If you want to have​ $1,200 in 27​ months, how much money must you put in a savings account​ today? Assume that the savings account pays​ 14% and it is compounded monthly​ (round to the nearest​ $10).

880

**If you put​ $700 in a savings account with a​ 10% nominal rate of interest compounded​ monthly, what will the investment be worth in 21 months​ (round to the nearest​ dollar)?

= P(1+ R/m)^m*t (years) =700(1+(.1/21))^21*(21/12)

Future Values

= present value (1+r )^N

The par value of a bond is...

The face value of the bond, which is received by the bondholder when the bond matures at its normal maturity date

Initial Public Offering (IPO)

The first time a corporation sells stocks to the public

Maximum Profit of a Call

Unlimited

Debenture

Unsecured bond

Derivative Securities

Values is based on the value of another security or asset

Examples of Private equity firms

Venture capital firms and leveraged buyout firms

What is the future value of $6,000 invested for 5 years at 6 percent compounded​ semiannually?

6000*(1+ 0.06/2)^ 2*5 *2 because semi-annual

What is the future value of $6,000 invested for 5 years at 6 percent compounded​ bimonthly?

6000*(1+ 0.06/6)^ 6*5 *6 because bimonthly

Only _ in 10 workers save for retirement

6; 60%

**Shorty Jones wants to buy a one−way bus ticket to Mule−​Snort, Pennsylvania. The ticket costs​ $142, but Mr. Jones has only​ $80. If Shorty puts the money in an account that pays​ 9% interest compounded​ monthly, how many months must Shorty wait until he has​ $142 (round to the nearest​ month)?

77

shareholder wealth

market price of share of common x number of shares of common stock outstanding

The par value of a bond is usually ____ amount

$1000

EAR (effective annual rate)

((1+ r/m) ^m) - 1 (monthly, m =12)

Assume the expected inflation rate is 3.8 percent. If the current real rate of interest is 6.4 percent, what should the nominal rate of interest​ be?

(.038+.064)+(.038*.064)= .104432 =10.44%

Payday loans issued by banks are often referred to as​ "direct deposit​ advances." In early​ 2013, the average direct deposit advance charged $10 for a $100 advance and was due in 10 days. What is the effective annual rate on this type of​ loan?

(1 +( (10/100)* (365/10) )/ (365/10) ) ^ (365/10) -1 - x100

Banks collect the savings of individuals and businesses and then lend these pooled savings to other individuals and businesses. In this​ role, banks​ are:

-Financial Intermediaries -Making money by charging a rate of interest to BORROWERS that exceeds the rate they pay to SAVERS

preferred stock

-Has seniority rights -Owners receive their dividends before dividends are distributed to common stock shareholders -Preferred stock dividends which are unpaid may accrue to be paid later when the corporation returns to profitability -Preferred stock is sometimes referred to as a hybrid security -During the liquidation of a​ company, holders of preferred stock would have a claim on assets before any claims by common stock shareholders -Unlike common​ stock, NO VOTING RIGHTS

**EBITDA

-Measure of Cash Flow of Operations -EBIT + Depreciation + Amortization

Issuer

-Not legally obligated to make payments -No maturity date -Issuing common stock leads to more cushion

Exercise or striking price

-Price you buy stock (call) -Price you sell stock for (put) -Price at which the stock or asset may be purchased from​ (or sold​ to) the option writer is referred to as

Secondary market

-Tradings and securities between individuals (NY stock exchange) -are concerned with the trading of previously issued securities between investors.

Securitization Process

1. Homebuyer borrow money by taking out mortgages loan 2. Lender sells the mortgage to another firm or finance institution 3. Finance institution pools together a portfolio of mortgages. The purchases of that portfolio is financed through sale of MBS 4. MBS's are sold to investors who can hold them as investments or resell them to others

All else equal, investors prefer... (3 things)

1. More money than less money 2. Their money earlier than later 3. Safe to risky assets

Basis points

1/100 of 1%

Options are sold in "lots" or contracts of ___

100

At a discount rate of 8.50​%, find the present value of a perpetual payment of $1,000 per year. If the discount rate were lowered to 4.25​%, half the initial​ rate, what would be the value of the​ perpetuity?

1000/ .085 = 11764.7 1000/0.0425= 23529.4

**Selma and Patty Bouvier are twins and both work at the Springfield DMV. Selma and Patty Bouvier decide to save for​ retirement, which is 35 years away. ​ They'll both receive an annual return of 8 percent on their investment over the next 35 years. Selma invests $2,000 per year at the end of each year only for the first 10 years of the​ 35-year period—for a total of $20,000 saved. Patty​ doesn't start saving for 10 years and then saves $2,000 per year at the end of each year for the remaining 25 years—fora total of $50,000 saved. How much will each of them have when they​ retire?

198,421 146,211

If you let $20,000 grow for 10.25 years at 7 percent​, how much will you​ have?

20000* (1.07)^10.25

Marginal tax rate

21% (multiply taxable income by 0.21 to get taxes)

If you put your $20,000 inheritance in an account that earns 7 percent interest compounded​ annually, how many years will it be before your inheritance grows to ​$30,000​?

30000= 20000(1.07)^N 1.5= 1.07^N ln(1.5) = N* ln(1.07) =6

Income Statement

A financial statement showing the revenue and expenses for a fiscal period.

VIX (fear index/ fear gauge)

A measure of the market's expected volatility (based on S&P 500)

Measure that can be taken to limit the agency problem

A. Firms that fail to maximize shareholder wealth may be taken over and their management team replaced. B. Compensation plans can be put in place to reward managers when they maximize shareholder wealth. C. Financial markets play a key role in monitoring management. D. The board of directors can actively monitor the actions of managers to keep pressure on them to act in the best interest of shareholders.

Average PE ratio

About 16

Liquidity Preference Theory Equilibrium

Adjustment of the yield curve (liquidity premium) must take place

Corporate debt can be privately placed with

All of the above

Roth IRA

Allow you to put in after tax money that get interest without taxes

Par value

Amount of money you get at bond maturity ($1000)

Accounts Receivable Turnover Ratio

Annual Credit Sales/ Accounts Receivable

Perpetuity

Annuity that goes on forever PV= PP/i

ROE> ROA

Assets= debt + EQ vs. just equity in denom., (dividing by a bigger number give you smaller answer)

Dow Jones Industrial Average (DJIA or Dow)

Average of 30 largest companies

Upward sloping yield curve

Averaging higher numbers/rates

Agency problem

result of separation of management and ownership which may interfere with implementation

Speculator

Bettings on the future movement of prices

Note

Bonds with maturities up to 10 years (*think debt)

Corporation

Business existing separate from its owners; limited liability; less control and double tax on dividends (corporation tax)

Depreciation after 2018

Businesses can deduct 100% of the cost of eligible property

In a large corporation, the primary responsibility for overseeing the​ firm's finance-related activities falls to​ the

CFO

It gives the investor holding it the​ right, but NOT THE OBLIGATION, to buy the stock at the specified price at the stated date in the future.

Call option

Cash Flows are the Source of Value

Cash flows, not profits, drives value of business

Governance of stock

Common shareholders elect the board; PS have no say

Equity

Common stock; ownership position

Futures contract

Contract to buy or sell a stated commodity (such as soybeans or corn) or a financial claim (US Treasury Bonds) at a specific price at some future time - Allow you to pick a time to not deal with price fluctuations

Inventory Turnover

Cost of Goods Sold/ Inventory

Interest paid

Coupon rate x par value

Government bonds have lower yield to maturity than do corporate bonds of the same maturity because the​ ________ premium is lower for government bonds.

Default

Depreciation before 2018

Depreciate over assets depreciable life

Compounded semi-annually

Divide %rate by 2

common stock

Dividends vary and can be omitted

Proprietorship

Easy to form; but unlimited legal responsibility

Break-even point of a call/put

Exercise price/ premium

Non-Annual Compounding

FV=PV(1+i/m)^n*m

Options can only be purchased for individual​ stocks, not for funds or indexes.

False

Tax deduction on interest expense makes borrowing money less expensive

False

The current yield is the average rate of interest a bond will from the time of purchase until it matures.

False

preffered stock

Fixed dividends (bonds) - Has a preference in terms of claims on assets in bankruptcy & income for dividends - Dividends can be omitted without bankruptcy risk - Has a tax benefit for corporations (not individuals)

Unlike the owner of​ a(n) ________​ contract, the owner of​ a(n) ________ contract does not have to exercise it

Futures; option

Securities

General term to represent stock, bonds, any financial asset

Price of a bond

Given in percent of par value (multiply given amount by 1000 is what you pay)

Option

Gives the owner the right to buy (call option-- price up) or sell (put option-- price down) an asset at a specified price

At​ 8% compounded​ annually, how long will it take​ $750 to​ double?

Rule of 72. 72/ 8% = 9

Semi annually

I/Y = rate / 2 (in terms of months) (convert back to years by dividing answer by 2)

Unbiased Expectations theory

If long-term rate is unbiased avg. of the current short-term rate and future short-term rate expected to prevail over the life of the obligation (2yr= (1yr+1yr forward)/2)

The detailed legal agreement between a​ bond's issuer and and its trustees is

Indenture

The principal savers in the financial markets are

Individuals

CDOs

Issue bonds with collateral as student debt and credit card debt (Collateralized Debt Obligation)

Partnership

Jointly responsible for liabilities; unlimited legal responsibility

Liquidity Preference theory

Lenders prefer to make short-term loans; borrowers prefer long-term debt/borrowing

Money market

Less than a year market

Limitations on interest deductions

Limit on how much interest is tax deductible (max deducted is 30% of Earnings before interest, taxes, depreciation, and amortization)

Which of the following is NOT an advantage of the sole​ proprietorship?

Limited liability

LLC

Limited liability; partnership and corporation combined

Capital market

Long-term market; more than one year

Taxes after 2018

Lowered tax rate dramatically; flat rate of 21%

Jillian has purchased AAA rated corporate bonds that will mature in 20 years . She plans to sell the bonds in 10 years as she approaches retirement age. The most significant risk she faces is

Maturity risk

Stock Market Index

Measures what's happening to stocks

Time Value of Money

Money today is worth more than money received in the future; can be invested to earn interest

Examples of investment companies that provide financial services to business: savings and loans. A. Savings and loans B.mutual funds. C.hedge funds. D.private equity firms. E.public equity firms.

Mutual, hedge, and private equity firms

Determine the present value of an ordinary annuity of $1,000 per year for 10 years, assuming it earns 10 percent. Assume that the first cash flow from the annuity comes at the end of year 8 and the final payment at the end of year 17. That​ is, no payments are made on the annuity at the end of years 1 through 7. Instead, annual payments are made at the end of years 8 through 17. Then, what is PV of annuity today?

N= 10 I/Y= 10 PV= ? PMT= -1000 FV= 0 6144.6 N= 7 I/Y= 10 PV= ? PMT= 0 FV= 6144.6 3153.1

*Determine the present value of an annuity due of $1,000 per year for 10 years discounted back to the present at an annual rate of 10 percent. What would be the present value of this annuity due if it were discounted at an annual rate of 15 percent?

N= 10 I/y= 10 PV= ? x (1.10) PMT= -1000 FV= 0

TO pay for student loans you take a loan for $25,000. If you make monthly payments for 15 years at 7% compounded monthly, how much is your monthly student loan payment?

N= 15 *12 I=7/12 PV=-25000 PMT= ? = 0 ; 224707

An insurance agent just called them and offered them the opportunity to purchase an annuity for $21,074.25 that will pay them $3,000 per year for 20 years. They​ don't have the slightest idea what return they would be making on their investment of ​$21,074.25. What rate of return would they be​ earning?

N= 20 I/y= ? PV= -21074.25 PMT= 3000 FV= 0 13%

Upon graduating from college 35 years​ ago, Dr. Nick Riviera was already planning for his retirement. Since​ then, he has made deposits into a retirement fund on a quarterly basis in the amount of $300. Nick has just completed his final payment and is at last ready to retire. His retirement fund has earned 9 percent compounded quarterly. How much accumulated?

N= 35*4 I/Y= 9/4 PV= 0 PMT= 300 FV= ? 287138

Don Draper has signed a contract that will pay him $80,000 at the beginning of each year for the next 6 years, plus an additional $100,000 at the end of year 6. If 8 percent is the appropriate discount​ rate, what is the present value of this​ contract?

N= 6 I/Y= 8 PV= ? PMT= -80000 FV= 0 =369,830 * 1.08 =399,416.8 N= 6 I/Y= 8 PV= ? PMT= 0 FV= 100,000 = 63,016.96 sum them together

Approximately how many years would it take for an investment to grow by sevenfold if it was invested at 10% compounded semi-annually

N= ? (ans/2) I= 10/2 PV= -1 PMT=0 FV= 7

EXAM***** You are to receive a 10 yr $100,000 annuity (ten cash flows of $100,000 each) with the first cash flow occurring at the end of yr 5. Given a 10% discount rate, what's the present value?

N=10 I=10 PV= ? PMT= 100,000 FV= 0 ~614,457 N=4 I=10 PV=? 419,682 PMT= 0 FV= 614457

***Borrowed $200,000 to buy a house with a 15-yr 9% monthly mortgage. Pay additional $500 monthly. How long will it take to payoff?

N=15*12 I=9/12 PV= -200000 PMT= ? 2028 FV= 0 (Add $500) N=? 120.38 ~10 yrs I=9/12 PV= -200000 PMT= 2528 (plug in) FV= 0

*5 years ago you took out a $300,000​, 25​-year mortgage with an annual interest rate of 7 percent and monthly payments of $2,120.34. What is the outstanding balance on your current loan if you just make the 60th payment?

N=240 (5x60=300) 300-60 I/Y= 7/12 PV= ? PMT= -2120.34 FV= 0 273,486

*Imagine Homer Simpson actually invested $100,000 5 years ago at 7.5% annual interest and he invests an additional 1,500 a year today for 20 years at the same 7.5%. How much money in 20 years?

N=25 I=7.5 PV=-100,000 PMT=0 FV= ? 609833 N=20 I=7.5 PV= 0 PMT= 1,500 FV= ? * (1+i) 64957* 1.075= 69828 =609833+ 69828

Five years ago you took out a $300,000 loan, 25-year mortgage with an annual interest of 7% and monthly payments of $2,120.34. What is the outstanding balance on your current loan if you just made the 60th payment?

N=25*12 I= 7/12 PV= ? ~273,486 PMT= 2120.34 FV= 0

How long will it take to pay off a loan of $50,000 at an annual rate of 10% compounded monthly is monthly payments are $600?

N=? I= 10/12 PV= -50000 PMT=600 FV=0 ~142.86 (months) years, divide by 12

Times Interest Earned

NOI/ Interest Expense

Operation Profit Margin

NOI/ Sales

When interest rates are low

Need high liquidity premium (more borrowers in the market, takes more time to get them their money; want to lock in a long-term rate)

When interest-rates are high

Need low liquidity premium to move people

ROI (Return on Investment)

Net Income/ measure of investment (assets or equity)

Net Profit Margin

Net Income/Sales

Real rate of interest

Nominal rate - Inflation rate -After inflation is taken out

Foregoing the earning potential of a dollar today is... time value of money creation of wealth opportunity cost concept

Opportunity cost concept

NASDAQ

Over the counter market, not traded on the stock exchange

FV=

PV (1+i)^n or PMT Sigma (1+i)^t t=0; n-1

You are to receive $100,000 perpetuity with first payment at the end of year 5. If 10 percent is the discount rate, what is the perpetuity's present value?

PV= 100,000 / 0.1 ~1 million N=4 I= 10 PV= ? PMT= 0 FV= 1 million

Barriers to entry

Patents (Lipitor, Square, Dropbox) Quality (BMW) Service (Frito-Lay) Product differentiation (Nike or Whole Foods) Cost advantage (Walmart) Control of Raw Materials (De Beers Diamonds)

Maximum Loss call

Premium

Maximum Loss of a Put

Premium

Premium

Price you pay for an option

ROA

Profit after taxes/ Sales * Sales/Asset (Profit margin x asset turnover ratio)

ROE

Profit after taxes/ Sales * Sales/Asset * Assets/Equity (Profit margin x asset turnover ratio x Equity Multiplier) -Measure of leverage (amount of borrowing)

Taxes before 2018

Progressive

*****Nominal rate of interest (quoted rate)

Real rate + anticipated inflation rate (Not adjusted for inflation) (real rate in decimal form + inflation rate in decimal) + (real rate X inflation rate) or (book) (amount charged/ amount borrowed) x m (compounds)

Nominal interest rate

Real risk-free interest rate + inflation premium +default risk premium +maturity risk premium +liquidity risk premium

Hedger

Reduce risk by locking in buying or selling price

An advantage to borrowing in the private market

Reduced initial costs

Advantages of privately placing debt include all of the following except 1. restrictive covenants 2. reduced placement costs 3. flexibility 4. speed

Restrictive covenants

EXAM******Gross Profit

Sales revenue - COGS

Total Asset Turnover

Sales/ Total Assets

Selling short

Sell the stock first, then buy it back later (hoping the stock price falls)

Best describes goal of the firm... risk management profit max max of total market value of the firm's common stock

The maximization of the total market value of the​ firm's common stock

term structure of interest rates

The relationship between interest rates and maturity with risk held constant

Finance is about...

The study of how people and businesses make investment decisions and how to finance those decisions

Which of the following is true about​ bonds? A.They have a fixed​ maturity, and they pay an amount equal to the maturity value times the coupon rate each year. B.They are obligations from the investor to the corporation. C.Their interest rate always varies with the Consumer Price Index D.At maturity of the​ bond, the investor receives the market price of the bond.

They have a fixed​ maturity, and they pay an amount equal to the maturity value times the coupon rate each year.

TTM

Trailing twelve months (P/E ratio earnings are based on the past)

An increase in the stated interest rate will increase the future value of a given sum. ​ Likewise, an increase in the length of the holding period will increase the future value of a given sum.

True

As the time to maturity​ increases, the maturity premium increases

True

Capital structure refers to the financing of long-term investment

True

Financial decisions can be difficult because the cost of investments can be estimated with greater confidence than future payoffs.

True

If the issuing company becomes​ insolvent, the claims of the bondholders are honored before those of preferred stockholders.

True

Long−term government bonds are not without maturity risk.

True

Mutual Funds and ETFs provide the investor a chance to diversify without having to buy shares in numerous corporations.

True

The difference between mutual funds and ETFs is that ETFs are traded on exchanges and mutual funds are not.

True

The higher costs affect firms that use large amounts of debt (incur higher interest expense)

True

The life of a corporation is not dependent upon the status of the investor

True

The loan is more attractive if it offers a lower EAR.

True

The purpose of financial markets is to bring savers and borrowers together

True

All of the following operate as financial intermediaries EXCEPT: US Treasury Mutual funds Insurance companies Commercial banks

US Treasury

S&P 500

Weighted Average of 500 largest companies (larger stocks have more weight)

Seasoned Equity Offering (SEO)

When a corporation that already has stock outstanding issues more stock

Agency problem

When managers have little or no ownership in the​ firm, they are less likely to work energetically for the​ company's shareholders

Primary market

Where securities are sold by a corporation or govt. to the public (or individual)

annuity

a series of equal regular deposits; assuming cash flows occur at the end of the period

Balance Sheet

a statement of the assets, liabilities, and stockholder's equity

3 questions addressed by the study of finance

a. What​ long-term investments should the firm undertake​ (capital budgeting​ decisions)? b. How should the firm raise money to fund new investments​ (capital structure​ decisions)? c. How can the firm best manage its cash flows as they arise in its​ day-to-day operations​ (working capital management​ decisions)?

beginning of each year

annuity due PV *(1+i)

In finance, we assume investors are _____ to risk.

averse

annuities due

cash flow occurs are the beginning of each period ANS*(1+i)

ICONV

converts nominal to APY

Current ratio

current assets /current liabilities

Yield curve

graphical relationship between interest rates and risks held constant

Current yield

interest paid / price of bond

MBS

mortgage backed securities

Springfield Learning sold zero coupon bonds​ (bonds that​ don't pay any​ interest, instead the bondholder gets just one​ payment, coming when the bond​ matures, from the​ issuer) and received $900 for each bond that will pay $20,000 when it matures in 30 years. Find rate

n= 30 i/y = solve pmt= 0 pv= -900 fv= 2000

A private equity firm is a financial intermediary that invests in securities that are...

not traded on the public capital markets.

Price Earnings Ratio (PE ratio)

ratio of the stock's price to the stock's earnings (price/earnings); how much people are willing to pay

Interest on corporate bonds is typically paid

semiannually

The yield on a corporate bond with a 20 year maturity would include

the risk−free rate plus a default risk​ premium, a liquidity risk premium and a maturity risk premium.

Yield spread

the difference in yield between a non-Treasury bond and the yield on the Treasury bond (spread gives you idea of how much risk your bond holds; treasury bonds have no risk bc gov will pay it back)

Assuming two investments have equal​ lives, a high discount rate tends to favor

the investment with large cash flow EARLY

The longer the maturity of the bond...

the more it fluctuates

Debt Ratio

total liabilities/total assets