Finance Exam 2 (chapter 7,8)
Par Value
Face value, maturity value, principal value, future value, default=$1,000. - Principal amount of a bond that is repaid at the end of the term
Bert owns a bond that will pay him $75 each year in interest plus a $1,000 principal payment at maturity. What is the $1,000 called?
Face value.
Emst & Frank stock is listed on NASDAQ. The firm is planning to issue some new equity shares for sale to the general public. This sale will definitely occur in which one of the following markets?
Primary
Coupon Rate
The annual coupon divided by the face value of a bond
Call Provision
An agreement giving the corporation the option to repurchase a bond at a specified price prior to maturity
If R increases prices decreases then...
(recall inverse relationship between discount rates and prices)
Municipal Securities
- Debt of state and local governments - Varying degrees of default risk, rated similar to corporate debt - Interest received is tax-exempt at the federal level - Much lower yields than taxable bonds
Features of a bond
- Par Value - Maturity Data - Coupon Rate - Coupon Payment - Yield or Yield to Maturity
Other Rights of Common Stock
- Share proportionally in declared dividends - Share proportionally in remaining assets during liquidation - Preemptive Right: first shot at a new stock issue to maintain proportional ownership if desired
Government Bonds
- Treasure Security - Municipal Security
Features of Common Stock
- Voting Rights - Proxy Voting - Classes of Stock - Other Rights
Fisher Effect
- emphasizes the effects of inflation on an investor's rate of return - r = R - h <- note inflation decreases the real rate of interest - Defines the relationship between real rates, nominal rates, and inflation
Nominal vs Real Rates
-Nominal have not been adjusted for inflation. -Real rates have been adjusted for inflation
Difference between Debt and Equity
1. Debt is not an ownership interest in the firm. Creditors generally do not have voting power 2. The corporation's payment of interest on debt is considered a cost of doing business and is fully tax deductible. Dividends paid to stockholders are not tax deductible 3. Unpaid debt is a liability of the firm.
Drawbacks to bearer bonds:
1. They are difficult to recover if they are lost or stolen 2. Because the company does not know who owns its bonds, it cannot notify bondholders of important events (now less common than registered bonds)
Zero Coupon Bonds
A bond that pays no coupons at all must be offered at a price that is much lower than its stated value
What is a bond?
A contract between two parties; one is the investor (you) the other is a company or government agency (like a municipal bond) Contains 3 Key Elements: - The par value (usually $1,000) - The length of time (often 10-20) - A coupon interest rate
Answer this question based on the dividend growth model. If you expect the market rate of return to increase across the board on all equity securities, then you should also expect:
A decrease in all stock values.
Protective Covenant
A part of the indenture limiting certain actions that might be taken during the term of the loan, usually to protect the lender's interest
Note
An unsecured debt, usually with a maturity under 10 years
Target Stock Price
Benchmark PEx Current EPS
Bid vs Ask Price
Bid: What the dealer is willing to pay for a security Ask: what the dealer is willing to take for it (difference is bid-ask spread)
Structured Notes
Bonds that are based on stocks, bonds, commodities, or currencies
An agent who arranges a transaction between a buyer and a seller of equity securities is called a:
Broker
Clean Price vs Dirty Price
Clean: the quoted price Dirty:(what you actually pay) Includes the accrued interest, the full or invoice price
Common Stock vs Preferred Stock
Common Stock: Equity without priority for dividends or in bankruptcy Preferred stockholders generally do not have voting rights, as common stockholders do, but they have a greater claim to the company's assets. Preferred stock shareholders receive their dividends before common stockholders receive theirs, and these payments tend to be higher.
Level Coupon Bond
Constand and paid every year
Convertible vs Non-Convertible Bond
Convertible Bonds: can be swapped for a fixed number of shares anytime before maturity at the holder's option Nonconvertible debentures are unsecured bonds that cannot be converted to company equity or stock. Nonconvertible debentures usually have higher interest rates than convertible debentures
Callable vs Non-Callable Bond
Corporate bonds are usually callable. Allows company to repurchase part or all of the bond issue at stated prices over a specific period
Coupon Payment
Coupon Rate x Face Value Fixed; stock dividends changed or "grow" overtime
Which one of the following applies to a premium bond?
Coupon rate > current yield > yield to maturity.
Allison just received her semiannual payment of $35 on a bond she owns. Which term refers to this payment?
Coupon.
Creditor/Lender vs Debtor/Borrower
Creditor/Lender: Person or firm making the loan Debtor/Borrower: Corporation borrowing the money
Voting Rights
Cumulative Voting: A procedure in which a shareholder may cast all votes for one member of the board of directors Straight Voting: A procedure in which a shareholder may cast all votes for each member of the board of directors
A decrease in which of the following will increase the current value of a stock according to the dividend growth model?
Discount Rate
What is the model called that determines the present value of a stock based on its next annual dividend, the dividend growth rate, and the applicable discount rate?
Dividend growth.
Which one of the following statements is correct? A. Stocks can only be assigned one dividend growth rate. B. Preferred stocks generally have constant growth rates. C. Dividend growth rates must be either zero or positive. D. All stocks can be valued using the dividend discount models. E. Stocks can have negative growth rates.
E. Stocks can have negative growth rates.
Price of any asset
EQUALS present value of the asset's expected future cash flows, thus: Price of bond= PV of Coupon Payments+PV of Par Value Price stock=PV of future dividends
Which one of the following applies to the dividend growth model?
Even if the dividend amount and growth rate remain constant, the value of a stock can vary.
Interest Rate Risk
How much interest rate a bond has depends on how sensitive its price is to interest rate changes. Sensitivity depends on time to maturity and coupon rate. - The longer the time to maturity the greater the interest rate risk - The lower the coupon rate the greater the interest rate risk
Premium Bond
If YTM<Coupon Rate, then FV<PV
Par Value Bond
If YTM=Coupon rate, then FV=PV
Discount Bond
If YTM>Coupon Rate, then FV>PV
As a bond's time to maturity increases, the bond's sensitivity to interest rate risk:
Increases at a decreasing rate.
Inverse relationship between bond prices and discount rate
Price Risk Fluctuations in realised yield caused by capital gains and losses constitute price risk!
Indenture vs Debenture
Indenture: Is the underlying contract between the company issuing bonds and the bondholders. Generally includes: 1. Basic terms of bonds 2. The total amount of bonds issued 3. A description of property used as security 4. The repayment arrangements 5. The call provisions 6. Details of the protective covenants Debenture: Bonds issued on the basis of the general credit of the corporation are called debenture bonds. (debt securities)
Seniority
Indicates preference in position over other lenders
Default or Credit Risk
Likelihood that bond issuer may not meet its obligations. Measured using Bond ratings
National Trucking has paid an annual dividend of $1 per share on its common stock for the past 15 years and is expected to continue paying a dollar a share long into the future. Given this, one share of the firm's stock is:
Priced the same as a $1 perpetuity.
The current yield is defined as the annual interest on a bond divided by which one of the following?
Market price.
Using calculator to find price of bond with semiannual coupon payments
N= # of years bond has to mature ( X2) I/Y= the bond yield to maturity (divided by 2) PV= COMPUTE Pmt= bonds coupon (coupon rate x FV)/2 FV= 1,000 unless specified other
Using Calculator to find the price of a bond with annual coupon payments
N= # of years bond has to mature I/Y= the bond yield to maturity PV= COMPUTE Pmt= bonds coupon (coupon rate x FV) FV= 1,000 unless specified other
Finding coupon rate with annual coupons
N= # of years bond has to maturity I/Y= Bonds Yield to Maturity PV= Price of the bond (negative #) PMT= COMPUTE (divide # by fv to get coupon rate) FV= 1,000 unless specified other (positive #)
Using calculator to find YTM of bond with annual coupon payments
N= # of years until maturity I/Y= COMPUTE PV= price of bond (negative #) PMT= Bonds Coupon (positive #) (coupon rate X future value) FV= 1,000 unless specified other (positive #)
Using calculator to find yield to maturity of bond with semiannual coupon payments
N= # of years until maturity (X2) I/Y= COMPUTE (then X2) PV= price of bond (negative #) PMT= Bonds Coupon (positive #) (coupon rate X future value)/2 FV= 1,000 unless specified other (positive #)
Finding coupon rate with semiannual coupons
N= # years bond has to mature (x2) I/Y= Bonds Yield to Maturity (/2) PV= Price of the bond (negative #) PMT= COMPUTE (X2) then /by fv to get cpn rate) FV= 1,000 unless specified other (positive #)
Yield curve is a plot of YTM against maturity of bond
Normal Yield Curve is upward sloping. • Long-term yields are higher than short term yields Inverted yield curve is downward sloping • Long-term yields are lower than short-term yields
Maturity
Number of years until face value is paid
Blanket Mortgage
Pledges all the real property owned by the company
Which one of the following is a type of equity security that has a fixed dividend and a priority status over other equity securities?
Preferred stock.
Classes of Stock
Primary reasons for creating dual or multiple classes of stock has to do with control of the firm. If such stock exists, management of a firm can raise equity capital by issuing non-voting or limited-voting stock while maintaining control
Inflation
Rate at which prices in general are increasing in the economy. Erodes the purchasing power of savings
Real Interest Rate
Rate at which purchasing power of savings grow
Nominal Interest Rates
Rate at which savings grow
Which one of the following rates represents the change, if any, in your purchasing power as a result of owning a bond?
Real rate.
The Fisher effect is defined as the relationship between which of the following variables?
Real rates, inflation rates, and nominal rates
A decrease in which of the following will increase the current value of stock according to the dividend growth model?
Required Rate of Return
The constant dividend growth model:
Requires the growth rate to be less than the required return.
Hardy Lumber has a capital structure that includes bonds, preferred stock, and common stock. Which one of the following rights is most apt to be granted to the preferred shareholders?
Right to share in company profits prior to other shareholders.
Mortgage Securities
Secured by a mortgage on the real property of the borrower. i.e. usually involved in real estate
Secured Bond vs Debenture
Secured: Bond that is secured by the issuer's pledge of a specific asset, which is a form of collateral on the loan. In the event of a default, the bond issuer passes title of the asset onto the bondholders. Debenture: A unsecured debt, usually with a maturity of 10 years or more
Bond With vs Bonds Without Sinking Fund
Sinking Fund: An account managed by the bond trustee for early redemption (Early repayment) Bonds that are repaid at maturity; will receive the stated or face, value of the bond
Coupon
Stated interest payment made on a bond
Floating Rate Bonds
The coupon payments are adjustable. the adjustments are ties to an interest rate index such as the Treasury Bill interest rate of the 30-year Treasury bond rate
Debt ratings are an assessment of what?
The creditworthiness of the corporate issuer
Proxy Voting
The grant of authority by a shareholder to someone else to vote his or her shares
Bond ratings are concerned with only what?
The possibility of default
Yield or Yield to Maturity
The rate required in the market on a bond
Maturity Data
The specified date on which the principal amount of a bond is paid
The largest securities market in the world in terms of trading volume
U.S Treasury Market
When does a bond occur?
When a corporation or government wishes to borrow money from the public on a long-term basis, it usually does so by issuing or selling debt securities that are bonds. - Normally interest only bond; pay interest every period but none of the principal will be repaid until end of loan
A bond has a market price that exceeds its face value. Which one of these features currently applies to this bond?
Yield to maturity less than the coupon rate.
A bond that has only one payment, which occurs at maturity, defines which one of these types of bonds?
Zero coupon.
All else constant, a bond will sell at _____ when the coupon rate is _____ the yield to maturity.
a discount; less than
Brand values depend on...
interest rate
Brand price and interest rates always move in what direction
opposite
If g increases then...
price increases g= capital gains yield
Dividends are expected to increase then...
price will increase
Collateral
securities that are pledged as security for payment of debt. i.e. Collateral trust bonds often involve a pledge of common stock held by the corporation
Cash flow from the bond stays the same while
value of the bond fluctuates
Treasury Security
• Federal government debt • T-bills: max maturity of 1 year, pay no coupons, pure discount bond • T-notes: original maturity between 1 to 10 years, pays coupons • T-bond: original maturity greater than 10 years, pays coupons