FINC Exam 2
Technical Analysts
1. Investors who attempt to identify undervalued stocks by searching for patterns in past stock prices. 2. Forecast stock prices based on the fluctuations in historical prices ("wiggle watchers")
Term Structure of Interest Rates
A listing of bond maturity dates and the interest rates that correspond with each date
Perpetuity
A stream of level cash payments - starting next period - that never ends.
Constant Growth DDM
A version of the DDM in which dividends grow at a constant rate (a/k/a Gordon Growth Model).
Current Yield (loser)
Annual coupon payment divided by the bond price
Coupon Rate
Annual interest payment, as a percentage of face value
Junk bonds
Bond with a rating below Baa or BBB
Investment grade
Bonds rated Baa or above (Moody's) or BBB or above by S&P
Blue Skies just paid a $3.00 dividend. Blue skies investors require a 12.0% return on investments of comparable risk, and they anticipate dividends to increase at 4.0% forever. What is an appropriate price for Blue Skies' stock?
DIV1 = DIVo (1+g) Po= DIV1 / r - g
Yield to Maturity (YTM) winner/ interest rate synonym
Discount rate for which the present value of the bond's payments equals the price.
Dividend Discount Model (DDM)
Discounted CF model which states that today's stock price equals the present value of all expected future dividends
Rate of Return
Earnings per period per dollar invested
Annuity
Equally spaced level stream of cash flows - starting next period - for a limited period of time.
You deposit $125 into an account which pays 6.5% per year for the first two years. However, the rate of interest drops to 3.5% thereafter. What is the value of your investment five years from today (assume annual compounding)?
FV2 = 125 (1.065)2 FV5 = 141.7781 (1.035)3
Market Value Balance Sheet
Financial statement that uses market value of all assets and liabilities
Initial Public Offering (IPO)
First offering of stock to the general public
Payout Ratio
Fraction of earnings paid out as dividends
Plowback Ratio
Fraction of earnings retained by the firm
How many years will it take $1 million to grow to $4 million with an annual interest rate of 7%?
I/Y= 7 PV= -1 PMT= 0 FV= 4 N= ? 20.49
Annual Percentage Rate (APR)
IR that is annualized using SIMPLE interest
Effective Annual Interest Rate (EAR)
IR that is annualized using compound interest
Discount Rate
Interest rate used to compute present values of future cash flows
Ten years ago, Jane invested $1,000 and locked in an 8% annual interest rate for 30 years (ending 20 years from now). James can make a 20 year investment today and lock in a 7% interest rate. How much money should be invested now in order to have the same amount off money in 20 years as Jane?
Jane N= 30 I/Y= 8 PV= -1000 PMT= 0 FV= ? 10,062.66 James N= 20 I/Y= 7 PMT= 0 FV= 10,062.66 PV= ? 2,600.38
Annuity Due
Level stream of cash flows starting immediately
Efficient Market
Market in which prices reflect all available information
Discounted Cash Flow (DCF)
Method of calculating PV by discounting future cash flows
A 10-year maturity bond with a face value of $1,000 makes annual coupon payments and has a coupon rate of 8.0% what is the bond's YTM if the bond is selling for $900?
N= 10 PV= -900 PMT= 80 FV= 1000 I/Y= ? 9.60%
A 9.0% coupon bond with 10 years left to maturity is offered for sale at $1,017.20. What yield to maturity is the bond offering? Assume interest payments are paid semi-annually
N= 20 PV= -1017.20 PMT= 45 FV= 1000 YTM= ? 4.3693 x 2
What is the price of a 30-year 10% annual coupon bond with a $1,000 face value that offers a yield to maturity of 10%?
N= 30 I/Y= 10 PMT= 100 FV= 1,000 PV= ? 1,000
What is the price of a 30-year 10% annual coupon bond with a $1,000 face value that offers a yield to maturity of 12.5%?
N= 30 I/Y= 12.5 PMT= 100 FV= 1000 PV= ? 805.84
What is the price of a 30-year 10% annual coupon bond with a $1,000 face value that offers a yield to maturity of 8.5%?
N= 30 I/Y= 8.5 PMT= 100 FV= 1,000 PV= ? 1,161.20
With an interest rate of 7%, what is the present value of $500 received four years from today?
N= 4 I/y= 7 PMT= 0 FV= 500 PV= ? 381.45
You have $1,000 in an account which pays 6% ANNUAL compound interest. How many ADDITIONAL dollars of interest do you earn over a four-year period if you moved the money to an account earning 8%?
N= 4 N= 4 I/Y=8 I/Y= 6 PV= -1000 PV= -1000 PMT= 0 PMT= 0 FV= ?1360.49 FV= ?1262.48
You need to borrow $20,000 to purchase a new truck. The current loan rate is 7.7% compounded MONTHLY. You decide that you want to pay the loan off in equal monthly payments over 4 years. What is the size of your monthly payment?
N= 4*12= 48 I/Y= 7.7/12= .6417 PV= -20,000 FV = 0 PMT= ? 485.45
How much would be in your savings account in 5 years after depositing $1,200 today if the bank pays 4% interest per year?
N= 5 I/Y= 4 PV= -1,200 PMT= 0 FV= ? 1,459.98
What is the YTM of a 10.0% semi-annual coupon with $1,000 par value, which matures in 3 years? Assume the current market price of the bond is $1,081.95
N= 6 PV= -1081.95 PMT= 50 FV= 1000 YTM= ? 3.46x2
What annual rate of return is earned on a $5,000 investment when it grows to $7,000 in eight years?
N= 8 PV= -5000 PMT= 0 FV= 7000 I/Y= ? 4.3%
What is the value of a bond that has a par value of $1,000, a coupon rate of 6.0% (semi-annually), and matures in 10 years? Assume an interest rate of 5.50%.
N=20 I/Y= 2.75 PMT= 30 FV= 1000 PV= ? 1038.07
Liquidation Value
Net proceeds that could be realized by selling the firm's assets and paying off it's creditors
Book Value
Net worth of the firm according to the balance sheet
What is the present value of a 30 year annuity of $1,100 each year if your required return is 12%?
PVa = c/r [ 1 - 1/(1+r)t ]
If the present value of an ordinary, 5-year annuity is $6,000 and interest rates are 10%, what's the present value of the same annuity due?
PVann (1+r)
What is the present value of a $1,100 perpetual cash flow if your required return is 12%?
PVp = c / r
Face Value (Par Value or Principal Value)
Payment at the maturity of the bond
Dividend
Periodic cash distribution from the firm to the shareholders
Yield Curve
Plot of relationship between bond YTMs and time ton maturity
What is the price of a stock with an expected dividend and price next year of $0.16 and $60 respectively? Use a 12% discount rate.
Po= DIV1 + P1 / (1+r)t
Financial analysts forecast Bearkat Stores, Inc (NYSE: BKS) growth for the future to be 8%. Their recent annual dividend was $0.83. What is the value of their stock when the investors require a rate of return of 12%
Po= DIV1 / r - g
Discount Factor (DF)
Present value of a $1 future payment
Nominal Interest Rate
Rate at which money invested grows
Seasoned Issue
Sale of new shares by a firm that has already been through an IPO
Present Value (PV)
Value today of a future cash flow
Compound interest
interest earned in interest
Simple Interest
interest earned only on the original investment
Primary Market
market for the sale of new securities by corporations
Secondary Market
market in which previously issued securities are traded among investors
PVGO
net present value of a firm's future investments
Common Stock
ownership shares in a publicly held corporation
Bearkat Stores, Inc. (NYSE: BKS) stock is currently selling for $23.00. The firm is expected to pay a dividend of $2.75 one year from now. Dividends are expected to grow at a constant rate of 4% indefinitely. Compute the required rate of return for BKS stock.
r = (DIV1 / Po) + g
Inflation
rate at which prices as a whole are increasing
Real Interest Rate
rate at which the purchasing power of an investment increases
P/E Ratio
ratio of stock price to earnings per share
Bond
security that obligates the issuer to make specified payments to the bondholder
You just bought a new computer for $5,000. The payment terms are 3 years same as cash. If you can earn 6% on your money, how much should you set aside today in order to make the payment when due in three years
PV= FV / (1+r)t
What is the present value of the following set of cash flows at an interest rate of 9%: $1,000 today, 2,000 at the end of year one, 4,000 at the end of year three, and 6,000 at the end of year five?
PV= C0 + + C1/(1+r ) + C2/(1+r)t + C3/(1+r)t
Your auto dealer gives you the choice to pay $19,999 cash now, or make three payments: $10,000 now, $7,000 at the end of year one, and $4,000 at the end of year two. If your cost of money is 8%, what is the PV of the installment plan?
PV= C0 + C1/(1+r ) + C2/(1+r)t 19,910.84 < 19,999
What is the total PRESENT value of $50 received in one year, $250 received in two years, and $900 received in six years if the discount rate is 8%
PV= C0 + C1/(1+r ) + C2/(1+r)t + C6/(1+r)t
You are scheduled to receive an $800 cash flow in one year, $800 cash flow in two years, and pay a $1,000 payment in three years. If interest rates are 7% per year, what is the combined present value of these cash flows?
PV= C0 + C1/(1+r ) + C2/(1+r)t - C3/(1+r)t
default premium
The additional yield on a bond that investors require for credit risk
Sustainable Growth Rate (g)
The firm's growth rate if it plows back a constant fraction of earnings, maintains a constant ROE, and keeps its debt ratio constant
Coupon
The interest payments made to the bondholder
Expected Return
The percentage yield that an investor forecasts from a specific investment over a set period of time. Sometimes called the holding period return (HPR)
PV Annuity Factor
The present value of $1 a year for each of t years
Ask Price
The price at which current shareholders are willing to sell their shares
Bid Price
The price at which investors are willing to buy shares
Default or Credit Risk
The risk that a bond issuer may default on its bonds
Future Value (FV)
amount to which an investment will grow after earning interest