Finance 380 Chapter 4&8

Falls

If interest rates rise, then the value of the bond

Below

If the stock market is reasonably efficient, differences between the stock price and intrinsic value should not be very large and they should not persist for very long. When investing in common stocks, an investor's goal is to purchase stocks that are undervalued (the price is the stock's intrinsic value) and avoid stocks that are overvalued.

Premium

A bond is one that sells above its par value. This situation occurs whenever the going rate of interest is below the coupon rate.

Discount

A bond is one that sells below its par value. This situation occurs whenever the going rate of interest is above the coupon rate.

Above

A company is more likely to call its bonds if they are able to replace their current high-coupon debt with less expensive financing. A bond is more likely to be called if its price is par—because this means that the going market interest rate is less than its coupon rate.

Call

A provision gives the issuer the right to redeem the bonds under specified terms prior to their normal maturity date, although not all bonds have this provision.

$22.5

Carlysle Corporation has perpetual preferred stock outstanding that pays a constant annual dividend of $1.80 at the end of each year. If investors require an 8% return on the preferred stock, what is the price of the firm's perpetual preferred stock? Round your answer to the nearest cent. Do not round intermediate calculations.

are not

Common stock dividends specified by contract—they depend on the firm's earnings

Ownership

Common stock represents the position in a firm

Inverse

For fixed-rate bonds it's important to realize that the value of the bond has a(n) relationship to the level of interest rates

$29.47

Hubbard Industries just paid a common dividend, D0, of $1.70. It expects to grow at a constant rate of 4% per year. If investors require a 10% return on equity, what is the current price of Hubbard's common stock? Round your answer to the nearest cent. Do not round intermediate calculations.

$929.76

Potter Industries has a bond issue outstanding with an annual coupon of 6% and a 10-year maturity. The par value of the bond is $1,000. If the going annual interest rate is 7%, what is the value of the bond? Round your answer to the nearest cent. Do not round intermediate calculations.

Less

Real assets are generally liquid than financial assets, but different financial assets vary in their liquidity

Rises

if interest rates fall, then the value of the bond

Principal, Less

Although investing in short-term T-bills preserves one's , the interest income provided by short-term T-bills is stable than the interest income on long-term bonds.

More

Assets with higher trading volume are generally liquid.

$44.87

Assume today is December 31, 2013. Imagine Works Inc. just paid a dividend of $1.35 per share at the end of 2013. The dividend is expected to grow at 18% per year for 3 years, after which time it is expected to grow at a constant rate of 6% annually. The company's cost of equity (rs) is 10%. Using the dividend growth model (allowing for nonconstant growth), what should be the price of the company's stock today (December 31, 2013)? Round your answer to the nearest cent. Do not round intermediate calculations.

Interest

Because interest rates can and do occasionally rise, all long-term bonds, even Treasury bonds, have an element of risk called rate risk

Safer

Because sinking fund provisions facilitate their orderly retirement, bonds with these provisions are regarded as being

Lower

Because sinking fund provisions facilitate their orderly retirement, bonds with these provisions are regarded as being Safer so they will have coupon rates than similar bonds without these provisions.

Floating

Bonds can be Fixed rate bonds with a constant coupon rate over the life of the bond, or they can be rate bonds with a coupon rate that varies over time depending on the level of interest rates.

Fixed

Bonds can be rate bonds with a constant coupon rate over the life of the bond,

Fixed Assets

Mortgage bonds are backed by . First mortgage bonds are senior in priority to claims of second mortgage bonds. Debentures are long-term bonds that are not secured by a mortgage. Subordinated debentures are bonds having claims on assets only after senior debt has been paid in full in the event of liquidation

Increase

Over time its value will approaching its maturity value at maturity

Decrease

Over time its value will approaching its maturity value at maturity. A par value bond is one that sells at par; the bond's coupon rate is equal to the going rate of interest. Normally, the coupon rate is set at the going market rate the day a bond is issued so it sells at par initially.

$928.94

Potter Industries has a bond issue outstanding with a 6% coupon rate with semiannual payments of $30, and a 10-year maturity. The par value of the bond is $1,000. If the going annual interest rate is 7%, what is the value of the bond? Round your answer to the nearest cent. Do not round intermediate calculations.

Par

The value of a bond is its stated face value or maturity value, and its coupon interest rate is the stated annual interest rate on the bond. The maturity date is the date on which the par value must be repaid.

Sinking Funds

Some bonds have provisions which require the issuer to systematically retire a portion of the bond issue each year.

Larger

The average default risk premium varies over time, and it tends to get when the economy is weaker and borrowers are more likely to have a hard time paying off their debts.

Nominal

The interest rate on debt, r, is also equal to the risk-free rate plus a default risk premium plus a liquidity premium plus a maturity risk premium.

Free Cash Flows

The model is an alternative model used to value a firm, especially one that does not pay dividends or is privately held.

Dividend Growth

The model values a common stock as the present value of its expected future cash flows at the firm's required rate of return on equity. Variations of this model are used to value constant growth stocks, zero growth stocks, and nonconstant growth stocks.

Decline

The prices of long-term bonds whenever interest rates rise

Short-term

The real risk-free rate of interest may be thought of as the interest rate on U.S. Treasury securities in an inflation-free world.

Greater

The the bond's risk of default, the higher the market rate.

Equal to

The value of a share of common stock depends on the cash flows it is expected to provide, and those flows consist of the dividends the investor receives each year while holding the stock and the price the investor receives when the stock is sold. The final price includes the original price paid plus an expected capital gain. The actions of the marginal investor determine the equilibrium stock price. Market equilibrium occurs when the stock's price is its intrinsic value.

Maturity

Therefore, a risk premium, which is higher the longer the term of the bond, is included in the required interest rate.

D. There are actually two differences between the discounted dividend and corporate valuation models: the expected cash flow stream and the discount rate used in the models are different. The discounted dividend model calculates the firm's stock price as the present value of the expected future dividends at the firm's required rate of return on equity, while the corporate valuation model calculates the firm's stock price as the present value of the expected free cash flows at the firm's weighted average cost of equity.

Which of the following statements is correct? A. The only difference between the discounted dividend and corporate valuation models is the expected cash flow stream. Expected future dividends are the cash flow stream in the discounted dividend model and expected free cash flows are the cash flow stream in the corporate valuation model. Both models use the same discount rate to calculate the present value of the cash flow stream. B. The discounted dividend model is especially suited for valuing companies that are privately held. C. The only difference between the discounted dividend and corporate valuation models is the discount rate used to calculate the present value of the cash flow stream. The discount rate used in the discounted dividend model is the firm's required rate of return on equity, while the discount rate used in the corporate valuation model is the firm's weighted average cost of capital. Both models use the same expected cash flow stream in the discounting process. D. There are actually two differences between the discounted dividend and corporate valuation models: the expected cash flow stream and the discount rate used in the models are different. The discounted dividend model calculates the firm's stock price as the present value of the expected future dividends at the firm's required rate of return on equity, while the corporate valuation model calculates the firm's stock price as the present value of the expected free cash flows at the firm's weighted average cost of equity.

Interest, Reinvestment

While long-term bonds are heavily exposed to rate risk, short-term bills are heavily exposed to risk

Dividend

and is valued as the present value of its expected future stream.

Convertible

bonds are exchangeable at the option of the holder for the issuing firm's common stock. Bonds can be issued with warrants giving the holder the option to purchase the firm's stock for a stated price, thereby providing a capital gain if the stock's price rises

Investment Grade

bonds are rated triple B or higher, and many banks and other institutional investors are legally limited to only holding these bonds. In contrast, junk bonds are high-risk, high-yield bonds.

Putable

bonds contain a provision that allows holders to sell them back to the company prior to maturity at a prearranged price.

Income

bonds pay interest only if the firm has earnings, while an indexed (purchasing power) bond bases interest payments on an inflation index to protect the holder from inflation.

Zero Coupon

bonds pay no annual interest but are sold at a discount below par, thus compensating investors in the form of capital appreciation.