Ch 6 & 7

NASDAQ

has a multiple market maker system and a computer network of securities dealers

when talking about stocks

remember that this represents owners equity. variety of classes of stock, all with different voting rights. voting can be cumulative or straight. with cumulative voting - all of the directors are elected at the same time, which gives minority stockholders a better chance of acquiring a seat

primary

shares of stock are first brought to the market and sold to investors in the ____ market

net present value NPV

take the discounted cash flows, add them together, then subtract the cost of the project. you prefer the option with the greatest positive NPV or the smallest negative solution if there are no positive outcomes some problems: ignores the size of the projects being compared. may run into a problem with duration as well.

treasury notes treasury bonds

the US government borrows money by issuing

a real rate of return

1. it is a percentage change in buying power. an inflation rate measures changes in buying power 2. it is a rate of return that has been adjusted for inflation

the 4 variables that are required to calculate the value of a bond:

1. par value 2. yield to maturity 3. time remaining to maturity 4. coupon rate

preferred stock has preference over common stock in the

1. payment of dividends 2. distribution of corporate assets

true of debt and equity :

1. the maximum reward for owning debt is fixed 2. equity represents an ownership interest.

the ratios that might be used to estimate the value of a stock

1. the price / sales ratio 2. the price / earnings ratio

the term structure of interest rates describes:

1. the relationship between nominal rates and time to maturity 2. the pure time value of money

call provision

a provision in the bond indenture giving the issuing company the option to repurchase the bonds before maturity

constant growth model

the constant growth model can be used to value the stock of firms that have dividends that are either constant or change annually at a constant rate

order flow

the fundamental business of the new york stock exchange is to attract ___

market interest rate fluctuations

the most important source of risk from owning bonds is

inflation premium

the portion of a nominal interest rate that represents compensation for future expected inflation

term structure of interest rates

the relationship between short and long term interest rates on default free, pure discount securities and time to maturity; that is, the pure time value of money. the term structure of interest rates tells us what NOMINAL interest rates are on DEFAULT-free, Pure Discount bonds of all maturities. these rates are "pure" interest rates because they involve no risk of default and a single, lump sum future payment. the term structure tells us the pure time value of money for different lengths of time

non-constant

the type of growth that describes a company that grows quickly at first, then slower in future years

growth

the value of a firm is a function of its ____ rate and its discount rate

indenture

the written agreement that contains the specific details related to a bond issue i

greater

the yield to maturity on a discount bond is _______ than both the current yield and the coupon rate

bearer form bond

this means the certificate is the basic evidence of ownership, and the corporation will "pay the bearer". ownership is not recorded otherwise.

long term debt securities

ultimately, all long-term debt securities are promises made by the issuing firm to pay principal when due and to make timely interest payments on the unpaid balance.

target price

using a benchmark PE ratio against current earnings yields a forecasted price called a ___

upward

when long term rates are higher than short term rates, the term structure of interest rates will have a _____ sloping shape

lower than

when using trial and error to compute the yield to maturity for a 6% coupon bond that trades at a premium, the process can be shortened if the initial guess is _____ 6%

dividend

when valuing a stock using the constant-growth model, D1 represents the next expected annual ______ .

profitability index

will tell us whether one project is preferred over the other just because of size takes the size / cost of the project out of the equation 1 + anything means that the return is greater than the cost

net present value

(1) NPV is always just the difference between the market value of an asset or project and its cost, and (2) the financial manager acts in the shareholders' best interests by identifying and taking positive NPV projects. cant be observed in the market, so we have to make estimates

$ 12.16

Healthy Foods just paid its annual dividend of $1.62 a share. The firm recently announced that all future dividends will be increased by 2.1 percent annually. What is one share of this stock worth to you if you require a rate of return of 15.7 percent?

current yield

a bond's annual coupon payment divided by its closing price

registered form bond

corporate bonds are usually in this form. it means that the company has a registrar who will record the ownership of each bond and record any changes in ownership. the company will pay the interest and principal directly to the owner of record.

long-term debt

has maturities greater than one year

nominal rate

have not been adjusted for inflation

higher

historical data suggests that sometimes short-term rates are higher and sometimes long-term rates are ___

yield to maturity (YTM)

the interest rate required in the market on a bond

rights of common stock holders

the right to share proportionally in any common dividends paid the right to vote on matters of importance the right to share proportionally in any residual value in the event of liquidation

dividend growth rate

the second part of the total return is the growth rate, g. dividend growth rate is also the rate at which the stock price grows..... so the growth rate can be seen as the capital gains yield, which is the rate at which the value of the investment grows

time to maturity and coupon rate

the sensitivity of a bonds price to interest rate changes is dependent on....

coupon

the stated interest payment made on a bond. a fixed amount of interest that is paid annually or semiannually by the issuer of its bondholders.

level coupon bond

the type of bond that has a coupon that is constant and paid every year

senior

the type of debt that is given preference in the event of default

preferred stock

"has preference" over common stock in case of bankruptcy, but typically has no voting rights. Has some characteristics of debt, a fixed return that may have to be paid before common dividends (and may be cumulative)

Proxy

Kate could not attend the last shareholders' meeting and thus she granted the authority to vote on her behalf to the managers of the firm. Which term applies to this granting of authority?

Dividends that are either constant or change annually at a constant rate

The constant growth model can be used to value the stock of firms that have which type(s) of dividends?

next years expected dividend divided by the current market price per share

The dividend yield is defined as:

yield to maturity

The market-required rate of return on a bond that is held for its entire life is called the:

$ 0.78

Triad common stock is selling for $27.80 a share and has a dividend yield of 2.8 percent. What is the dividend amount?

the bond must be priced at par

What condition must exist if a bond's coupon rate is to equal both the bond's current yield and its yield to maturity? Assume the market rate of interest for this bond is positive.

face value

What is the principal amount of a bond that is repaid at the end of the loan term called?

debenture

an unsecured bond, for which no specific pledge of property is made, usually with 10 years of maturity or more

interest rate risk

the risk that arises for bond owners from fluctuating interest rates

required rate of return

The required rate of return on a bond is the interest rate that a bond issuer must offer in order to get investors interested

interest rate risk

The risk that arises for bond owners from fluctuating interest rates is called interest rate risk. How much interest rate risk a bond has depends on how sensitive its price is to interest rate changes 1) All other things being equal, the longer the time to maturity, the greater the interest rate risk. 2) All other things being equal, the lower the coupon rate, the greater the interest rate risk.

indenture

The written agreement that contains the specific details related to a bond issue is called the bond:

premium

a bond that sells for more than face value is known as a premium bond If a 1000 par value bond is trading at a premium, that means the bond is trading for More than 1000 in the market

rating

a bond's ___ reflects the ability of the firm to repay its debt and interest on time

coupon rate vs yield to maturity

A bond's coupon rate is the actual amount of interest income earned on the bond each year based on its face value. A bond's yield to maturity (YTM) is the estimated rate of return based on the assumption it is held until maturity date and not called. Yield to maturity includes the coupon rate within its calculation.

a share of common stock is more difficult to value in practice than a bond...

A share of common stock is more difficult to value in practice than a bond, for at least three reasons. First, with common stock, not even the promised cash flows are known in advance. Second, the life of the investment is essentially forever because common stock has no maturity. Third, there is no way to easily observe the rate of return that the market requires.

$ 903.05

The 4.5 percent bond of JL Motors has a face value of $1,000, a maturity of 7 years, semiannual interest payments, and a yield to maturity of 6.23 percent. What is the current market price of the bond?

4.96 %

The 6 percent semiannual coupon bonds of IPO, Inc., are selling for $1,087. The bonds have a face value of $1,000 and mature in 11 years. What is the yield to maturity?

4.52 %

Sweet Treats pays a constant annual dividend of $2.38 a share and currently sells for $52.60 a share. What is the rate of return?

Treasury yield Curve

The 3 components that influence the treasury yield curve: 1. the interest rate risk premium 2. expected future inflation 3. the real rate of return

note

a term generally used for such instruments if the maturity of the unsecured bond is less than 10 or so years when the bond is originally issued

broker

an agent who arranges security transactions among investors

zero

if the growth rate (g) is zero, the capital gains yield is ___

1. growth rate 2. dividend yield

in the dividend discount model, the expected return for investors comes from 2 sources

payback method

not used very often only used when a rapid rate of return of capital is required does not consider post payback cash flows does not consider the time value of money (but the discounted payback method does somewhat) does not explicitly consider risk the "acceptable" time period is arbitrary

equity..

one reason that corporations try to create a debt security that is really equity is to obtain the tax benefits of debt and the bankruptcy benefits of equity

a face to face auction market and a physical location

the NYSE differs from the NASDAQ primarily because the NYSE has :

dividend

the _______ yield is defined as next years expected dividend, divided by the current market price per share.

original issue price

the _________ of a bond is NOT required to calculate the value of a bond

face value / par value

the amount that will be repaid at the end of the loan. the principal amount of the bond that is paid back.

coupon rate

the annual coupon divided by the face value of the bond

a corporate bond's yield to maturity:

1) changes over time 2) is usually not the same as a bond's coupon rate

terms that apply to a bond:

1) coupon rate 2) time to maturity 3) par value

variables that are required to calculate the value of a bond:

1) remaining life of bond 2) coupon rate 3) market yield to maturity NOT required = original issue price of bond

true of bonds:

1) they are issued by both corporations and governments 2) they are normally interest-only loans

reasons that make valuing a share of stock more difficult than valuing a bond

1. dividends are unknown and uncertain 2. the required rate of return is unobservable 3. stock has no set maturity

the 3 components that determine the shape of the term structure of interest rates

1. inflation premium 2. real interest rate 3. interest rate risk premium

1. constant growth 2. non-constant growth 3. zero growth

3 special case patterns of dividend growth discussed in ch 7 include :

value of a bond

4 variables that are required to calculate the value of a bond: 1. yield to maturity 2. par value 3. time remaining to maturity 4. coupon rate

growing perpetuity

An asset with cash flows that grow at a constant rate forever is called a growing perpetuity.

Ror vs YTM

Both rate of return and yield describe the performance of investments over a set period of time (normally a year), but they have subtle and sometimes important differences. The rate of return is a specific way of expressing the total return of an investment that shows the percentage increase over the initial investment cost. Yield shows how much income has been returned from an investment based on initial cost, but it does not include capital gains in its calculation.

cumulative

Mary owns 100 shares of stock. Each share entitles her to one vote per open seat on the board of directors. Assume there are three open seats in the current election and Mary casts all 300 of her votes for a single candidate. What is the term used to describe this type of voting?

the next expected annual dividend

When valuing a stock using the constant-growth model, D1 represents the:

increase in the capital gains yield

Which one of the following will increase the current value of a stock?

E

Which one of the following will increase the current value of a stock? a) Decrease in the dividend growth rate b) Increase in the required return c) Increase in the market rate of return d) Decrease in the expected dividend for next year e) Increase in the capital gains yield

forward

a PE ratio that is based on esimated future earnings is known as a ____ PE ratio

1. a company's own historical PEs 2. the PEs of similar companies

a benchmark PE ratio can be determined using

discount bond

a bond that sells for less than face value

current yield

a bond's annual coupon divided by its price. it only considers the coupon portion of your return; it doesnt consider the built-in gain from the price discount OR the built-in loss

dividend yield

a stocks expected cash dividend divided by its current price

dealer

an agent who buys and sells securities from inventory

change in interest rates

an investor in the bond market should be concerned about changes in interest rates because changes in interest rates cause changes in bond prices. (par value is set when the bond is issued and does not change during the life of the bond)

annual coupon

annual payment....?

payback approach

answers the question, which project will return my money the quickest

equity

as a general rule, ____ represents an ownership interest, and it is a residual claim. this means that equity holders are paid after debt holders. the risks and benefits associated with owning debt and equity are different.

when interest rates in the market fall,...

bond values will increase because the present value of the bond's remaining cash flows increases

unsecured

bonds are classified based on the collateral provided to protect bondholders in case of default. these are unsecured forms of debt: 1. debentures (in the USA, but not in the UK) 2. Notes

-

how much interest rate risk a bond has depends on how sensitive its price is to interest rate changes. this sensitivity directly depends on 2 things: the time to maturity and the coupon rate. a 1 year bond is less sensitive to interest rate changes than a 30 year bond is

greater than

if a bond is selling at a discount from its par value, the yield to maturity must be greater than the coupon rate. if the yield to maturity is less than the coupon rate, investors are willing to pay more than par value for the bond. if a bond is selling at a discount from its par value, the yield to maturity must be _______ the coupon rate.

the key difference between interest payments and dividends payments is:

interest is tax deductible. dividends are not tax deductible.

sinking fund

is an account managed by the bond trustee for the purpose of repaying bonds. the company makes annual payments to the trustee, who then uses the funds to retire a portion of the debt.

protective covenant

is that part of the indenture or loan agreement that limits certain actions a company might otherwise with to take during the term of the loan

nominal rate of return on an investment

is the actual percentage change in the dollar value of an investment adjusted for inflation.

a bond's time to maturity:

is the number of years until the face value is paid off

primary market

is where stocks are issued for the first time

there is no best way to compute g

most often use the change in dividends to compute g when it is a constant growth