FIN 305W Midterm II

• US Government securities • Municipal Bonds • Corporate Bonds • Mortgage-backed securities • Federal Agency Securities • Foreign Government Bonds

types of bonds

Most of the time the term structure is

upward sloping (but not always - 2006 was flat)

The value of any asset is the present value of

its expected future cash flows

What is the price of a perpetuity bond that pays $100 coupon annually if the required annual rate of return is 8%?

$1250

individual mortgages -> mortgage-backed securities (MBS) -> collaterized debt obligations (CDO) which are low risk equity

"Big Short"

2% inflation —What will be the purchasing power of $1 in a year? —In two years?

$0.9804 $0.9611

What is the price at the time of issuance of an 8-year bond with a 9% annual coupon rate? The market interest rate for eight-year horizon is 7%. The face value is $1000. Assume two years have passed since the above bond was issued. What is the price of the bond if the interest rate is still 7%?

$1,119.43 $1,095.33

Determine the market value of a corporate bond with 20 years to maturity that has a 9% coupon rate, if the market's required rate of return is - 7% - 9% - 11%

$1,211.88 $1,000 $840.73

Pagemaster Corp just made a dividend payment. Dividends are expected to grow at 20 % per year during the next five years (until year 5), and starting from year 6 the growth will slow down to 10%. The required return on this stock is 15 percent, and the stock currently sells for $50 per share. What is the projected next dividend payment?

$1.8233

- you have deposited $1,000 at 10% for a year. If the interest is paid at the end of the year, your end-of-the-year balance is: - If you receive 5% after 6 month, and 5% at the end of the year, your end-of-the-year balance is:

$1100 $1102.50

Suppose you have $100 in a savings account that pays 1% interest rate every month. - How much will you have accumulated by the end of the year? - What is the effective annual interest rate you are getting? - How much money will you find in your account: — after 3 months? —after 6 months?

$112.68 12.68% $103.03 $106.15

Your child will go to college 18 years from today. You estimate that at that time tuition will be $25,000 per year (in years 18-21). It will have to be paid semiannually, in 8 equal installments of $12,500 each, the first payment is due exactly 18 years from now. You want to deposit an equal amount every six months in an interest bearing bank account to finance the tuition expense. You will make the first deposit six months from now and there will be 32 (semi-annual) deposits in total. The bank offers you a stated annual rate of 4.5% compounded monthly. What should be the amount of your semi- annual deposit?

$1827.26

Janicek Corp. is experiencing rapid growth. Dividends are expected to grow at 30 percent per year during the next three years, 18 percent over the following year, and then 8 percent per year indefinitely. The required return on this stock is 13 percent, and the stock currently sells for $65 per share. What is the projected dividend for the coming year?

$2.12

Elixir Drug Company is enjoying rapid growth. The dividend per share payable 1 year from today will be $1.00. In years 2 through 5, the dividend is expected to grow at 12% per year (g1=12%). After year 5, the dividend is expected to grow at 10% per year (g2=10%). The appropriate discount rate is 15% per year. What is PV?

$21.3378

What is the present value of receiving $50,000 every other year (once every two years) for 20 years (so you will have 10 payments in total) if the stated interest rate is 8% compounded monthly and the first payment is in 6 months?

$259,789.52

What is the price of a corporate zero-coupon bond that matures in 15 years if the required annual rate of return is 9%? The face value is $1000

$275

A prestigious investment bank designed a new security that pays a quarterly dividend of $5 in perpetuity. The first dividend occurs one quarter from today. What is the price of the security if the stated annual interest rate is 7 percent, compounded quarterly?

$285.71

Compute the future value of $1,900 continuously compounded for 1. 5 years at a stated annual interest rate of 12 percent. 2. 3 years at a stated annual interest rate of 10 percent. 3. 10 years at a stated annual interest rate of 5 percent. 4. 8 years at a stated annual interest rate of 7 percent.

$3,462.03 $2,564.73 $3,132.57 $3,326.28

if inflation is 2% for the next year. How much will a jar of Nutella hazelnut spread cost one year from now if its price is $3.25 today?

$3.32

Suppose you know that a company's stock currently sells for $64 per share and the required return on the stock is 13 percent. You also know that the total return on the stock is evenly divided between a capital gains yield and a dividend yield. If it's the company's policy to always maintain a constant growth rate in its dividends, what is the current dividend per share?

$3.91

North Side Corporation is expected to pay the following dividends over the next four years: $9, $7, $5, and $2.50. Afterwards, the company pledges to maintain a constant 5 percent growth rate in dividends forever. If the required return on the stock is 13 percent, what is the current share price?

$38.57

Metallica Bearings, Inc., is a young start-up company. No dividends will be paid on the stock over the next nine years, because the firm needs to plow back its earnings to fuel growth. The company will pay a $9 per share dividend in 10 years and will increase the dividend by 5.5 percent per year thereafter. If the required return on this stock is 13 percent, what is the current share price?

$39.95

Four years ago, Bling Diamond, Inc, paid a dividend of $0.80 per share. Bling paid a dividend of $1.66 per share yesterday. Dividends will grow over the next five years at the same rate they grew over the last four years. Thereafter, dividends will grow at 8% per year. The required return on the stock is 18%. What will Bling Diamond dividend be in 7 years?

$4.82

market cap of bond market vs equity

$45T (bond) vs $35-40T (equity)

Every holiday season the Klaus family decorates a new Christmas tree. Assuming that a tree costs $100 today, the next purchase will be exactly one year from now, and the Klaus family will keep decorating trees forever, what is the total cost of this lovely tradition in terms of dollars today? Nominal interest rate is 5% and annual inflation is 3%. give in real terms & in nominal terms

$5,150 real: r = 1.9417% nominal: growing perpetuity formula

what is the price of a stock if its EPS is $.30 and P/E ratio is 18?

$5.40

An account pays 8% per year, compounding continuously. If you deposit $500 today, how much will you have 4.5 years from now?

$716.66

Hughes Co. is growing quickly. Dividends are expected to grow at a 25 percent rate for the next three years, with the growth rate falling off to a constant 7 percent thereafter. If the required return is 12 percent and the company just paid a $2.40 dividend, what is the current share price?

$80.40

A bond currently sells for $932.90 It pays an annual coupon of $70 and matures in 10 years. It has a face value of $1,000. What are coupon rate, coupon payment, YTM?

- 7% - $70 - 8%

What if a stock does not pay dividends?

- Eventually will (Microsoft: IPO - 1986; first dividend - 2003) - Stock repurchase - Liquidating dividends

Valuation of Different Types of Stocks

- Zero Growth - Constant Growth - Differential Growth - A biotech company that develops therapeutic products based on antisense and cancer immunotherapy technology. (EPS: -4.13. Dividends: 0%. Next year EPS projection: -3.57) - Coca-Cola. (EPS: 2.07. Dividends: 3.14%. Next year EPS projection: 2.13)

Consider 2 companies - Cash Cow and Growth Prospects. Both expect earnings of $5 per share and could pay a $5 dividend in perpetuity. If the discount rate for these firms were 12.5%, they both would be valued at... - Now suppose Growth Prospects has investment opportunities that generate a return on investment of 15% (higher than the cost of capital). Suppose Growth Prospects reduces its dividend payout ratio from 100% to 40% (i.e., it increases its plowback ratio or earnings retention ratio to 60%). Dividends will fall from $5 to $2, but what will happen to the stock price? - Suppose Cash Cow also cuts its dividend (thinking that the market values growth), but its ROE is only 10% (less than cost of capital). What will happen to Cash Cow's stock price? Why?

- both = $40 - increase to $57.14 (We can think of the share price as the sum of the no-growth value plus the present value of the investment opportunities) - decrease to $30.76. Because the return on new projects (10%) is less than the cost of capital (12.5%). Therefore, maximizing the growth rate of earnings is an inappropriate goal

Stock ownership produces cash flows from:

- dividends - capital gains

The Faulk Corp. has a 6 percent coupon bond outstanding. The Gonas Company has a 14 percent bond outstanding. Both bonds have 8 years to maturity, make semiannual payments, and have a YTM of 10 percent. If interest rates suddenly rise by 2 percent, what is the percentage change in the price of these bonds? What if interest rates suddenly fall by 2 percent instead? What does this problem tell you about the interest rate risk of lower coupon bonds? The interest rate in this question is a stated annual rate with semiannual compounding.

-11.03% -9.51% 12.80% 10.92% All else the same, the lower the coupon rate on a bond, the greater is its price sensitivity to changes in interest rates.

Laurel, Inc., and Hardy Corp. both have 8 percent coupon bonds outstanding, with semiannual coupon payments, and both are priced at par value. The Laurel, Inc., bond has 2 years to maturity, whereas the Hardy Corp. bond has 15 years to maturity. If interest rates suddenly rise by 2 percent, what is the percentage change in the price of these bonds? If interest rates were to suddenly fall by 2 percent instead, what would the percentage change in the price of these bonds be then? What does this problem tell you about the interest rate risk of longer-term bonds? The interest rate in this question is a stated annual rate with semiannual compounding.

-3.55% -15.37% 3.72% 19.60% All else the same, the longer the maturity of a bond, the greater is its price sensitivity to changes in interest rates. Notice also that for the same interest rate change, the gain from a decline in interest rates is larger than the loss from the same magnitude change. This is because bond prices are convex in interest rates.

Friendly's Quick Loans, Inc., offers you "three for four or I knock on your door." This means you get $3 today and repay $4 when you get your paycheck in one week (or else). What's the effective annual return Friendly's earns on this lending business? If you were brave enough to ask, what APR would Friendly's say you were paying?

.3333(52) = 1,733.33% 313,916,515.69%

Which investment would you prefer? An investment paying interest of 10.5% compounded semiannually? An investment paying interest of 10% compounded daily? An investment paying interest of 9.9% compounded continuously?

1 10.776% 10.516% 10.407%

Microhard has issued a bond with the following characteristics: Par: $1,000 Time to maturity: 25 years Annual coupon rate: 7 percent Semiannual payments Calculate the price of this bond if the stated annual interest rate, compounded semiannually is: 1. 7 percent 2. 9 percent 3. 5 percent

1. $1000 When the YTM and the coupon rate are equal, the bond will sell at par. 2. $802.38 When the YTM is greater than the coupon rate, the bond will sell at a discount. 3. $1,283.62 When the YTM is less than the coupon rate, the bond will sell at a premium.

What is the price of a 10-year, zero coupon bond paying $1,000 at maturity if the YTM is: 1. 5 percent? 2. 10 percent? 3. 15 percent?

1. $613.91 2. $385.54 3. $247.18

Three versions of the Price-to-Earnings ratio are commonly used

1. TTM 2. Forward looking P/E 3. CAPE

price-earnings ratio simultaneously captures two different factors:

1. The level of "expensiveness" of a stock 2. Its growth prospects

Low price to earnings ratios can signal two things:

1. The stock is cheap. Buy! 2. Future earnings will be impaired. Low or negative growth.

what effective rate is equivalent to a 10% stated interest rate compounded semiannually?

1.05^2 −1=10.25%

If Treasury bills are currently paying 5 percent and the inflation rate is 3.9 percent, what is the exact real rate?

1.06%

Find the APR, or stated rate, in each of the following cases: Number of Times Compounded: - Semiannually - Monthly - Weekly - Continuously Effective Rate (EAR) - 10.3% - 9.4% - 7.2% - 15.9%

10.05% 9.02% 6.96% 14.76%

What is the effective rate that is equivalent to: —10% semiannually stated rate? —10% quarterly stated rate? —10% monthly stated rate? —10% daily stated rate? —10% compounded every second?

10.25% 10.38% 10.47% 10.5155% 10.5171% - As interest gets compounded more often, the equivalent effective rate will rise

the interest rate to be paid on the face value of a bond

coupon rate

A 4% monthly effective rate is equivalent to a ___ quarterly effective interest rate A 2% daily effective rate is equivalent to a ___ annual effective interest rate Assume there are exactly 365 days, 52 weeks, and 12 months in a year.

12.4864% 1376.408%.

Suppose I invest $100 under 5% nominal rate. How much richer (in real terms) will I be next year if the inflation rate is 2%?

2.94% richer

Which investment would you prefer? 1.An investment paying interest of 12% compounded annually? 2.An investment paying interest of 11.7% compounded semiannually? 3.An investment paying interest of 11.5% compounded continuously?

3. 12% 12.04% 12.19%

An investment offers a 17 percent total return over the coming year. Alan Wingspan thinks the total real return on this investment will be only 11 percent. What does Alan believe the inflation rate will be over the next year?

5.41%

If you can save up for a pair, put away a dollar a week. Assuming that the APR compounded weekly is 3%, how long would it take Rosie's fans to save up for the cheapest pair that costs $700?

589 weeks

Consider a bond with an 8% coupon rate that matures in 3 years. The market price is $1,053. What is the yield to maturity of the bond?

6%

Ayden, Inc., has an issue of preferred stock outstanding that pays a $6.40 dividend every year, in perpetuity. If this issue currently sells for $103 per share, what is the required return?

6.21%

Reflects the change in the purchasing power of money over time.

inflation

Pagemaster reported earnings of $2 million last year. They plan to retain 40% of their earnings and their Return on Equity (ROE) is 16%. What is the expected growth in earnings? What is the value of Pagemaster if its required rate of return (cost of capital) is 12%?

6.4% $22.8M

Suppose the real rate is 2.5 percent and the inflation rate is 4.7 percent. What rate would you expect to see on a Treasury bill?

7.32%

You save up for a purchase of a new BMW. Its current price is 40,000$. Assume that it will remain the same in the future. For this purpose you plan to deposit 500$ per month in a bank account with a stated annual rate of 4.5% compounded monthly. Your first deposit will be one month from now. How long will you have to wait until you have enough savings to buy the car?

71 months

Consider a 2-year bond with annual 8% coupons that trades at par What is the effective return investors realize if... - the first coupon can be reinvested at 8%? - the first coupon can be reinvested at 5%?

8% 7.89%

A bond is sold at $923.14 (below its par value of $1,000). The bond matures in 15 years and has a 10% yield to maturity, expressed as a stated annual interest rate, compounded semi-annually. What is the annual coupon rate on the bond, if the coupon is paid semi-annually? The next payment occurs six months from today.

9%

When coupon rate < YTM, price BLANK par value

< (discount bond)

When coupon rate = YTM, price BLANK par value

=

When coupon rate > YTM, price BLANK par value

> (premium bond)

Preferred Stocks: Warren Buffet and Goldman Sachs > In October 2008 Goldman Sachs turned to Omaha, Nebraska-based Berkshire in 2008 to bolster capital and shore up market confidence. > Buffet bought $5 Billion worth of preferred shares and got warrants to buy $5 Billion of common stock for $115 share. - The warrants could be exercised any time within a 5-year window. - Preferred stock promised a yearly 10% dividend and Goldman had an option to buy back the stock at any time for 10% more than what Berkshire had paid, which Goldman did in April 2011 for $5.5 billion. - In March 2013, as part of an amendment to its earlier deal, Goldman said it would hand $1.4 billion worth of shares to Berkshire > What is the cash flow from Buffet's investment? > What is the annualized rate of return? > What would the cash flow be if Buffet exercised his warrants in October 2009, when GS was trading at 185$ per share?

> Oct 2008: -5 B Oct 2009: 0.5 B Oct 2010: 0.5 B Apr 2011: 5.5+0.25B (pro-rated dividend) March 2013: 1.4 B > 𝑟𝑚= 1.55% or 20.2% annualized return > $3.04B

During the two-year period of 2011 - 2013 the prices of a country Priceria have doubled. What was the annual inflation rate during that period? A. 41.42% B. 50.00% C. 100.00% D. 200.00%

A. 41.42% (1+i)^2 = 2

growth in prices over time

inflation (h)

Bond A has a face value of 1000, a 10% annual coupon rate and matures in 10 years. Bond B is a zero coupon rate and also matures in 10 years. Both bonds trade at par. Which of the two bonds is more sensitive to changes in the interest rate? A. Bond A B. Bond B C. Bonds A and B have the same sensitivity to interest rate changes D. Not enough information to answer

A. Bond A

Gabelli Corp has two different bonds currently outstanding. Bond A has a face value of $40,000 and matures in 20 years. The bond makes no payments for the first six years, pays $2,000 semiannually for the subsequent eight years, and finally pays $2,500 semiannually for the last six years. Bond B also has a face value $40,000 and matures in 20 years. However, it makes no coupon payments over the life of the bond. If the stated annual interest rate is 12% compounded semiannually, What is the price of Bond A? What is the price of Bond B?

A: $18,033.36 B: $3,888.89

Bond A: Face Value $1000 Coupon Rate 9% Time to maturity 2 years YTM 9% Bond B: Face Value $1000 Coupon Rate 9% Time to maturity 10 years YTM 9% What happens to the prices of the bonds if interest rates increase, leading to an increase in required rate of return to 12%?

A: 949.30 B: 830.49

Timber Co. is a mature manufacturing firm. The company just paid a $5.40 annual dividend and management expects to reduce the payout by 9 percent each year, indefinitely. How much are you willing to pay today per share to buy this stock if you require a return of 14.5 percent? A. $34.79 B. $20.91 C. $18.27 D. $89.35

B. $20.91

An investment at 10.47% effective annual rate is equal to a ___ stated annual rate compounded monthly. A. 9.57% B. 10% C. 10.99% D. None of the above

B. 10%

A company with a relatively low P/E ratio can be an indication that A. This company is likely overvalued B. Investors expect low or even negative earnings growth in the future C. Earnings are expected to growth at a rather high rate in the future D. None of the above

B. Investors expect low or even negative earnings growth in the future

The higher is the inflation rate, the _____ will be the purchasing power of $1 one year from now, and the ______ will be the real interest rate that corresponds to a nominal rate of R%. A. higher; higher B. lower; lower C. higher; lower D. lower; higher

B. lower; lower

The bank offers you three alternative rates. Which one is the best if you're thinking of opening a savings account? —Option 1: APR of 15% compounded daily —Option 2: monthly effective rate of 1.3% —Option 3: EAR of 15.6% A.Option 1 B.Option 2 C.Option 3 D.Either option 2 or 3

B.Option 2 16.18% 16.77% 15.6%

New Homes has a bond issue with an annual coupon rate of 5.5 percent that matures in 8.5 years. The bonds have a par value of $1,000 and a market price of $977.80. Interest is paid semiannually. What is the (annualized) yield to maturity? A. 2.21% B. 3.14% C. 5.92% D. None of the above

C. 5.92%

What is the price at the time of issuance of an 5-year bond with a 5% annual coupon rate? The market interest rate for 5-year horizon is 7%. The face value is $1000. A. 205.01 B. 712.99 C. 918.00 D. None of the above

C. 918.00

"Cyclically adjusted price-to-earnings ratio" or "Shiller P/E" (after Robert Shiller, a Nobel Laureate). Current price divided by the average of ten years of earnings.

CAPE

- a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund. Unlike mutual funds, an ETF trades like a common stock on a stock exchange. ETFs experience price changes throughout the day as they are bought and sold. ETFs typically have higher daily liquidity and lower fees than mutual fund shares, making them an attractive alternative for individual investors. - For an individual investor the easiest way to invest in preferred stocks is through these - For example, PGX: Holds 50+ securities. Pays a 6% dividend

ETF or exchange traded fund

First National Bank charges 10.1 percent compounded monthly on its business loans. First United Bank charges 10.4 percent compounded semiannually. As a potential borrower, to which bank would you go for a new loan?

First National Bank 10.58% 10.67%

Using next year expected earnings instead

Forward looking P/E

Assume that you could choose between two investments: An investment paying a nominal interest rate of 5% An investment paying a real interest rate of 2% You know for sure that the inflation is going to be 3.5%. Which investment would you prefer?

Investment 2 Nominal: R1 = 5% R2 = 5.57% Real: r1 = 1.4493% r2 = 2%

- Longer-term bonds are less liquid - Inflation is more uncertain over a longer horizon hence potentially more risk - Changes in the interest rates are harder to predict for longer horizons - In addition, default risk is higher over longer horizons (for corporate bonds)

Liquidity / inflation /risk premium

3 major credit-rating agencies

Moodys (AAA) Standard & Poor's (downgraded gov't debt AAA-> AA+ Fitch - summer 2011 U.S. Treasuries inc (still safest security) = Flight to Safety - corporate bonds -> investment grade or junk/high yield bonds

not adjusted for inflation

Nominal interest rates (R)

Assume that you could choose between two investments: An investment paying a nominal interest rate of 10% An investment paying a real interest rate of 7% You know for sure that the inflation is going to be 4%. Which investment would you prefer?

Option 2 real: r1 = 5.77% r2 = 7% nominal: R1 = 10% R2 = 11.28%

how much investors are willing to pay for a $1 of current earnings - A good way to compare stocks within an industry

Price-Earnings Ratio

adjusted for inflation

Real interest rates (r)

of r per annum compounded m times a year — Each sub-period you get an interest rate of r/m

Stated/Quoted interest rate/Annual Percentage Rate (APR)

(trailing twelve months): Current price over last 12 month's total earnings.

TTM (most used)

- "VALUE" investor - underpriced companies - strong fundamentals (low risk, good CF, no financial distress, low volatility)

Warren Buffet

Is yield to maturity always equal to the actual return investors realize if they buy the bond?

YES, but ONLY if 1. The bond is default free AND 2. The bond is zero coupon OR all coupons can be reinvested at YTM

Utah Mining will pay a dividend of $3 per share one year from today. The dividend is expected to grow at 10% per year. What is the dividend per share in each of the next 5 years? Assume the discount rate for Utah Mining is 15%. What is the value of one share of Utah Mining common stock? What will be the value 2 years from today (just after the dividend has been paid)?

Year 1: 3 Year 2: 3.3 Year 3: 3.63 Year 4: 3.99 Year 5: 4.34 $60 $72.60

California Real Estate Inc., expects to earn $100 million per year in perpetuity if it does not undertake any new projects. The firm has an opportunity to invest $15 million today and $5 million in one year in real estate. The new investment will generate annual earnings of $10 million in perpetuity, beginning two years from today. The firm has 20 million shares of common stock outstanding, and the required rate of return on the stock is 15%. What is the price of a share of stock if the firm does not undertake the new investment? What is the value (NPV) of the investment? What is the per-share stock price if the firm undertakes the investment?

a) $33.33 b) $38,623,188.41 c) $35.26

You just bought a bond with 8 years to maturity, 8% annual coupon rate with semi- annual coupon payments. The bond currently sells at par (the face value of the bond is 1000$). Assume that the yield curve is flat at an 8% stated annual yield (with semi-annual compounding) and remains constant for three years. You reinvest all cash flows in the first 3 years at this rate. However, starting at the beginning of the fourth year, the interest rate drops to 5% stated annual rate (with semi-annual compounding). a) What will be your effective semi-annual and annualized rate of return if you sell the bond 3 years from now (just after the drop in the interest rate)? b) What will be your effective rate of return if you hold your bond until maturity and reinvest all cash flows from the bond at the prevailing interest rate?

a) 5.73% 11.78% b) 3.70% 7.53%

Fundamental fact about the relation between bond prices and interest rates:

bond prices move inversely to interest rates!

— Own the right to the stream of interest and principal payments — Have the highest priority of their claims in liquidation — If the firm fails to make a contractual payment, bondholders can initiate a bankruptcy procedure — No voting rights — Most bonds are traded OTC (over the counter)

bondholders of Public debt (corporate bonds)

debts coupons & principal fixed maturity no voting rights highest priority in bankruptcy lower risk - lower return gov't debt over-the-counter less transparency

bonds

the senior securities of a firm. The law requires bankrupt firms to pay off their bondholders before their equity holders

bonds

— Are the owners of the corporation — Have residual claims on the assets and proceeds of the firm — Have limited liability — Have the preemptive right, which grants existing shareholders the first right to purchase any new stock — Have the right to vote on major matters affecting the firm — Have the right to receive dividends (however, not all firms pay dividends) > Common stocks can be both bought and sold short ("shorted").

common stockholders

the periodic interest payment paid by the issuer to the bondholder.

coupon payment

the ratio of the interest payment to the current market value of the bond

current yield

bank loans, bonds, commercial paper, leases

debt capital markets

- This model can be applied to any firm by simply calculating the present value of future dividends - The model is often used for firms with a high initial growth rate followed by a lower long run growth rate

differential growth

- the net return on the investment over the year (the rate expressed as if it were compounded once a year). It is an equivalent annually compounded rate

effective annual interest rate of interest (EAR)

common, preferred, warrants

equity capital markets

the company issues new shares & sells to me

exercise warrant

term structure reflects the expected changes in the short-term rate - Does not explain why the term structure is usually upward sloping

expectation hypothesis

A bond with longer maturity has (higher/lower) relative (%) price change than one with shorter maturity when interest rate (YTM) changes. All other features are identical.

higher

>Germany (1922-1923): prices double every day >Monthly inflation:

hyperinflation 2^30 - 1 = 107,374,182,300% Recent examples: - Yugoslavia (1992-1994): 313,000,000% a month (at its peak) - Angola (1993-1996): 2,300% a year - Argentina (1989-1990): 2,600% a year - Russia (1992-1994): 1,000% a year

An arrangement between a bank and a firm, typically for a short-term loan, whereby the bank authorizes the maximum loan amount, but not the interest rate, when setting up the line of credit.

line of credit

An arrangement that requires a bank to lend up to a maximum prespecified loan amount at a prespecified interest rate at the firm's request as long as the firm meets the requirements established when the commitment was drawn up.

loan commitment

stated interest rate of 3%, compounded quarterly -What is m? -How much do I get each quarter?

m=4 .03/4=.75%

MSFT valuation

maybe a little expensive, definitely not undervalued

Both Cash Cow and Growth Prospects had expected earnings of $5 in year 1. But, because of their different investment opportunities, their prices were $40 and $57.14 respectively. Thus, Cash Cow had a price-earnings multiple of 8, and Growth Prospects had a price-earnings multiple of 11.4. Does that mean that Growth Prospects is too expensive?

no it's bc of its growth potential

negative inflation (deflation) is it good?

no, people just save their money for next year to get things for cheaper, thus slowing down the economy

(consol) is a bond that lasts forever and pays only interest

perpetuity bond

— Are a hybrid of financing, combining features of debt and common stock — Occupies a middle position between bonds and common stocks both in terms of priority of payment of income and in case the firm is liquidated — Pay dividends, which are specified and known in advance. Preferred stock dividends are discretionary — Most preferred dividends are cumulative. If the firm omits a dividend, it must pay it later before any new dividends are paid — Have no voting rights unless the company is unable to pay dividends during a specified period

preferred stockholders

no maturity limited / no voting rights middle priority in bankruptcy intermediate risk dividend PMT fixed in advance

preferred stocks

how much $1 can buy - In other words, PP is the value in today's dollars of an amount of goods that $1 can buy at some point in time in the future

purchasing power (PP)

to combat inflation, the gov't...

raises interest rates

Real cash flows are discounted by... Nominal cash flows are discounted by...

real interest rates (r) nominal interest rates (R)

Selling a security (a stock) that you do not own. The security is borrowed from another investor by your broker. An implicit obligation is to purchase the stock at some future date and return to the broker (to cover your short position). In the mean time you are responsible for all the dividends that the stock would otherwise pay to its owner. - betting against a stock - when an investor borrows a security and sells it on the open market, planning to buy it back later for less money. Short sellers bet on, and profit from, a drop in a security's price. Short selling has a high risk/reward ratio: It can offer big profits, but losses can mount quickly and infinitely

short selling

equity dividends & capital gains no maturity voting rights lowest rights lowest priority in bankruptcy high risk - high return exchange traded

stocks

The relationship between short- and long-term interest rates

term structure of interest rates

The constant growth dividend discount model is usually called

the Gordon Dividend Discount Model after Myron Gordon who popularized it In this model, P0 grows to infinity as g approaches r P0 is not defined for g=r or g>r

the right to buy shares at a future date for a price agreed upon today

warrant

the average rate of return an investor will receive from a bond if purchased at the current market price and held to maturity. In other words, this is the rate that makes the price of the bond just equal to the present value of its future cash flows

yield to maturity

(pure discount bond) is a bond which does not pay any interest before maturity

zero-coupon bond