FIN 3104- Exam 1
In early 2013, typical terms on a payday loan involved a $15 charge for a two-week payday loan of $100. Assuming there are 26 14-day periods in a year, what is the effective annual rate on such a loan?
(1 +( (15/100)* 26 )/ (26) ) ^ 26 -1 x100
Acid-Test (Quick Ratio)
(Current Assets - Inventory) / Current Liabilities
Gross Profit Margin
(Sales - COGS)/ Sales
APY (annual percentage yield) or EAR (equivalent annual rate)
-
Mutual Funds
- Classified as load or no load - shares must be bought from or sold to the Fund by investors -NAV = value of stock held/ number of shares -index fund is NOT fund with highest expenses payable
Interest Expense
- Deducted before taxes -When you pay interest, you lower taxes
Why prefer a dollar today?
- Earn interest - Opportunity cost of passing up the earning potential of a dollar
PE ratio increase (go up)
- Expect future earnings to go up - Less risk - Less inflation (earnings are worth more)
When you buy a bond you get...
- Interest paid semi-annually - At maturity, return of its par value
Long-term debt for borrower
- Interest rate are locked - Has a tax advantage
Dividend Payments
- Made from after tax money
Lower corporate tax rate means...
- More cash available to corporations for reinvesting/ paying dividends - US corporations are more competitive - Will cause an inc. in after-tax cost of borrowing
Call option
- Option to buy stock at a set price over set time period - Want price to go up -Gives the holder the right to buy a stated number of shares at a specified price for a limited time
Put option
- Option to sell something at a set price over set time period - Want price to go down
Russell 2000
- Rank companies by size (market cap= number of shares x price per share) - Stocks ranked 1000 to 3000 (looks at middle size companies)
Long-term debt for investor
- Used to generate income - Less risky than common stock
don't know**You have been offered a credit card with an interest rate of 1.5% per month. This is equivalent to and effective annual rate (EAR) of
---19.56
**If you want to have $1,200 in 27 months, how much money must you put in a savings account today? Assume that the savings account pays 14% and it is compounded monthly (round to the nearest $10).
880
**If you put $700 in a savings account with a 10% nominal rate of interest compounded monthly, what will the investment be worth in 21 months (round to the nearest dollar)?
= P(1+ R/m)^m*t (years) =700(1+(.1/21))^21*(21/12)
Future Values
= present value (1+r )^N
The par value of a bond is...
The face value of the bond, which is received by the bondholder when the bond matures at its normal maturity date
Initial Public Offering (IPO)
The first time a corporation sells stocks to the public
Maximum Profit of a Call
Unlimited
Debenture
Unsecured bond
Derivative Securities
Values is based on the value of another security or asset
Examples of Private equity firms
Venture capital firms and leveraged buyout firms
What is the future value of $6,000 invested for 5 years at 6 percent compounded semiannually?
6000*(1+ 0.06/2)^ 2*5 *2 because semi-annual
What is the future value of $6,000 invested for 5 years at 6 percent compounded bimonthly?
6000*(1+ 0.06/6)^ 6*5 *6 because bimonthly
Only _ in 10 workers save for retirement
6; 60%
**Shorty Jones wants to buy a one−way bus ticket to Mule−Snort, Pennsylvania. The ticket costs $142, but Mr. Jones has only $80. If Shorty puts the money in an account that pays 9% interest compounded monthly, how many months must Shorty wait until he has $142 (round to the nearest month)?
77
shareholder wealth
market price of share of common x number of shares of common stock outstanding
The par value of a bond is usually ____ amount
$1000
EAR (effective annual rate)
((1+ r/m) ^m) - 1 (monthly, m =12)
Assume the expected inflation rate is 3.8 percent. If the current real rate of interest is 6.4 percent, what should the nominal rate of interest be?
(.038+.064)+(.038*.064)= .104432 =10.44%
Payday loans issued by banks are often referred to as "direct deposit advances." In early 2013, the average direct deposit advance charged $10 for a $100 advance and was due in 10 days. What is the effective annual rate on this type of loan?
(1 +( (10/100)* (365/10) )/ (365/10) ) ^ (365/10) -1 - x100
Banks collect the savings of individuals and businesses and then lend these pooled savings to other individuals and businesses. In this role, banks are:
-Financial Intermediaries -Making money by charging a rate of interest to BORROWERS that exceeds the rate they pay to SAVERS
preferred stock
-Has seniority rights -Owners receive their dividends before dividends are distributed to common stock shareholders -Preferred stock dividends which are unpaid may accrue to be paid later when the corporation returns to profitability -Preferred stock is sometimes referred to as a hybrid security -During the liquidation of a company, holders of preferred stock would have a claim on assets before any claims by common stock shareholders -Unlike common stock, NO VOTING RIGHTS
**EBITDA
-Measure of Cash Flow of Operations -EBIT + Depreciation + Amortization
Issuer
-Not legally obligated to make payments -No maturity date -Issuing common stock leads to more cushion
Exercise or striking price
-Price you buy stock (call) -Price you sell stock for (put) -Price at which the stock or asset may be purchased from (or sold to) the option writer is referred to as
Secondary market
-Tradings and securities between individuals (NY stock exchange) -are concerned with the trading of previously issued securities between investors.
Securitization Process
1. Homebuyer borrow money by taking out mortgages loan 2. Lender sells the mortgage to another firm or finance institution 3. Finance institution pools together a portfolio of mortgages. The purchases of that portfolio is financed through sale of MBS 4. MBS's are sold to investors who can hold them as investments or resell them to others
All else equal, investors prefer... (3 things)
1. More money than less money 2. Their money earlier than later 3. Safe to risky assets
Basis points
1/100 of 1%
Options are sold in "lots" or contracts of ___
100
At a discount rate of 8.50%, find the present value of a perpetual payment of $1,000 per year. If the discount rate were lowered to 4.25%, half the initial rate, what would be the value of the perpetuity?
1000/ .085 = 11764.7 1000/0.0425= 23529.4
**Selma and Patty Bouvier are twins and both work at the Springfield DMV. Selma and Patty Bouvier decide to save for retirement, which is 35 years away. They'll both receive an annual return of 8 percent on their investment over the next 35 years. Selma invests $2,000 per year at the end of each year only for the first 10 years of the 35-year period—for a total of $20,000 saved. Patty doesn't start saving for 10 years and then saves $2,000 per year at the end of each year for the remaining 25 years—fora total of $50,000 saved. How much will each of them have when they retire?
198,421 146,211
If you let $20,000 grow for 10.25 years at 7 percent, how much will you have?
20000* (1.07)^10.25
Marginal tax rate
21% (multiply taxable income by 0.21 to get taxes)
If you put your $20,000 inheritance in an account that earns 7 percent interest compounded annually, how many years will it be before your inheritance grows to $30,000?
30000= 20000(1.07)^N 1.5= 1.07^N ln(1.5) = N* ln(1.07) =6
Income Statement
A financial statement showing the revenue and expenses for a fiscal period.
VIX (fear index/ fear gauge)
A measure of the market's expected volatility (based on S&P 500)
Measure that can be taken to limit the agency problem
A. Firms that fail to maximize shareholder wealth may be taken over and their management team replaced. B. Compensation plans can be put in place to reward managers when they maximize shareholder wealth. C. Financial markets play a key role in monitoring management. D. The board of directors can actively monitor the actions of managers to keep pressure on them to act in the best interest of shareholders.
Average PE ratio
About 16
Liquidity Preference Theory Equilibrium
Adjustment of the yield curve (liquidity premium) must take place
Corporate debt can be privately placed with
All of the above
Roth IRA
Allow you to put in after tax money that get interest without taxes
Par value
Amount of money you get at bond maturity ($1000)
Accounts Receivable Turnover Ratio
Annual Credit Sales/ Accounts Receivable
Perpetuity
Annuity that goes on forever PV= PP/i
ROE> ROA
Assets= debt + EQ vs. just equity in denom., (dividing by a bigger number give you smaller answer)
Dow Jones Industrial Average (DJIA or Dow)
Average of 30 largest companies
Upward sloping yield curve
Averaging higher numbers/rates
Agency problem
result of separation of management and ownership which may interfere with implementation
Speculator
Bettings on the future movement of prices
Note
Bonds with maturities up to 10 years (*think debt)
Corporation
Business existing separate from its owners; limited liability; less control and double tax on dividends (corporation tax)
Depreciation after 2018
Businesses can deduct 100% of the cost of eligible property
In a large corporation, the primary responsibility for overseeing the firm's finance-related activities falls to the
CFO
It gives the investor holding it the right, but NOT THE OBLIGATION, to buy the stock at the specified price at the stated date in the future.
Call option
Cash Flows are the Source of Value
Cash flows, not profits, drives value of business
Governance of stock
Common shareholders elect the board; PS have no say
Equity
Common stock; ownership position
Futures contract
Contract to buy or sell a stated commodity (such as soybeans or corn) or a financial claim (US Treasury Bonds) at a specific price at some future time - Allow you to pick a time to not deal with price fluctuations
Inventory Turnover
Cost of Goods Sold/ Inventory
Interest paid
Coupon rate x par value
Government bonds have lower yield to maturity than do corporate bonds of the same maturity because the ________ premium is lower for government bonds.
Default
Depreciation before 2018
Depreciate over assets depreciable life
Compounded semi-annually
Divide %rate by 2
common stock
Dividends vary and can be omitted
Proprietorship
Easy to form; but unlimited legal responsibility
Break-even point of a call/put
Exercise price/ premium
Non-Annual Compounding
FV=PV(1+i/m)^n*m
Options can only be purchased for individual stocks, not for funds or indexes.
False
Tax deduction on interest expense makes borrowing money less expensive
False
The current yield is the average rate of interest a bond will from the time of purchase until it matures.
False
preffered stock
Fixed dividends (bonds) - Has a preference in terms of claims on assets in bankruptcy & income for dividends - Dividends can be omitted without bankruptcy risk - Has a tax benefit for corporations (not individuals)
Unlike the owner of a(n) ________ contract, the owner of a(n) ________ contract does not have to exercise it
Futures; option
Securities
General term to represent stock, bonds, any financial asset
Price of a bond
Given in percent of par value (multiply given amount by 1000 is what you pay)
Option
Gives the owner the right to buy (call option-- price up) or sell (put option-- price down) an asset at a specified price
At 8% compounded annually, how long will it take $750 to double?
Rule of 72. 72/ 8% = 9
Semi annually
I/Y = rate / 2 (in terms of months) (convert back to years by dividing answer by 2)
Unbiased Expectations theory
If long-term rate is unbiased avg. of the current short-term rate and future short-term rate expected to prevail over the life of the obligation (2yr= (1yr+1yr forward)/2)
The detailed legal agreement between a bond's issuer and and its trustees is
Indenture
The principal savers in the financial markets are
Individuals
CDOs
Issue bonds with collateral as student debt and credit card debt (Collateralized Debt Obligation)
Partnership
Jointly responsible for liabilities; unlimited legal responsibility
Liquidity Preference theory
Lenders prefer to make short-term loans; borrowers prefer long-term debt/borrowing
Money market
Less than a year market
Limitations on interest deductions
Limit on how much interest is tax deductible (max deducted is 30% of Earnings before interest, taxes, depreciation, and amortization)
Which of the following is NOT an advantage of the sole proprietorship?
Limited liability
LLC
Limited liability; partnership and corporation combined
Capital market
Long-term market; more than one year
Taxes after 2018
Lowered tax rate dramatically; flat rate of 21%
Jillian has purchased AAA rated corporate bonds that will mature in 20 years . She plans to sell the bonds in 10 years as she approaches retirement age. The most significant risk she faces is
Maturity risk
Stock Market Index
Measures what's happening to stocks
Time Value of Money
Money today is worth more than money received in the future; can be invested to earn interest
Examples of investment companies that provide financial services to business: savings and loans. A. Savings and loans B.mutual funds. C.hedge funds. D.private equity firms. E.public equity firms.
Mutual, hedge, and private equity firms
Determine the present value of an ordinary annuity of $1,000 per year for 10 years, assuming it earns 10 percent. Assume that the first cash flow from the annuity comes at the end of year 8 and the final payment at the end of year 17. That is, no payments are made on the annuity at the end of years 1 through 7. Instead, annual payments are made at the end of years 8 through 17. Then, what is PV of annuity today?
N= 10 I/Y= 10 PV= ? PMT= -1000 FV= 0 6144.6 N= 7 I/Y= 10 PV= ? PMT= 0 FV= 6144.6 3153.1
*Determine the present value of an annuity due of $1,000 per year for 10 years discounted back to the present at an annual rate of 10 percent. What would be the present value of this annuity due if it were discounted at an annual rate of 15 percent?
N= 10 I/y= 10 PV= ? x (1.10) PMT= -1000 FV= 0
TO pay for student loans you take a loan for $25,000. If you make monthly payments for 15 years at 7% compounded monthly, how much is your monthly student loan payment?
N= 15 *12 I=7/12 PV=-25000 PMT= ? = 0 ; 224707
An insurance agent just called them and offered them the opportunity to purchase an annuity for $21,074.25 that will pay them $3,000 per year for 20 years. They don't have the slightest idea what return they would be making on their investment of $21,074.25. What rate of return would they be earning?
N= 20 I/y= ? PV= -21074.25 PMT= 3000 FV= 0 13%
Upon graduating from college 35 years ago, Dr. Nick Riviera was already planning for his retirement. Since then, he has made deposits into a retirement fund on a quarterly basis in the amount of $300. Nick has just completed his final payment and is at last ready to retire. His retirement fund has earned 9 percent compounded quarterly. How much accumulated?
N= 35*4 I/Y= 9/4 PV= 0 PMT= 300 FV= ? 287138
Don Draper has signed a contract that will pay him $80,000 at the beginning of each year for the next 6 years, plus an additional $100,000 at the end of year 6. If 8 percent is the appropriate discount rate, what is the present value of this contract?
N= 6 I/Y= 8 PV= ? PMT= -80000 FV= 0 =369,830 * 1.08 =399,416.8 N= 6 I/Y= 8 PV= ? PMT= 0 FV= 100,000 = 63,016.96 sum them together
Approximately how many years would it take for an investment to grow by sevenfold if it was invested at 10% compounded semi-annually
N= ? (ans/2) I= 10/2 PV= -1 PMT=0 FV= 7
EXAM***** You are to receive a 10 yr $100,000 annuity (ten cash flows of $100,000 each) with the first cash flow occurring at the end of yr 5. Given a 10% discount rate, what's the present value?
N=10 I=10 PV= ? PMT= 100,000 FV= 0 ~614,457 N=4 I=10 PV=? 419,682 PMT= 0 FV= 614457
***Borrowed $200,000 to buy a house with a 15-yr 9% monthly mortgage. Pay additional $500 monthly. How long will it take to payoff?
N=15*12 I=9/12 PV= -200000 PMT= ? 2028 FV= 0 (Add $500) N=? 120.38 ~10 yrs I=9/12 PV= -200000 PMT= 2528 (plug in) FV= 0
*5 years ago you took out a $300,000, 25-year mortgage with an annual interest rate of 7 percent and monthly payments of $2,120.34. What is the outstanding balance on your current loan if you just make the 60th payment?
N=240 (5x60=300) 300-60 I/Y= 7/12 PV= ? PMT= -2120.34 FV= 0 273,486
*Imagine Homer Simpson actually invested $100,000 5 years ago at 7.5% annual interest and he invests an additional 1,500 a year today for 20 years at the same 7.5%. How much money in 20 years?
N=25 I=7.5 PV=-100,000 PMT=0 FV= ? 609833 N=20 I=7.5 PV= 0 PMT= 1,500 FV= ? * (1+i) 64957* 1.075= 69828 =609833+ 69828
Five years ago you took out a $300,000 loan, 25-year mortgage with an annual interest of 7% and monthly payments of $2,120.34. What is the outstanding balance on your current loan if you just made the 60th payment?
N=25*12 I= 7/12 PV= ? ~273,486 PMT= 2120.34 FV= 0
How long will it take to pay off a loan of $50,000 at an annual rate of 10% compounded monthly is monthly payments are $600?
N=? I= 10/12 PV= -50000 PMT=600 FV=0 ~142.86 (months) years, divide by 12
Times Interest Earned
NOI/ Interest Expense
Operation Profit Margin
NOI/ Sales
When interest rates are low
Need high liquidity premium (more borrowers in the market, takes more time to get them their money; want to lock in a long-term rate)
When interest-rates are high
Need low liquidity premium to move people
ROI (Return on Investment)
Net Income/ measure of investment (assets or equity)
Net Profit Margin
Net Income/Sales
Real rate of interest
Nominal rate - Inflation rate -After inflation is taken out
Foregoing the earning potential of a dollar today is... time value of money creation of wealth opportunity cost concept
Opportunity cost concept
NASDAQ
Over the counter market, not traded on the stock exchange
FV=
PV (1+i)^n or PMT Sigma (1+i)^t t=0; n-1
You are to receive $100,000 perpetuity with first payment at the end of year 5. If 10 percent is the discount rate, what is the perpetuity's present value?
PV= 100,000 / 0.1 ~1 million N=4 I= 10 PV= ? PMT= 0 FV= 1 million
Barriers to entry
Patents (Lipitor, Square, Dropbox) Quality (BMW) Service (Frito-Lay) Product differentiation (Nike or Whole Foods) Cost advantage (Walmart) Control of Raw Materials (De Beers Diamonds)
Maximum Loss call
Premium
Maximum Loss of a Put
Premium
Premium
Price you pay for an option
ROA
Profit after taxes/ Sales * Sales/Asset (Profit margin x asset turnover ratio)
ROE
Profit after taxes/ Sales * Sales/Asset * Assets/Equity (Profit margin x asset turnover ratio x Equity Multiplier) -Measure of leverage (amount of borrowing)
Taxes before 2018
Progressive
*****Nominal rate of interest (quoted rate)
Real rate + anticipated inflation rate (Not adjusted for inflation) (real rate in decimal form + inflation rate in decimal) + (real rate X inflation rate) or (book) (amount charged/ amount borrowed) x m (compounds)
Nominal interest rate
Real risk-free interest rate + inflation premium +default risk premium +maturity risk premium +liquidity risk premium
Hedger
Reduce risk by locking in buying or selling price
An advantage to borrowing in the private market
Reduced initial costs
Advantages of privately placing debt include all of the following except 1. restrictive covenants 2. reduced placement costs 3. flexibility 4. speed
Restrictive covenants
EXAM******Gross Profit
Sales revenue - COGS
Total Asset Turnover
Sales/ Total Assets
Selling short
Sell the stock first, then buy it back later (hoping the stock price falls)
Best describes goal of the firm... risk management profit max max of total market value of the firm's common stock
The maximization of the total market value of the firm's common stock
term structure of interest rates
The relationship between interest rates and maturity with risk held constant
Finance is about...
The study of how people and businesses make investment decisions and how to finance those decisions
Which of the following is true about bonds? A.They have a fixed maturity, and they pay an amount equal to the maturity value times the coupon rate each year. B.They are obligations from the investor to the corporation. C.Their interest rate always varies with the Consumer Price Index D.At maturity of the bond, the investor receives the market price of the bond.
They have a fixed maturity, and they pay an amount equal to the maturity value times the coupon rate each year.
TTM
Trailing twelve months (P/E ratio earnings are based on the past)
An increase in the stated interest rate will increase the future value of a given sum. Likewise, an increase in the length of the holding period will increase the future value of a given sum.
True
As the time to maturity increases, the maturity premium increases
True
Capital structure refers to the financing of long-term investment
True
Financial decisions can be difficult because the cost of investments can be estimated with greater confidence than future payoffs.
True
If the issuing company becomes insolvent, the claims of the bondholders are honored before those of preferred stockholders.
True
Long−term government bonds are not without maturity risk.
True
Mutual Funds and ETFs provide the investor a chance to diversify without having to buy shares in numerous corporations.
True
The difference between mutual funds and ETFs is that ETFs are traded on exchanges and mutual funds are not.
True
The higher costs affect firms that use large amounts of debt (incur higher interest expense)
True
The life of a corporation is not dependent upon the status of the investor
True
The loan is more attractive if it offers a lower EAR.
True
The purpose of financial markets is to bring savers and borrowers together
True
All of the following operate as financial intermediaries EXCEPT: US Treasury Mutual funds Insurance companies Commercial banks
US Treasury
S&P 500
Weighted Average of 500 largest companies (larger stocks have more weight)
Seasoned Equity Offering (SEO)
When a corporation that already has stock outstanding issues more stock
Agency problem
When managers have little or no ownership in the firm, they are less likely to work energetically for the company's shareholders
Primary market
Where securities are sold by a corporation or govt. to the public (or individual)
annuity
a series of equal regular deposits; assuming cash flows occur at the end of the period
Balance Sheet
a statement of the assets, liabilities, and stockholder's equity
3 questions addressed by the study of finance
a. What long-term investments should the firm undertake (capital budgeting decisions)? b. How should the firm raise money to fund new investments (capital structure decisions)? c. How can the firm best manage its cash flows as they arise in its day-to-day operations (working capital management decisions)?
beginning of each year
annuity due PV *(1+i)
In finance, we assume investors are _____ to risk.
averse
annuities due
cash flow occurs are the beginning of each period ANS*(1+i)
ICONV
converts nominal to APY
Current ratio
current assets /current liabilities
Yield curve
graphical relationship between interest rates and risks held constant
Current yield
interest paid / price of bond
MBS
mortgage backed securities
Springfield Learning sold zero coupon bonds (bonds that don't pay any interest, instead the bondholder gets just one payment, coming when the bond matures, from the issuer) and received $900 for each bond that will pay $20,000 when it matures in 30 years. Find rate
n= 30 i/y = solve pmt= 0 pv= -900 fv= 2000
A private equity firm is a financial intermediary that invests in securities that are...
not traded on the public capital markets.
Price Earnings Ratio (PE ratio)
ratio of the stock's price to the stock's earnings (price/earnings); how much people are willing to pay
Interest on corporate bonds is typically paid
semiannually
The yield on a corporate bond with a 20 year maturity would include
the risk−free rate plus a default risk premium, a liquidity risk premium and a maturity risk premium.
Yield spread
the difference in yield between a non-Treasury bond and the yield on the Treasury bond (spread gives you idea of how much risk your bond holds; treasury bonds have no risk bc gov will pay it back)
Assuming two investments have equal lives, a high discount rate tends to favor
the investment with large cash flow EARLY
The longer the maturity of the bond...
the more it fluctuates
Debt Ratio
total liabilities/total assets