Finance 3320 Midterm 1

mid-year convention

A method of discounting in which cash flows that arrive continuously throughout the year are treated as though they arrive at the middle of the year. This mid-year convention is a reasonable approximation to continuous discounting.

limited partnership

A partnership with two kinds of owners, general partners and limited partners.

yield curve

A plot of bond yields as a function of the bonds' maturity date.

Fintech

A recent term describing the use of new technologies in finance.

value additivity

A relationship determined by the Law of One Price, in which the price of an asset that consists of other assets must equal the sum of the prices of the other assets.

bond

A security sold by governments and corporations to raise money from investors today in exchange for the promised future payment.

stream of cash flows

A series of cash flows lasting several periods.

hostile takeover

A situation in which an individual or organization, sometimes referred to as a corporate raider, purchases a large fraction of a target corporation's stock and in doing so gets enough votes to replace the target's board of directors and its CEO.

partnership

A sole proprietorship with more than one owner.

growing annuity

A stream of cash flows paid at regular intervals and growing at a constant rate, up to some final date.

growing perpetuity

A stream of cash flows that occurs at regular intervals and grows at a constant rate forever.

perpetuity

A stream of equal cash flows that occurs at regular intervals and lasts forever.

annuity

A stream of equal periodic cash flows over a specified time period. These cash flows can be inflows of returns earned on investments or outflows of funds invested to earn future returns.

Tax Cut and Jobs Act of 2017 (TCJA)

An act that significantly reduced the differential between the effective corporate tax rate in the U.S. and the median for the OECD in 2017 by lowering the federal corporate tax rate from 35% to 21% in 2018.

financial security

An investment opportunity that trades in a financial market.

security

An investment opportunity that trades in a financial market.

equity holder

An owner of a share of stock in a corporation.

shareholder

An owner of a share of stock in a corporation.

stockholder

An owner of a share of stock or equity in a corporation.

arbitrage opportunity

Any situation in which it is possible to make a profit without taking any risk or making any investment.

liquidation

Closing down a business and selling off all its assets; often the result of the business declaring bankruptcy.

limit order book

Collection of all current limit orders for a given security.

robo-advisors

Computer programs that provide detailed and personalized investment advice in place of a financial advisor.

"C" corporations

Corporations that have no restrictions on who owns their shares or the number of shareholders, and therefore cannot qualify for subchapter S treatment and are subject to direct taxation.

liquid

Describes an investment that can easily be turned into cash because it can be sold immediately at a competitive market price.

liquidity

Extent to which the market for an asset is liquid. Limit orders provide liquidity by making available an immediate opportunity to trade.

valuation principle

The value of an asset to the firm or its investors is determined by its competitive market price: The benefits and costs of a decision should be evaluated using these market prices, and when the value of the benefits exceeds the value of the costs, the decision will increase the market value of the firm.

short sale

Selling a security you do not own.

discount factor

The value today of a dollar received in the future.

blockchain

Technology that allows a transaction to be recorded in a publicly verifiable way without the need for a trusted third party to certify the authenticity of the transaction.

chief executive officer (CEO)

The person charged with running the corporation by instituting the rules and policies set by the board of directors.

arbitrage

The practice of buying and selling equivalent goods or portfolios to take advantage of a price difference.

bid price

The price at which a market maker or specialist is willing to buy a security.

compounding

The process of converting a cash flow to its future value, taking into to account the fact that interest is earned on prior interest payments.

discounting

The process of converting a cash flow to its present value.

real interest rate

The rate of growth of purchasing power after adjusting for inflation.

discount rate

The rate used to discount a stream of cash flows; the cost of capital of a stream of cash flows.

term structure

The relationship between the investment term and the interest rate.

effective annual rate (EAR)

The total amount of interest that will be earned at the end of one year.

future value (FV)

The value of a cash flow that is moved forward in time.

present value (PV)

The value of a cost or benefit computed in terms of cash today.

"S" corporations

Those corporations that elect subchapter S tax treatment and are allowed, by the U.S. Internal Revenue Tax code, an exemption from double taxation.

public companies

Those corporations whose stock is traded on a stock market or exchange, providing shareholders the ability to quickly and easily convert their investments into cash.

high frequency traders (HFTs)

Traders who place, update, cancel, and execute trades many times per second.

ask price

the price at which a market maker or specialist is willing to sell a security

competitive market

A market in which goods can be bought and sold at the same price.

amortizing loan

A loan on which the borrower makes monthly payments that include interest on the loan plus some part of the loan balance.

Dodd-Frank Act

A 2010 Congressional act that sought to bring about financial stability by bringing about sweeping changes to the financial regulatory system in response to the 2008 financial crisis.

consol

A bond that promises its owner a fixed cash flow every year, forever.

sole proprietorship

A business owned and run by one person.

private companies

A company whose shares do not trade on a public market.

normal market

A competitive market in which there are no arbitrage opportunities.

cryptocurrency

A currency whose creation and ownership is determined via a public blockchain.

board of directors

A group elected by shareholders that has the ultimate decision-making authority in the corporation.

corporation

A legally defined, artificial being, separate from its owners.

limited liability company (LLC)

A limited partnership without a general partner.

timeline

A linear representation of the timing of (potential) cash flows.

compound annual growth rate (CAGR)

Geometric average annual growth rate; year-over-year growth rate which, if applied to the initial value and compounded, will lead to the final value.

no-arbitrage price

In a normal market, when the price of a security equals the present value of the cash flows paid by the security.

separation principle

In a perfect market, the NPV of an investment decision can be evaluated separately from any financial transactions a firm is considering.

Law of One Price

In competitive markets, securities or portfolios with the same cash flows must have the same price.

transaction cost

In most markets, an expense such as a broker commission and the bid-ask spread investors must pay in order to trade securities.

annual percentage rate (APR)

Indicates the amount of interest earned in one year without the effect of compounding.

market makers

Individuals on the trading floor of a stock exchange who match buyers with sellers.

specialists

Individuals on the trading floor of the NYSE who match buyers with sellers; also called market makers.

simple interest

Interest earned without the effect of compounding.

nominal interest rate

Interest rate quoted by banks and other financial institutions that indicates the rate at which money will grow if invested for a certain period of time.

secondary market

Market shares continue to trade on after the initial transaction between the corporation and investors.

primary market

Market used when a corporation itself issues new shares of stock and sells them to investors.

adjustable rate mortgages (ARMs)

Mortgages with interest rates that are not constant over the life of the mortgage. These were the most common type of "subprime" loans.

interest rate factor

One plus the interest rate, it is the rate of exchange between dollars today and dollars in the future.

limit order

Order to buy or sell a set amount of a security at a fixed price.

stock market (or stock exchange)

Organized market on which the shares of many corporations are publicly traded.

dividend payments

Payments made at the discretion of the corporation to its equity holders.

bid-ask spread

The amount by which the ask price exceeds the bid price.

opportunity cost of capital

The best available expected return offered in the market on an investment of comparable risk and term to the cash flow being discounted; the return the investor forgoes on an alternative investment of equivalent riskiness and term when the investor takes on a new investment.

equity

The collection of all the outstanding shares of a corporation.

continuous compounding

The compounding of interest every instant (an infinite number of times per year).

net present value (NPV)

The difference between the present value of a project's or investment's benefits and the present value of its costs.

return

The difference between the selling price and purchasing price of an asset plus any cash distributions expressed as a percentage of the buying price.

time value of money

The difference in value between money today and money in the future; also, the observation that two cash flows at two different points in time have different values.

compound interest

The effect of earning "interest on interest."

cost of capital

The expected return available on securities with equivalent risk and term to a particular investment.

risk-free interest rate

The interest rate at which money can be borrowed or lent without risk over a given period.

internal rate of return (IRR)

The interest rate that sets the net present value of the cash flows equal to zero.

chief financial officer (CFO)

The most senior financial manager, who often reports directly to the CEO.

federal funds rate

The overnight loan rate charged by banks with excess reserves at a Federal Reserve bank (called federal funds) to banks that need additional funds to meet reserve requirements. The federal funds rate is influenced by the Federal Reserve's monetary policy, and itself influences other interest rates in the market.

stock

The ownership or equity of a corporation divided into shares.

dark pools

Trading venues in which the size and price of orders are not disclosed to participants. Prices are within the best bid and ask prices available in public markets, but traders face the risk their orders may not be filled if an excess of either buy or sell orders is received.

limited liability

When an investor's liability is limited to her initial investment.

agency problem

When decision makers, despite being hired as the agents of other stakeholders, put their own self-interest ahead of the interests of the stakeholders.