Finance All Vocab

Downsides of bearer bonds

1. difficult to recover if lost or stolen 2. bondholders can't be notified of important events (company does not know who owns it) LESS COMMON THAN REGISTERED BONDS

Special circumstances where we can value a stock

1. dividend has a zero growth rate 2. dividend grows at a constant rate 3. dividend grows at a constant rate after some length of time

What causes interest rate risk to be greater?

1. longer time to maturity 2. lower coupon rate

Arrearage

A past due obligation such as interest, or dividends on a cumulative preferred stock.

Change in Net Working Capital

Ending NWC - Beginning NWC

True or False: portfolio risk is a weighted average of the individual standard deviations of the stocks

False

True or False: The cash flows from a bond change as time passes and interest rates change

False (only the value of the bond changes)

Junk bonds

High-risk, high-interest bonds

Proxy and Proxy Fight

Proxy: the authority to vote someone else's stock proxy fight: develops when a group solicits proxies in order to replace the existing board and thereby replace existing managers

DuPont Equation

ROE = Profit Margin x Total Assets Turnover x Equity Multiplier

Do risky securities or riskless securities have higher returns?

Risky securities

Mortgage securities

Securities by a mortgage on the real property of the borrower

Why should you diversify your portfolio and not just invest in the fastest growing stocks?

Slower growing stocks are steadier

Profitability Index (PI)

The present value of an investment's future cash flows divided by its initial cost. Also called the benefit-cost ratio.

Dirty price

The price of a bond including accrued interest, also known as the full or invoice price. This is the price the buyer actually pays.

Capital budgeting

The process of planning and managing a firm's long-term investments

What is the fundamental relationship between risk and return?

The reward-to-risk ratio must be the same for all the assets in the market

Capital structure

The specific mixture of long-term debt and equity the firm uses to finance its operations

Partnership Agreement

The way partnership gains and losses are divided

What is different about municipal bonds?

They are exempt from federal income taxes

What securities have risk-free return?

Treasury bills

True or False: There are more bond issues than stock issues

True

True or False: when we discuss portfolios of stocks, the standard deviation of the individual stocks is not the relevant measure of risk

True

true or false: Corporate bonds are usually callable

True

security market line (SML)

a positively sloped straight line displaying the relationship between expected return and beta

Straight Voting

a procedure in which a shareholder may cast all votes for each member of the board of directors

Cumulative Voting

a procedure in which a shareholder may cast all votes for one member of the board of directors

Unsystematic risk

a risk that affects at most a small number of assets. Also called unique or asset-specific risk

Systematic Risk

a risk that influences a large number of assets. Also called market risk

Mutually exclusive investment decisions

a situation in which taking one investment prevents the taking of another

Common-Base Year Statements

a standardized financial statement presenting all items relative to a certain base year amount

Dividend yield

a stock's expected cash dividend divided by its current price

normal distribution

a symmetric, bell-shaped frequency distribution that is completely defined by its mean and standard deviation

Consol

a type of perpetuity

Electric Communications Network (ECN)

a website that allows investors to trade directly with each other

Federal Corporate Tax Rate

about 21%

strong form efficient

all information of every kind is reflected in stock prices (no such thing as inside information)

If the market is efficient, what is one implication

all investments in that market are zero NPV investments

Put bond

allows the holder to force the issuer to buy back the bond at a stated price

Marginal Tax Rate

amount of tax payable on the next dollar earned

Sinking fund

an account managed by the bond trustee for early bond redemption

Broker

an agent who arranges security transactions among investors

Dealer

an agent who buys and sells securities from inventory

Call provision

an agreement giving the corporation the option to repurchase a bond at a specified price prior to maturity

Perpetuity

an annuity in which the cash flows continue forever

growing perpetuity

an asset with cash flows that grow at a constant rate forever

IRR rule

an investment is acceptable if the IRR exceeds the required return. It should be rejected otherwise.

Average accounting return (AAR)

an investment's average net income divided by its average book value

NYSE member

an owner of a trading license in the NYSE

Debenture

an unsecured debt, usually with a maturity of 10 years or more

Note

an unsecured debt, usually with a maturity under 10 years

Annuity Due

annuity for which the cash flows occur at the beginning of the period

Free Cash Flow

another name for cash flow from assets

Modern trading is

automated and cheaper to do than ever

Price of Stock at time T (no dividends) =

benchmark PE ratio x Earnings Per Share at time T

Inflation-linked bonds

bond's whose coupon rate changes over time based on rate of inflation.

Structured notes

bonds that are based on stocks, bonds, commodities, or currencies

Catastrophe (Cat) Bonds

bonds with a return that depends on the incidence of natural catastrophes

Interest-only Loans

borrower pays interest each period and repays the entire principal at some point in the future

Discount

calculate the present value of some future amount

Ordinary Annuity

cash flows occur at the end of each period

Operating Cash Flow

cash generated from a firm's normal business activities

Income component of return

cash you receive from your return on investment

Requirements to be listed on NYSE

company is expected to have a market value for its publicly held shares of at least $100 million

What makes a market efficient?

competition among investors

Double Taxation

corporate profits are taxed first at the corporate level when they are earned and then again at the personal level when they are paid out (as dividends)

Variable costs

costs that vary with the quantity of output produced

floating-rate bonds (floaters)

coupon payments are adjustable

Net working capital

difference between a firm's current assets and it's current liabilities

Cash Flow

difference between number of dollars that came in and number of dollars that went out

Total dollar return =

dividend income + capital gain (or loss)

R =

dividend yield + capital gains yield

Cash Flow to Stockholders

dividends paid out by a firm - net new equity raised

EV/EBITDA Ratio

enterprise value/a measure of its cash created

Common stock

equity without priority for dividends or in bankruptcy

Announcement =

expected part + surprise

Total return =

expected return + unexpected return

Risk premium equation

expected return - risk-free rate

Noncash items

expenses charged against revenues that do not directly affect cash flow, such as depreciation

Diversification reduces ___

exposure to extreme outcomes, both good and bad

Balance Sheet

financial statement showing a firm's accounting value on a particular date

Income Statement

financial statement summarizing a firm's performance over a period of time

Pro forma financial statements

financial statements projecting future years' operations

To have a stock listed:

firms must meet certain minimum criteria concerning asset size, number of shareholders, etc.

Warrant

gives the buyer of a bond the right to purchase shares of stock in the company at a fixed price

Stocks of small companies have higher or lower average returns than larger companies?

higher

More liquid stocks have ___ valuations but ___ returns than less liquid stocks

higher, lower

over-the-counter (OTC) market

securities market in which trading is almost exclusively done through dealers who buy and sell for their own inventories

Payday loans

short-term loans to consumers

Which type of investment did the best?

small-company stocks

principle of diversification

spreading an investment across a number of assets will eliminate some, but not all, of the risk

Restricted Stock Units (RSUs)

stock units offered to employees at bargain prices, but are only distributed when it vests

Preferred stock

stock with dividend priority over common stock, normally with a fixed dividend rate, sometimes without voting rights

semistrong form efficiency

suggests that security prices fully reflect all public information, such as firm announcements, economic news, or political news

Total risk =

systematic risk + unsystematic risk

Call premium

the amount by which the call price exceeds the par value of a bond

beta coefficient

the amount of systematic risk present in a particular risky asset relative to that in an average risky asset

Payback period

the amount of time required for an investment to generate cash flows sufficient to recover its initial cost

Coupon rate

the annual coupon divided by the face value of a bond

Stand-alone principle

the assumption that evaluation of a project may be based on the project's incremental cash flows

Geometric average return

the average compound return earned per year over a multiyear period

Variance

the average squared difference between the actual return and the average return

Pure discount loan

the borrower receives money today and repays a single lump sum at some time in the future

Erosion

the cash flows of a new project that come at the expense of a firm's existing projects

Marginal cost

the change in costs that occurs when there is a small change in output. also called incremental cost

marginal revenue

the change in revenue that occurs when there is a small change in output. also called incremental revenue

Capital gain/loss on your investment

the change in the value of the asset you purchased

Interest rate risk premium

the compensation investors demand for bearing interest rate risk

weak form efficiency

the current price of a stock reflects the stock's own past prices

Operating leverage

the degree to which a firm or project relies on fixed costs

Scenario analysis

the determination of what happens to NPV estimates when we ask what-if questions

Incremental cash flows

the difference between a firm's future cash flows with a project and those without the project

Net present value (NPV)

the difference between an investment's market value and its cost

Bid-ask spread

the difference between the bid price and the asked price

The internal rate of return (IRR)

the discount rate that makes the NPV of an investment zero

Capital gains yield

the dividend growth rate, or the rate at which the value of an investment grows

Capital Asset Pricing Model (CAPM)

the equation of the SML showing the relationship between expected return and beta

Alpha

the excess return an asset earns based on the level of risk taken

Risk premium

the excess return required from an investment in a risky asset over that required from a risk-free investment

Systematic risk principle

the expected return on a risky asset depends only on that asset's systematic risk

Order flow

the flow of customer orders to buy and sell securities

Bearer form

the form of bond issue in which the bond is issued without record of the owner's name; payment is made to whomever holds the bond

Registered form

the form of bond issue in which the registrar of the company records ownership of each bond; payment is made directly to the owner of record

Inside quotes

the highest bid quotes and the lowest ask quotes for a security

Efficient markets hypothesis (EMH)

the hypothesis that actual capital markets, such as the NYSE, are efficient

Annual Percentage Rate (APR)

the interest rate charged per period multiplied by the number of periods per year

Effective Annual Rate (EAR)

the interest rate expressed as if it were compounded once per year

Stated Interest Rate

the interest rate expressed in terms of the interest payment made each period. Also known as the quoted interest rate

Main difference between public-issue and privately placed debt

the latter (privately placed debt) is directly placed with a lender and not offered to the public

Amortized Loan

the lender may require the borrower to repay parts of the loan amount over time (pay interest for a period + some fixed amount)

Discounted Payback Period

the length of time required for an investment's discounted cash flows to equal its initial cost

The higher the required rate of return...

the less valuable the firm

Primary market

the market in which new securities are originally sold to investors

secondary market

the market in which previously issued securities are traded among investors

slope of the SML is equal to

the market risk premium

cost of capital

the minimum required return on a new investment

The higher the growth rate...

the more valuable the firm

Opportunity cost

the most valuable alternative that is given up if a particular investment is undertaken

Primary Markets

the original sale of securities by governments and corporations

The real rate on an investment is ____

the percentage change in how much you can buy with your dollars - in other words, the percentage change in your buying power

degree of operating leverage

the percentage change in operating cash flow relative to the percentage change in quantity sold

The nominate rate on an investment is ___

the percentage change in the number of dollars you have

portfolio weight

the percentage of a portfolio's total value that is invested in a particular asset

Liquidity premium

the portion of a nominal interest rate or bond yield that represents compensation for lack of liquidity

Default risk premium

the portion of a nominal interest rate or bond yield that represents compensation for the possibility of default

Taxability premium

the portion of a nominal interest rate or bond yield that represents compensation for unfavorable tax status

Inflation premium

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

Standard Deviation

the positive square root of the variance

Agency Problem

the possibility of conflict of interest between the stockholders and management of a firm

Forecasting Risk

the possibility that errors in projected cash flows will lead to incorrect decisions

multiple rates of return

the possibility that more than one discount rate will make the NPV of an investment zero

Equivalent Annual Cost (EAC)

the present value of a project's costs calculated on an annual basis

Bid price

the price a dealer is willing to pay for a security

asked price

the price a dealer is willing to take for a security

Clean price

the price of a bond net of accrued interest; this is the price that is typically quoted

Face/par value

the principal amount of a bond that is repaid at the end of the term

Compounding

the process of accumulating interest on an investment over time to earn more interest

Diversification

the process of spreading an investment across assets (and therefore forming a portfolio)

Discounted cash flow valuation

the process of valuing an investment by discounting its future cash flows

Yield to Maturity (YTM)

the rate required in the market on a bond

Term structure of interest rates

the relationship between nominal interest rates on default-free, pure discount securities and time to maturity; that is, the pure time value of money

Fisher effect

the relationship between nominal returns, real returns, and inflation

Arithmetic average return

the return earned in an average year over a multiyear period

Expected return

the return on a risky asset expected in the future

Cost of equity

the return that equity investors require on their investment in the firm

Cost of debt

the return that lenders require on the firm's debt

Interest rate risk

the risk that arises for bond owners from fluctuating interest rates

Financial break-even

the sales level that results in a zero NPV

Cash break-even

the sales level that results in a zero operating cash flow

accounting break-even

the sales level that results in zero project net income

Capital rationing

the situation that exists if a firm has positive NPV projects but cannot find the necessary financing

Hard rationing

the situation that occurs when a business cannot raise financing for a project under any circumstances

Soft rationing

the situation that occurs when units in a business are allocated a certain amount of financing for capital budgeting

Market risk premium

the slope of the SML, which is the difference between the expected return on a market portfolio and the risk-free rate

Maturity

the specified date on which the principal amount of a bond is paid

Liquidity

the speed and ease with which an asset can be converted to cash

coupons

the stated interest payment made on a bond

Depreciation Tax Shield

the tax saving that results from the depreciation deduction, calculated as depreciation multiplied by the corporate tax rate

Rule of 72

the time it takes to double your money is given approximately by (72/r%)

Cash flow from assets

the total of cash flow to creditors and cash flow to stockholders

Pure play approach

the use of a WACC that is unique to a particular project, based on companies in similar lines of business

Financial Leverage

the use of debt in a firm's capital structure

The cost of capital depends primarily on...

the use of the funds, not the source

Weighted average cost of capital (WACC)

the weighted average of the cost of equity and the aftertax cost of debt

Indenture

the written agreement between the corporation and the lender detailing the terms of the debt issue

Average Tax Rate

total taxes paid divided by total taxable income

Which type of investment did the worst?

treasury bills

examples of systematic risk

uncertainties about general economic conditions (GDP, interest rates, inflation)

What is a bond

when a corporation or government wishes to borrow money from the public on a long-term basis, they issue or sell debt securities call bonds

Return on your investment

your gain (or loss) from an investment (ex: buying an asset)

Dealer Markets

secondary market: dealers buy and sell for themselves at their own risk --> over-the-counter markets

Quick Ratio

(Current Assets - Inventory/Current Liabilities) used to measure short-term liquidity of firm

Current Ratio

(Current Assets/Current Liabilities) --> used to measure short-term liquidity of firm

CPI

(consumer price index) a measure of the overall cost of the goods and services bought by a typical consumer

R (required rate of return) =

(dividend/stock price) + growth rate

What does capital market efficiency say about market efficiency?

1. prices appear to respond rapidly to new info 2. the future of market prices (particularly in the short run) is hard to predict based on publicly available info 3. if mispriced stocks exist, then there is no obvious means of identifying them

Why is it harder to value a share of common stock than a bond?

1. promised cash flows are not known in advance 2. life of investment is essentially forever 3. theres no way to easily observe the rate of return that the market requires

Rights of Shareholders

1. right to vote for directors 2. right to share proportionally in dividends paid 3. right to share proportionally in assets remaining after liabilities have been paid in a liquidation 4. the right to vote on stockholder matters of great importance, such as a merger

Two important points about diversification

1. some of the riskiness associated with individual assets can be eliminated by forming portfolios 2. there is a minimum level of risk that cannot be eliminated by diversifying

What does the bond indenture include

1. the basic terms of the bond 2. the total amount of bonds issued 3. a description of property used as security 4. the repayment arrangements 5. the call provisions 6. details of the protective covenants

Primary Disadvantages of Sole Proprietorships and Partnerships

1. unlimited liability for business debts on the part of the owners 2. limited life of the business 3. difficulty of transferring ownership

What is the beta of an average asset?

1.0

Average annual return percentage for large-company stocks, historically

12.1%

Limit of NYSE members

1366

average annual return for small company stocks

16.3%

Forward PE ratio

A PE ratio that is based on estimated future earnings

Reverse Convertible Bonds

A bond that can be converted to cash, debt or equity at the discretion of the issuer at a set date

Discount bond

A bond that sells below its par value; occurs whenever the going rate of interest is above the coupon rate

Corporation

A business created as a distinct legal entity composed of one or more individuals or entities

Sole Proprietorship

A business owned by one person

Clawback

A corporation can take back a bonus for specific reasons, like fraud

Working capital

A firm's short-term assets and liabilities

Common-Size Statements

A standardized financial statement presenting all items in percentage terms. Balance sheet items are shown as a percentage of assets and income statement items as a percentage of sales.

General Partnership

All partners share in gains or losses, all have unlimited liability for all partnership debts

Net present value rule

An investment should be accepted if the net present value is positive and rejected if it is negative.

Is the geometric average or arithmetic average higher?

Arithmetic

Another way to get geometric return

Arithmetic return - half the variance

Why do we want to diversify our portfolio?

Because by diversifying, unsystematic risk can essentially be eliminated. A portfolio with many stocks will see the effects of unsystematic risk cancelling each other out

convertible bonds

Bonds that can be converted into common stock at the bondholder's option

Cash Ratio

Cash / Current Liabilities

Cash Flow from assets =

Cash flow to creditors + cash flow to stockholders

Fixed costs

Costs that do not vary with the quantity of output produced in a certain period

Interval Measure

Current Assets/Average Daily Operating Costs

supplemental liquidity providers (SLPs)

Investment firms that are active participants in stocks assigned to them. Their job is to make a one-sided market (i.e., offering to either buy or sell). They trade purely for their own accounts.

Sukuk

Islamic bond which by Islamic law cannot charge interest

Designated market makers (DMMS)

NYSE members who act as dealers in particular stocks. Formerly known as "specialists"

Floor brokers

NYSE members who execute customer buy and sell orders

Return on Equity (ROE)

Net Income/Total Equity

Net working capital to total assets

Net Working Capital / Total Assets

Can systematic risk be diversified away?

No

Can we get answers from the dividend growth model formula if, indefinitely, the growth rate is more than or equal to the discount rate?

No

How are most bonds traded?

Over the counter (OTC)

Zero growth stock price formula

P = dividend/rate of return

Stakeholders

Someone other than a stockholder or creditor who potentially has a claim on the cash flows of the firm

Preemptive Right

Stockholders' right to maintain their proportionate interest in a corporation with any additional shares issued.

Even though 2008 saw stock prices decrease, were there still positives for investors?

Yes, because as stocks fell, bonds soared

Standard Industrial Classification (SIC) code

a U.S. government code used to classify a firm by its type of business operation

Zero coupon bond

a bond that makes no coupon payments and is thus initially priced at a deep discount

Premium bond

a bond that sells above its par value; occurs whenever the going rate of interest is below the coupon rate

Call-protected bond

a bond that, during a certain period, cannot be redeemed by the issuer

Current yield

a bond's annual coupon divided by its price

Deferred call provision

a call provision prohibiting the company from redeeming a bond prior to a certain date

Simulation analysis

a combination of scenario and sensitivity analysis

Sunk cost

a cost that has already been committed and cannot be recovered and therefore should not be considered in an investment decision

Accelerated cost recovery system (ACRS)

a depreciation method under U.S. tax law allowing for the accelerated write-off of property under various classifications

Statement of Cash Flows

a firm's financial statement that summarizes its sources and uses of cash over a specified period

Cash Flow to Creditors

a firm's interest payments to creditors - net new borrowing

DMMs Post

a fixed place on the exchange floor where the DMM operates

Proxy

a grant of authority by a shareholder allowing another individual to vote his or her shares

Net present value profile

a graphical representation of the relationship between an investment's NPVs and various discount rates

portfolio

a group of assets such as stocks and bonds held by an investor

Annuity

a level stream of cash flows for a fixed period of time

Efficient capital market

a market in which security prices reflect available information

Key Performance Indicators (KPIs)

a measurable value that shows how a company is progressing toward achieving a business goal

Dividend growth model

a model that determines the current price of a stock as its dividend next period divided by the discount rate less the dividend growth rate

Protective covenant

a part of the indenture limiting certain actions that might be taken during the term of the loan, usually to protect the lender's interest

Treasury yield rate

a plot of the yields on Treasury notes and bonds relative to maturity

Total cash if stock is sold =

initial investment + total return

Compound Interest

interest earned on both the principal amount and any interest already earned

Interest on Interest

interest earned on the reinvestment of previous interest payments

Simple Interest

interest earned only on the original principal amount invested

Real rates

interest rates or rates of return that have been adjusted for inflation

Nominal rates

interest rates or rates of return that have not been adjusted for inflation

Sensitivity Analysis

investigation of what happens to NPV when only one variable is changed

Municipal notes and bonds (munis)

issued by the state or local government

Examples of unsystematic risk

labor strikes, part shortages

Which 5 types of financial investments did Ibbotson and Sinquefield's studies deal with?

large-company stocks, small-company stocks, long-term corporate bonds, long-term government bonds, U.S. treasury bills

Tobin's Q Ratio

market value of firm's assets / replacement cost of assets

Secondary Markets

markets where securities are bought and sold after the original sale

Goal of Financial Management

maximize the current value per share of the existing stock

Capital Spending

money spent on fixed assets - money received from the sale of fixed assets

Limited Partnership

one or more general partners will run the business and have unlimited liability, but there will be one or more limited partners who will not actively participate in the business

Highly liquid asset

one that can be quickly sold without significant loss of value

Illiquid asset

one that cannot be quickly converted to cash without a substantial price reduction

Income bonds

pay no interest unless the issuing company is profitable

Dividends

payments by a corporation to shareholders, made in either cash or stock

Blanket Mortgage

pledges all the real property owned by the company

bond value =

present value of the coupons + present value of the face amount

Ask price

price at which dealer will sell security

Dividend growth model formula

price per share = (dividend * (1 + growth rate))/(rate of return - growth rate)

PE Ratio

price per share/earnings per share

Price-Sales Ratio

price per share/sales per share

Nominal rate =

real rate + inflation rate

Financial Ratios

relationships determined from a firm's financial information and used for comparison purposes

Auction Market

secondary market: brokers and agents match buyers and sellers, but they do not actually own the commodity that is bought or sold --> has a physical location (like Wall Street)