Finance Exam 2 Terms

compound interest

Interest earned on both the initial principal and the interest reinvested from prior periods.

interest on interest

Interest earned on the investment of previous interest payments

simple interest

Interest earned only on the original principal amount invested

face value

The principal amount of a bond that is repaid at the end of the term. Also called par value.

zero coupon bond

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

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 -different than a bond's yield to maturity

deferred call provision

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

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 -P0= D1 / (R - g)

protective covenants

a part of the indenture limiting certain action that might be taken during the term of the loan, usually to protect the lender. -Negative covenant: prohibits actions company may take -Positive covenant: specifies an action the company agrees to take or a condition the company must abide by

sinking fund

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

call provision

an agreement giving the corporation the option to repurchase a bond at a specified price prior to maturity. corporate bonds are usually callable

annuity due

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

perpetuity

an annuity in which the cash flows continue forever

debenture

an unsecured debt, usually with a maturity of 10 years or more -no specific pledge of property is made

note

an unsecured debt, usually with a maturity under 10 years

convertible bonds

bond that can be swapped for a fixed number of shares of stock any time before maturity at the holder's option

floating rate bonds

bonds with interest rates that change with current interest rates otherwise available in the economy -adjustable interest rates

discount

calculate the present value of some future amount

discounted cash flow valuation

calculating the present value of a future cash flow to determine its value today -DCF

Interest Only Loan

calls for the borrower to pay interest each period and to repay the entire principal (the original loan amount) at some point in the future.

catastrophe bonds

corporate bonds that permit the issuer to skip or defer scheduled payments if a catastrophic loss occurs

common stock

equity without priority for dividends or in bankruptcy -have voting rights

seniority

in general terms, seniority indicates preferences in position over the other lenders, and debts are sometimes labeled as senior or junior to indicate seniority

mortgage securities

secured by a mortgage on the real property of the borrower

pure discount loan

simplest form of loan; the borrower receives money today and repays a single lump sum at some time in the future

preferred stock

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

future value

the amount an investment is worth after one or more periods -FV= PV (1+r)^t

call premium

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

coupon rate

the annual coupon divided by the face value of a bond

present value

the current value of future cash flows discounted at the appropriate discount rate -PV= FV / (1+r)^t

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

annual percentage rate

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

effective annual rate

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

stated interest rate

the interest rate expressed in terms of the interest payment made each period, also known as the quoted investment rate

Yield to Maturity (YTM)

the interest rate required in the market on a bond

Amortized Loan

the lender may require the borrower to repay parts of the loan amount over time. -the process of providing for a loan to be paid off by making regular principal reductions is called amortizing a loan

compounding

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

discount rate

the rate used to calculate the present value of future cash flows

maturity

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

coupon

the stated interest payment made on a bond

indenture

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

Non-Constant Growth Model

to see what the stock is worth today, we first find out what it will be worth once dividends are paid. We can then calculate the PV of that future price to get today's price. -Then, calculate the total value of the stock as the PV of the first three dividends plus the present value of the price at Pt

Zero Growth Model

A constant dividend forever, find PV using perpetuity formula -P0= D / R

annuity

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

collateral

A security pledged for the repayment of a loan.

income bonds

Bonds that pay no interest unless the issuing company is profitable.

consol

a type of perpetuity

constant growth model

a widely cited dividend valuation approach that assumes that dividends will grow at a constant rate, but a rate that is less than the required return

put bond

allows the holder to force the issuer to buy back the bond at a stated price -therefore, put feature is the reverse of the call provision