Financial Management Unit 2

Portolio

A group of assets such as stocks or bonds held by an investor.

Protective covenant

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

C

A recently issued bond has a coupon rate of 7% and a yield to maturity of 9%, its price is most likely: A.More than par B.Equal to par C.Less than par

Systematic risk

A type of risk that affects almost all assets in the economy, at least to some degree.

Unsystematic risk

A type of risk that affects only a small number of assets in the economy. (Can be diversified away.)

Indenture (deed of trust)

A written agreement between the corporation (the borrower) and its creditors.

Constant dividend amount

A zero growth model for stock valuation is distinguished by a ______.

overestimate, underestimate

Estimates using the arithmetic average will probably tend to __________ values over the long-term while estimates using the geometric average will probably tend to __________ values over the short-term.

Return on stock

Expected Returns+Unexpected returns=

Risk premium

Expected return - risk free rate

Value of a bond

Number of periods remaining till maturity, face value coupon, and yield to maturity are needed to calculate _______.

Financial failure

One of the costs of issuing debt is this.

Zero

Over time, the average of the unexpected component is _________.

Bond value

Present value of the coupons + Present value of the face amount=

A

Risk that affects a large number of assets, each to a greater or lesser degree, is called _____ risk. A) systematic B) diversifiable C) total

Standard deviation

Square root of varianece

Variance

Sum of squared deviation/n-1 (for sample population)

Lower

The ______ the coupon rate, the greater the interest rate risk.

Longer

The ______ the time to maturity, the greater the interest rate risk.

expected rate of return

The __________ on the portfolio is a weighted average of the expected returns on the securities in the portfolio

Rate of Return

The __________ on the portfolio is a weighted average of the returns on the stocks and bonds in the portfolio

Coupon rate

The annual coupon divided by the face value of a bond.

Equity

The average excess return on common stocks is called the ________ risk premium

individual securities

The characteristics of _______________ that are of interest are the: Expected Return Variance and Standard Deviation Covariance and Correlation

Bid-ask spread

The difference between the bid price and the asked price

Internal rate of return

The discount rate that sets NPV to zero, but is not necessarily the minimum required return for a project. That is set by the riskiness of the project itself.

Bonds

When a corporation or government wishes to borrow money from the public on a long term basis, it usually does so by issuing or selling debt securities that are generally called______?

Rises

When interest rates fall, the present value of the bond's remaining cash flows ______.

Falls

When interest rates rise, the present value of the bond's remaining cash flows ______.

Treasury

When the government wishes to borrow money for more than one year, it sells what are known as __________ notes and bonds.

still

When the stock being valued does not pay dividends, the dividend growth can _____ be used.

Share of common stock

Which is more difficult to value, a bond or a share of common stock?

Geometric

Which type of average will always be smaller, arithmetic or geometric?

Debt holders

Who is paid first, equity holders or debt holders?

U.S.

Who is the biggest borrower in the world?

Cash flows

With common stock, the promised _______ ______ are not known in advance.

Floating rate

With this sort of bond, the coupon payments are adjustable.

Dealer

maintains an inventory and stands ready to trade at quoted bid (price at which they will buy) and ask (price at which they will sell) prices. Make their profit from the difference between the bid and ask prices, called the bid-ask spread.

Efficient market hypothesis

markets are efficient, therefore it is not possible to consistently outperform the market when returns are adjusted for risk

broker

matches buyers and sellers. They perform the search function for a fee (commission). They do not hold an inventory of securities.

Arithmetic average

return earned in an average period over multiple periods, overly optimistic over long periods

Total Risk

systematic risk + unsystematic risk=

Coupons

Municipal ________ are exempt from federal incomes taxes, which makes them very attractive to high-income, high-tax bracket investors.

Zero

No matter what the stock price, the present value is ____ if we push the sale of stock far enough away.

Negative covenant

A covenant that limits of prohibits actions the company might take.

Transparent

A financial market is this if it is possible to easily observe its prices and trading volume.

Premium bond

A bond that sells for more than face value, due to the coupon rate being more than the market interest rate.

Dollar Return

= Dividend + Change in Market Value

Percentage return

=Dollar Return/Beginning Market Value =(Dividend+Change in Market Value)/Beginning Market Value =Dividend+Capital gains yeild

Discount bond

A bond that sells for less than face value, due to the coupon rate being less than the market interest rate.

The risk free rate of return

According to the capital asset pricing model, what is the expected return on a security with a beta of zero?

A

All else constant, a bond will sell at _____ when the yield to maturity is _____ the coupon rate. A) a discount; higher than B) a discount; less than C) a premium; higher than

Sinking fund

An account managed by the bond trustee for early bond redemption.

Call provision

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

Bond ratings

An assessment of the creditworthiness of the corporate issuer.

Future

An asset's value is determined by the present value of its ______ cash flows.

A

Assume that you are using the dividend growth model to value stocks. If you expect the market rate of return to increase across the board on all equity securities, then you should also expect the: A) market values of all stocks to decrease, all else constant. B) stocks that do not pay dividends to decrease in price while the dividend-paying stocks maintain a constant price. C) market values of all stocks to remain constant as the dividend growth will offset the increase in the market rate.

Deviation

Compares return in each state to the expected return

Seniority

Indicates preference in position over other lenders, and debts are sometimes labeled as senior or junior to indicate this.

Real rates

Interest rates that have been adjusted for inflation.

Nominal rates

Interest rates that have not been adjusted for inflation.

C

The growth rate of a company can be estimated by: A.Payout ratio times return on assets B.Payout ratio times return on equity C.Retention ratio times return on equity

U.S. Treasury Market

The largest securities market in the world in terms of trading volume is?

Maturity

The life of an investment is essentially forever because common stock has no __________.

portfolio weight

The percentage of a portfolio's total value invested in a particular asset is called that asset's:

Portfolio weight

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

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

Dirty price

The price of a bond including accrued interest. This is the price the buyer actually pays.

Clean price

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

Expected

The price of a share of common stock is equal to the present value of all ________ future dividends.

Face value (Par value)

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

yield to maturity

The rate of return required by investors in the market for owning a bond is called the:

Yield to maturity

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.

Fisher effect

The relationship between nominal rates, real rates, and inflation is known as the

Fisher effect

The relationship between nominal returns, real returns, and inflation.

Expected return

The return on a risky asset expected in the future.

B

The risk premium is computed by ______ the average return for the investment. A) subtracting the inflation rate from B) subtracting the average return on the U.S. Treasury bill from C) adding the inflation rate to

Interest rate risk

The risk that arises for bond owners from fluctuating interest rates

market risk premium

The slope of an asset's security market line is the:

Maturity

The specific date on which the principal amount of a bond is paid.

Coupon

The stated interest payment made on a bond.

coupon

The stated interest payment, in dollars, made on a bond each period is called the bond's:

B

The underlying assumption of the dividend growth model is that a stock is worth: A) an amount computed as the next annual dividend divided by the required rate of return. B) the present value of the future income which the stock generates. C) the same amount as any other stock that pays the same current dividend and has the same required rate of return.

Present, future

The underlying assumption of the dividend growth model is that a stock is worth: the _______ value of the ______ income which the stock generates.

Common stock

The value of _______________ today depends on: the expected future dividends, capital gains and the discount rate

Growth, discount

The value of a firm is the function of its ________ rate and its ________ rate.

expected future

The value of any asset is the present value of its __________ cash flows

Dividends

The value of common stock today depends on: the expected future ____________, capital gains and the discount rate

Discount rate

The value of common stock today depends on: the expected future dividends, capital gains and the ___________

Capital Gains

The value of common stock today depends on: the expected future dividends,_____________ and the discount rate

risk-return trade-off

There is a reward for bearing risk The greater the potential reward, the greater the risk This is called the ___________

Municipal

These types of notes and bonds are sold by state and local governments in order to borrow money.

constant dividend growth

This model is generally not used in practice because most stocks grow at a non constant rate

State income

Treasury issues are exempt from what type of taxes?

False

True of false: Debt implies ownership of the firm. Creditors thus have voting power.

False

True or False: Interest risk continues to increase exponentially as time goes on.

True

True or False: Interest risk increases at a decreasing rate as time goes one.

False

True or false: Interest risk decreases at an increasing rate as time goes on

True

True or false: Unlike equity, debt is not an ownership interest in the firm. Creditors generally do not have voting power.

Risk premium and risk free rate

What are the two components of the expected return on the market?

Bonds

What can be paid at maturity, in part, or in entirety before maturity?

Indenture

What document generally includes the following?: 1. The basic terms of the bonds. 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

Steady growth

What is the explicit goal for companies concerning dividend growth?

The risk free rate

What is the intercept of the security market line?

Treasury

What type of issues have no default risk?

Diversification

__________ can substantially reduce the variability of returns without an equivalent reduction in expected returns

fundamental analysis

all current information is known-semi-strong form

technical analysis

all historical information is known-weak form

insider trading

all information is known-strong form

Geometric average

average compound return per period over multiple periods, overly pessimistic over short periods

Percentage returns

the sum of the cash received and the change in value of the asset, divided by the initial investment.

Dollar returns

the sum of the cash received and the change in value of the asset, in dollars

systematic risk

the total risk for a diversified portfolio is essentially equivalent to the ______________