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FIL 240 Exam 3 (final exam review)
Terms in this set (10)
1) opportunity cost
--cost of best foregone alternative
2) replacement cost
--cost of replacing an asset at current market value
Explain two costs critical to financial analysis that are not in financial statements, and how do these costs affect the net income of a corporation reported in those financial statements?
The price of a bond moves further from par as the spread between its coupon and yield increases
What happens to the price of a bond as the spread between its coupon and its yield increases?
--adv: limited life
--disadv: if it not paid in timely manner, bond holders can end corporation
--adv.: shareholders cannot end the corporation
--disadv.: diluted ownership of corporation
A corporation can finance major capital projects by issuing debt or by issuing equity. Give one advantage and disadvantage of each.
Components of risk free rate:
--real rate of return
--expected inflation premium
What are the components of the risk-free rate and what are the components of the risk premium?
The shareholders have the residual claim. The shareholders receive nothing until the debtholders have been paid in a timely manner.
Debtholders have the prior claim on the cash flows of a corporation. What does this mean for the shareholders of the corporation?
the expected return on stocks and portfolios increases
If the Federal Reserve signal that it will decrease short-term interest rates, but the expected return to the market portfolio remains unchanged, what happens to the expected return on stocks and portfolios with betas above one?
The greater the systematic risk, the greater the expected return.
What is the relationship between risk and return?
The market premium is the additional expected reward one should receive for bearing the risk of the market portfolio over risk-less investments
Explain what is meant by the "expected market premium over the risk-free rate"?
The two modern decision rules are the Net Present Value rule and the Internal Rate of Return rule. The relationship between them is that the Internal Rate of Return is the discount rate that makes the Net Present Value zero.
You were taught about two modern investment decision rules corporations use. What are they and what is their relationship?
Unsystematic risk can be reduced by adding stocks to the portfolio, while systematic risk cannot be. Systematic risk is related to the expected return on a stock or portfolio.
What is the difference between systematic and unsystematic risk, and which one is related to the expected return on a stock or portfolio?
Recommended textbook explanations
Principles of Economics
N. Gregory Mankiw
Krugman's Economics for AP*
David Anderson, Margaret Ray
Principles of Microeconomics
William A. McEachern
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