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Social Science
Economics
Finance
Fin 301 Midterm
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Terms in this set (28)
What is the most likely reason a bond issuer would decide to call (buy back) its bonds?
Interest Rates have decreased
If the growth rate of a dividend increases, but required return decreases, what would be the impact on stock price?
Stock price Increases
If Bond C is callable and Bond N is non-callable and they both sell for the same stock price, what are the relative coupon rates and YTM for the two bonds?
Bond C coupon rate > Bond N coupon rate; Bond C YTM > Bond N YTM
Annuity
Level cash flows for a set number of periods
Perpetuity
-Level cash flows forever
-PV=(PMT/r)
FV of an annuity
Gives a value at the time of the final payment
PV of an annuity
Gives a value one period before the first payment
Bond Price
-Discount if price < $1000
-Premium if price > $1000
-Face value (at par) if price = $1000
Market Interest Rate (r) alternative names
Required Return, Cost of Capital, opportunity cost of capital
Par Value ($1000) alternative names
Principal Value, Face Value, Maturity Value
Bond Price
Primarily determined by the market interest rate (cost of capital)
Market interest rate vs. Coupon Rate
-Market interest rate > Coupon Rate = Bond sells at discount
-Market interest rate < Coupon Rate = Bond sells at premium
Inverse relationship between bond price and interest rates
-If rates increase then prices will decrease
-If rates decrease then prices will increase
Bond Maturity
As bond price approaches maturity, price will approach principal value ($1000)
Impact of rate changes
Rate changes have greater impact on bonds with longer time to maturity
Current Yield
-Total annual coupon payment / Price Paid
-Calculates annual return on investment
YTM vs. Rate of Return
-If market interest rates rise: YTM > Rate of Return
-If market interest rates fall: YTM < Rate of Return
Which is more risky equity or debt?
Equity
Goal of Finance
Maximize shareholder value
Net Present Value
Value that is added (or subtracted from) shareholder value
NPV Decision Criteria
-NPV > 0 Project should be accepted
-NPV < 0 Project should be rejected
Mutually Exclusive Projects
Accept the project with highest NPV
Internal Rate of Return (IRR)
-Accept project if IRR > Required Return
-Reject Project if IRR < Required Return
NPV, IRR and Required Return
-If NPV > 0, IRR > Required Return
-If NPV < 0, IRR < Required Return
-If NPV = 0, IRR = Required Return
IRR vs. NPV disagreements
-Cash inflows become before cash outflows
-Multiple changes in cash flow signs
-Mutually exclusive benefits
-Use NPV in these situations
You are given two annuities, each of which makes one payment per year. Annuity F begins in one year and makes five payments of $200. Annuity G begins in four years and makes five payments of $200. All else equal, what do you know about the future value of Annuity F at the end of year five compared to the future value of Annuity G at the end of year eight?
FV Annuity F = FV Annuity G
You borrow $15,000 from a credit union to purchase a car. The term of the loan is five years. The credit union requires quarterly loan payments and charges interest at 24% annual percentage rate (APR). All else equal, if the credit union begins requiring payments on a monthly basis, what will happen to the size of each payment and the effective annual rate (EAR) on the loan?
Each payment is smaller; EAR increases
Sharon purchased Bond Q two years ago for $940. Currently the bond has 6 years remaining to maturity, a 10% annual coupon and the market interest rate is 5%. Assuming that the bond is priced correctly, what has happened to the bond rate of return and yield to maturity (YTM) from the time Sharon bought the bond until now?
Rate of Return has increased, YTM has decreased
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