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FINANCE 300 TEST 2
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Terms in this set (82)
Ordinary Annuity or Annuity
-1st Cash Flow occurs one year from today
-A stream of equal periodic cash flows over a specified time period.
-These cash flows can be inflows or returns earned on investments or outflows of funds invested to earn future returns
Annuity Due
-1st Cash Flow occurs now
-An annuity for which the cash flow occurs at the beginning of the period
Annuity Due is always worth __ than the Future Value not ___
-More
-Less
Future Value
The value at a given future date of an amount placed on deposit today and earning interest at a specified rate
Present Value
The current dollar value of a future amount, the amount of money that would have to be invested today at a given interest rate over a specified period to equal the equal amount
Return is normally expressed as a
Percentage
___ is used interchangeably with uncertainty to prefer to the variability in returns for a given asset
Risk
TEST QUESTION: Problems with the measure of return
-Do not reflect time value money
-Do not adjust for risk
If the actual return is known with certainty then
There is No Risk
Systematic Risk or Nondiversifiable Risk
-Cannot be eliminated (called market risk)
-Diversification doesn't matter here
Factors that Systematically impact all firms such as
-MACRO
-Wars
-Inflation
-Recession
-High Interest Rates
-Confidence
Unsystematic Risk or Diversifiable Risk
-Can be reduced by diversification
-Unique to the company should affect economy
Factors that affect a firm or industry such as
-MICRO
-Strike
-Interruption of raw materials
-Lawsuits
-Marketing Programs
-Competition
-Theft
-Management Errors
-Location
We can lower ___ risk but __ risk will always be present
-Unsystematic
-Systematic
Characteristic Line
Characterizes the risk of a firm's Systematic Risk
____ ___ is found by a simple linear regression and is called the best fit line.
Characteristic Line
Beta
-Slope of the Characteristic Line
-Is the measure of systematic risk and contribution to the riskiness of the portfolio
Beta: >1 means
More risk than the overall market
Beta: =1 means
Equal risk to the market
Beta: <1 means
Less risk than the market
TEST QUESTION: What is the slope of the Market if Beta against Market =1?
Beta for market =1
Efficient Market Hypothesis (EMH)
-Theory that describes the behavior of a capital market
-Accurate value
-Fairly Represents Stock prices
____ is where bonds are sold for capital
Efficient Market Hypothesis (EMH)
TEST QUESTION: Which method for best rep for truth for accurate rep?
Present Value of Dividend
Interest Percent
Price for borrowing and the $ is the cost
TEST QUESTION: Lefthand side= Nominal Rate= ____
R
Coupon Interest Rate: CIR=rd:
Par
Coupon Interest Rate: CIR<rd:
Discount
Coupon Interest Rate: CIR>rd:
Premium
TEST QUESTION: Preferred Stock you
-Buy to receive dividend
-Annuity (same amount)
-Last Forever
TEST QUESTION: The lowest CV is the
Preferred Selection
Coefficient of Variation (CV) is
A ratio
Capital Asset Pricing Market (CAPM)
-Describes the relationship between the required return, rs, and the nondiversifiable risk of the firm as measured by the beta coefficient, b
-The basic theory that links risk and return for all assets
Security Market Line (SML)
Shows the relationship between systematic risk and expected return
TEST QUESTION: Change is risk Aversion is demanding higher yield for
The same level of risk
Risk Aversion
The attitude towards risk in which investors would require an increased return as compensation for increased
Bond
A long term debt instrument indicating that a corporation has borrowed a certain amount of money and promises to repay it in the future under clearly defined terms
___ are Corporate IOUs
Bonds
Bond Indenture
Legal document that spells out the right of bond holders and the duties of the issuing corporation
Restrictive Covenants
-When bonds can be called level ratios before further bond issues, payments of dividends
-Restricts what Corporate can do
-Stops corporations from taking advantage of bond holders
Mortgage Bonds
Property pledged as security
Debentures
Unsecured Bond (no lien)
Preferred Stock
-Hybrid (Part Debt/Part Equity)
-A special form of ownership having a fixed periodic dividend that must be paid prior to payment of any dividends to common stockholders
Common Stock
The purest and most basic forms of corporate ownership
Gordon Model
A common name for the constant growth model that is widely cited in divided valuation
A well ___ investor doe not worry about a single company's ___. They are more concerned with the __ as a whole
-Diversified
-Return
-Market
Constant Growth Model
Assumes that dividends will grow at a constant rate, but a rate that is less than required return
Diversification
It is in an investor's best interest to diversify his/her portfolio so that risks are perfectly uncorrelated
The more different your portfolio is the __ risk
Less
If the actual return is unknown or uncertain then
There is Risk
Coefficient of Variation (CV)
Ratio used to discover which asset provides the best return for its level of risk
Standard Deviation
Used to calculate the measure of risk for assets
Portfolio
A collection or group of assets
Basic Valuation Model (Basic Bond Valuation)
A value of a bond is the present value of the payments its issuer is contractually obligated to make from the current time until it matures
The ___ Model is discounting Cash Flows to present Value (value of Assets). The higher the risk, the higher the discount rate but has a lower value. Has a positive relationship.
Basic Valuation Model (Basic Bond Valuation)
Perpetuity
An annuity with an infinite life providing continual annual cash flow
Real Rate of Interest
The rate that creates equilibrium between the supply of savings and the demand for investment funds in a perfect world without inflation where suppliers and demanders of funds have no liquidity preferences and there is no risk
Nominal Rate of Interest
The actual rate of interest charged by the supplier of funds and paid by the demander
Yield Curve
A graphic depiction of the term structure of interest rate
Expectations Theory
Theory that the yield curve reflects investor expectations about future interest rates
An expectation of ____ interest rates results in an upward sloping yield curve.
Rising
An expectation of ___ interest rates results in a downward sloping yield curve.
Declining
Liquidity Preference Theory
Theory suggesting that long term rates hence the yield curve is upward sloping because investors perceive short term investments to be more liquid and less risky long term investments
Borrowers must offer __ rates on long term bonds to entice investors away from their preferred short term securities
Higher
Net Present Value (NPV)
A sophisticated capital budgeting technique
Net Present Value (NPV) is found by ___ projects initial investment from the ___ of its cash flows discounted rate = to the firms ____
-Subtracting
-Present Value
-Cost of Capital
In Particular to the Effective Market Hypothesis the capital market is very ___ and it is difficult to "______"
-Efficient
-Beat the Market
Book Value is the strict accounting value of an ___. Calculated by ___ its accumulated depreciation from its ___
-Asset
-Subtracting
-Installed cost
Book Value Per Share is the amount per share of ____ that would be received if all the firms assets were sold for their exact book value and the proceeds remaining after paying all ___ were divided among the ___
-Common Stock
-Liabilities
-Common Stockholders
Price Earnings (P/E) Multiple Approach
A popular technique used to estimate the firm's share value
P/E Multiple Approach is calculated by multiplying the firm's _____ per share by the average _____ ratio for the industry
-Expected Earnings
-P/E Ratio
P/E Ratio is calculated by dividing the ___ by the ____
-Price (P0)
-Earnings Per Share
___ is the chance of loss or the variability of returns associated with a given asset
Risk
The Future Value of an annuity due is always less than the future value of an otherwise identical ordinary annuity.
TRUE/FALSE
False
Real Rate of interest is the actual rate of interest charged by the supplier to the demander.
TRUE/FALSE
False
With respect to the time value of money, a dollar in the future __, than a dollar today.
Is Worth Less
Beta is the measure of unsystematic risk.
TRUE/FALSE
False
In the valuation process, risk and discount rate have what?
Positive Relationship
If required return is greater than the coupon interest rate, a bond will sell at
Premium
The key inputs to the valuation process include
-Profits
-Cash Flows
-Discount Rate
The best way to value an asset is to discount the asset's profits to present value.
TRUE/FALSE
True
The goal of the firm is to maximize the ___ wealth or maximize __
-Stockholder's
-The Value of the Firm
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