question

Duration

answer

Compares the impact of interest rate changes on a bond. How many percentage points the price of a bond will go up/down if interest rates go down/up. Multiply decimal interest x percentage.

question

Inverse Price Relationship

answer

When interest rates drop, bond rates go up. When interest rates rise, bond rates go down.

question

Sensitivity

answer

How sensitive a bond is to fluctuating interest rates (calculated with duration)

question

Debenture

answer

Bond that has no collateral

question

Par Value

answer

Face value of a bond (usually 1k)

question

Coupon Rate

answer

Interest rate of the bond, payable in installments. Cannot be changed for the life of the bond.

question

Yield to Maturity

answer

rate of return on a bond

question

Affirmative covenants

answer

things firm promises to do

question

negative covenants

answer

things firm promises to not do

question

current yield of a bond

answer

coupon payment divided by bond amount. NOT the same as YTM.

question

Subordinated debenture

answer

debentures that take last place in a payoff

question

Zeros

answer

bonds that pay no coupon, but sell at a lower price.

question

Eurobond

answer

Pays out in a non-domestic currency (US bond in europe that pays in dollars)

question

Foreign Bond

answer

Bond floated by another country but that is payable in the domestic currency (chinese debt payable in dollars floated in the us)

question

Muni-bonds

answer

floated by local govts to fund infrastructure, exempt from taxes.

question

Convertible bonds

answer

can be converted into equity securities.

question

Junk Bonds

answer

bond that is rated BB or below. higher yield and higher risk.

question

Primary Factors influencing bond sensitivity

answer

Coupon rate, time to maturity (primary factor).

question

Primary financial instruments

answer

stocks and bonds

question

Syndicate

answer

Group that is formed to handle a stock or bond issue. Made up of large investment banks or investors. They may also underwrite.

question

Competitive Sale

answer

underwriters will submit bids, firm will select lowest interest rate, highest price.

question

Negotiated sale

answer

Firm will investigate underwriter bids and will negotiate after more investigation.

question

Secondary Markets

answer

Where stocks are traded after IPO. "the stock market"

question

Auction financial Market

answer

Has a physical location. NYSE. Uses specialists.

question

Dealer (stock) market

answer

does not require a physical location. Uses a network of dealers. NASDAQ.

question

Specialist

answer

provides liquidity in the stock market (NYSE) and sets the spread.

question

ASK Price

answer

Minimum price sellers are willing to sell for

question

BID price

answer

the maximum price buyers are willing to 'bid'/Pay

question

Market Order

answer

executes at the market price

question

Limit Order

answer

executes at the price requested, if available.

question

Calculating a simple stock dollar return

answer

Price (new) - Price (old) + div or coupon

question

Calculating a simple stock percentage return

answer

{Price (new) - Price old +DIV}/ Price old+ X 100

question

Agency Costs

answer

Costs that are incurred when management does not act in the best interest of shareholders.

question

Indirect method starts with...

answer

Net income!

question

Formula for CFO

answer

NI+Depreciation expense + changes in operating accounts

question

Increase in an asset account means..

answer

cash has left the firm. Considered an outflow, decrease in cash on a cash flow statement.

question

Increase in a liability account means...

answer

Cash has come into the firm. Considered inflow, increase cash on cash flow statement.

question

Formula for CFI

answer

Change in gross PP&E OR change in net PPE plus depreciation.

question

Formula to calculate dividends

answer

DIV = (Old RE plus NI) - new RE

question

Formula to calculate NI

answer

NI=Change in RE +divs

question

Formula to calculate new RE

answer

New RE = old RE +NI - DIVS

question

Free Cash Flow

answer

Distributable Cash - can be distributed after funding required reinvestment in PP&E.

question

Free Cash Flow Formula (F)

answer

FCFF= EBIT (1-tax) + depr - change in CAPEX(CFI) - increase in NWC

question

Free Cash Flow Formula (Equity holders)

answer

FCFE = NI + Depreciation - CAPEX - Increases in NWC + Increases in Debt

question

Current Ratio (L)

answer

higher = better likelihood company can meet short term obligations. current assets/current liabilities

question

Quick Ratio (L)

answer

current assets - inventory/current liabilities. greater ability to meet ST obligations since it removes the slower moving inventory.

question

AR Turnover/Average collection Period (L)

answer

how often AR turns over and in how many days.

question

Inventory turnover/days on hand (L)

answer

how often inventory turns over/how many days.

question

Total Asset Turnover (E)

answer

how many sales per dollar of assets

question

FAT/Fixed asset turnover (E)

answer

how many sales per dollar of FIXED assets

question

OIROI (Op income ROI) (E)

answer

tells us how much pre-tax, pre-financing profit per dollar of assets.

question

Debt Ratio (F)

answer

proportion of firms assets financed by debt

question

IBDTC (interest bearing debt to total capital) (F)

answer

omits a/p and accruals from debt ratio calculation.

question

Times interest earned (F)

answer

How many times interest expense can be covered by operating profit.

question

FLR Financial Leverage Ratio (F)

answer

how much is financed with debt or equity.

question

ROA (P)

answer

earnings as a percent of capital invested.

question

ROE (P)

answer

How much did I earn as a percentage of each dollar invested? Also calculated as result of Dupont.

question

Gross Margin (P)

answer

percent of revenue remaining after COGS.

question

Operating Margin (P)

answer

percent of sales remaining after covering the cost of the goods sold AND operating expenses. pre-interest, frequently used to compare firms with different capital structures (i.e., different amounts of debt).

question

net margin (P)

answer

how much remains for equity holders after all other costs.

question

DUPONT

answer

efficiency, leverage, financing NISSTAAE. Also = ROE. Also net Margin x TAT X FLR

question

Three ways to use ratios

answer

trend analysis(over time), cross sectional analysis (compare to a peer group) and internal goal monitoring

question

pitfalls with ratios

answer

accounting issues, timing issues

question

inflation

answer

annual decay in the purchasing power of money

question

risk premium

answer

compensation for bearing the risk of an investment.

question

TVM - composed of

answer

amount of cash flows, timing of cash flows, rate of change due to passing of time.

question

Annuity (ordinary)

answer

equally spaced series of cash flows all of the same magnitude. Starts at the END of a period.

question

Annuity (due)

answer

equally spaced series of cash flows all of the same magnitude. Starts at the beginning of a period.

question

perpetuity

answer

annuity that is perpetual. PV = CF/r (payment over interest rate)

question

mixed stream cash flows

answer

series of payments with different magnitudes. Use CF/NPV on calculator!

question

TVM in Risk Assessment

answer

Risk buckets, sensitivity analysis

question

Corporate Governance

answer

control issues in running a company

question

Intrinsic value of any asset (stock/bond)

answer

present value of the stream of expected future cash flows discounted at an appropriate required rate of return.

question

Gordon Growth Model

answer

used for stock valuation V0=(D1 / kcs-g), g = kcs - D1/V0, kcs = D1/V0 + g

question

Preferred Stock

answer

hybrid security, resembles both equity and debt. No fixed maturity, legally equity, can't vote, FIXED Dividends (no matter how well or poorly company does) must be paid before common stockholders and will go into arrears. Paid off first when company liquidated.

question

Valuation of Preferred Stock

answer

V= D/interest rate (perpetuity, as payment is always the same)

question

FCF measure of stock valuation

answer

Used instead of GG model (D0) when no dividend is paid

question

Weighted average Return

answer

Recessionary/Expansionary x returns. Weighted average return to account for economic states.

question

Standard deviation of weighted average return

answer

Probability (return-ER)squared, then sqr root. Gives another measure of risk/volatility wrt economic states

question

idiosyncratic risk

answer

percentage that can be diversified away.

question

systematic risk

answer

cannot be diversified away.

question

Return Risk Tradeoff

answer

Quadrant A is preferred (higher reward, lower risk)

question

Markowitz efficient frontier

answer

consists of a frontier of various portfolios of a given set of stocks that are efficient, or, in other words, have the highest level of expected return for a given level of risk.

question

Market portfolio

answer

all investors will eventually hold the market portfolio.

question

CAPM

answer

Expected Return = risk free rate +beta (market rate - risk free rate). <--risk premium. Suggests that a firm's return is only a function of the level of systematic risk. Most commonly used method to find ER for stocks! Beta =1 at the market.

question

Beta in CAPM

answer

the slope of the market line, ratio of the covariance of returns to the variance of market returns. MEASURES THE FIRMS SYSTEMATIC (NON DIVERSIFIABLE) RISK. market =1

question

The covariance between Y and X to the variance of X

answer

the estimate for beta.

question

Independent variable placement

answer

on the X axis

question

Mean

answer

overall best estimate for expected value

question

WACC

answer

Weighted Average Cost of Capital (Common Equity/Preferred Equity/Debt over market value x cost. Debt also has 1-tax rate multiplier).

question

Why use WACC?

answer

The cost of capital in rate of return (%) terms - can help decide if an investment is a good idea. WACC is the discount rate for the future cash flows that are proposed for the new investment.

question

Cost of Common Equity

answer

usually calculated (in percent) by using the GGM (shareholders), the CAPM , or the mean of past returns. CAPM used most often.

question

Cost of Preferred Equity

answer

calculated using perpetuity model (in percent)

question

Before-tax cost of debt

answer

yield to maturity on bonds OR the interest rate on debt

question

after tax cost of debt

answer

equal to the yield to maturity on a company's bonds multiplied by 1 minus the marginal tax rate

question

Method most often used to calculate cost of Common Equity

answer

CAPM

question

Flotation Costs

answer

costs associated with the issuance of new equity or debt - often due to underwriting fees. Can reduce the price of a new security or add a percentage to the cost of capital.

question

Which type of bond will have a higher YTM?

answer

Long term bonds. A longer length to maturity implies greater risk so yields on bonds will actually increase as time to maturity increases

question

Difference between cost of internal and external equity?

answer

Flotation costs

question

If income tax rates increase, cost of debt will....

answer

Decrease (due to tax shelter)

question

DFN

answer

Discretionary Financing Needed. If positive, funding needed for discretionary accounts (long term debt, notes payable, stock). If negative, company has enough funding.

question

Percent of Sales Method

answer

Most common method of forecasting

question

Spontaneous Accounts

answer

Accounts that will vary automatically with sales - a/p, a/r, cash, inventory - most current asset and liabilities accounts.

question

Discretionary accounts

answer

left to the discretion of management. Long term debt, notes payable, common stock accounts.

question

Calculating the change in a spontaneous account

answer

divide last year's spontaneous account by last year's sales to determine the percentage it holds. That percentage would be multiplied against this year's projected sales to predict the spont account this year.

question

Formula for projected RE

answer

Old RE + projected sales x net margin x (1-div/ni) OR old RE + NI - dividends. OR old RE + change in RE

question

Dividend payout ratio

answer

DIV/NI

question

Plowback ratio

answer

1-(DIV/NI) (amount of funds firm retains)

question

DFN formula

answer

Projected Total Assets - Projected Total Liabilities - Projected Owners' Equity

question

Sustainable Growth Rate (SGR)

answer

level of growth where four key financial ratios—profitability, asset utilization, leverage and payout (plowback)—are constant and where the firm does not need to issue any new equity to fund the growth.

question

SGR Formula

answer

ROE (1 - div/ni), OR Dupont x (1-div/ni)

question

Capital Budgeting Decisions

answer

Estimation of the allocation of money, timing of cash flows to perform a cost benefit analysis of a proposed project.

question

Differential cash flow

answer

cash flows associated with using the asset each year.

question

Terminal Cash Flow

answer

Cash flow associated with unwinding the project at the end. Generally the money from disposing of the asset (inc taxes) and recapture of NWC.

question

Soft Skills

answer

Project evaluation is based on incremental cash flows, as well as incidental cash, opportunity costs, sunk costs

question

Hard skills

answer

Tax code and TVM issues (depreciation/taxes)

question

MACRS (Modified Accelerated Cost Recovery System)

answer

Used to depreciate assets instead of straight line (33/45/15/7)

question

WCinv (working capital investment)

answer

Current assets - current liabilities. (change in inventory, a/r) Cash outflow at the beginning, cash inflow at the end when recaptured.

question

Differential Cash Flows

answer

incremental revenue - incr expenses - diff depreciation = (EBT), then minus tax, add back depreciation. No recognition of interest expense, as tax is considered in WACC.

question

Payback period

answer

number of years required to recoup the initial outlay

question

hurdle period

answer

used during payback analysis to see if project will be paid back by that time. Flawed because cash flows after hurdle are not considered, no risk adjustment.

question

NPV (Net Present Value)

answer

net of all the present cash flow values. If positive, accept the project. Reject if negative. Zero would mean indifference. better used with multiple projects or sign changes in cash flows.

question

IRR (internal rate of return)

answer

solves for the rate of return that makes present value of inflows = initial outlay. If > required return (WACC), accept project. Difficult to use with multiple sign changes.

question

capital structure

answer

the mixture between a firm's level of debt and a firm's level of equity. Remember, debt is cheaper than equity!

question

business or operating risk

answer

risk that firms face because of variability in operating income.

question

Degree of Operating leverage (DOL)

answer

measures business risk. (sales - variable costs)/EBIT. tells how much EBIT will change for a given percent in sales. Higher values mean the company has higher fixed costs and faces higher business risk.

question

Degree of Financial Leverage (DFL)

answer

EBIT/(ebit - interest). Percentage change in pre-tax profit r/t change in EBIT. Financial leverage can increase profitability of a firm (can also be dangerous).

question

Degree of Combined Leverage (DCL)

answer

Percentage change in operating income for every percentage change in sales. (sales -variable costs)/(EBIT - interest expense). Remember that fixed costs are generally financed with debt and higher fixed costs result in higher business risk (DOL). Also, remember that more debt leads to more interest expense, which affects financial risk (DFL). DOL x DFL.

question

leveraged recapitalization

answer

used to increase debt to equity. Issue new debt, pay back outstanding shares or issue dividends.

question

leveraged buyout

answer

take on new debt to acquire another company

question

nationalization

answer

government purchases controlling shares in a company

question

cash cycle

answer

the length of time between when the inventory is paid for and the time when the company is paid for the finished product

question

operating cycle

answer

the length of time between when the raw materials are received to the time when the company is paid for the finished product

question

operating balance

answer

amount of cash the firm needs to pay its immediate bills

question

reserve balance

answer

amount of cash the firm must hold as a safety net. could be determined by lenders or management.

question

Comparable Multiples method of firm valuation

answer

multiply p/e ratio of comparable for your firm, multiply by your firm's earnings. = estimated price of your firm. most often method used in entrepreneurial firms

question

earnings yield

answer

earnings/price = sometimes preferred over p/e because number will be very small when earnings fall close to zero (P/E would be very large).

question

EBITDA

answer

earnings before interest, taxes, depreciation and amortization. popular to compare entrepreneurial firms (EBITDA/Price ratio - multiply by your firm's price).

question

DCF Method of firm valuation

answer

value (a) = cash flow measure / (1 + discount rate measure) to the t power. Common to use FCFF as the CF, WACC as the discount rate, then put into GGM)

question

Value of firm equation

answer

Vfirm=Vequity+Vdebt

question

Five steps of DCF firm valuation

answer

Forecast as far into the future as you reasonably can (usually 3-5 years is the maximum you can forecast) and construct pro forma statements; Compute the free cash flow for each of these forecasted years; In the last year of the forecast, estimate a terminal value and add it to the last year's free cash flow from step 2; Compute an appropriate discount rate; and Use time value of money to discount back the cash flows to the present value (net present value/tvm)

question

National banking act

answer

Act that began financial regulation in the uS

question

Dodd Frank act

answer

Established risk-based insurance premiums for banks known as CAMELS,Creation of Financial Stability Oversight Council, Volcker Rule, "too big to fail" , monitoring of insurance industry

question

CAMELS

answer

Capital Adequacy, Asset Quality, Management quality, Earnings, Liquidity, Sensitivity to market risj

question

Volcker Rule

answer

limits bank investments in hedge funds and proprietary trading.

question

Financial Stability Oversight Council

answer

Dodd-Frank Act, monitors how systematic risk impacts the industry

question

Form S-1 "red herring"

answer

initial offering prospectus for IPO

question

Form 10-Q

answer

quarterly report with the SEC

question

Form 10-K

answer

yearly report with the SEC

question

Rule 144a

answer

from the securities act of 1933. Allows accredited investors to buy capital without registration

question

Regulation S

answer

from securities act of 1933. Allows raising capital in other countries without registration. Cannot be sold to us citizens or corporations.

question

Securities Act of 1933

answer

Requires firms to register with SEC before a public offering, except wrt rule 144a/regulation s.

question

Prospectus

answer

includes audited financial statement information, the name of the lead underwriter(s), a discussion about the firm and its prospects by management, the price of the offer, the number of shares being offered, and even a section of risk factors, among many other requirements

question

Firm commitment offering

answer

underwriter purchases shares then sells them to the primary market at the offer price. they then can throw them into the secondary market (NYSE/NASDAQ)

question

SOX 2002

answer

designed to ensure that public company boards of directors actually represented the shareholders in good faith. Second, it was designed to monitor company executives and ensure they were truthful in their SEC reporting. also to ensure that public accounting firms were being honest in their audits of public companies

question

Section 302 of SOX

answer

requires a set of internal control policies that can add significant expense to operating firms

question

FINRA (Financial Industry Regulatory Authority)

answer

the largest independent regulating service for all securities firms operating within the United States.Companies that trade in equities, corporate bonds, financial futures, and options that are not regulated by another SRO, must be members to be compliant with the SEC.

question

Functions of FINRA

answer

to license individuals, admit firms to the industry, write rules to govern their behavior, examine firms for regulatory compliance, and to discipline members that do not comply with federal securities laws . Along with these oversight roles, it offers education opportunities for industry professionals, qualification exams, and outsourced regulatory products to various markets and exchanges

question

Terminal Value

answer

final year CF/ WACC

question

Statistical Moment

answer

measure of the shape of the distribution at a particular point (such as the mean)

question

Best estimate for expected value

answer

mean

question

standard deviation of expected returns

answer

estimate of volatility

question

Collection float

answer

the time it takes for a firm to be able to use the payments from customers

question

disbursement float

answer

the time it takes for a company's payment to become an actual outflow

WGU C214 Finance (Ch 1-15) – Flashcards

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