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Investment Planning > Bond and Stock Valuation Concepts > Flashcards

Bond and Stock Valuation Concepts Flashcards

1
Q

What is duration?

A

The average time for a bondholder to receive the interest and principle payments from a bond in PV.

Duration should be aligned with the time horizon of financial goals.

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2
Q

What is y, c & t in bond calculations?

A 
y = yield (current)
c = coupon rate
t = time (# of periods)
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3
Q

What happens to the coupon rate, duration, and maturity when the interest rate goes up or down?

A

Interest rate up = coupon rate up and duration, maturity down
Interest rate down = coupon rate down and duration, maturity up

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4
Q

What is convexity?

A

Convexity measures the duration when there are interest rate changes greater than +/- 1%

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5
Q

What type of bonds does convexity have the greatest impact?

A

Low coupon
Low YTM
Long maturity

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6
Q

What are balance sheets?

A

A snapshot of a company’s Financial standing at a point in time which includes assets, liabilities, and stockholders’ equity.

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7
Q

What is a business income statement?

A

Known as the profit and loss statement or P&L, it shows a businesses income and loss over a period of time (like a year)

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8
Q

What is a business statement of cash flows?

A

This statement assists in the reconciliation of the business income statement., It shows typically three areas: cash flows from business operations, business investments, and business financing

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9
Q

What is a pro forma income statement?

A

Similar to an income statement, it predicts future cash flows. Important - if done correctly, a business can predict when there might be a decline in profitability and make adjustments now to prevent that.

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10
Q

What is a business book value?

A

Refers to the amount of equity available to its stockholders - meaning, the amount that the shareholders have invested in the business

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11
Q

What is fundamental analysis?

A

The process of determining the fair market value or intrinsic value of a security stock

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12
Q

What is ratio analysis?

A

A series of ratios used to evaluate a business

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13
Q

What are liquidity ratios?

A

Determine if a company can meet its obligations as they come due

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14
Q

What are activity ratios?

A

Determine how rapidly assets move through the business

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15
Q

What are profitability ratios?

A

Measure performance and profitability of the business

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16
Q

What are leverage ratios?

A

Measure the extend to which a company uses debt

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17
Q

What is technical analysis?

A

An attempt to work out the demand side of supply and demand in order to evaluate where the business is going

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18
Q

What is top down fundamental analysis?

A

A look at the economy, then the industry, and then specific stocks in that industry

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19
Q

What is fundamental analysis?

A

The process of determining the fair market value, or intrinsic value, of a security and looking for mispricing. This is done by looking at drivers in the economy, in the industry, and within a company themselves.

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20
Q

What is market value?

A

The price of stock as it is determined by investors in the secondary market.

21
Q

What do liquidity ratios determine?

A

Whether a company can meet its obligations as they come due

22
Q

What do activity ratios determine?

A

How rapidly assets move, or how quickly turnover occurs with how payments are received.

23
Q

What do profitability ratios determine?

A

How profitable the firm is and what kind of return they are getting on their capital and equity

24
Q

What do leverage ratios determine?

A

Measure to what extent a company uses debt financing

25
Q

What is technical analysis?

A

Attempts to determine the demand side of supply and demand in order to predict future stock prices. TAs believe that the history of stock prices will determine the future prices

26
Q

What is the difference between fundamental analysis and technical analysis?

A

FA attempts to determine the intrinsic value of a stock whereas TA is only concerned with trades that have occurred.

27
Q

What are contrary opinion rules?

A

The theory that most investors are wrong most of the time. In that case, an investor should then do the opposite.

Mutual fund cash position: when an investor holds cash, the contrarian invests

Odd-lot: if the investor is selling, the contrarian buys and vice versa

Investment advisory: If advice is bearish, the contrarian is bullish

Put-call ratio: indicators of bullish behaviors would lead the contrarian to be bearish

28
Q

Constant growth dividend discount model, multi-stage growth dividend discount model, and discounted free cash flow model are all what type of valuation method?

A

Intrinsic

29
Q

Price to earning, free-cash flow, and sales are all what type of valuation methods?

A

Relative

30
Q

What is the Price-to-Earning ratio?

A

Used to compare a company’s current market price to its EPS.

P/E = current market price / earnings per share (EPS)

31
Q

What is the Price-to-Earning Divided by Growth (PEG) ratio?

A

This is a measure of relative value that can be used to compare companies with different growth rates

PEG = P/E / g

32
Q

What is the Price-to-Free-Cash-Flow (P/FCF) ratio?

A

Measures how effectively the issuing company uses its free cash flow to generate earnings.

P / FCF = (1 + g) / (r - g)

33
Q

What is the Price-to-Sales (P/S) ratio?

A

An indication of how much an investor is willing to pay for a revenue stream

P/S = market price per share / sales per share

34
Q

What is the no-growth (perpetuity) dividend discount model?

A

A stocks intrinsic value when the dividend is expected to remain constant

V = D0 / r

35
Q

What is the constant growth dividend discount model?

A

Used to determine an intrinsic value when the dividends are growing at a constant rate. Most appropriate for valuing mature companies.

V = D1 / r - g

OR (if given “current” year dividend)

V = [D0 x (1 + g)] / r - g

36
Q

What is the multistage growth dividend discount model?

A

Measures the intrinsic value of a stock when the dividend amount changes over time.

1. Compute the value of each future dividend until it stabilizes 
   D1 = $2 x 1.06 = $2.12
   D2 = $2.12 x 1.06 = $2.25
   D3 = $2.25 x 1.06 = $2.39
2. Use the constant growth dividend discount on the stabilized growth rate
   D4 = $2.39 x 1.07 = $2.56
   V = $2.56 / (1.07 - 1.06) = $128
3. Using uneven cash flows, solve for NPV
   CF0 = 0
   CF1 = $2.12
   CF2 =$2.25
   CF3 =$2.39 + 128 = $130.39
I/YR = 9% (required return)
Solve for NPV = 104.52
37
Q

What is the discounted Free Cash Flow Model?

A

Use this if a company does not or is not going to issue dividends

V = FCFE1 / r - g

OR

V = FCFE0 x (1 + g) / r - g

38
Q

What is the relationships in the value of PAR, the coupon rate, the yield to maturity, yield to call, and current yield?

A

Premium PAR = lower CR -> CY -> YTM -> YTC
PAR = CR = CY = YTM = YTC
Discount PAR = higher CR -> CY -> YTM -> YTC

39
Q

Price to earnings divided by growth (PEG) ratio

A

=P/E * g (do not turn into percentage)

40
Q

Intrinsic value (or PV) of bond formula… go!

A 
N = years (annual or semi payments)
I/YR = bond rates
PV = solve
PMT = coupon rate * PAR / 2
FV = PAR
41
Q

Change in bond price formula

A

= -D ((chg) y / 1 + (cur) y)

42
Q

No growth (or constant) dividend discount formula

A

= stock price / r

43
Q

Duration of a bond formula… go!

A

N = 1, I/YR = bond rate, PV=solve, FV=(coupon rate * PAR); Yr 1 * PV
N = 2, I/YR = bond rate, PV=solve, FV=(coupon rate * PAR); Yr 2 * PV (etc…)
N=Last year, I/YR=bond rate, PV=solve, FV=(CR*PAR)+PAR; Yr * PV

Add all of FV column and divide by PV column to get duration

44
Q

ROE formula…go!

A

= Profit / equity (which is assets - liabilities)

45
Q

Formula for free cash flow to equity (FCFE) intrinsic value of stock… go!

A

=FCFE / r-g

46
Q

Constant growth dividend discount model formula…go!

A

=D1 / r - g

OR (if dividend is for current year)

=D0 (1 +g) / r - g

47
Q

Change in the market price of a bond formula… go!

A

ΔP/P = −D[Δy ÷ (1 + y(old yield))]

48
Q

Multistage dividend discount model formula… go!

$1.05 dividend @ 2% for 3 years, then 3%. r=6%

A

Compute the value of each future dividend until the growth rate stabilizes (years 1 through 3 for example).
D1 = $1.05 × 1.02 = $1.07
D2 = $1.07 × 1.02 = $1.09
D3 = $1.09 × 1.02 = $1.11

Use the constant growth dividend discount model to compute the remaining intrinsic value of the stock at the beginning of the year when the dividend growth rate stabilizes (year 4).

D4 = $1.11 × 1.03 = $1.14
V = $1.14 ÷ (0.06 – 0.03) = $38.00
Use the uneven cash flow method to solve for the net present (intrinsic) value of the stock.
CF0 = $0
CF1 = $1.07
CF2 = $1.09
CF3 = $1.11 + $38.00 = $39.11
I/YR = 6%
Solve for NPV = 34.8170, or $34.82
49
Q

Convexity has an inverse relationship with all aspects of a bond except?

A

Time to Maturity - direct relationship

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