Capital Market Theory Flashcards
(11 cards)
What is the primary characteristic of the cash flow pattern for a typical corporate bond?
A stream of annual or semiannual interest payments and a final principal repayment
This describes how most corporate bonds operate, providing regular interest payments until maturity when the principal is repaid.
How is the number of periods (n) calculated for a bond paying semiannual coupons?
It is multiplied by 2.
For a bond with semiannual coupon payments, the number of periods is found by multiplying the number of years until maturity by 2.
In the case of bankruptcy, what represents a primary difference in the claim hierarchy between common and preferred stockholders?
Preferred stockholders have a higher claim on company assets in case of liquidation.
This means that in the event of liquidation, preferred stockholders are paid before common stockholders.
What is a key advantage of holding common stock over preferred stock?
Potential for capital appreciation
Common stock can increase in value over time, offering higher returns compared to preferred stock, which typically has fixed dividends.
What is the book value per share if a company’s total equity is $200 million and it has 20 million shares outstanding?
$10
The book value per share is calculated by dividing total equity by the number of shares outstanding: $200 million / 20 million shares.
What is the company’s earnings per share (EPS) if it has a market capitalization of $500 million, net income of $25 million, and 10 million shares outstanding?
$2.50
EPS is calculated as net income divided by the number of shares outstanding: $25 million / 10 million shares.
What is the value of the stock using the Gordon growth model if a company is expected to pay a dividend of $1.80 next year, growing at 7% per year, with a required rate of return of 11%?
$45.00
The value is calculated using the formula D1/(k − g) = $1.80/(0.11 − 0.07).
What is the impact of portfolio diversification on expected returns?
It reduces the variability of expected returns.
Diversification helps to spread risk across various assets, leading to more stable returns.
What is the primary purpose of diversification in a portfolio?
To reduce the idiosyncratic risk
Diversification aims to mitigate the risk associated with individual securities by holding a variety of investments.
In the capital asset pricing model (CAPM), what is the significance of the market risk premium?
It is the extra return over the risk-free rate expected from the market.
The market risk premium reflects the additional return investors expect for taking on the risk of investing in the stock market.
What does the capital asset pricing model (CAPM) imply about stocks with a beta greater than 1?
They are more volatile than the market.
A beta greater than 1 indicates that a stock’s price is expected to move more than the market average in response to market changes.
