Chapter 6 Bonds

Question 1

Zero-Coupon Bonds

Answer 1

A single payment at a fixed future date.

Question 2

Maturity Date

Answer 2

The date when the issuer of the bond makes the last payment.

Question 3

Face Value

Answer 3

The payment at maturity.

Question 4

Coupon

Answer 4

Payments at fixed dates.

Question 5

Clean Price

Answer 5

The quoted price.

Question 6

Dirty Price

Answer 6

The price actually paid including accrued interest.

Question 7

Consols

Answer 7

Bonds that never stop paying a coupon with no final maturity date.

Question 8

Which government still commits to giving out consols even during hard times?

Answer 8

English Government

Question 9

Discount

Answer 9

When the present value is less than face value.

Question 10

Premium

Answer 10

When the present value is higher than face value.

Question 11

Yield To Maturity

Answer 11

The rate of return that the holder is earning on the bond.

Question 12

Holding Period Return

Answer 12

The total return received from holding an asset or portfolio.

Question 13

Shares of Capital Stock

Answer 13

Residual claims to after-tax earnings or to the firm’s asset if there’s dissolution.

Question 14

Preferred Shares

Answer 14

Priority in dividend payments and liquidation (over common shareholders) but no voting rights.

Question 15

Common Shares

Answer 15

Dividends for an ongoing firm and control over firm’s decisions.

Question 16

Dividends

Answer 16

A distribution of the company’s earnings.

Question 17

Capital Gains

Answer 17

Share price appreciation.

Question 18

Zero Growth Dividend Model

Answer 18

Assumes that the dividend will remain at the same level forever.

Question 19

Constant Growth Dividend Model

Answer 19

Assumes that dividends will grow at a constant rate forever.

Question 20

Differential Growth Dividend Model

Answer 20

Estimate the future dividends in the foreseeable future, estimate the future stock price and compute the total PV of estimated future dividends.

Question 21

Growth Rate

Answer 21

Retention Ratio x Return on Earnings (Historical ROE)

Question 22

Payout Ratio

Answer 22

Dividends/Earnings

Question 23

Dividend Discount Model Concerns

Answer 23

• What if firms don’t pay dividends?
• The model is well-specified if r >g
• if g > r than assume differential growth
• Very hard to estimate

Question 24

Cash Cow

Answer 24

EPS = DIV, a company with a level stream of earnings per share in perpetuity.

Question 25

NPV of Growth Opportunities

Answer 25

The sum of the firm value given a 100% dividend payout ratio and net present value of growth opportunities (NPVGO)

Question 26

Dividend Discount Model

Answer 26

Use TVM tools to value the firm's equity as a function of its expected dividend distributions.

Question 27

Relative Valuation: Price Earnings Ratio

Answer 27

- Values a company by comparing it with that of publicly traded companies in the same industry. - Often the last 4 quarters' earning are used.

Question 28

Growth Stocks

Answer 28

Firms whose shares at high multiples and with value concentrated in NPVGO.

Question 29

Value Stocks

Answer 29

Firms whose shares sell at low multiples and with value concentrated in cash cow.

Question 30

Limitation of P/E

Answer 30

- Uninformative when companies have negative or very low, earnings - One year's earning can fall, but a stock price is a function of many years.

Question 31

Price/Cash Flow

Answer 31

Cash Flow = Net Income + Depreciation

Question 32

Price/Sales

Answer 32

Current stock price over annual sales per share.

Question 33

Price/Book

Answer 33

Current price over book value of equity. | Book Value = Assets - Liabilities

Question 34

Spot Interest Rate

Answer 34

The interest rate fixed today on a loan today.

Question 35

Forward Interest Rate

Answer 35

A hypothetical interest rate that is specified now for a loan that will occur in the future.

Question 36

Expectations Theory

Answer 36

Investors set interest rates so that the forward rate equals the spot rate expected at that time.

Question 37

Liquidity Preference Theory (Risk Avoidance Theory)

Answer 37

Investors demand a "risk premium" to hold riskier longer-term debt instrument.

Question 38

Market Segmentation Theory

Answer 38

- Separate markets exist for securities of different maturities. - Each market determines a rate based on supply/demand forces

Question 39

Upward Sloping Yield Curve

Answer 39

Long-Term Rates > Short-Term Rates

Question 40

Downward Sloping Yield Curve

Answer 40

Short-Term Rates > Long-Term Rates

Question 41

Flat Yield Curve

Answer 41

Short-Term Rates = Long-Term Rates

Question 42

Humped Yield Curve

Answer 42

Medium-Term rates are higher than Short-Term and Long-Term rates