Fakta Flashcards
What is the nominal interest rate?
The rate at which your money will grow if invested for a certain period.
What is the real interest rate?
The rate of growth of your purchasing power?
What is the yield curve?
A yield curve is a line that plots yields (interest rates) of bonds having equal credit quality but differing maturity dates. The slope of the yield curve gives an idea of future interest rate changes and economic activity. There are three main types of yield curve shapes: normal (upward sloping curve), inverted (downward sloping curve) and flat.
What is cost of capital?
The best available expected return offered in the market on an investment of comparable risk and term to the cash flow being discounted.
What stocks have the largest fluctuations in price and most return over time?
Small stocks
What are two difficulties with using past return to predict the future?
- We’can’not’know’what’investors’expected’in’the’past,’we’can’only’ observe’the’actual’returns’that’were’realized’
- The’average’return’is’just’an’estimate’of’the’true’expected’return,’and’is’ subject’to’estimation’error’
What is covariance?
The expected product of the deviation of two returns from their means.
What is correlation?
A measure of the common risk shared by stocks that does not depend on their volatiloty.
What is the efficient portfolio?
There is no way to reduce the volatility of the portfolio without lowering it’s E(R)
How do we identify the tangent portfolio?
Find the portfolio that generates the steepest possible line when we combine with the risk-free investment
What is the Sharpe ratio?
The Sharpe ratio measures the ratio of reward-to-volatility provided by a portfolio. The tangent portfolio has the highest Sharpe ratio of any portfolio.
What does CAPM say?
All investors should choose a portfolio on the CML, by holding some combo of the risk-free security and the market portfolio.
What is the difference between the SML and the CML?
CML - Bara optimala portföljer ligger på linjen, alla andra ligger under.
SML - Alla värdepapper på linjen, var de ligger beror på vilken risk de har.
What is a value-weighted portfolio?
Equal ownership portfolio - each security is held in proportion to its market capitalization
What is a passive portfolio?
A portfolio that is not rebalanced in response to price changes, only in changes of number of shares.
What is a price-weighted portfolio?
Holds and equal number of shares of each stock, independent of their size.
What is Yield To Maturity?
YTM is the IRR an investor will earn from holding the bond to maturity and receiving its promised payments.
What happens to the cost of capital when the fixed costs are higher?
higher beta –> higher cost of capital
What is alpha?
If the market portfolio is not efficient –> all stocks will not lie on the SML –> the distance of a stock above or below the SML = the stocks alpha. Regardless of how much information an investor has access to, he can guarantee himself a alpha=0 by holding the market portfolio.
What are typical behavior of individual investors?
- Under diversification and portfolio biases
- Exessive trading and overconfidence
- Hanging on to losers and the disposition effect
What are three strategies for selecting portfolios?
- Market capitalization strategies: buys small stocks and finances by short selling big stocks (SMB)
- Book-to-market ratio: Long position in the high M/B ratio portfolio and short position in the low. (HML)
- Past Return strategy: Past returns, buys 30 best and sells 30 worst past performing stocks. (PR1YR)
What is the multifactor risk model?
More than one portfolio used to capture risk, FFC Factor specification most popular choice. Better than CAPM.
What is M&M proposition 1?
The company’s capital structure does not impact it’s value. VL=VU
What is M&M proposition 2?
The cost of capital of levered equity increases with the firm’s market value of debt-equity ratio. Se formel.
What is dilution?
If a firm issues new shares, the CF generated by the firm must be divided along a larger number of shares –> reducing the value of each individual share.
What is recapitalization?
When a firm makes a significant change to its capital structure
What is an optimal level of leverage from a tax savings perspective?
Interest expense = EBIT, more interest is called excess interest and does not reduce taxes.
Why are firms underleveraged?
Increasing the level of debt increases the profitability of bankruptcy.
Why do creditors agree on reorganization?
Value of cash and securities are generally less than the amount each creditor is owed, but more than the creditor would recieve if chapter 7 would be used.
What are two direct costs of bankrupcty
- Outside professionals are generally hired - costly
- Creditors get costs, e.g. legal representation
What are indirect costs of financial distress?
- Loss of costumers
- Loss of suppliers
- Loss of employees
Who pays for the financial distress costs?
When securities are fiarly priced, the original shareholders of a firm pay the present value of the costs associated with bankruptcy and financial distress.
What does the trade-off theory say?
Combine benifits of leverage from the interest tax shield with the costs of financial distress to determine the amount of debt –> maximize value.
What are three factors that determine the PV of the financial distress costs?
- Probability of financial distress
- Magnitude of the costs
- Firms market risk
What are agency costs of leverage?
Levered firm –> conflict of interest –> does the investment decision have different consequenses for the value of equity and the value of debt.
What is the debt overhang/under-investment problem?
When a company has a hard time attracting investors because profits are eaten up by the debt overhang –> can’t invest.
What is the leverage ratchet effect?
When an unlevered firm issues new debt, equity holders bear any anticipated agency or bankruptcy costs. Once a firm already has debt, some of the agency or bankruptcy cost that result from taking on additional leverage will fall on existing debt holders. –> Shareholders may have incentive to increase debt, but not decrease.
What is a positve effect leverage can have on management?
Leverage –> managers run the firm more effectively.
Why does managers overspend on personal perks and make lage unprofitable investments?
- Empire building: want to run large firms
- Free Cash Flow Hypothesis: Excess cash after investments
What is the declaration date?
The date on which the board authorizes an dividend
What is the record date?
Shareholders record by this date will receive the dividend
What is the ex-dividend date?
Two business days prior to the record date, will not receive dividend
How does a 4:1 stock split work?
Every share generates four more shares.
What are three types of repurchases?
- Oper market repurchase: Long period of time… (95%)
- Tender offer: Short time, price premium.
- Targeted repurchase: Firm buys from a major shareholder.
What does M&M say about payout policies?
In perfect capital markets, dividend or share repurchases does not matter. When a dividend is paid, the share price drops by the amount of the dividend.
When is it better to pay no dividend?
If taxes are the only important market imperfection, when the tax rate on dividend exceeds the tax rate on capital gains, the optimal dividend policy is for the firm to pay no dividend. –> share repurchase.
What are clientele effects when it comes to payout policy?
The dividend policy of a firm is optimized for the tax preference of its investor clientele.
What does M&M say about retention of cash and payout
In perfect capital markets, if a firm invests excess cash flows in the financial securities, the firm’s choice of payout versus retention is irrelevant and does not affect the initial value of the firm.
What is true about retaining cash and taxes?
Corporate taxes make it costly for a firm to retain excess cash. A firm receives interest –> it owes taxes on interest. Also agency costs with retaining cash.
What are two reasons to retain cash?
- Avoid financial distress costs
- Preserve financial slack for future growth opportunities.
What are two types of signaling with payout policy?
- Dividend smoothing
- Dividend signaling
What is a spin-off?
E.g. 100 shares of Pharmacia stock –> receive 17 shares of Monsanto stock