Final Review Flashcards by Taylor Thomas

Four Types of Firms

Sole Proprietorship
Partnership
Limited Liability Companies
Corporation

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Corporation pays tax on its profits and shareholders pay their own personal income taxes

C Corporation

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Firm’s profits/losses are not subject to corporate taxes

S Corporation

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Financial Management Tasks

Investment decisions
Financing decisions
Manage cash flow from operating activities

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Holding the time period constant while decreasing the interest rate _______ present values.

Increases

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Equally-spaced cash flows that increase in size at a constant rate forever

Growing Perpetuity

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Equally-spaced cash flows that increase in size at a constant rate for a finite number of periods

Growing Annuity

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Does not account for the number of compounding periods or adjust the annualized interest rate for the time value of money

APR

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Accounts for the number of compounding periods and adjusts the annualized interest rate for the time value of money

EAR

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More accurate measure of rates involved in lending and investing

EAR

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Real rate of interest

Interest rate that would exist in the absence of inflation

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Nominal rate of interest

Interest rate adjusted for inflation

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Interest rates tend to follow

the business cycles

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Interest rates tend to decrease during an

economic contraction

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Interest rates tend to increase during an

economic expansion

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Slopes upward from left to right and imply higher interest rates are likely

Ascending Yield Curve

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Slopes downward from left to right and implies lower interest rates are likely

Descending Yield Curve

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Implies interest rates are unlikely to change

Flat

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Three factors that influence the shape of the yield curve:

Real rate of interest
Expected rate of inflation
Interest rate risk

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The longer the maturity of a security, the _______ its interest rate risk.

greater

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The interest rate risk premium adds _______ _____ to the slope of the yield curve

Upward bias

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Treasury notes

Original maturities from one to ten years

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Treasury bonds

Original maturities of more than ten years

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If coupon rate is equal to the yield, the bond is sold at?

par

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If coupon rate is less than its yield, the bond is sold at?

A discount

If coupon rate is greater than its yield, the bond is sold at?

A premium

Bonds with higher coupon rates are _____ sensitive to interest rate changes because they pay higher cash flows up-front

less

Four features of debt instruments responsible for the differences in corporate borrowing costs and determine the level and structure of interest rates:

Marketability Call feature Default risk Term-to-maturity

Yield to maturity of a defaultable bond is not equal to what?

the expected return of investing in the bond

Risks affecting individual companies or industries are called ________ risk

Unsystematic or Private

Risks affecting the entire market are called _________ risk

Systematic

________ risk can be diversified away in a large portfolio

Unsystematic

Risk premium of a security is only determined by its __________ risk

Systematic

The total risk of a portfolio is the _____

volatility

Small firms and value firms do better than big firms and growth firms according to what model

Fama-French

WACC Assumptions

Average Risk Constant Debt-Equity Ratio Limited Leverage Effects

A private company can seek funding from several potential sources:

Angel investors Venture capital firms Institutional investors Corporate Investors

Advantages of going public:

Greater liquidity | Better access to capital

Disadvantages:

Equity holders more dispersed | Must satisfy requirements of public companies

Investment banking firm that manages the IPO and designs its structure

Underwriter

Syndicate

other underwriters that help market and sell the issue

Underwriter Tasks

SEC Filings | Valuation

Underwriter guarantees that it will sell all of the stock at the offer price

Firm Commitment Arrangement

Underwriter does not guarantee that the stock will be sold

Best-efforts basis

Company or its investment bankers auction off the shares directly to the public

Auction IPO

Private Debt

Bank Loans | Private Placements

Bank Loans

Term Loan Syndicated Bank Loan Revolving Line of Credit Asset-Backed Line of Credit

Public Debt

Notes Debentures Mortgage Bonds Asset-backed Bonds

Subordinated Debenture

debenture issue that has a lower priority claim to the firm's assets than other outstanding debt

Tranches

different classes of securities that comprise a single bond issuance

Debt that involves foreign investors:

Domestic bonds Foreign Bonds International Bonds

Issued by a local entity and traded in a local market, but purchased by foreigners

Domestic Bonds

Issued by a foreign company in a local market and are intended for local investors

Foreign Bonds

International bonds that are NOT denominated in the local currency of the country in which they are issued

Eurobonds

Combines the features of domestic, foreign, and Eurobonds and are offered for sale in several different markets simultaneously

Global bonds

Limits the issuer in a bond contract from taking actions that might hinder its ability to pay bondholders

Covenants

Advantages of Covenants

May reduce a firm's cost of borrowing, and the reduction might more than outweigh the cost of the loss of flexibility associated with covenants

Yield of a callable bond assuming that the bond will be called on the earliest call date

Yield to Call

When coupon rate is above current market yield, YTC is less than YTM what will the firm do?

call the bond

When coupon rate is below current market yield, YTC is greater than YTM what will the firm do?

NOT call the bond

A perfect capital market is a market in which:

Securities are fairly priced No tax consequences or transaction costs Investment cash flows are independent of financing choices

MM Prop I:

In perfect capital market, the total value of a firm is equal to the market value of the free cash flows generated by its assets and is not affected by its choice of capital structure

Indirect costs of financial distress:

Loss of customers Loss of suppliers Loss of employees Fire sale of assets

As debt increases, tax benefits increase until ______ _______ exceeds EBIT

interest expense

Costs that arise when there are conflicts of interest between stakeholders

agency costs

Pecking order hypothesis

Managers have a preference to fund investment using retained earnings, followed by debt, and will only choose to issue equity as a last resort

Share repurchases to distribute cash to shareholders:

Open Market Repurchases Tender offer Targeted Repurchase

A firm must _______ the tax costs of holding cash with the potential benefits of not having to raise external funds in the future

balance

Paying out excess cash through dividends or share repurchases can ______ the stock price by reducing managers' ability and temptation to waste resources

boost

Asymmetric information

when managers have better information than investors regarding the future prospects of the firm, their payout decisions may signal this information

The practice of maintaining relatively constant dividents

dividend smoothing

Dividend signaling

the idea that dividend changes reflect managers views about a firm's future earnings prospects

Consequences of Stock Dividends

- Firm doesn't pay out any cash to shareholders - Increase in the number of shares outstanding (stock price will fall) - Stock dividends are not taxed

Why issue a stock dividend?

Typical motivation for a stock split is to keep the share price in a range thought to be attractive to small investors

When a firm sells a subsidiary by selling shares as a non-cash special dividend in the subsidiary alone

Spin-offs

Advantages of a spin-off

- avoids the transaction costs associated with such a sale | - special dividend is not taxed as a cash distribution

What is the financial managers most important job?

Making investment decisions

What strategies are available to shareholders to help ensure managers are motivated to act in the shareholders interests?

- Ensure that employees are paid with company stock and/or stock options - Mount hostile takeovers - Ensure that underperforming managers are fired - Write contracts that ensure the interests of the managers and shareholders are closely aligned

What is an example of a physical market?

New York Stock Exchange (NYSE)

What is an example of an over-the-counter market?

NASDAQ

Final Review Flashcards

(80 cards)