Finance 2 Flashcards

1
Q

what is the simple formula for the current price of a share, P0

A
  • P0 = (D1 + P1) / (1+r)
  • D1 = dividend next year
  • P1 = price next year
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2
Q

what is the dividend discount model (or the share price valuation model)

A
  • P = Σ(t=1 to ∞) D_t / (1+r)^t
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3
Q

how does the dividend discount model change for constant dividend growth

A
  • D1 remains constant but is multiplied by (1+g)^t-1
  • so P =Σ D1*(1+g)^t-1 / (1+r)^t
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3
Q

how does the dividend discount model change for zero dividend growth

A
  • zero dividend growth means D1 = D2 = D3 = ….
  • so the model decays to just being the simple perpetuity model
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4
Q

what is the dividend growth model (gordon-shapiro model)

A
  • P_n = D_n+1 / r - g
  • given r > g
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5
Q

how does the dividend discount model change for non-constant dividend growth

A
  • step 1: find the PV of dividends from year 1 to year n
  • step 2: add the PV of the share price in year n
  • step 3: discount step 2 and add step 1
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6
Q

what is a bond

A
  • a bond is a ceritificate showing that the borrower owes a specific amount
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7
Q

what is the formula for the price of a bond, P_bond

A
  • P_bond = C/(1 + YTM) + C/(1+YTM)^2 + … + C+F/(1+YTM)^n
  • C = coupon = face value * coupon rate
  • F = face value
  • YTM = yield to maturity
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8
Q

how does the formula for the price of a bond change if the coupon is paid semi-annually instead of annually

A
  • the C’s and YTM’s are divided by 2
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9
Q

when is a bond said to sell at a premium, discount or at par

A
  • sell at a premium = when the bonds price is higher than its face value
  • to sell at a discount = when the bonds price is lower than its face value
  • to sell at par = the bonds price and face value are the same
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10
Q

what are the two forces that determine the yield-to-maturity

A
  • central bank policy
  • future expectations
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11
Q

how do central banks influence the YTM

A
  • central banks use monetary yields to manage the economy by increasing or decreasing interest rates (the base rate)
  • they can lower rates to stimulate economic activity or raise rates to cool down the economy
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12
Q

what is the yield curve

A
  • a plot of the comparison between bonds with the same characteristics but different terms of maturities
  • its basically a ratio of long-term bonds to short-term bills
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13
Q

what are the 4 types of risks that investors expose themselves to with bonds

A
  • default risk
  • liquidity risk
  • regulatory risk
  • interest rate risk
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14
Q

what is default risk

A
  • the risk that a bond issuer will default on making the promised interest and principal payments to the buyer of the bond
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15
Q

what is liquidity risk

A
  • the risk that a bond can be sold at a predictable price with low transaction costs on short notice
16
Q

what is regulatory risk

A
  • the risk that regulators will change the rules so as to adversely impact the earnings of the institution
17
Q

what is interest rate risk

A
  • the risk that volatility in the interest rate can change the value of the bond
  • since bond holders receive a fixed coupon and will only realize all returns when the bond expires
18
Q

which of the 4 types of risks are the most important and why

A
  • interest rate risk
  • because bond prices are affected whenever the government or central banks change interest rates
19
Q

how are the prices of bonds influenced by a rise or drop in interest rates

A
  • when interest rates go up, bond prices fall
  • when interest rates go down, bond prices rise
20
Q

what is the difference between growth shares and income shares

A
  • for growth shares, investors expect to benefit from capital gains and are interested in future growth of earnings
  • for income shares, investors seek cash dividends
21
Q

what is the formula for payout ratio

A
  • payout ratio = dividends / EPS
  • EPS = earnings per share
22
Q

what is the formula for earnings per share, EPS

A
  • EPS = (net income - dividends to preferred shares) / average shares outstanding
23
Q

what is the formula for return on equity, ROE

A
  • ROE = net income / shareholders equity
24
Q

what is the formula for plowback or retention ratio, b

A

b = 1 - payout

25
Q

what is the formula for price earnings ratio, PER

A
  • PER = market value per share / EPS
26
Q

as a fund investing in growth stocks, what are the key factors you need to consider

A
  • the factors that influence the growth rate of dividends, g
  • and the net present value of growth opportunity, NPVGO
27
Q

what is the formula for the growth rate of dividends, or capital gain yield, g

A
  • g = b * ROE
  • b = plowback ratio
  • ROE = return on equity
28
Q

what is the formula for the net present value of growth opportunity, NPVGO

A
  • NPVGO = share price - EPS/r