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Finance and investment Flashcards

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1
Q

Four types of firms

A

1) sole proprietorship
2) Partnership
3) Limited liability company
4) Corporations

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2
Q

Sole proprietorship

A

Business is owned and run by one person. It typically has few, if any, employees

Advantage: easy to set up

Disadvantages: No separation between firm and owener, Unlimited personal liability and a limited life

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3
Q

Partnership

A

Like sole proprietorship but with more than one owner. All partners are personally liable for all the firms debts and the partnership ends with the death or withdrawal of any single partner

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4
Q

General partners

A

liable for the firms debt obligation

Run day to day business

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5
Q

Limited partners

A

Have limited liablility (their investment or less), are transferable (in case of death or withdrawl) and have no management authority and no legal involvement in the managerial decision makeing for the business

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6
Q

Corporation

A

Legal entity separate from its owner, can enter in contracts, own assets and borrow money

Corporation is soley responsible for its own obligations its owners are not liable for any obligation the corporation enters into

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7
Q

Formation (Corporation)

A

Corporation ust be legally formed. The corporation files a charter with the state it wishes to incorporate in. The state then charters the corporation, formally giving its consent in the incorporation

β–ͺ Due to its attractive legal environment for corporations,
Delaware is a popular choice for incorporation

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8
Q

Ownership

A

Represented by a share of stock

shareholder, stockholder or equityholder

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9
Q

Equity

A

Sum of all ownership value

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10
Q

What happens if a firm fails to repay its debt

A

Corporate bankrptcy –> Reogranization &liquidation

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11
Q

Primary markets

A

When a corporation itself issues new shares of stock and sells them to investors

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12
Q

Secondary markets

A

After the initial transaction in the primary market, the s hares continue to trade in a secondary market between investors

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13
Q

Bid price

A

The price at which they (market managers) are willing to buy the stock

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14
Q

Ask price

A

The price at which market makers are willing to sell the stock

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15
Q

Limit order

A

An order to buy or sell a set amount at a fixed price

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16
Q

Limit order book

A

The collection of all limit orders

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17
Q

Market orders

A

Orders that trade imediatly at the best outstanding limit order

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18
Q

High frequency traders

A

A class of traders who with the aid of computers execute trades many times per second in response to new information

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19
Q

Negatives of corporations

A

Costly to set up

Corporate charter specifies the initial rules that govern how the corporation is run

Double taxation

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20
Q

Cash management

A

Financial manager must ensure that the firm has enough cash on hand to meet its day to day demands

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21
Q

Dark pools

A

An alternative to buying stock (limit order not visible)

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22
Q

Corporate management team

In a corporation ownership and direct control are separate (2 elements)

A

Board of directors have ultimate decision making

CEO delegates day to day decision making

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23
Q

Hostile takeover

A

Low stock prices may entice a corporate raider who gets control by buying stocks and replaces current management

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24
Q

Marketing

A

To forecast the increase in revenues resulting from an adverising capaigne

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25
Valuation principle
The value of an asset to the firm or its investors is determined by its competitive market price. The benefits and costs of a decision should be evaluated using these market prices, and when the value of the benefits exceeds the value of the costs, the decision will increase the market value of the firm.
26
Risk free interest rate (rf)
For a given period as the interest rate at which money can be borrowed or lent without risk over that period
27
Value of investment in one year formula
Cost = origional value times interest rate in one year
28
NPV (net present value)
NPV = PV(benefits)-PV(costs)
29
NPV decision rule
When making an investment decision take the alternative with the highest NPV. Choosing this alternative is equivalent to receiving its NPV in cash today
30
Accept or reject a project (NPV) ?
Accept those projects with positive NPV because accepting them is equivalent to receiving their NPV in cash today, Reject thos eprojects with negative NPV
31
Arbitrage
The practice of buying and selling equivalent goods in different markets to take advantage of a price difference
32
Law of one price
If equivalent investment opportunities trade simultaneously in different competetive markets, the nthey must trade for the same price in all markets
33
Separation principle
We can evaluate the NPV of an investment decision separately from the decision the firm makes regarding how to finance the investment or any other security transaction the firm is considering
34
Three rules of time travel
1) Comparing and combining values 2) Moving cash flows forward in time 3) Moving cash flows back in time
35
Annuities
When a constand cash flow will occur at regular intervals for a finite number of N periods it is called annuity
36
Growing annuity PV formula
PV = C x 1/(r-g) x (1-((1+g)/(1+r))^N
37
annuity
A stream of N equal cash flows paid at regular invtervals. The difference between an annuity and a perpetuity is that an annuity ends after some fixed number of payments
38
PV annuity
PV = C x 1/r x(1- (1/(1+r)^N))
39
FV annuity Formula
FV = PV x (1+r)^N = C/r((1+r)^N-1)
40
Growing perpetuity
A steam of cash flows that occur at regular intervals and grow at a constant rate
41
EAR
The total amount of interest that will be earned at the end of the year
42
Annual percentage rate (APR)
Indicates the amount of simple interest earned in one year Typically less than EAR
43
Simple interest
The amount of interest earned without the effect of compounding
44
EAR to APR
(1+APR/k)^k = 1 + EAR
45
Fischer formula
(1+nom) = (1 + inf) x (1+ real)
46
Term structure
The relationship between the investment term and the interest rate
47
Yield curve
A graph of the term structure
48
After tax interest rates + formula
Taxes reduce the amount of interest an investor can keep, and we refer to this reduced amount as the after tax income rate π‘Ÿβˆ’(𝜏 Γ— r) = π‘Ÿ (1 βˆ’ 𝜏)
49
Effective annual rate (EAR)
The actual amount of interest that will be earned at the end of ONE year
50
Annual percentage rate (APR)
Indicates the amount of simple interest earned in one year, that is, the amount of interest earned without the effect of compounding
51
Interest rate per compounding period
APR / k periods
52
Converting APR to EAR
1 + EAR = (1+APR/k)^k
53
Amortizing loans
Each month you pay interest on the loan plus some part of the loan balance
54
Computing the outstanding loan balance
The outstanding balance on a loan, also called the outstanding principal, is equal to the present value of the remaining future loan payments, again evaluated using the loan interest rate
55
Nominal interest rate
Indicates the rate at which your money will grow if invested for a certain period
56
Real interest rate
The growth of your purcahsing power after adjusting for inflation
57
Opportunity 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
58
Market risk premium
Expected return % - Risk free interest rate %
59
Yield to maturity formula zero coupon bond
ytm= (FV/P)^1/n -1
60
Origional price of a bond
P = C x 1/r x (1-1/(1+r)^N) + FV/(1+r^n)
61
Forward rate formula
fn = ((1 + YTMn)^n)/ ((1 + YTMn-1)^n-1)
62
IRR rule
When the IRR is higher than the cost of capital you should take it
63
Effective annual interest rate Formula
(1 + (nominal rate / number of compounding periods)) ^ (number of compounding periods) - 1.
64
Internal rate of return
the interest rate that sets the net present value of | the cash flows equal to zero
65
Amount of coupon payment formula
Coupon rate x face value / Number of payments per year
66
Zero coupon bond
Bond that makes no coupon payments Always sells at a discount (a price lower than face value), so they are also called pure discount bonds Treasury Bills are U.S. government zero-coupon bonds with a maturity of up to one year.
67
Yield to maturity definition
The yield to maturity of a bond is the discount rate that sets the present value of the promised bond payments equal to the current market price of the bond. Anticipated return if you hold the bond until maturity
68
Price of a bond formula
Face value / (1+YTM)^N
69
Yield to Maturity of a coupon bond:
P = CPN/y x (1/(1+y)^N) + FV/(1+y)^N (y=interest rate y)
70
Default spread (Credit spread)
the difference between the yields of the corporate bonds and the Treasury yields
71
Yield to maturity formula
nth root of FV/PV - 1
72
Forward rate definition
A forward rate is an interest rate applicable to a financial transaction that will take place in the future.
73
Examples of partnerships
1) Law firm 2) Group of doctors 3) Accounting firms
74
What is good about corporations in practice
No limitation on who can own its stock! This allows free trade in the share of corporation. Corporations can raise capital because they can sell ownership shares to anonymous outside investors.
75
financial managers Responsibilities
1) Investment decision 2) How to raise money 3) Cash management Management,β†’meet day-to-day operations + managing working capital
76
Moral hazard (definition)
In economics, a moral hazard is a situation where an economic actor has an incentive to increase its exposure to risk because it does not bear the full costs of that risk. For example, when a corporation is insured, it may take on higher risk knowing that its insurance will pay the associated costs.
77
Liquid investment
any investment that can be easily converted into cash without having a significant impact on its value.
78
Bid ask spread
Ask price - Bid price | --> Transaction cost investors have to pay
79
Competetive market
A market in which goods can be bought and sold at the same price
80
Discount factor formula
1/1+rf
81
Interest rate factor
1 +rf
82
Normal market
Market with no arbitrage opportunities
83
Price of a security
PV (all cash flows paid by the security)
84
Moving cashflows backward in time: What is the present value of a bond that pays x in y years
PV = C/1+r^n
85
Internal rate of return how it works
``` PV(growingperpetuity) = C/(r βˆ’ g) Thus, the NPV of this investment would equal zero if 1,000,000=1000,000/rβˆ’0.04 We can solve this equation for r r= 1000,000/1,000,000+0.04=0.14 ```
86
Interest rate for non annual payments
rn =(1 + ryear)^1/n -1
87
Real interest rate formula
nominal interest rate - inflation rate
88
nominal interest rate formula
1+nom = (1+inf) x (1+real)
89
The yield curve is influenced by
Interest rates Inverted yield curve = interest rates are expected to decline in the future
90
Three reasons bonds are important
1 The price of risk free government bonds can be used to determine risk free interest rates that produce the yield curve. 2. Firms often issue bonds to fund their own investment. 3. Bond’s return will help us to determine a firms cost of capital.
91
bond certificate
states the terms of the bond
92
Maturity date
Final repayment date
93
Term
Time remaining until maturity date
94
Coupon
Promised interest payments
95
Face value
Notional amount used to calculate the interest payments
96
Coupon rate
Determines the amount of each coupon payment expressed in apr
97
Coupon payment formula
Coupon rate x face value /Number of payments per year
98
Price of a zero coupon bond
P = FV/(1+YTM)^n
99
YTM of a zero coupon bond
YTM = (FV/Price)^1/n -1
100
Discount (bond)
A bond is selling at a discount if the price is less than the face value. Coupon Rate < YTM
101
Premium (bond)
β–ͺ A bond is selling at a premium if the price greater than the face value. β–ͺ Coupon Rate >YTM
102
As interest rates and bond yields rise bond prices
Fall
103
Bonds with high durations are sensitive to
Changes in interest rates
104
On-the-Run Bonds
Most recently issued bonds
105
YTM corporate bond
YTM gov bond + Credit spread
106
forward rate
an interest rate that we can guarantee today for a loan or investment that will occur in the future.
107
Forward interest rate formula
fn = ( 1 + YTMn)^n/(1+YTMn-1)^n-1 -1
108
Expected Future Spot Interest Rate formula
Forward Interest Rate + Risk Premium
109
IRR rule
Accept any project if IRR> Cost of capital
110
When does IRR rule and NPV rule may be in | conflict ?
1) Delayed Investment (When the benefits of an investment occur before the costs, the N P V is an increasing function of the discount rate.) 2) Non-existent IRR 3) Multiple IRRs
111
Payback period
Time it takes to pay back initial investment If the payback period is less than a pre- specified length of time, you accept the project.
112
ProfitabilityIndex formula
Value Created/ ResourceConsumed = NPV/Resource Consumed

Finance & investment (2 decks)

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