Introduction

Question 1

What is the core idea behind the Time Value of Money?

Answer 1

A dollar today is worth more than a dollar tomorrow because it can be invested to earn a return.

Question 2

What is the formula for Future Value (FV)?

Answer 2

FV = PV × (1 + r)^n

Question 3

What is the formula for Present Value (PV)?

Answer 3

PV = FV / (1 + r)^n

Question 4

What is the formula for a perpetuity?

Answer 4

PV = CF / r

Question 5

What is the formula for a growing perpetuity?

Answer 5

PV = CF1 / (r - g)

Question 6

What is the formula for Effective Annual Rate (EAR)?

Answer 6

EAR = (1 + APR/m)^m - 1

Question 7

How does the finance perspective differ from accounting in viewing the balance sheet?

Answer 7

Finance uses market values and forward-looking cash flows, while accounting uses book values and historical costs.

Question 8

Why might a balance sheet not balance in finance?

Answer 8

Because finance uses market values and the value of equity may be treated as a plug to make the balance sheet work.

Question 9

What is arbitrage?

Answer 9

The opportunity to make risk-free profit with no capital by exploiting price differences for the same cash flows.

Question 10

What is the no-arbitrage principle?

Answer 10

Two assets with the same cash flows and timing must have the same price, or arbitrage exists.

Question 11

How do zero-coupon bonds help in arbitrage examples?

Answer 11

They are used to replicate the cash flows of a coupon bond to determine its fair price.

Question 12

What are the three key corporate finance questions?

Answer 12

1) How do you get cash? 2) How do you invest the cash? 3) What do you do with the returns?

Question 13

What is the difference between AFM 273 and AFM 274?

Answer 13

AFM 273 teaches how to use tools to value companies. AFM 274 teaches how to think like a decision-maker to create value for the firm.

Question 14

What does the Law of One Price state?

Answer 14

Identical cash flows with same timing and risk must be priced the same.

Question 15

What does WACC stand for?

Answer 15

Weighted Average Cost of Capital.

Question 16

What is the WACC formula?

Answer 16

WACC = (E/(E+D)) * rE + (D/(E+D)) * rD * (1 - Tc)

Question 17

Why is debt adjusted by (1 - Tc) in the WACC formula?

Answer 17

Because interest payments are tax-deductible, reducing the effective cost of debt.

Question 18

When should you use WACC as a discount rate?

Answer 18

When a project’s financing and risk exposure matches that of the firm.

Question 19

What does WACC represent conceptually?

Answer 19

The minimum return a firm must earn on its investments to satisfy both debt and equity holders.

Question 20

What is the Efficient Market Hypothesis (EMH)?

Answer 20

The theory that asset prices fully reflect all available information.

Question 21

What are the three forms of market efficiency?

Answer 21

Weak (past prices), Semi-strong (all public info), Strong (all info including private).

Question 22

Can you consistently beat the market under semi-strong efficiency?

Answer 22

No, because all public information is already reflected in prices.

Question 23

Why do we care about the time value of money in capital budgeting?

Answer 23

Because cash flows occur over time, and we must compare them on a present value basis.

Question 24

What is the role of the discount rate in present value calculations?

Answer 24

It adjusts future cash flows for the time value of money and risk.

Question 25

Why is it important that cash flow timing, amount, and risk are matched when applying the Law of One Price?

Answer 25

Because differences in any of these would invalidate the comparison and remove the arbitrage opportunity.

Question 26

What are the two types of risk in finance?

Answer 26

Systematic (market) risk and unsystematic (firm-specific) risk.

Question 27

Which type of risk is rewarded with higher expected return?

Answer 27

Only systematic risk is rewarded because it cannot be diversified away.

Question 28

What is diversification?

Answer 28

The strategy of combining different assets to reduce unsystematic risk.

Question 29

What does CAPM stand for?

Answer 29

Capital Asset Pricing Model.

Question 30

What is the CAPM formula?

Answer 30

Expected Return = rf + β × (rm - rf)

Question 31

What does beta (β) measure?

Answer 31

The sensitivity of an asset’s returns to the overall market returns.

Question 32

What does a beta of 1 mean?

Answer 32

The asset has the same volatility as the market.

Question 33

What does a beta greater than 1 mean?

Answer 33

The asset is more volatile (riskier) than the market.

Question 34

What does a beta less than 1 mean?

Answer 34

The asset is less volatile (less risky) than the market.

Question 35

What is the Efficient Frontier?

Answer 35

A set of optimal portfolios offering the highest return for a given level of risk.

Question 36

What happens to portfolio risk as you add more uncorrelated assets?

Answer 36

Portfolio risk decreases due to diversification benefits.

Question 37

What is the primary benefit of diversification?

Answer 37

It reduces unsystematic risk without lowering expected return.