Study Unit 7 Flashcards

(35 cards)

1
Q

Indenture

A

document that states terms of bond agreement
may require issuer to establish and maintain bond sinking fund
-objectives of pmts into fund is to segregate and accumulate assets to pay bond principal at maturity

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2
Q

Advantages and disadvantages of bond to issuer

A

Advantages
interest paid on debt is deductible
maintain ctrl of firm

Disadvantages
pmt of interest and debt are legal obligations; if not enough cash flow to pay could become insolvent
legal req raises firm’s risk level; s/h demand higher cap rates on r/e, decreasing mkt price of stock
require collateral (restricts assets)
debt financing limited; cost of debt may rise rapidly

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3
Q

Maturity Pattern Bonds

A

term- single maturity date at end of term

serial- matures in stated amnt at regular intervals

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4
Q

Valuation Bonds

A

Variable (floating) rate- pay interest based on mkt conditions
zero-coupon or deep discount - no stated rate of interest, no periodic cash pmt, interest is the bond’s discount
commodity backed- payable at prices related to a commodity (i.e. gold)

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5
Q

Redemption Provisions

A

Callable- able of issuer to repurchase at specific price before maturity (good when interest rates fall b/c issuer an replace high interest debt with lower interest rate); pay higher yield than non callable

Convertible-convert into equity security of issuer

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6
Q

Call provisions

A

provisions on a bond allowing issuer to repurchase and retire bonds early

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7
Q

Value proposition of callable bonds

A

favorable for issuer b/c can retire & pay debt earlier
-no more interest pmts

unfavorable for investor bc amnt rec’d when not retired is more than premium company pay to retire

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8
Q

Securitization

A

Mtg bonds- backed by assets (real estate)

Debentures- backed by borrower’s general credit not specific collateral

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9
Q

Ownership

A

Registered bonds- issued in name of holder; only holder receives interest and principal pmts

bearer bonds- not individually registered; interest and principal paid to whomever presents bond

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10
Q

Priority

A

Subordinated debentures- junior securities with claims inferior to sr bonds

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11
Q

Repayment provisions

A

income bonds- pay interest contingent on issuer’s profitability
revenue bonds- issued by govt and payable from specific revenue sources

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12
Q

Bond discount vs premium

A

discount- stated rate (coupon) mkt rate

-investor pay more bc interest pmts are higher than available for mkt

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13
Q

Leverage

A

relative amnt of FC in firm’s overall cost structure

-creates risk bc FC must be covered regardless of sales level

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14
Q

Operating Leverage

A

firms’ cost of operating are fixed rather than variable
degree of op leverage (DOL) measures effect given level of fixed operating costs has on firm earnings

DOL=% change in earnings before interest & taxes (EBIT)/% change in sales

  • help find best level of operating leverage to maximize EBIT
  • firm w/ high FC more risky than firm w/ more VC
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15
Q

Financial leverage

A

degree of debt (fixed financial costs) in the financial structure
degree of financial leverage (DFL)
DFL=% change in EPS/ % change in EBIT

high % of fixed financial costs, firm takes more risk to increase its EPS

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16
Q

Degree of total (combined) leverage

A

DTL= DOL * DFL

high DTL has higher return for investors, but is more risky

17
Q

Disadvantages of issuers of common stock

A

cash dividends aren’t tax deductibe; paid out of after tax profits
new c/s sales dilute EPS to existing s/h
underwriting costs higher
too much equity raises avg cost of capital above optimal level

18
Q

Preemptive rights

A

common shareholder have right to purchase adtl stock issuance in proportion to current ownership %

19
Q

Dividend payout model for constant dividend

A

Price per share now = divident per share (constant)/req rate of return

P(0)=D/r

when dividend is constant & expected to be paid continuousy

20
Q

Constant growth model

A

dividend discount model
P(0)=D(0) (1+g) / r-g
P(0)=D(1)/r-g

21
Q

preferred stock

A

hybrid of debt & equity; has fixed charge, pmts not obligation

22
Q

Advantages of issuers of preferred stock

A

builds creditworthiness (form of equity)
control held by common s/h (no voting rights)
superior earning of firm reserved for common s/h
doesn’t req periodic pmts; failure to pay doesn’t lead to bankruptcy

23
Q

Disadvantages to issuers of preferred stock

A

cash dividend aren’t tax deductible

during rough economy, accumulated unpaid div create managerial and financial problems

24
Q

Future dividends of preferred stock

A

D=par value of preferred * preferred div rate
preferred stock price P(p)
P(p)= D(p)/r

25
IPO (advantages & disadvantages)
advantage - raise $ - establish value in mkt - increase liquidity of firm's stock disadvantage - cost of reporting req - access to firm's operating data by competitors - access to net worth by s/h - limitation on self-dealing by corporate insiders - pressure from outside s/h for earnings growth - stock prices don't accurately reflect NW - loss of control by mgt - increased s/h service costs
26
Types of leases
sale leaseback- alternative for raising capital; allow firms to acquire capital from sale of asset while retaining use service or operating- both financing and maint services financial- don't provide maint, noncancelable and fully amortize cost of lease over term of basic lease contract (installment purchases)
27
Capital lease
essentially the purchase of an asset 4 part test (meet at least 1) -Bargain purchase option -Lease term is at least 7% of useful economic life -Title transfered at end of lease -Minimum lease pmt (PV MLP =90% or more of FV of leased property)
28
Operating lease
off B/S rental contract no entry recorded, expense as incurred
29
Cost of capital used to discount FCF of LT projects
investments w/ RoR higher than cost of capital increase the value of the firm (s/h wealth)
30
Risk for Investors
firm not legally obligated to pay return | if firm liquidates, creditors have priority
31
3 components of financing structure
LT debt, preferred equity, common equity (r/e included) | RoR demanded is component cost for that form of capital
32
Component cost for LT, preferred stock, common equity
LT -Effective rate * (1-Marginal TR) P.Stock (use dividend yield ratio) -cash dividend on p stock/mkt price of p stock mkt price = net proceeds from issuance (gross proceeds-flotation costs) flotation costs reduce net proceeds rec'd and raise cost of capital -alternative component cost= cash dividend on p stock/p stock mkt price-issuance cost component cost of r/e is same for c/s -cash dividend/mkt price
33
WACC
composite RoR on its combined components of capital with weights based on target capital structure ``` WACC= E/V *R(E) +D/V*R(D) * (1-T) R(E)=cost of equity R(D)=cost of debt E=mkt value of firm's equity D=mkt value of firm's debt T=Corp TR V=D+E=Capital used to generate profits ```
34
Optimal cap structure
minimize WACC don't focus just on increasing EPS can't ID this point, find optimal range
35
Modigliani-Miller theore
no optimal cap structure doesn't matter if finance w/ all debt, all equity, or equity and debt bc no consequence to s/h wealth -any increase in expected return from debt is offset by increase in RoR on equity from the risk -debt to equity ratio not useful to s/h