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Flashcards in Term 1 Deck (80):
1

What is the main objective in CF?

Shareholder value maximisation

2

What is an activist investor?

Somebody who buys shares to influence board decisions

3

What are the three key issues of CF?

Investment Decisions
Finance Decisions
Dividend Decisions

4

Key issues of Investment Decisions?

Use NPV to value investments, take highest

5

Key issues of Financing Decisions

Can use retained earnings or external sources (equity v debt)

6

What are the key issues of dividend devisions?

Dividends are not a legal obligation, therefore should have a higher ROR than debt

7

What is BETA?

Measure of company risk, likelihood of dividend failure

Based on assumption markets are efficient

8

What is the current macroeconomic environment?

Brexit Uncertainty
Slowing Economic Growth
Rising Inflation
Volatile Currency

9

What are the three costs of the principal agent problem?

Monitoring expenditures by the principal- So principal can ensure that agent is working well
The bonding expenditures by the agent- A long term contract to show the agent is dedicated
Residual loss

10

How can you limit detrimental managerial behaviour?

Incentives
Monitoring
Internal Control Mechanisms
External Control Mechanisms

11

What determins a firms share price?

Value of the company
Dividends

12

How to you calculate the future value of a sum?

FV=Sum(1+i)^n

13

How do you calculate the Present value of a future value?

Future Value / (1+i)^n

14

What are the financial returns to a shareholder?

Dividends
Growth of share price

15

How do you calculate a share price?

P0=(D1+P1)/1+ke

Ke is discount rate

16

What are the sources of uncertainty when calculating financial returns?

Difficult in estimating dividends
Difficult to calculate cost of capital

17

How do you calculate dividend yeild?

D1/P0

18

How do you calculate Capital gains yeild?

P1-P0/P0

19

How do you calculate Total Return?

Div Yeild + Capital Gains Yeild

20

How do you calculate a share price if held for multiple years?

P0=D1/1+Ke + D2+P2/(1+Ke)^2...

21

How do you calculate the price for constant dividends?

P0=D1/Ke-g
G is dividend growth
Can be manipulated to determine cost of capital

22

How do you calculate the share price for non constant dividends?

P=D1/1+Ke + D2/(1+Ke)^2 + D3/(1+Ke)^3 +(D4/Ke-G)/(1+ke)^4

23

What are home made dividends?

Selling a portion of your shares to provide the dividends if they are withheld

24

How do you calculate the yield on a bond?

CY=NI/P

25

How do you calculate the YTM/Price of a bond?

PB= C[(1-(1/(1+i)^n))/i) +FaceValue/(1+i)^n

C=Annual interest Payment

26

What is the fisher sepeartion theorem?

Seperation of investment and consumption decisions raises consumer utility

27

What are the assumptions of FST?

Outcomes of investment are certainty
No transactions costs or taxes
Decision relates to one period only
Y0 income is received at the beginning of the period and Y1 income at end
MU of consumption is positive
MU of consumption is decreasing as consumption increases

28

What is C0 and C1

C0 is consumption at begining
C1 is at end
C1=Y1+I0(1+rI)

29

Discuss the IR method for FST?

The IR declines as more is invested, for that extra amount:
First 100 = 10%
Second 100 = 9%

30

How do you calculate wealth in P0 and P1

W0=Y+Y1/1+r
W1=W0(1+r)

31

What is the slope of the Financial Market Line?

-(1+r)

32

What is the optimum point of consumption with the Financial market line

Where it is tangential to an IC

33

What is the optimum point with all 3 Lines drawn?

Where the Production opportunity set is tangential to financial market line

34

Name some forms of capital expenditure?

Expansion of business
Development of new business
Replacement of machinery
R&D

35

What is the process of capital budgeting?

Planning
Estimating
Evaluating
Selecting
Implementing
Post-Auditing

36

What is the difference between in-dependant and mutually exclusive projects?

Independent - Cash flows to not impact on other project
Mutually Exclusive - Accepting one may prevents others

37

What is payback period:

Time required to recoup initial investment
Benefits: Simple and easy to use
Disadvantages
Does not consider profitability

38

What is the Accounting ROR?

Average rate of profit:
AverageProfit/Inital Invesment

39

What is NPV?

CF/(1+r)^t-I
Cash flow from each period, discounted

40

What is IRR?

Set NPV =0
Can be multiple IRR, Unconventional cash flows can cause issues, therefore must use incremental cash flow

41

How do you use incremental cash flows

Take project B away from project A
This gives the NPV is switching from A to B
If positive, B is the better project

42

What else can cause issues with IRR?

If you have unconventional cash flows, rely on NPV

43

How do you ration capital

Calculate B/C by dividing NPV by Initial Invesment
Rank them in order
Assume all projects are divisible

44

How do yo calculate Real Interest Rate?

RIR=(1+NIR)/(1+INF)-1

45

What are the two types of capital rationing?

Hard - Has problems raising funds
Soft - Internal constraints to prevent investment

46

What is a sensitivity analyisis?

Calculate NPV in a positive, negative and middle ground mindset
Then change key variables and see how they are altered

47

What are modern approaches to risk ananalysis?

Maximin
Maximax
Bayes - Laplace
Hurwicz
Minimax Regret

48

What is a maxi-min approach

Consider worst possible outcomes and choose the best

49

What is Maximax

Consider best possible outcomes and choose the best

50

What is Bayes - Laplace?

Average payoffs across all states, take best, assume all probabilities equal

51

What is Hurwicz criterion?

A weighted average of Maximax and Minimax
Weights are a and 1-a
If A =1, maximin outcome

52

What is Minimax Regret?

This approach penalises for wrong decisions
If P1 is chosen, but N2 occurs, the opportunity cost is the forgone payoff of N2

53

How do you calculate returns to an asset?

Rt=Pt/Pt-1 -1

54

How do you calculate returns to an assset adjusting for Dividends?

R=(Pt-Pt-1)/Pt-1 + DT/Pt-1

R=Capital Yeild + Dividend Yield

55

How do you calcualte average return on a stock?

Sum the values and divide by the number

56

How do you calculate the variance of risk?

Sum (X-MeanX)^2/T-1

57

How do you choose between investments, the easy way?

If same risk, choose higher returns
If same returns, choose lower risk

58

What is unsystematic risk?

Unique Risk, associated with particular assets
Can be diversified

59

What is systematic Risk

Unique Risk, effects all assets
Cannot be diversified away

60

What is the market portfolio?

The portfolio that maximises diversification thus minimising risk

61

How do you calculate Expected Return on a portfolio?

Weight multiplied by return

62

How do you calculate the covarience of a portfolio?

Sum(Ri-ERi)(Rj-ERj)/T-1

63

How do you calculate correlation coefficent?

Corr=Cov/SDiSDj
1=No Risk Reduction
-1=Max Risk Reduction

64

How do you calculate the portfolio Variance?

X^2VarX1 +X^2VarX2+ 2XXCov

Remember Cov=CorrSDxSDY

65

What is the efficiency boundary?

A line which will be chosen by an efficient investor, as it maximises returns

66

If you have a risk free asset, what happens to the portfolio?

Constant Return, no risk
Variance(P) becomes Variance of X1 times weight

67

What is the slope of a Risky-Risk free Portfolio Line?

E(RA)-RF/SDA

68

What is the optimum combination of a risky-risk free portfolio, the marker portfolio?

A point of tangent between the risk free line and the efficient portfolio

69

Can an investor borrow to invest?

Any point on the line after the tangent point will need to be borrowed to achieve

70

What are the characteristics of the market portfolio?

Represents maximum diversification
Exists on capital market line

71

What is the expected return on the market portfolio?

ER = Rf+[E(Rm-Rf)/SDRm]SDRi

Lamda = E(Rm-Rf)/SDRm
Market price of risk

72

What does diversification look like when plotted on a graph?

1/x, assymptope at bottom is systematic risk

73

What determined the level of systematic risk faced by a firm?

Sensitivity of revenues to economic activity
Degree of cost senstivity
Gearing - More Debt = more Risk

74

An investor will only be rewarded for taking which type of risk?

Systematic

75

What are the assumptions of CAPM?

Investors are risk averse and utility maximises
Perfect Competition
Single rate of interest
All assets perfectly divisible

76

What is the CAPM expression?

Er=Rf+ (E(Rm)-Rf)Cov(i,m)/VarM

(E(Rm)-Rf) = Market risk premium

Cov/Variance referes to how the asset is related to the market

77

What is BETA?

Measure of risk = Cov(i,m)/VarM

78

How can you calculate correlation coefficient?

B=P*SDi/SDM

P=Correlation coefficient between market and i

79

Why do all assets return to SML line?

If ROR is above equilibrium, investors invest and price rises, causing ROR to fall

80

How does BETA relate to an assets ROR relative to the market

BETA>1 means an asset is more volatile than the makrket