Test 2

Question 1

Compound interest

Answer 1

to compute the future value of an amount we push forward the current amount by ADDING interest for each period in which the money can earn interest in the future

Question 2

Time Value of Money

Answer 2

money at different points in time are not the same

Question 3

Implications of time value of money

Answer 3

Dollar amounts from different time periods should never be compared; rather, amounts should be compared only when they are stated in dollars at the same point in time.
TVM concepts provide the principles and computations used to revalue cash payoffs from different time periods so they are stated in dollars of the same time period.
The most important concept in finance used in nearly every financial decision

Question 4

Expected return

Answer 4

the weighted average of all the possible returns, weighted by the probability that each return will occur

Question 5

Risk

Answer 5

the chance that some unfavorable event will occur

Question 6

Risk vs Diversification

Answer 6

Diversification reduces risk

Question 7

Specific risk

Answer 7

Non-systematic risk–
risk that affects only a specific firm, which can be eliminated through diversification (labor strikes)

Question 8

Market risk

Answer 8

Systematic risk–a risk that affects all firms, which cannot be eliminated through diversification (tax rate changes, war)

Question 9

How is total risk different from systematic risk (when are the two equal to each other?)

Answer 9

Suppose that in the coming year, you expect Target stock to have a standard deviation of 30% and a beta of 1.32, and Starbucks’s stock to have a standard deviation of 41% and a beta of 0.6. Which stock carries more total risk? Which has more systematic risk?

Question 10

Total risk

Answer 10

measured as standard deviation or coefficient variation of the portfolio return

Question 11

What is the beta of a portfolio?

Answer 11

the risk that remains once a stock is in a diversified portfolio is its contribution to the portfolio’s market risk

Question 12

What does the beta measure?

Answer 12

Beta coefficient measures a stock’s market risk, and shows a stock’s volatility relative to the market. It indicates how risky a stock is if the stock is held in a well diversified portfolio

Question 13

What is the beta for the market and the risk-free asset?

Answer 13

market portfolio beta=1
risk-free asset beta=0

Question 14

CAPM model

Answer 14

a theoretical model in finance that finds the risk premium for an equity security

Question 15

What does CAPM measure?

Answer 15

Expected return for an investment, considering its risk. Determines the required rate of return or cost of equity for a security based on its beta, the risk-free rate, and the market risk premium

Question 16

Who issues treasury bonds?

Answer 16

US Government

Question 17

Who issues corporate bonds?

Answer 17

Companies

Question 18

Who issues municipal bonds?

Answer 18

State or local governments

Question 19

Who issues foreign bonds?

Answer 19

A foreign entity

Question 20

Par value

Answer 20

the stated face value of the bond, which is paid to the bondholder at maturity

Question 21

Characteristics on bonds

Answer 21

Par value
Coupon interest rate
Maturity
Indenture
Call provisions
Sinking funds
Callable bonds and convertible bonds

Question 22

Coupon interest rate

Answer 22

Stated interest rate (generally fixed) paid by the issuer.
Zero coupon bonds (zeros)

Question 23

Maturity

Answer 23

The length of time until the bond issuer returns the par value to the bondholder and terminates or redeems the bond

Question 24

Indenture

Answer 24

Formal contract, also known as a trust indenture, that outlines the terms and conditions of a bond issue–restrictive covenant

Question 25

Call provisions

Answer 25

A bond contract (bond indenture) gives the issuer the right, but not the obligation, to redeem the bond before its stated maturity date

Question 26

Sinking funds

Answer 26

Call for redemption by annual lottery, buy bonds on the open market

Question 27

Callable bonds

Answer 27

Bonds that can be redeemed or paid off by the issuer prior to the bonds' maturity date

Question 28

Convertible bonds

Answer 28

A type of bond that the holder can convert into a specified number of shares of common stock in the issuing company or cash of equal value

Question 29

Types of corporate bonds

Answer 29

Debentures Subordinated Debentures Mortgage Bonds Junk Bonds Bond ratings

Question 30

Debentures

Answer 30

an unsecured loan certificate issued by a company, backed by general credit rather than by specified assets

Question 31

Subordinated Debentures

Answer 31

an unsecured bond or loan that ranks below other, more senior debt in terms of repayment priority

Question 32

Mortgage bonds

Answer 32

type of bond secured by a pool of mortgages on real estate, typically residential property

Question 33

Junk bonds

Answer 33

a high-yield, high-risk security, typically issued by a company seeking to raise capital quickly in order to finance a takeover

Question 34

Bond ratings

Answer 34

a letter grade assigned by independent agencies to reflect a bond issuer's creditworthiness--an indication of its default risk

Question 35

Valuation of bonds

Answer 35

Intrinsic/economic value YTM for bonds Bonds traded

Question 36

Intrinsic value

Answer 36

estimate of a stock’s “true” value based on accurate risk and return data

Question 37

Economic value

Answer 37

The theoretical fair value of a bond is calculated by discounting the future value of its coupon payments by an appropriate discount rate

Question 38

Yield to Maturity (YTM) for bonds

Answer 38

YTM refers to the average rate of return the investor will earn if the bond is held to maturity. YTM is also known as the bondholder's expected rate of return.

Question 39

Where are bonds traded?

Answer 39

some bonds are traded publicly through exchanges, most trade over-the-counter between large broker-dealers acting on their clients' or their own behalf

Question 40

Common stock features

Answer 40

Par value Dividends Voting rights Maturity Priority to assets and earning Preemptive right Maturity

Question 41

Common stock properties

Answer 41

A certificate that indicates ownership in a corporation. Common stockholders are the true owners of the firm.

Question 42

Types of common stock

Answer 42

Classified stock: common stock that is given a special designation, such as Class A, Class B, etc. to meet special needs of the company (voting and non-voting)

Question 43

Types of stock market transactions

Answer 43

order types (like market, limit, and stop orders) and trading strategies (like day trading, swing trading, and position trading)

Question 44

Types of markets common stock is traded in

Answer 44

Public and private markets, with the most common being the secondary market where trading occurs on exchanges like the New York Stock Exchange (NYSE) and Nasdaq

Question 45

Valuation of common stock

Answer 45

to value stock, we use the same approach described for valuing bonds—find the present value of all the cash flows expected to be received from the stock in the future

Question 46

Multi-period model with constant growth

Answer 46

a stock whose dividends are expected to grow forever at a constant rate, g

Question 47

Characteristics of preferred stock

Answer 47

Preferred dividends Par value Cumulative dividends Voting rights No specific maturity date Convertability