Valuation of Debt and Equity (3&4) Flashcards
(31 cards)
What is the equation for Total assets?
Total assets = total liabilities + owners equity
What is an interest rate?
A compensation of risk
What is a bond?
A security sold by governments or corporations to raise money from investors today in exchange for the promised future payments.
What are the important parts of a bond?
Maturity
Face value
Coupon rate
Coupon payment interval
What is the Maturity of a bond?
The length of time remaining until the repayment date
What is the Face value of a bond?
The amount of money that must be repaid at the end of the bond’s life
What is the Coupon rate of a bond?
The interest rate set by the bond issuer as the promised interest payments
What is the Coupon payment interval?
The number of interest payments during a year
Why a bonds considered less risky then equity?
Face value may be secured against assets
Equity holders come second to bond holders in terms of creditor position if a business were to go bankrupt
What are debt covenants?
Debt covenants are conditions or rules set by lenders that a borrower must follow as part of a loan agreement.
What are the different types of debt covenants + examples ?
Positive - Things the borrower must do, e.g., provide regular financial reports
Negative -Things the borrower must NOT do, e.g. selling key assets
Financial - Keeping debt levels below a certain threshold
How can bonds be used as a tax shield?
Interest payable on bonds is removed from profits before tax whereas share dividend yield isn’t
How are bonds rated?
In terms of their credit risk
What are the rough maturity times of different bonds?
Short Maturity- less than 5 years
Medium Maturity - more than 5 less than 15
Long Maturity - greater than 15 years
What are call and put provisions?
Call provisions : Issuers can call back bonds at pre-specified price on pre-specified date before maturity
Put provisions: bondholders can sell a bond back to issuer at pre-specified price on pre-specified date before maturity
What are the yields for callable bonds and puttable bonds?
Callable - higher yield to compensate lenders
Puttable bonds - lower yield due to having the option to cancel the debt
How do we value a bond?
value bond equations in formula sheet
What are the variables you need to remember when valuing a bond?
FV - face value
C - annual coupon payments (coupon rate times face value)
n - maturity
r - YTM (yield to maturity)
What happens when:
coupon rate < YTM
coupon rate = YTM
coupon rate > YTM
When:
coupon rate < YTM
price < par value
(discount bond)
coupon rate = YTM
price = par value
coupon rate > YTM
price > par value
What is the relationship between interest rate (YTM) and bond value?
As YTM rises bond value falls and vice versa
What is the Macaulay Duration and its variables you need to remember?
PVi - present value of cash flow
V - bond price
ti - time period
What do you do when calculating the value of a bond if it is paid semi-annually?
r = YTM/2
calculate coupon value semi-annually
times n (years) by 2
Why is being a shareholder a risky position in the firm?
Dividends paid from net profit after tax
Should the firm go into liquidation, shareholders are the last to receive funds
What is the different in the nature and cost of finance between equity and debt finance?
Equity (shares) - permanent capital and higher cost of finance due to higher risk
Debt (bonds) - semi-permanent capital and lower cost of finance due to lower risk
