| A | B |
|---|
| bond issued? | a bond is first issued on the primary market as a brand new bond. Typically, the bonds coupon rates are set equal to current market interest rates that apply to bonds with similar risk. The coupon payment remains fixed over the bonds life. |
| coupon payment | remains fixed over the bond's life |
| increased time to maturity= | increased interest rate risk= lower price of bond |
| what happens when the market rate changes | whenever we have inflation or changes in the economy, interest rate change. Inflation up= Interest rate up= lower price on bonds |
| default risk | the possibility that the borrower won't repay the entire obligation. increased default risk= increased bankruptcy= increased chance bonds are not paid |
| measuring default risk | can be measured by credit rating or bond rating. Rating up= Credit up= Decrease in default risk |
| yield to call | return on bond yield if investors hold bond until first date that bonds can be called on. |
| Why call the bonds in? | bonds are called in when a company can re-issue them @ lower coupon. |
| inportance ranking | 1) YTM 2) Current Yield 3) Yield to call |
| bond rating | simply measures the riskiness if a company's bonds. Show the likelihood that a company defaults on bond payments. Based on the state of a company's financial position on balance sheet and income statements |
| criteria for ratings | financials- ratios, net income; forecast; pending litigations; pending regulations; competition |
| premium | price > face value; YTM<CR |
| discount | price<face value; YTM>CR |
| ways to profit from a bond | 1) long-term investor- buy a bond and hold until maturity 2)speculator- buy high risk 3)buy bonds with the idea that interest rates will fall. |
| money markets | markets include debt contracts that have a term of 1 year or less. these securities typically trade in large volumes each day and feature high liquidity. short-term debt |
| interest rate determined | they are determined in various debt markets where interest rates are determined by supply and demand |
| 4 main money market instruments | 1) gov't- treasury bills 2) corporation- commercial paper 3)small business owner- banker's note/ credit line 4) bank- C.D.'s |
| who uses money market instruments | large institution trade money market instruments. Insurance companies, brokerages |
| capital markets | long-term debt markets. need for capital but desire a longer term over which to repay the principal |
| why Yield Curve upward sloping | interest rate risk. downward slope if investors beliece inflation will be lower in the future |
| multiple period setting | investors will seek to estimate all the cash flows that the stock will generate |
| once estimated all cash flows of stock | can then discount or capatilize all the flows to arrive at the exstimation of the PV or intrinsic value |
| fundamental analysis | the process of finding a stock's price. one has to examine fundamental information on the firm's operations and management to make accurate estimations of the firm's earnings and ultimately it's dividends, future price and k. |
| weakness of intrinsic value of stock | 1) prediciting whole series of dividends. 2) prediciting selling price of stock (main one to eliminate) |
| few basic events that can affect a stock'e price | compared to expectations of analysis 1) increase in net income- NI up= Dividends up= Stock price up. 2) Increase in sales- Sales up= NI up= dividends up= stock price up |
| risk associated with stock increases | risk up= return up= stock price down |
| weakness of finite model | predicting a selling price |
| weakness of infinite model | constant growth forever |
| purpose of capital budgeting | to plot a course of action for the firm. the firm should only take projects that expand shareholder value. |
| key component of capital budgeting | estimate the project cash flows associated with a project. |
| 2 best rules of NPV/IRR | uses time value of money |
| NPV strength | uses cost of capital, best represents shareholder |
| IRR strength | measures profitability, easier to understand, and more commonly used in workplace |
| NPV weakness | difficult to understand |
| IRR weakness | can have multiple IRR's, can conflict with NPV |
| payback period strength | great liquidity measure, great for small business owner, useful but only in constant with other rules |
| payback perod weakness | ignore time value of money, what is a good value for payback, ignore what happens beyond payback period |
| PI | NPV+INITIAL COST/ INITIAL COST |
| why use PI? | when firms have constrained project budget, must choose between good projects. PI can rank projects, greater PI= greater return for dollar invested |
| EAA | measure repeatable projects with different lengths. Effective annual annuity. |
