FIN 323 : Study guide chapter 6 and 7 : Bond and Stock ( MId - term exam )
FIN 323 : Study guide chapter 6 and 7 : Bond and Stock ( MId - term exam ) FIN 323
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This 11 page Study Guide was uploaded by Leosinh on Wednesday March 9, 2016. The Study Guide belongs to FIN 323 at Marshall University taught by Dr. Shaorong Zhang in Spring 2016. Since its upload, it has received 35 views. For similar materials see Principles of Finance in Business at Marshall University.
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Date Created: 03/09/16
Study Guides for FIN 323 Mid-T erm Exam Chapter 6 and 7 : Bonds and Stocks Important More Important Most important Book : Essentials of Corporate Finance 8e of Ross Westerfield Jordan Chapter 6 : Interest rates and Bond Valuation Bond features and Prices : 1- Coupon : stated interest payment made on a bond. 2- Face value : the principal amount of a bond that is repaid at the end of the term. Also, par value. 3- Coupon rate : the annual coupon divided by the face value of a bond 4- Maturity : Date on which the principal amount of a bond is paid. Bond Values and Yields : 1- Yield to maturity ( YTM ) : the rate required in the market on a bond 2- Bond value : Interest Rate Risk : 1) All other things being equal, the longer the time to maturity, the greater the interest rate risk. 2) All other things being equal, the lower the coupon rate, the greater the interest rate risk. Finding the Yield to Maturity : More trial and error. Summary of bond valuation : I ) Finding the value of bond. II ) Finding the yield on a bond. Given a bond value, coupon, time to maturity and face value, it is possible to find the implicit discount rate, or yield to maturity, by trial and error only. To do this, try different discount rates in the formula above until formula above until the calculated bond value equals the given bond value. Remember that increasing the rate decreases the bond value. More on bond feature : 1- Equity securities and debt securities : is securities issued by corporations may be classified roughly. 2- Creditor, lender : the person or firm making the loan. 3- Debtor, borrower : the corporation borrowing the money. Long-term Debt : The Basics a) The maturity of a long-term debt instrument is the length of time the debt remains outstanding with some unpaid balance. b) Short-term debt : unfunded debt. c) Debt securities : notes, debentures , or bonds. The Indenture : 1) Indenture : is the written agreement between the corporation ) the borrower and its creditors. ( deed of trust ). 2) Registered form : the form of bond issue in which the registrar of the company records ownership of each bond; payment is made directly to the owner of record. 3) Bearer form :the form of bond issue in which the bond is issued without record of the owner’s name; payment is made to whomever holds the bond. Sinking fund : an account managed by the bond trustee for early bond redemption. Call provision : an agreement giving the corporation the option to repurchase the bond at a specific price prior to maturity. Call premium : the amount by which the call price exceeds the par value of the bond. Deferred call provision : a call provision prohibiting the company from redeeming the bond prior to a certain date. Call protected bond : a bond that currently cannot be redeemed by the issuer Protective covenant: that part of the indenture or loan agreement that limits certain actions as a company might otherwise wish to take during the term of the loan. a) A negative covenant is a “thou shalt not” type of covenant. It limits or prohibits actions that the company might take. Here are some typical examples : 1) The firm must limit the amount of dividends it pays according to some formula. 2) The firm can not pledge say any assets to other lenders. 3) The firm can not merge with another firm. 4) The firm can not sell or lease any major assets without approval by the lender 5) The firm can not issue additional long-term debt. b) A positive covenant is a “thou shalt” type of covenant. It specifies an action that the company agrees to take or a condition the company must abide by. Here are some examples : 1) The company must maintain its working at or above some specified minimum level. 2) The company must periodically furnish audited financial statements to the lender. 3) The firm must maintain any collateral or security in good condition. Some different types of bond : 1- Government bonds: a bond issued by a national government, generally with a promise to pay periodic interest payments and to repay the face value on the maturity date. Government bonds are usually denominated in the country's own currency. Another term similar to government bond is "sovereign bond". Technically any bond issued by a sovereign entity is a sovereign bond but sometimes the term is used to refer to bonds issued in a currency other than the sovereign's currency. If a government or sovereign is close to default on its debt the media often refer to this as a sovereign .ebt crisis 2- Zero coupon bonds : a bond that makes no coupon payments and thus is initially priced at a deep discount. 3- Floating-Rate bonds : bonds that have a variable coupon, equal to a money market reference rate, like LIBOR or federal fundsrate, plus a quoted spread (also known as quoted margin). The spread is a rate that remains constant Bond markets : 1) How bonds are bought and sold : a) Bid price : the price a dealer is willing to pay for a security. b) Asked price : the price a dealer is willing to take for a security. c) Bid-ask spread : the difference between the bid price and the asked price. Inflation and interest rates : Real versus Nominal Rates : a) Real rates : interest rates or rates of return that have been adjusted for inflation. b) Nominal rates : interest rates or rates of return that have not been adjusted for inflation. The fisher effect : the relationship between nominal returns, real returns and inflation. ( 1 + R ) = ( 1 + r ) ( 1 + i) With : R : rate of return r : real rate of return i : inflation rate i) Inflation premium : the portion of a nominal interest rate that represents compensation for expected future inflation. ii) Interest rate risk premium : the compensation investors demand for bearing interest rate risk. iii) Default risk premium : the portion of a nominal interest rate or bond yield that represents compensation for the possibility of default. iv) Taxability premium : the portion of a nominal interest rate or bond yield that represents compensation for unfavorable tax status. v) Liquidity premium : the portion of a nominal interest rate or bond yield that represents compensation for lack of liquidity. Chapter 7 : Equity Market and Stock Evaluation Book : Essentials of Corporate Finance 8e of Ross Westerfield Jordan 7.1 ) Common Stock Valuation : Cash flows : Some special cases : 1- Zero growth : Or 2- Constant growth : Dividend growth model : a model that determines the current price of a stock as its dividend next period divided by the discounted rate less the dividend growth rate. 3- Nonconstant growth : 4- Components of the Required Return : Po = D1 / (R –g ) a) The first of these D1/Po is the dividend yield. Because this is calculated as the expected cash dividend divided by the current price. b) The growth rate , g. It is the rate at which the stock price grows. It can be interpreted as the capital gain yield , the rate at which the value of the investment grows. R = dividend yield + capital gains yield R= D1/Po + g 5- Stock Valuation Using Multiples : Price at time t = Pt = Benchmark PE ratio x EPSt Explains : The benchmark PE ratio could come from one of several possible sources : _ Based on similar companies ( perhaps an industry average or median ) _ Based on a company’s own historical values 7.2 ) Some features of common and preferred stock : Common stock features : Common stock : the different things to different people , but it is usually applied to stock that has no special preference either in paying dividends or in bankruptcy. Shareholder Rights: Cumulative voting: a procedure in which a shareholder may cast all votes for one member of the board of directors. Straight voting: a procedure in which a shareholder may cast all votes for each member of the board of directors Staggering has two basic effects : a) Staggering makes it more difficult for a minority to elect a director when there is cumulative voting because there are fewer directions to be elected at one time. b) Staggering makes takeover attempts less likely to be successful because it makes it more difficult to vote in a majority of new directors. Proxy Voting : Proxy is the grant of authority by a shareholder to someone else to vote the shareholders’ shares. For convenience, much of the voting in large public corporations is actually done by proxy. Dividend : payments by a corporation to shareholders, made in ether cash or stock It paid to shareholders represent a return on the capital directly or indirectly contributed to the corporation by the shareholders. Some important characteristics : a) It is not a liability of the corporation. b) The payment of dividends by the corporation is not a business expense. Dividends are not deductible for corporate tax purposes. In short , dividends are paid out of the corporation’s after-tax profits. c) Dividends received by individual shareholders are taxable. 6- Preferred stock features : Preferred stock differs from common stock because it has preference over common stock in the payment of dividends and in the distribution of corporation assets in the event of liquidation. 7.3 ) The Stock Markets : 1) Primary markets : the market in which new securities are originally sold to investors. 2) Secondary markets: the market in which previously issued securities are traded among investors. 3) Dealer : agent who buys and sells securities from inventory. 4) Broker : an agent who arranges security transactions among investors. 5) Designated market maker ( DMM) : NYSE members who act as dealers in particular stocks. Formerly known as “specialists” 6) floor brokers : NYSE members who execute customer buy and sell orders. 7) supplemental liquidity providers (SLPs) : investment firms that are active participants in stocks assigned to them. Their job is to make a one- sided market ( example : offering to either buy or sell ) . They trade purely for their own products. 8) order flow : the flow of customer orders to buy and sell securities. 9) Inside quotes : the highest bid quotes and the lowest ask quotes for a security. 10) electronic communications networks (ECNs) : websites that allow investors to trade directly with one another.
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