study guide exam 2
study guide exam 2 FINANC 3000 - 01
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This 9 page Study Guide was uploaded by Richard A. on Monday October 12, 2015. The Study Guide belongs to FINANC 3000 - 01 at University of Missouri - Columbia taught by Joseph Hegger in Summer 2015. Since its upload, it has received 129 views. For similar materials see Corporate Finance in Business Administration at University of Missouri - Columbia.
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Date Created: 10/12/15
Finance study guide Ch 5 Future Value of Multiple Cash Flows Multiple cash ows Regular evenlyspaced Car loans and home mortgage loans Saving for retirement Companies paying interest on debt Companies paying dividends Annuitites A stream of level and frequent cash flows paid at the end of each time period often referred to as an ordinary annuity Future value F g Payment til en annulusr 39J 3 nnuity eeaupeuneling a 1 Ji39i 1 Fli lyPillilTH Equot 55 i present value for multiple cash flows iiifl Present Value of Multiple Cash Flows Multiple cash flows Car loans and home mortgage loans Determining value of business opportunities PF T ESE39HE ez ue u f ret cash ew Preeeui velour e viaf geeuh d eagh ew a E Preeeui v iili l t fl E E h ew PM mm n a i a 1rl m 1 i P lv 39 535 ll JP Present value of level cash flows lIEJElEl lf itai tlL le aytnent 3 F tnnt titr dieenunt 1 1 Ll ii I Flt3AM an H a Eli4 perpetuity is a special type of annuity with a stream of level cash ows that are paid forever These arrangements are called perpetuities because payments are perpetual regent val nf 1e139antuitr Payment lititereet rate t r E Ell til PitInt perpetl utiy39 r i n g l An annuity in which the cash ows occur at the beginning of each period is called an annuity due Ordinary Annuity Payment occurs at the end of each period Annuity Due Cash ows at beginning not at end of period Five annuitydue cash flows basically same as payment today plus 4 year ordinary annuity Payments occur one period sooner than ordinary annuity earn extra period of interest Future valuen f an Future value E ate year at annuity elue nf annuity r entupuuntling Hf due HEAR l El iiiEl Flt y clue Flt4 nt l 1 H titTil Compounding Frequency Used in situations that do not use yearly time periods Semiannual bond payments Quarterly stock dividends Consumer loans monthly payments EARS and APRS Quoted or nominal rate called annual percentage rate APR Rate that incorporates compounding called effective annual rate EAR Relationship between APR and EAR Al EAE1 m 1 Hi Finding Payments on an Amortized Loan A loan structured for annuity payments that completely pay off the debt is called an amortized loan a y39ment regent value nt tmrtieatien Paii iE r Fit 3 IJ Lli l 1 wr t1iJ39quot Ch 6 Financial markets exist to manage the flow of funds from investors to borrowers as well as from one investor to another we can distinguish markets along two major dimensions Page 131 0 Primary versus secondary markets 0 Money versus capital markets Primary Markets Used by corporations and governments Used to issue new financial instruments Stocks Bonds In the United States financial institutions called investment banks arrange most primary market transactions for businesses Secondary Markets Benefit investors and issuers Securities traded after issue Provide liquidity and diversification benefits for investors Security valuation information for issuers Money Markets vs Capital Markets Money markets trade debt securities or instruments with maturities of one year or less Capita1 markets trade stocks and long term debt with maturities greater than one year Money market instruments Treasury bills Shortterm US government obligations Federal funds Shortterm funds transferred between financial institutions usually for no more than one day Repurchase agreements repos Agreements involving security sales by one party to another with the promise to reverse the transaction at a specified date and price usually at a discounted price Commercial paper Shortterm unsecured promissory notes that companies issue to raise shortterm cash sometimes called paper Negotiable certificates of deposit Bankissued time deposits that specify an interest rate and maturity date and are negotiable that is traded on an exchange Their face value is usually at least 100000 Banker acceptances BAs Bankguaranteed time drafts payable to a vendor of goods Capital markets are markets in which parties trade equity stocks and debt bonds instruments that mature in more than one yea Ca ptl market instruments US Treasury notes and bonds US government agency bonds 0 State and local government bonds 0 Mortgages and mortgage backed securities 0 Corporate bonds 0 Corporate stocks Treasury notes and bonds US Treasury longterm obligations issued to finance the national debt and pay for other federal government expenditures US government agency bonds Longterm debt securities collateralized by a pool of assets and insured by agencies of the US government State and local government bonds Debt securities issued by state and local eg county city school governments usually to cover capital longterm improvements Mortgages Longterm loans issued to individuals or businesses to purchase homes pieces of land or other real property Mortgagebacked securities Longterm debt securities that offer expected principal and interest payments as collateral These securities made up of many mortgages are gathered into a pool and are thus backed by promised principal and interest cash flows Corporate bonds Longterm debt securities issued by corporations Corporate stocks Longterm equity securities issued by public corporations stock shares represent fundamental corporate ownership claims Foreign exchange markets trade currencies for immediate also called spot or some future stated delivery Subject to foreign exchange risk due to currency uctuations Other Markets Derivatives 0 Highly leveraged financial securities linked to underlying security Potentially high risk 0 Used for hedging and speculating Financial institutions eg banks thrifts insurance companies mutual funds perform vital functions to securities markets of all sorts They channel funds from those with surplus funds suppliers of funds to those with shortages of funds demanders of funds Financial Institutions 0 Perform economic functions 0 Monitor costs 0 Provide liquidity 0 Price risk Commercial banks Depository institutions whose major assets are loans and whose major liabilities are deposits Commercial bank loans cover a broader range including consumer commercial and real estate loans than do loans from other depository institutions Because they are larger and more likely to have access to public securities markets commercial bank liabilities generally include more nondeposit sources of funds than do those of other depository institutions Thrifts Depository institutions including savings associations savings banks and credit unions Thrifts generally perform services similar to commercial banks but they tend to concentrate their loans in one segment such as real estate loans or consumer loans Credit unions operate on a notforprofit basis for particular groups of individuals such as a labor union or a particular company39s employees Insurance companies Protect individuals and corporations policyholders from financially adverse events Life insurance companies provide protection in the event of untimely death or illness and help in planning retirement Property casualty insurance protects against personal injury and liability due to accidents theft fire and so on Securities firms and investment banks Underwrite securities and engage in related activities such as securities brokerage securities trading and making markets in which securities trade Finance companies Make loans to both individuals and businesses Unlike depository institutions finance companies do not accept deposits but instead rely on short and longterm debt for funding and many of their loans are collateralized with some kind of durable good such as washerdryers furniture carpets and the like Mutual funds Pool many individuals39 and companies financial resources and invest those resources in diversified asset portfolios Pension funds Offer savings plans through which fund participants accumulate savings during their working years Participants then withdraw their pension resources which have presumably earned additional returns in the interim during their retirement years Funds originally invested in and accumulated in a pension fund are exempt from current taxation Participants pay taxes on distributions taken after age 55 when their tax brackets are presumably lower Nominal int rates The interest rates actually observed in nancial markets Factors That Influence Interest Rates For Individual Securities Specific factors that affect nominal interest rates for any particular security include 0 Inflation o The real risk free rate 0 Default risk Liquidity risk 0 Page 142 Special provisions regarding the use of funds raised by a particular security issuer o The security39s term to maturity Inflation A continual increase in the price level of a basket of goods and services throughout the economy as a whole Real riskfree rate Riskfree rate adjusted for inflation generally lower than nominal riskfree rates at any particular time Default risk Risk that a security issuer will miss an interest or principal payment or continue to miss such payments Liquidity risk Risk that a security cannot be sold at a price relatively close to its value with low transaction costs on short notice Special provisions Provisions eg taxability convertibility and callability that impact a security holder beneficially or adversely and as such are reflected in the interest rates on securities that contain such provisions Time to maturity Length of time until a security is repaid used in debt securities as the date upon which the security holders get their principal back In ann lThe continual increase in the price level of a basket of goods and services P car cpl T Her 3 i if a l l A real risk free rate is the rate that a riskfree security would pay if no inflation were expected over its holding period eg a year Fisher effect I Expected IF FR MfrEl RF l Expected JP flint33 Default risk is the risk that a security issuer may fail to make its promised interest and principal payments to its bondholders or its dividend in the case of preferred stockholders HEP i ire4 if a security is illiquid investors add a liquidity risk premium LRP to the interest rate on the security Interest rates also change sometimes daily because of a bond39s term to maturity Financial professionals refer to this daily or even hourly changeability in interest rates as the term structure of interest rates or the yield curve A forward rate is an expected or implied rate on a short term security that will originate at some point in the future Ch7 Bonds are debt obligation securities that corporations the federal government or its agencies or states and local governments issue to fund various projects or operations Bonds are also known as fixed income securities because bondholders investors know both how much they will receive in interest payments and when their principal will be returned legal contract called the indenture agreement outlines the precise terms between the issuer and the bondholders The date the principal will be repaid the maturity date Page 163 The par value or face value of each bond which is the principal loan amount that the borrower must repay The coupon interest rate 0 A description of any property to be pledged as collateral Steps that the bondholder can take in the event that the issuer fails to pay the interest or principal Treasury In ation Protected Securities TIPS have proved one of the most successful recent innovations in the bond market
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