F370 Final Exam Study Guide
F370 Final Exam Study Guide BUS-F 370
Popular in I-CORE - FINANCE COMPONENT
verified elite notetaker
Popular in Business
This 0 page Study Guide was uploaded by Elizabeth Frabotta on Sunday November 15, 2015. The Study Guide belongs to BUS-F 370 at Indiana University taught by Rearick T in Fall 2015. Since its upload, it has received 170 views. For similar materials see I-CORE - FINANCE COMPONENT in Business at Indiana University.
Reviews for F370 Final Exam Study Guide
Report this Material
What is Karma?
Karma is the currency of StudySoup.
You can buy or earn more Karma at anytime and redeem it for class notes, study guides, flashcards, and more!
Date Created: 11/15/15
F370 Final Exam Vocabulary Capital Investment Function 0 Management of a firm s combined portfolio of projects 0 Considers how managers can deploy and manage existing corporate assets to create as much stockholder value as possible 0 Also considers the idea that managers may have the opportunity to capture additional value by acquiring other rms whose assets and product lines combine favorably with theirs Bl o YTM implied return N 1000 FV PV CouponRate PMT I o Maturity Risk Premium YTM Risk Free Rate 0 The Competitive Yield Rtx on any treasury bond of maturity x will be 0 Rtx rf rmp x o Rmpx stands for the current maturityrisk premium for treasury bonds of length x o Rcx rtx rdp o Rcx rf rmpx rdp As a debt contract s remaining term increases implied return increases 0 A bond s price can amp does change over time o If coupon rate r selling at parface value 0 Bond prices move in the opposite direction of competitive yields or quotinterest ratesquot in the economy o If YTM increases Bond Price decreases Bonds w longer remaining terms have more dramatic price swings with changes in r 0 Thus Maturity Risk grows larger as a debt contract s term or maturity grows larger 0 Any corporate bond w same remaining term as some treasury bond will have same risk free rate and same maturity risk premium 0 Competitive yield of any corporate bond with remaining term x o Rcx Rtx de o de YTM of corp bond YTM of TBond w same maturity Default Risk Premium 0 Treasury Debt 0 Gov t uses to borrow from rms and investors o Promised cash ows always delivered no default risk rdp 0 Active investors 0 Very high levels of liquidityeasy to sell quickly Maturity Risk 0 Risk that a bond s price will vary as competitive yields change in the overall economy 0 Maturity Premium 0 Bonds w same remaining term will have roughly the same size maturity premium Bonds issued by US Treasury will have no Default Risk de 0 Yield to Maturity vs Competitive Yield 0 YTM An implied return implied win its own cash ows Investor uses bond s Market Price remaining term amp coupon payments to nd YTM Return that IS available to investors if they hold the bond til maturity Viewing the bond in isolation 0 Competitive Yield quotshould bequot return that will bring the bond into a risk return equilibrium w the overall bond market views the bond in the context of some sample of other bonds o If YTM gt r Think that the bond is underpriced w respect to some sample of bonds they analyzed 0 r gt YTM think that the bond is overpriced w respect to some sample of bonds they analyzed 0 Default Risk 0 Risk that a borrower may not make a set of promise cash ows to lender 0 Factors that in uence the risk Financial condition of borrower Covenants in contract Collateral in contract Seniority The state of the economy 0 Collateral Gives lender an asset to claim if a rm won t pay 0 Covenants Prevent rms from misuse of borrowed capital 0 Collateral amp Covenants make lenders feel safer l Allow rms to pay LOWER INTEREST PAYMENTS rms gain capital at lower quotcostquot by taking steps to ease lender s concerns 0 Default Risk is a Payment Risk 0 Can also be a PRICE RISK 0 Ex Bondholder can lose money if a bond is downgraded while investor owns bond 0 Bond s price will drop when rating adjustment hits the market o If a bond s remaining term shortens o Maturity Risk decreases Default Risk and Growth Rate 0 Average rm grows at a positive g gt 0 rate 0 Helps bondholders by reducing chances of a default BZ Market Price of Stocks 0 O O The aggregate market opinion of all traders in the market Potential stream of future cash ows a share of stock will generate Capitalized value of all future ows assumed to grow at a rate quotgquot Intrinsic Value Growing Perpetuity Model P0D1r g News event causes investors to perceive a change in drivers of D1 r or g causing the Stock Price to change usually news events 0 CAPM Theory 0 O O O O RRfBEP Connects risk B to competitive or fair return r demanded by investors at a time A stock s required return ONLY MarketWide news events and risk are priced into the stock so that a positive longrun return is likely MarketWide risk measured by stock s Beta Find Beta by running a regression of stock s past returns w returns on overall market Beta relative measure of market risk w average level of 10 B of 100 Average B gt 100 l ex 175 o 75 more sensitive to unexpected Market Wide news than an average stock 0 for each 1 market portfolio gains or loses the B175 stock will see a 175 gain or loss 0 rm focused events could occur and change this gain or loss 0 News Events Marketwide Events 0 Macro news events that impact all stocks in market 0 All stocks move in same direction up or down w that event Positively correlated l don t cancel each other out 0 Market risk cannot be avoided by diversi cation FirmFocused or Micro Events 0 May only impact one rm or a few competitors at a time Firm Focused 0 Events independent of each other 0 Zero correlation across stock 0 Diversi cation of investment portfolio cancels out rmfocused risk for investors each day 0 does NOT provide any extra longrun return for investors 0 can cause stock s price to move up or down but stock s price will on average only increase at Rf risk free rate 0 Equity Premium 0 Amount of extra return beyond the riskfree rate that investors want so they are willing to take on the average level of market risk 0 EP Rm Rf 0 Pricing of Risk 0 Investors will not buy a riskier future cash ow unless they can on average expect a higher return 0 Extra return premium is prewired into the stock s price 0 Price adjusts downward to provide a competitive return for investors Returns 0 lmplied Return Based on research into an investment s cash ows expect to apy some observable market price and collect future cash ows What is believed to be available in this investment The is return Does not consider other investments in market 0 Required Return A theoretical return that should keep a stock in balance with other investments in the market Can calculate using CAPM The quotshould bequot return 0 Realized Return What return actually earned during the past year The actual return 0 Statistical Domination 0 Mean return r and Standard Deviation of returns 0 Prefer investments with HIGHER r and LOWER o One investment dominates another if 0 Higher r and lower 0 0 An equal r but lower 0 0 Higher r but equal 0 B3 0 Goal of CFO 0 Manage all the nancial systems and functions of a rm in a coordinated manner that will maximize the share price of the firm s current stockholders NPV and IRR metrics 0 Both decision variables related to value creation 0 lRR A project s implied return lf lRR gt r competitive return good investment if NPV gt owner of project gets extra returns or cash ow for investment 0 NPV Measures PV of the extra cash ow above what the average investor would get in mutual funds 0 NPV and PI metrics o NPV Tells you how many dollars of value your project created Could have taken a small initial investment ICF or a large one 0 Pl Tells you how many dollars of value you create for every dollar you invest in the project Helpful bc it tells you how concentrated the value creation mechanism is in that project PI of 50 is better than a PI of 11 ex 0 Payback Period Method 0 Adds up nominal cash ows 0 lgnores the time value of money assuming that r0 o Essentially gives no present value to project cash ows and beyond 0 Project can only be approved if its rst however many cash ows provide a positive net with no discounting done at all 0 Not consistent w stock and bond pricing where ALL cash ows are discounted at a positive riskadjusted market rate r 0 Agency Costs 0 Managers are asked as agents to evaluate choose and run projects for a rm s owners stockholders 0 Managers invest a lot of their own talent and resources into project I view each project in terms of its NPV to them personal 0 Agency con icts arise bc a project can create value for one group while destroying it for another 0 Misalignment of interests causes rms to miss out on potential value creation Agency Loss or Cost 0 Mislnvesting o Took on a Negative NPV l Over Investment 0 Rejected a Positive NPV Under Investment
Are you sure you want to buy this material for
You're already Subscribed!
Looks like you've already subscribed to StudySoup, you won't need to purchase another subscription to get this material. To access this material simply click 'View Full Document'