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Week 7 Notes FIN 305

by: Alia Coughlan

Week 7 Notes FIN 305 FIN 305

Marketplace > Colorado State University > Business > FIN 305 > Week 7 Notes FIN 305
Alia Coughlan

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Week 7 Notes
Fundamentals of Finance
John D. Hopkins
Class Notes
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This 6 page Class Notes was uploaded by Alia Coughlan on Friday October 7, 2016. The Class Notes belongs to FIN 305 at Colorado State University taught by John D. Hopkins in Fall 2016. Since its upload, it has received 4 views. For similar materials see Fundamentals of Finance in Business at Colorado State University.


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Date Created: 10/07/16
Week 7 Notes for FIN 305 9/30 Perpetuities ­fixed payments ­no maturity date ­pays the fixed payment forever *Most preferred stock does not have a maturity date and has a fixed dividend payment ­Required Return = Annual CF/Price *Must be a decimal Rule of 72 ­estimates how long it takes to double money given a rate of return ­estimates what rate of return must be earned to double money in a given holding period ­annual compound return ­N x i = 72 *i goes as a percentage *Make sure to go over practice problems found on canvas 10/3 Absent from class 10/5 Chapter 2 Securities in the Financial Market ­Money Market Securities ­Treasury bills ­Short term securities issued by the federal government ­Have active secondary market after initial sale ­Bought at a discount ­At maturity, investor receives full face value ­Certificates of Deposit (CDs) ­Interest­bearing securities issued by financial institutions ­Maturities of one year or less ­Commercial Paper ­Unsecured debt issued by corporations with good credit ratings ­Most buyers are large institutions ­Eurodollars ­Dollar denominated deposits located outside of US ­Buyers/Sellers are large institutions ­Banker’s acceptance ­Debt securities that have been guaranteed by a bank ­Used to facilitate international transactions *Money Market Mutual Funds = allows shareholders to invest in all 5 money market securities ­Capital Market Securities ­Bonds ­IOUs issued by the borrower and sold to investors ­Issuer promises to repay the face amount on the maturity date and to pay interest ­Types:  ­Treasury Bonds ­Issued by federal government ­Municipal Bonds ­Issued by state and local government ­Corporate Bonds ­Issued by corporation ­Face Value (Par Value) = $1000 ­Interest Paid = Coupon Rate x Face Value ­Market Price fluctuates *Relationship between bonds and interest rates ­Bond prices increase, interest rates decrease ­Bond prices decrease, interest rates increase *Market price has nothing to do with interest rates *Face Value, Coupons, and Coupon Payments never fluctuate ­Stocks ­Companies can raise funds by selling shares of stock ­Stockholders not guaranteed any return on investments ­Types: ­Common Stock ­Own a portion of the company and cane vote on major decisions ­Receive return on investment in form of dividends/capital gain ­Preferred Stock ­Don’t have voting rights, but have priority receiving dividends ­Paid dividends at set rate  ­Stated as percentage of face value *Intermediaries = help to facilitate the flow of funds in the marketplace ­ex: commercial banks, insurance companies Market Efficiency ­Ease ­Trades can be issued in seconds ­Generally seen in large companies ­Important because idle funds means lower growth for economy and higher unemplyment ­Speed ­Cost Interest Rates Determined By.. ­Real Rate of Interest ­Compensate for the lender’s lost opportunity to consume ­Expected Inflation ­Inflation erodes the purchasing power of money ­Expected inflation is added to real rate of return to protect lender’s purchasing power ­Default Risk ­For most securities, there is some risk that the borrower will not repay the interest ­Greater the chance of default, greater the interest rate the investor demands ­Maturity Risk ­If interest rates rise, lenders loans may earn rates that are lower than what they could  have had on new loans ­Risk is higher for longer maturity loans ­Lenders will adjust the premium they charge depending on whether rates will go  up/down ­Illiquidity Risk ­Investments that are easy to sell without losing value are more liquid ­Have higher interest rate to compensate the lender for the inconvenience of being stuck *Nominal Risk Free Rate = REAL Rate of Interest + Expected Inflation ­Considered “risk free” because no premiums for risk associated with lending money is included 10/7 Determination of Rates ­k = k* + IRP + DRP + MP + ILP ­k = the nominal or observed rate on security ­k* = real rate of interest ­IRP = inflation risk premium ­DRP = default risk premium ­MP = maturity premium ­ILP = illiquidity premium Yield Curves ­Illustrates the term structure for bonds with the same level of risk ­The graph ­X Axis ­Time to maturity ­Y Axis ­Yield to maturity ­The line represents YTMs for different maturities for securities with the same risk ­US Treasury Bonds ­AAA Corporate Bonds ­Can be used to show ­Interest rates for different maturities  ­Interest rates for different risk levels or providers ­AAA Corporate bonds vs Treasury bonds ­AAA Corporate bonds vs Junk bonds ­AAA Corporate bonds vs Municipal bonds


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