FIN 301 Exam 3

Bond issuer is the

borrower

Bond holder is the

lender

Coupon Value =

(coupon rate * face value) / number of coupon payments per year

coupon bond

promises periodic coupons and a one-time face value payment at maturity date

zero-coupon / pure discount bonds

promises a one-time face value at maturity but no coupons

consol / perpetual bonds

promises periodic coupons forever, but no face value payment

coupon bond price =

coupon/YTM * (1 - 1/(1+YTM)^n)) + FV/(1+YTM)^n

zero-coupon bond price =

FV/(1+YTM)^n

Zero-Coupon bonds are always traded at a

discount

treasury bill price =

FV/(1+YTM)^n

Bond traded at a discount means bond’s market price is

lower than the face value

Bond traded at a premium means bond’s market price is

higher than the face value

Why Bond Prices Change? - Term to Maturity

“Pull to Par”: price approaches face value as the maturity of the bond grows near

Why Bond Prices Change? - Interest Rates Change

the relation between prices and interest rates is always negative

Interest Rate Risk

the uncertainty caused by the effect of unanticipated changes in interest rates on bond prices

Duration

measure of interest rate risk; the percent reduction in a bond’s price when bond yields rise by 1%

The longer the term to maturity…

the higher the interest rate risk

The higher the coupon…

the lower the interest rate risk

Credit Spread

Difference between risk-free interest rate on Treasuries and interest rate on all other bonds

PV of Dividend Payments Determines the…

Stock Price

PV of Total Payouts Determines the…

Equity Value

Straight Voting

Number of votes = number of shares held

Cumulative Voting

Number of votes = number of open spots * number of shares held

Voting Rights

annual meeting, proxy voting

Cash Flow Rights

right to share profits through dividend payments, right to receive residual cash in case of total liquidation of the firm’s assets

Cumulative preferred stock

all missed preferred dividends must be paid before any common dividends can be paid

Non-cumulative preferred stock

missed dividends do not accumulate, only the current dividend is owed before common dividends can be paid

Preferred equity/stock price =

dividend / r

Dividend-Discount Model

values shares of a firm according to the present value of the future dividends the firm will pay

Dividend-Discount Model Equation: Price of stock =

DivN / (1 + r)^N + PN / (1 + r)^N

One Year Investor Equation: Price =

Div1 + P1 / 1 + r

Equity Cost of Capital

the expected rate of return available in the market on other investments that have equivalent risk to the risk associated with the firm’s shares

Dividend Yield

the expected annual dividend of a stock dividend by its current price; the percentage return an investor expects to earn from the dividend paid by the stock

Capital Gain

the amount by which the selling price of an asset exceeds its initial purchase price

Capital Gain Rate

An expression of capital gain as a percentage of the initial price of the asset

Total Return

the sum of a stock’s dividend yield and its capital gain rate

Dividend Yield =

annual dividend / price at the end of the last fiscal year

Capital Gain =

price end - price beginning / price beginning

Total Return =

dividend yield + capital gain

Dividend-Discount Model: if dividend growth is constant

price = div1 / r - g

Dividend Payout Rate =

earnings * dividend payout rate / shares outstanding

Change in Earnings =

new investment * return on new investment

Earnings Growth Rate =

change in earnings / earnings

Growth =

retention rate * return on new investment

Share Repurchases

a transaction in which a firm uses cash to buy back its own stock.

The more cash the firm uses for buybacks…

the less cash available for the firm to pay dividends

In share repurchases, the firm decreases its share count, therefore increasing…

earnings and dividends per share

Total Payout Model: Price =

PV(future total dividends and net repurchases) / shares outstanding