Financial Statements, Cash Flow, Taxes, and Interest Rates

Vocabulary flashcards covering financial statements, tax treatments of interest and dividends, interest rate determinants, premiums, term structure, yield curves, and macroeconomic factors.

Balance Sheet

A key financial statement that provides a snapshot of a firm's financial position at one point in time.

Income Statement

A key financial statement that summarises a firm's revenues and expenses over a given period of time.

Earnings Per Share (EPS)

A financial metric calculated as $\text{EPS} = \frac{\text{Net Income}}{\text{Common share outstanding}}$.

Book Value Per Share (BVPS)

A financial metric calculated as $\text{BVPS} = \frac{\text{Stockholders' equity}}{\text{Common share outstanding}}$.

Corporate Tax Treatment of Interest Paid

Interest paid by corporations is tax deductible and is paid out of pre-tax income.

Corporate Tax Treatment of Dividends Paid

Dividends paid by corporations are not tax deductible and are paid out of after-tax income.

Four Factors Affecting Interest Rates

The four fundamental factors that affect the level of interest rates: risk, production opportunities, expected inflation, and time preferences for consumption.

Real Risk-Free Rate ($r^*$)

The rate of interest on risk-free borrowing when there is zero expected inflation; it is affected by time preference for consumption and production opportunities.

Nominal Rate Formula

The equation representing the required return on a debt security: $r = r^* + \text{IP} + \text{DRP} + \text{LP} + \text{MRP}$.

Inflation Premium (IP)

A premium added to the real risk-free rate equal to the average expected inflation over the life of a debt security.

Default Risk Premium (DRP)

The compensation added to an interest rate to account for the risk of possible default by the borrower.

Liquidity Premium (LP)

The compensation added to an interest rate for possible difficulty selling a debt security quickly at fair market value.

Maturity Risk Premium (MRP)

Compensation for the possible loss in value due to increases in interest rates over the maturity of a debt security, which impacts longer-term securities more than shorter-term ones.

Term Structure of Interest Rates

The relationship between interest rates (or yields) and maturities of debt instruments.

Yield Curve

A graph illustrating the term structure of interest rates by plotting yields against maturities.

Corporate Yield Curve Spread

The difference between corporate and Treasury yield curves caused by the addition of Default Risk Premium (DRP) and Liquidity Premium (LP) to corporate debt.

Macroeconomic Factors Influencing Interest Rates

The key macroeconomic drivers that influence interest rate levels: Federal Reserve policy (monetary policy), government budget deficits or surpluses, international factors, and the level of business activity.