FIN Test 2

time value analysis is good for

planning for retirement, valuing stocks and bonds, setting up loan payment schedules, making corporate decisions regarding investing in new plants and equipment

a dollar is hand today is

worth more than a dollar to be recieved in the future

compounding

the process of going to future value from present value

compound interest

occurs when interest is earned on prior period’s interest

simple interest

occurs when interest is not earned on interest

opportunity cost

the rate of return you could earn on an alternative investment of similar risk

sunk cost

cash outlays that a company has made in the past that cannot be recovered

discounting

the process of finding the prevent value of a cash flow or a series of cash flows

goal of financial management

to maximize the firm’s value and the value of a business

annuity

when the payments are equal and made at fixed intervals

ordinary/deferred annuity

if the payments occur at the end of each year

annuity due

if the payments are made at the beginning of each year

FV of annuities due will be greater than a similar ordinary annuity because

each payment occurs one period earlier with an annuity due so all the payments earn interest for an additional period

perpetuity

a stream of equal payments at fixed intervals expected to continue forever

uneven/nonconstant cash flows

a series of cash flows where the amount varies from one period to the next

what type of uneven cash flow consists of a series of annuity payments plus an additional final lump sum

bonds

what represents an example of all other uneven cash flow streams

capital investments and stocks

debt

a promise by the borrower to repay the amount borrow plus interest

bills/paper

a short term obligation with an initial maturity less than 1 year

note

an obligation with maturity between 1 and 7 years

bonds

are a debt obligation with a term longer than 7 years

people who borrow the money are the

issuer

people who lend the money are

bondholders

traditional bond

annual and semi-annual coupon payments

no coupon bonds

no coupon payments, interest is either at the end or sold at a discount

coupon

the regular interest payment in every bond, and is semi-anunual unless told otherwise

coupons are based on

a % of the par value

par value

the face value of a bond

most corporate bonds have a standard face value of

$1000

coupon rate

the rate of interest paid on a bond as % of par → used to determine how much annually you pay on interest

term to maturity

how long until the bond matures or until face value is paid

indenture

a formal name for a bond agreement or the contract

terms

states when coupons are paid and whether the bond is a bearer bond or registered bonds

bearer format bonds

belongs to whoever physically holds the piece of paper

a registered bond format

electronically tracks the owners name in a database

securities

collateral like mortgage backed securities

unsecured/debentured bonds

no specific securities stated

seniority

hierarchy of claims, senior/junior debt, priority of claims when company goes bankrupt, ex. subordinated debt, bottom of the pile

call provisions

allows the issuer of the bond to repurchase or “call” all or part of the bond, the legal right to pay you back early and cancel the debt

the borrower (issuer)

the borrower is the entity that needs cash right now to pay for something, they print out the bond and sell it to get immediate cash

the lender (investor)

the lender is the person/group who has extra cash right now and wants to earn safe profit over time, they give the cash to borrower in exchance for the bond

call premium

the amount between call price and stated value, basically the apology bonus for breaking the contract

deferred call provision

the time lock that bans the company from paying you back early for a set number of years

protective covenants

strict legal rules written into the indenture to protect the lender from getting screwed over by the borrower, think of then like ground rules

call protected bond

keeps the issuer from calling the bond back usually for a certain set of times

negative covenants

restrictions that prevent the company from taking on too much risk or blowing cash, ex. limiting dividends, limiting extra debt, asset sales

postive covenants

mandatory actions the company takes to prove they are staying financially healthy, ex. maintaining insurance, financial reporting, collateral maintinence

sinking fund provision

when a company sets aside money each year in order to pay off the debt at maturity, or retiring some of the bonds

credit ratings

are when firms perform analyses that determine the financial stability of dbt obligations

NRSRO’s

determine the creditworthiness of issuers, or if they are low-risk or high-risk

high grade bond ratings

• Aaa and AAA → the capacity to pay is extremely strong

• Aa and AA → capacity to pay is very strong

medium grade bond rating

• A → capacity to pay is strong but vulnerable to long-term economic shifts

• Baa and BBB → adequate, but any major financial trouble could cause issues

speculative grade or junk bonds

BB, Ba, B, CCC, Caa, D, C → borrowers are financially unstable, highly unpredictable, or under large amounts of debt

why do people invest in junk bonds

they pay higher interest rates

the value of a straight bond is

the present value of the future cash flows on the bond

yield to maturity (YTM)

i = discount rate used in bonds