Finance Final Exam Vocab

FINA 3320

Bond Certificate

States the terms of a bond as well as the amounts and dates of all payments to be made

Annual Tax Savings (Formula)

Savings = (Debt * Interest Rate) * Corp Tax Rate

PV of Tax Shield from Debt (Formula)

PV = (Annual Tax Savings / Discount Rate)

WACC & Unlevered COC (Formula)

WACC/unlevered coc = ( (E/E+D)*Re + (D/E+D)*Rd ) * (1-Tc)

Coupon Rate

Determines the amount of each coupon payment of a bond

EPS (Formula)

EPS = Total Earnings / Shares Outstanding

Calculating Stock Price with Ratio’s

Price = P/E * EPS

Real Interest Rate (Formula)

(1+nominal rate / 1+inflation) -1

Coupon Rates are always stated as

an APR

Face Value / Par / Principal

The notional amount of a bond used to compute its interest payments. The face value of the bond is generally due at the bond's maturity.

Junk Bonds

Below investment grade, low credit worthiness, high risk of default

Maturity Date

Final repayment date of a bond

on-the-run bonds

The most recently issued treasury security of a particular original maturity

Par

price of coupon bonds = face value

Premium

Bonds trading at a price higher than face value

Yield to Maturity (YTM) / IRR

Discount rate setting the present value of the bond payments = to the current market price

Incremental IRR

IRR of incremental cash flows resulting from choosing one decision/project over another

IRR Investment Rule

Comparing the differences of CF's between two mutually exclusive projects

NPV (definition)

Calculates the difference between the present value of all cash inflows and all cash outflows for an investment… Benefits - Costs

NPV (formula)

NPV = -cash outflow + CF's/r or (r-g) if their is growth

Payback Investment Rule

Only projects that pay back their initial investment within the paybackperiod are undertaken

Profitability Index

Measures the NPV per unit of resource consumed

Break-even analysis

calculating the values where NPV of the project is zero… costs=benefits

Cannibalization

When sales of a firm's new product displaces and eats into an existing product's sales

Depreciation Tax Shield

Tax savings thayt result from the ability to deduct depreciation

Free Cash Flow

Incremental effect of a project on a firm's available cash

Overhead Expenses

expenses associated with activites that are not directly attributable to a signle business activity but instead affect many areas of the business

Sunk Cost

Unrecoverable costs where the firm is already liable

CapEx, Capital Expenditure

Money a company speads to acquire, upgrade, maintain long term assests like PPE. Can be expenses over time like machine deprecition

Constant Dividend Growth Model

Model for valueing a stock by viewing it's dividends as a constant growth perpetuity

Discounted Free Cash Flow Model

Estimating a firm's enterprise value by discounting its future free cash flows

Enterprise Value

Repersents total value of a company including debt and equity. Repersents the cost to acquire the company

Dividend-Discount Model

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

Dividend Payout Rate

Fraction of a firm's earnings that it will pay out as dividends to shareholders each year

Dividend Yield (definition)

percentage return an investors expect to earn from the dividend paid by the stock

Dividend Yield (formula)

=Div1/P0 Expected Div / Current Share Price

Retention Rate

fraction of a firm's current earning that the firm retains as compared to payed out as dividends

Share Repurchase

Firm uses cash to buy back its own stock

Sustainable Growth Rate

Rate at which a firm can grow using only retained earnings

Total Payout Model (definition)

Repersents a firm's total payout to equity holders… all the cash distributed as dividends and share repurchased

Total Payout Model (formula)

Total Equity = total payout(divs & repo's)/ cost of capital - growth ie discounted

Price Per Share

=Total equity / Total shares outstanding

Total Return / RE cost of capital

= Dividend Yield + Capital Gain Rate

Capital Gain Rate (formula)

% change in price =(P1-P0)/P0

If given P0, Div0, Earnings0 (this years)

find expected next year (P1, Div1, Earnings1) by applying growth (1+%)

Next Years Dividend

=(EPS1) x (Payout Rate)

Unlevered NI

Firm's income excluding any debt. It does includes taxes

Efficient Portfolio

Portfolio containing only systematic risk. An efficient portfolio cannot be diversified further; there is no way to reduce the volatility of the portfolio without lowering its expected risk. Offers highest expected return for a given level of risk - everyone’s investing with the same proportions/ratios

Market Risk Premium

Extra return you demand for taking on the risk of the stock market instead of playing it safe ie. Treasury Bond

Covariance

Measure direction and magnitude - Excel: Covariance.S(returns of stock A, returns of B)

Correlation

Just measure direction, volatility tracks with this, ex as one drops the other does as well - Excel: Correl(returns of A, returns of B)

Positive Covariance/Correlation

Stocks move in same direction

Systematic Risk

Risk that affects all market securities/all public companies, correlated across assets, return fluctuations due to market-wide news (common, market, non diversifiable)

Idiosyncratic Risk

Uncorrelated across assets, risk only affecting one company (individual, unique, independent, diversifiable)

Excess Return

Difference between average return for an investment and the average return for a risk free asset

Market Portfolio

A theoretical value-weighted portfolio of all shares of all stocks and securities in the market, expected return of market portfolio equals the expected return of the market as a whole

Alpha

Difference between a stocks expected return and its required return for its level of risk, if expected return>required return then alpha is positive & stock is undervalued/attractive

Asset Cost of Capital

Expected return required by the firms investors to hold the firms assets; used as a discount rate when valuing a project/firms FCF assuming risk and assets are similar; the weighted average of the firms equity and debt cost of capital

Debt Cost of Capital

Cost of capital, or expected return, that a firm must pay on its debt; interest rate a firm must pay on its borrowing; lower than ACOC since it only includes debt

Exchange-Trade Fund (ETF)

Security that trades on an exchange, like a stock, but represents ownership in a portfolio of stocks, many times built to track an index

Weight Average Cost of Capital (WACC)

Represents a company’s average cost of financing assets through a mix of debt and equity, weighted by the fraction of the firms enterprise value that corresponds to equity and debt, discounting FCF using WACC computes their value including the interest tax shield… “On average, what return do all capital providers together demand for the money tied up in this company?”

Homemade Leverage

Investors using leverage in their own portfolios to adjust the leverage choice made by a firm, ex: investor borrows to buy more shares of a company

Perfect Capital Markets

When investors and firms can trade the same set of securities at competitive market pricing without friction like taxes, transaction costs, issuance cost, asymmetric information, agency costs

Unlevered Equity

Equity in a firm without debt, a structure where all assets are funded 100% by equity, so there is no leverage risk from borrowing

Unlevered

Measuring the risk of a company’s underlying business as if it had no debt, removing financial risk caused by levered (debt)

Capital Asset Pricing Model (CAPM)

Formula linking an investments expected return to its risk relative to the market, saying that investors must earn the risk-free rate + extra return for taking on the systematic (market) risk …. sometimes also referred to as SML security market line

Lowering Portfolio Risk/Volatility

Diversify and increase # of stocks in portfolio

CAPM (Formula)

Expected Return = risk free rate + investment’s Beta *(expected market return + risk free rate)

Market Risk Premium (Formula)

Expected Market Return + Risk Free Rate

Beta

Tells you how much a stocks price tends to move/fluctuate when the overall market moves, BETA=1 = if market moves 1% then stocks moves 1%

2 way to calculate Beta in Excel

1. =SLOPE(StockReturns, MarketrReturns)

2. =COVARIANCE.P(StockReturns, MarketReturns) / VAR.P(MarketReturns)

C Corporation

Regular company, Separate taxpayer which files its own corporate return and pays corporate income tax on profits

S Corporation

They don’t pay tax themselves. Elects pass-through tax treatment- income, deductions, and credits flows to shareholders’ personal returns instead of being taxed at the corporate level

LLC (Limited Liability Company)

Flexible business type protecting owners personal assets, similar to s corp they do not pay federal income taxes at the entity level; instead, profits and losses pass through to members' personal tax returns

Partnership

A business with two or more owners sharing profits and losses, the business does not pay income tax and only each partner pays tax on their share

Sole Proprietorship

One-person business with no separate legal entity. the owner and the business are the same for tax, so all profit goes on the owners personal returns

Applications of the Annuity Formula

• PV-Find how much to borrow today or solve for a payment

• PV-how much is needed today to fund a stream of payments in the future

• FV-find how much to deposit for it to grow to an amount in the future

Relationship nature of bond yields and bond prices

Inverse

Dividend Discount Model (DDM) (Definition)

Values stock as the present value of all expected future dividends to shareholders

Free Cash Flow Valuation Models (Definition)

Values stock or the whole firm using the present value of the free cash flows

Growing Annuity (Formula)

PV= (pmt1*(1-(1+g/1+r)^n))/(r-g)