Frl 3000 test 2

Federal government bonds

﹒Debt issued by the federal government; generally considered low default risk.

State and local government bonds

﹒Municipal bonds issued by states, cities, or local governments.

Corporate bonds

Debt issued by companies; interest is usually taxable to investors.

Municipal bond

﹒A bond issued by a state or local government; interest is often tax-free federally.

Taxable bond

﹒A bond whose interest income is subject to taxes.

Tax-equivalent yield

The taxable yield needed to equal the return from a tax-free municipal bond.

Zero-coupon bond

A bond that makes no periodic interest payments and pays its face value at maturity.

Interest-only bond

A bond that pays interest periodically and repays the full principal at maturity.

Amortizing bond

A bond that repays part of the principal with each payment.

Discount loan

A loan in which interest is deducted from the amount borrowed, so the borrower receives less than the face value.

Real interest rate

The interest rate adjusted for inflation; it measures the change in purchasing power.

Nominal interest rate

The stated interest rate before adjusting for inflation.

Inflation rate

The rate at which the general price level increases.

Exact Fisher Effect

The exact relationship connecting nominal interest, real interest, and inflation.

Approximate Fisher Effect

A shortcut estimating the nominal rate as the real rate plus expected inflation.

Term structure

The relationship between interest rates and the time remaining until maturity.

Normal yield curve

An upward-sloping yield curve where long-term rates are higher than short-term rates.

Inverted yield curve

A downward-sloping yield curve where long-term rates are lower than short-term rates.

Flat yield curve

A yield curve where short-term and long-term rates are approximately equal.

Common stock

Ownership in a corporation that usually includes voting rights and potential dividends.

Preferred stock

Stock that usually receives a fixed dividend and has priority over common stock.

Voting rights

The right of common shareholders to vote on important corporate matters.

Dividend

A payment made by a corporation to its shareholders.

Liquidation value

The amount a shareholder would receive if the company were liquidated; preferred stock usually has priority.

Preemptive right

The right of existing shareholders to maintain their ownership percentage when new shares are issued.

Dividend yield

The portion of a stockholder’s return received from dividends.

Capital gains yield

The portion of a stockholder’s return caused by an increase in the stock price.

Total stock return

The combination of dividend income and capital gains.

Zero-growth stock

A stock whose dividend remains constant forever.

Constant-growth stock

A stock whose dividend grows at the same rate forever.

Nonconstant-growth stock

A stock whose dividend growth changes for a period before becoming constant.

Capital budgeting

The process of evaluating long-term investment projects.

Conventional cash flow

A project with one initial cash outflow followed by future cash inflows.

Nonconventional cash flow

A project with cash-flow signs that change more than once.

Independent projects

Projects where accepting one project does not affect the decision to accept another.

Mutually exclusive projects

Projects where accepting one project prevents accepting another.

Net present value (NPV)

The amount of value a project adds to the firm after considering the time value of money.

NPV decision rule

Accept an independent project when NPV is positive; reject it when NPV is negative.

Payback period

The amount of time required to recover the initial investment using undiscounted cash flows.

Payback advantage

It is simple and focuses on how quickly the investment is recovered.

Payback disadvantage

It ignores the time value of money and cash flows received after payback.

Internal rate of return (IRR)

The discount rate that makes a project’s NPV equal to zero.

IRR decision rule

Accept a project when IRR is greater than or equal to the required return.

IRR limitation

IRR can be unreliable with nonconventional cash flows or mutually exclusive projects.

Profitability index (PI)

The present value of future cash inflows divided by the initial investment.

PI decision rule

Accept a project when PI is greater than 1.

MIRR

Modified internal rate of return; a version of IRR that improves some reinvestment and multiple-IRR problems.

NPV profile

A graph showing how a project’s NPV changes as the discount rate changes.

NPV versus IRR conflict

When NPV and IRR rank mutually exclusive projects differently, NPV is generally preferred.

Incremental cash flow

The additional cash flow caused by accepting a project.

Sunk cost

A cost that has already occurred and should not be included in project cash flows.

Opportunity cost

The value of a benefit given up by using an existing resource for a project.

Side effect

A positive or negative effect of a project on other company operations.

Net working capital (NWC)

Current assets minus current liabilities; additional NWC is usually an initial cash outflow.

Financing cost

The cost of obtaining funds; it is generally reflected in the required return rather than project cash flows.

Initial cash flow

Cash flow occurring at the beginning of a project.

Operating cash flow

Cash flow generated by the project’s normal yearly operations.

Terminal cash flow

Cash flow received when the project ends, including salvage value and NWC recovery.

Depreciation

The accounting allocation of an asset’s cost over its useful life; it is not a direct cash outflow.

Depreciation tax shield

The tax savings created because depreciation reduces taxable income.

Straight-line depreciation

Depreciation method that spreads the depreciable cost evenly across the asset’s useful life.

MACRS

A tax depreciation system that assigns an asset’s cost to specific recovery-period percentages.

Book value

The asset value shown on the company’s accounting records.

Market value

The price an asset could currently be sold for in the market.

After-tax salvage value

The amount received from selling an asset after considering taxes on the gain or loss.

Unequal project lives

A situation where competing projects have different operating lifetimes; equivalent annual cost can help compare them.