FIN3403 - Exam 2

Future Value

The amount an investment is worth after one or more periods.

Compounding

The process of accumulating interest on an investment over time to earn more interest.

Interest on interest

Interest earned on the reinvestment of previous interest payments.

Compound interest

interest earned on both the initial principal and the interest reinvested from prior periods.

Simple interest

Interest earned only on the original principal amount invested.

Present Value

The current value of future cash flows discounted at the appropriate discount rate

Discount

Calculate the present value of some future amount.

Discount rate

The rate used to calculate the present value of future cash flows.

Discounted cash flow (DCF) valuation

Calculating the present value of a future cash flow to determine its value today.

Annuity

A level stream of cash flows for a fixed period of time.

Effective annual rate (EAR)

The interest rate expressed as if it were compounded once per year.

Annual percentage rate (APR)

The interest rate charged per period multiplied by the number of periods per year.

Ordinary annuity

A series of constant cash flows that arrive or are paid at the end of each period.

Coupons

The stated interest payment made on a bond.

Face/Par value

The principal amount of a bond that is repaid at the end of the term.

Coupon rate

The annual coupon divided by the face value of a bond.

Yield to maturity (YTM)

The rate required in the market on a bond.

Indenture

The written agreement between the corporation and the lender detailing the terms of the debt issue.

Registered form

The form of bond issue in which the registrar of the company records ownership of each bond; payment is made directly to the owner of record.

Bearer form

The form of bond issue in which the bond is issued without record of the owner’s name; payment is made to whomever holds the bond.

Debenture

An unsecured debt, usually with a maturity of 10 years or more.

Note

An unsecured debt, usually with a maturity under 10 years.

Sinking fund

An account managed by the bond trustee for early bond redemption.

Call provision

An agreement giving the corporation the option to repurchase a bond at a specified price prior to maturity.

Call premium

The amount by which the call price exceeds the par value of a bond.

Deferred call provision

A call provision prohibiting the company from redeeming a bond prior to a certain date.

Call-protected bond

A bond that, during a certain period, cannot be redeemed by the issuer.

Protective covenant

A part of the indenture limiting certain actions that might be taken during the term of the loan, usually to protect the lender’s interest.

Zero coupon bonds

A bond that makes no coupon payments and is thus initially priced at a deep discount.

Bid

The price a dealer is willing to pay for a security.

Asked price

The price a dealer is willing to take for a security.

Bid-asked spread

The difference between the bid price and the asked price.

Clean price

The price of a bond net of accrued interest; this is the price that is typically quoted.

Dirty price

The price of a bond including accrued interest, also known as the full or invoice price. This is the price the buyer actually pays.

Real/nominal rates

Interest rates or rates of return that have been adjusted for inflation.

Fisher effect

The relationship between nominal returns, real returns, and inflation.

Term structure of interest rates

The relationship between nominal interest rates on default-free, pure discount securities and time to maturity; that is, the pure time value of money.

Inflation premium

The portion of a nominal interest rate that represents compensation for expected future inflation.

Interest rate risk premium

The compensation investors demand for bearing interest rate risk.

Treasury yield curve

A plot of the yields on Treasury notes and bonds relative to maturity.

Default risk premium

The portion of a nominal interest rate or bond yield that represents compensation for the possibility of default.

Taxability premium

The portion of a nominal interest rate or bond yield that represents compensation for unfavorable tax status.

Liquidity premium

The portion of a nominal interest rate or bond yield that represents compensation for lack of liquidity.

Dividend growth model

A model that determines the current price of a stock as its dividend next period divided by the discount rate less the dividend growth rate.

Dividend yield

A stock’s expected cash dividend divided by its current price.

Capital gains yield

The dividend growth rate, or the rate at which the value of an investment grows.

Common stock

Equity without priority for dividends or in bankruptcy.

Cumulative voting

A procedure in which a shareholder may cast all votes for one member of the board of directors.

Straight voting

A procedure in which a shareholder may cast all votes for each member of the board of directors.

Proxy

A grant of authority by a shareholder allowing another individual to vote his or her shares.

Dividends

Payments by a corporation to shareholders, made in either cash or stock.

Preferred stock

Stock with dividend priority over common stock, normally with a fixed dividend rate, sometimes without voting rights.

Primary market

The market in which new securities are originally sold to investors

Secondary market

The market in which previously issued securities are traded among investors.

Dealer

An agent who buys and sells securities from inventory.

Broker

An agent who arranges security transactions among investors.

Designated market makers (DMM)

NYSE members who act as dealers in particular stocks. Formerly known as “specialists.”

Floor brokers

NYSE members who execute customer buy and sell orders.

Supplemental liquidity providers (SLPs)

Investment firms that are active participants in stocks assigned to them. Their job is to make a one-sided market (i.e., offering to either buy or sell). They trade purely for their own accounts.

Order flow

The flow of customer orders to buy and sell securities.

Over-the-counter (OTC) markets

Securities market in which trading is almost exclusively done through dealers who buy and sell for their own inventories.

Inside quotes

The highest bid quotes and the lowest ask quotes for a security.

Electric communications networks (ECNs)

A website that allows investors to trade directly with each other.