FIN3403 - Exam 2

Compounding

interest on top of interest… money is growing at that rate (FV)

Discounting

converting a value of an amount into today’s equivalent (PV)

Opportunity cost also is known as

interest rate

N

Total number of payments in the period (Ex. Monthly Payments over 12 years = 144)

As the number of N payments increases FV increases

TRUE (This means they’re positively / directly related)

If the interest rate goes up

PV goes down (They’re inversely / negatively related)

Formula for continuous compounding problems

PV(e^(years)(interest))

Annuity

a sequence of equal cash flows

Ordinary Annuity

DEFAULT / END Button, cash flows due at the end

Annuity due

BEGIN Button, cash flows at the beginning

Mortgage button

PV

Perpetuity

receive a fixed payment every period, FOREVER

Present Value of a Perpetuity Formula

PMT/Interest

Deferred annuity

you don’t start paying at year one (its delayed)

Amortized Loans

loans that are paid off with equal periodic payments

How to find first payment that goes into interest

1 INPUT

? SHIFT

AMMOR

= PRINCIPAL

= INTEREST

= REMAINING BALANCE

How to find effective annual interest rate

N/A Shift P/YR

I/YR

Shift EEF =

Treasuries

RISK FREE Government issued stock and bonds

Risk

possibility that an actual return will differ from our expected return

How to measure risk

standard deviation

Standard Deviation

measure of dispersion of possible outcomes (the greatest the uncertainty & risk = the greater than standard deviation)

Portfolios

combining several insecurities in a portfolio can reduce overall risk (not fully tho)

If the correlation is -1 then

it is inversely related

If the correlation is 1

same direction, positively related

How to diversify your risks

investing in more than one security in a portfolio, or a mutual fund

Market risk (systematic risk)

CANNOT BE DIVERSIFIED

Company-unique risk (unsystematic risk)

CAN BE DIVERSIFIED

Market risk is related to

• Changes in interest rates, tax rates, foreign competition

Unique risk is related to

• Company employees going on strike

• Top managers dying

• natural disaster

Risk premium only applies to

market risk (non diversified risk)

Beta

measure of market risk

Beta = 1

Average risk

Beta is greater than 1

More risky = more risk premium (ex. tech company)

Beta is less than 1

less risky = less risk premium (ex. utilities company)

Capital Asset pricing method

relationship between risk and required return

Capital Asset pricing formula

treasury bond + beta (average return - treasury bond)

If a stock price is above the SML

It is underpriced (GOOD)

If a stock price is below the SML

It is overpriced (BAD)

How to find expected return

add all the values of probability (return)

Standard deviation formula

(return-expected return) ² (probability) = then square root the final answer

The higher the standard deviation the higher the risk

TRUE

Simple return formula

sold for - bought for / bought for

Expected return of a portfolio/beta formula

(weight) (expected rate) + (weight) (expected rate)

What is par value always

1000

What do you do by coupon and par value

Multiply them together and divide by 2 to find PMT

Bond Indenture

A bond indenture is a legal contract between a bond issuer and bondholders. It outlines the rights of the bondholders and the obligations of the issuer. 

Book value

value of an asset as recorded on a balance sheet

Liquidation value

amount that could be received if an asset were sold individually

Market value

what the market is willing to pay, determined by supply and demand

Intrinsic Value

present value of all expected future cash flows

Yield to Maturity

expected rate of return on a bond when held to maturity

Zero Coupon Bond

no coupon interest payments (always sold at discount) (always ANNUAL INSTEAD OF SEMI)

Current Yield

annual PMT / Price (PV)

How to find PV with asked price

asked price / 32

Discount price

value less than 1000

Premium price

value more than 1000