Finance 3 Flashcards

Terms Definitions
Profit Margin
Net income/Sales
Return relative
1+(holding period return)
elctronically traded fund-can be traded anytime
(Limited Liability Company)= operate and to be taxed like a partnership but retain limited liability for its owners
borrower's interest rate fluxuates according to some index of interest rates based on rising or falling cost of credit in the economy, borrower assumes risk of interest rate changes, usually 1-3% points below fixed, have interest rate and payment caps
Degree of Total Leverage
the arithmetic process of determining the final value of a cash flow or series of cash flows when compound interest is applied
Anything that incurs a legal detriment or the forgoing of a legal benefit (i.e., you’ve got to give something to get something).
Monetary asset
liquid assetcash, checking, savings, money market funds
Capital Expenditure (PPE) = the difference of expenses of PPE from one year to the next.
• Uses of and limitations to ratio analysis
this is accomplished when the holder discontinues use, states his or her intention to do so or acts in a manner consistent with discontinued use
Free Cash Flow(EBT(1-T) + Dep and Amort) - (Capital expenditures + change in NOWC
Capital markets
where securities with maturities of more than a year (stocks and medium-to-long-term debt instruments) are traded
measures the degree to which the movements of variables are related, measured on a scale of -1.0 to +1.0
Usually through the local zoning authority (via public hearings); can often be quite controversial.
Legislative Relief
basis points
smallest measure used in quoting yeilds on bonds and notes. one basis pt is .01% of yield
three rating agencies
1. Moody's Investors Services
2. Standard & Poor's Corp
3. Fitch Ratings Ltd.
-specialize in rating the default risk and credit worthiness of a bond issue
-assign a bond rating AAA the highest with a very remote chance of default down to CCC the lowest, currently in default
the simultaneous purchase and sale of the same securities, commodities, or foreign exchange in different markets to profit from unequal prices
passive investment strategy
buy well- diversified portfolio w/out trying to find mispriced securities
Using the info from Question 10, and assuming all variables remain constnat over the next 25 years, what will your 401k fund value be in 25 yrs (wehn you expect to retire?
in conveyancing, the act by which a person who has executed an instrument, before an authorized officer, usually a notary, declares that the instrument is genuine and executed volunatarily
Motives of M&A

Operating Synergy: obtains if the merger results in imporvements in management, labor costs, production or distribution, resource acquisition and allocation, market power. [current stock price = current operating value + (expected takeover premium)*(takeover probability)]

Financial Synergy: obtains if the financial structure of the merged firm causes its market equity value to be greater than the sum of the market equity values of the separate firms.  In an ideal world, there should be none because capital structure is irrelevant and investor can just buy both stocks on own.  However, the diversification effect may increase debt capacity and brings tax benefits - increase leverage so that benefit doesn't just go to creditors - lesss risky, lower distress costs.

Bankruptcy avoidance for target: agree to be acuired to avoid deadweight costs of bankruptcy- results in restructure
Internal Capital Markets or Financial Slack: a cash-poor firm with substantial profitable investment opportunities faces the difficult choice of raising funds in external market or passing up profitable investments (pecking order).  REsolve problem by merging with cash-rich, investment-poor firm.
Hubris hypothesis: bidder's management overvalues the target because they overestimate their ability to create value.
Mitigating Management self-interest: (agency theory) mangaement of cash-rich, investment poor firm has incentive to overinvest in unprofitable investments.  Merging mitigates risk.
Taxes: if have tax benefis but not enough earnings to enjoy benefits
real world cosiderations
Stock repurchase allows investors to decide if they want the current cash flow and associated tax consequencesIn our current tax structure, repurchases may be more desirable due to the options provided stockholdersThe IRS recognizes this and will not allow a stock repurchase for the sole purpose of allowing investors to avoid taxes
what is stock?
stock is:the original capital paid into or invested in the business by its founders.
expenses that are the exact amount everytime
Power to regulate use of private property to protect public health, safety, morals, and general welfare.Land uses are interdependent, meaning that the way one property is used affects other nearby properties.
Police Power
a scheme that involves dividing one's portfolio into various asset classes to preserve capital by protecting against negative developments while taking advantage of positive ones
asset allocation
Value of security shown in the company's accounts.
Par Value
systematic risk
market related risk as measured by Beta
risk that CAN NOT be diversified away
risk you ARE PAID to take
numbered account
a bank account whose owner is identified by a number for the purpose of preserving anonymity
raw land
-larger area that does not include any improvements
-distinction vs. land important when value of land considered
one who owns a life estate cannot
devise one's interest
The third line of an income statement that represents the difference between a firm's sales revenues and its costs.
Intentional interference with a contract
knowingly and successfully taking action for the purpose of enticing a third party to breach a valid contract with the plaintiff
class life
The specified life of assets under the MACRS system.
Financial Instrument
a particular type of debt or equity that a company issues to the public to raise money. (Commercial Banks, Pension funds, mutual funds, insurance companies)
Net Absorption
the amount of space rented to tenants or sold to buyers after taking into considering space vacate by tenants or owners
Non-Navigable Bodies of Water
1) Riparian rights doctrine2) Prior appropriation doctrine
mortgage- backed bond whose holders are divided into classes based on the length of investment desired; principal is channeled to investors in order of maturity, with short-term classes first
collateralized mortgage obligation (CMO)
Difference between issue price and par value of stock. Also called capital surplus.
Additional Paid-In Capital
A level stream of cash flows for a fixed period of time. It's like a perpetuity, but it stops. PVo = (CF1/r) x [1-1/(1+r)^t]
a draft on the drawer or endorsers of a protested bill of exchange for the amount of the bill plus the costs and charges
economic & environmental impact statements
analyze the project's effect on surrounding areas
Littoral lands
lands that border on an ocean, a sea, or a lake
Statement of cash flows
reports the impact of a firms activites on cash flows over a given period of time
Senior (secured) bonds
the most senior bonds in a firms capital structure. They have the first claim on specific assets of the firm in case of bankruptcy.
Diff. between compound interest, simple interest, annual, interest on interest.
CI=interest earned on both the initial principal and the interest reinvested from prior periodsSI=Interest earned only on the original principal amount investedIonI=Interest earned on the reinvestment of previous interest paymentsAI=Every year
the return a fully taxable bond would have to provide to match the after-tax return of a lower-yielding, tax-free municipal bond
taxable equivalent yield
full payment not required when services are rendered (utility co.)
#1Credit Card Aspects: Teaser Rates
invoice price/seller's cost
reflects the price the dealer has been billed from the manufacturer
ROE = Profit Margin x Asset Turnover x Equity Multiplier
expected return on a portfolio
The weighted average of the expected returns on the assets held in the portfolio. (r^(p)
Steps for Percent-of-sales forecasting method

(step 3)
For the remaining balance sheet items, use common sense and estimate what each item will be
the Required Rate of Return
r=(CF1/PVo) + g, where CF1= Next period's dividend, PVo= the current price, r= total return, g= capital gains yield, & (CF1/PVo)=the income portion, or the dividend yield
What are the advantages of using exchange-traded derivatives to hedge a risk exposure? What are the advantages of over-the-counter derivatives?
Exchange traded derivatives are useful in that they can hedge a risk exposure, they are very liquid, regulated to prevent abuses and easily marketable. Over the counter derivatives are contracts that protect against adverse movements and also provide huge upside potential and can be used to generate income if the holder of the option sells the option rather than exercises it.  
Risk- Adjusted Cost of Capital
the cost of capital appropriate for a given project, given the riskiness of that project. the greater the risk, the higher the cost of captial
the concept of time value of money is important to financial decision making because
all of the above!
Price Behavior around the Ex-Dividend Date
In a perfect world, the stock price will fall by the amount of the dividend per share on the ex-dividend date (net nominal price drop)

Taxes: DPS is greater than the price drop because of taxes on dividends.  In anticipation of the upcoming dividends(which incurs higher taxes), the current price is already discounted to reflect the fact that some firm value will flow to the government.
How to estimate the dividend growth rate
(1) Look up historical growth rates. not the safest way (2) Look at analyst's forecasts. This is forward looking, but it could be an issue if they disagree (3) Using the Sustainable Growth Rate
What are the stages of the registration process with the SEC?
1. Pre-filing.  No offers to buy or sell shares or securites during this stage.
2. Waiting Period.  Oral offers are allowed but, not a final sale.  "Red Herring" > contains all info except the price.
3.  Post - Effective Period.  Usually 20 days.  Sale of shares may take place after the 20 days or upon commion approval, whichever is first.
what is the definition of a wicked person?
one who lives his life without regard to God
t-bills are...
short term
A long-term debt instrument
analysis of variance
Bid-Rent Curve
theoretical relationship between distance and land rent; refers to the maximum rent that a potential real estate space user would be willing to pay, or “bid”, for a specified location
a tip, present, or gratuity.
Calculate the annual cash flows (annuity payments) from a fixed-payment annuity if the present value of the 20-year annuity is $1 million and the annuity earns a guaranteed annual return of 10 percent. The payments are to begin at the end of five years.
Operating Capital
NOWC + Net fixed Assets
subchapter S
75>domestic stockholders avoid double taxatoin o earnings and paying taxes similar to partnerships limited liability
itemized deductions
deductions calculated using Schedule A. allowable deductions are added up and subtracted from taxable income
Income Statement
= Gross Income
- Operating Expenses
= EBITDA (Earnings Before Interest Taxes Depreciation Amortization)
- Depreciation and Amortization
- Interest and Taxes
=Net Income
Moral Hazard
- a loss from dishonest angents
A published opinion of an appellate court that serves as authority for determining a legal question in a later case that has substantially similar facts
Prepaid interest charged by a lending institution for the mortgage; each discount point is equal to 1 percent of the loan amount
Common stock
an equity investment that represent ownership of a firm with full participation in its success or failure. The firm’s directors must improve dividend payments
strike price
also known as exercise price, predetermined
An ownership interest in real property that normally ends upon the death of a named person.
Life Estate
What type of project accept all profitable projects out of the entire population?
operating profit margin
founders' shares
shares of stock given for consideration to the original subscribers of a corporation carrying special voting privileges
expectational data (return)
historical data (return)
expected return = sum of (probability(i) * rate(i))
annualized return = ins/outs * 360/holding period
• Trend analysis
o an analysis of a firm’s financial ratios over timeo used to determine improvement or deterioration in its financial situation
A document where the holder of an easement appurtenant or in gross may extinguish it by means of a written agreement to give up the right
wats an intestate?
without a valid will.or (i.e. testator) refers to a malerix (i.e. testatrix) refers to a female
Foreign Bonds
Bonds issued by foreign governments or by foreign corporations
stock dividends
new shares of stock distributed to existing stock holders as a supplement to or substitute for cash dividends
the actual dollar cost of using credit, which is calculated by the lender
Property leased to those who will live on the property.
Residential Lease
asset allocation plan in which weights for each asset category are adjusted periodically based on market analysis
flexible-weightings approach
Restriction on a firm to protect bondholders.
Protective Covenant
strong form efficiency
stock prices reflect all info, including info not available to the investment community
discount rate
the rate of interest charged in discounting commercial paper, the interest rate charged by Federal Reserve Banks on loans to their member banks
a state in which the volatility of a security changes at a low rate; shown on distribution curve w/ fat tails- (black swan: statistically unlikely to happen, but it does) unusual returns and unexpected stock prices
Effective Annual Rate
the annual rate of interest actually being earned
A business owned and run by one person.
Straightforward to set up.
No separation between the firm and the owner.
The owner has unlimited personal libaility for any of the firm's debts.
The life of a sole proprietorship is limited to the life of the owner.
Invasion of privacy
a privacy tort that consists of encroaching on the solitude, seclusion, or personal affairs of someone who has the right to expect privacy
mortgage bond
A bond backed by fixed assets. First mortgage bonds are senior in priority to claims of second mortgage bonds.
Money markets
where securities that mature in a year or less (short-term debt instruments) are traded
Multiple-Nuclei Model
a model of urban growth patterns that emphasizes more than one center of commercial activity
Where one party makes a promise that persuades another party to act (“a promise for an act”).
Unilateral Contract
the simplest kind of chart, on which share price is plotted on the vertical axis and time on the horizontal axis; stock prices are recorded as vertical bars showing high, low, and closing prices.
bar chart
Maximum number of shares that the company is permitted to issue.
Authirized Share Capital
rate of return
(Cash payment + change in price)/price paid
yield to maturity
a percentage that accounts for the difference in the interest on a bond based on current market value and that earned if the bond is held to maturity
improvements to the land
-components necessary to make the land suitable for building construction/other uses
-referred to as infrastructure: streets, walkways, storm H2O drainage systems, H2O, sewer, electric, telephone utilities
What are risk-based capital standards? What are they designed to do?
As capital requirements have increased, regulators have also implemented risk-based capital standards. Capital is measured against risk-weighted assets. Risk-weighting is a measure of total assets that weighs high-risk assets more heavily. The purpose is to require high-risk banks to hold more capital than low-risk banks.
Annual Percentage Rate (APR)
The percentage cost (or relative cost) of credit on a yearly basis. The APR yilds a true rate of interest for comparison with other sources of credit
Private placement
A new issue sold directly to a small group of investors, usually institutions.
Neighborhood Center (Convenience Center)
a shopping center intended to serve customers from a specific geographic area (1.5 mile radius, 2500-40,000 people); supermarket

Functional Def. and Formula
(Economic Value Added) = Measures the amount of Market Value Added that is assessed in one year.

EVA= Nopat - Capital supplied for Nopat
How to finance a project
Corporate Finance.1. Sell equity. - Stock.2. Borrow the money. - Sell debt securities. - Bonds3. Retain earnings. - Keep past profits to finance expansion.
billing date
last day of the month for which any transactions are reported on the statement
PV (annuity) = C/r (1-1/(1 + r)n)
incremental cash flow
A cash flow that will occur if and only if the firm takes on a project.
Four Basic Powers of Government Over Real Estate
1) Taxation2) Escheat3) Eminent Domain4) Police Power
Discuss the advantages and disadvantages of traditional financial ratio analysis
the advantages are that the financial ratios are easy to calculate, simple, readily available and appears on companys financial statements. They are widely used and good for companies for industry averages. They are good indicators, predict banckruptcy and evaluate credit scoring and good for predictions in the current year. The disadvantages are that even though they are simple, it doesn't describe reality very well, it allows distortions. Its not descriptive but prescreptive. It states what wrongs but does not tell how to fix it. Borroweres usually have to pay immediately, plus they are book value not market.
What are the major differences between large banks and small banks on the income statement? Why are there differences between the two groups of banks? For example, why is the net interest income higher for small banks?
The major differences between large banks and small banks on the income statement is that small banks holder a higher proportion of investment securities and loans than large banks. Large banks hold a higher proportion of assets held in trading accounts, federal funds sold and repurchased, trading account gains and fees and other noninterest income. The differences can be attributed to differences in lending practices of large and small banks. The interest income is higher for small banks than large banks because they have more investment securities which are more important to small banks than large banks as large banks generate a larger proportion of income from non-interest activities.
(A) Small banks’ interest and fee income on loans is GREATER than large banks because the differences can be attributed to differences in the lending practices of large and small banks. Recall from chapter 13 that small banks tend to make more real estate and agricultural loans, whereas large banks tend to make more commercial and industrial loans. (B) The interest earned on investment securities is higher and more important for small banks than large banks because small banks hold proportionally more investment securities. Small banks pay more interest on their deposits than large banks because of their greater reliance on deposits as a source of funds. Large banks pay more than small banks for federal funds purchased and securities sold under repurchase agreements as well as other borrowed money. Small banks tend to earn greater net interest income as a percentage of assets than large banks because small banks generate more interest income.
Revlon vs. Pantry Pride 1986
If target directors decide to pursue a sale of their company (ie. change in corporate control), then they must attempt to maximize shareholder value, and may not take defensive steps to thwart hostile bidders
Dilution of earnings occurs because
a new issue of common stock creates more shares outstanding which reduces earnings per share temporarily(A)
Why are bank failures considered to be so undesirable that the government should try to prevent them?
Unlike other business failures, bank failures reduce the money supply and disrupt the financing of a variety of other business activities.  Bank failures also tend to be contagious if liquidity is not promptly and decisively injected into troubled institutions to restore the confidence of the depositing public.
1. Character - will u repay loan?2. Capacity - ability to repay?3. Capital - assets + net worth?4. Collateral5. Conditions - eco cond + job security
What is the credit score range?
Why is payout policy irrelevant for a firm's value in an ideal world and what are the assumptions and intuition behind it?
Payout policies are irrelevant in an ideal world, but becomes relevant when considering real-world factors such as principal-agent problem, info asymmetry, and taxes/transaction costs.
Dividend policy is irrelevant as long as the firm's capital investments and debt policy are fixed.  Dividend payments are simply financed over time by a combination of excess retained earnings and, as neccesary, new equity.
Intuitions: size of the pizza is the same since investment plan is fixed, debtholders' share of pizza is the same since debt policy is fixed, shareholders' share of pizza does not depend when they eat it
Why do you think bankers prefer to use higher leverage than regulators would like them to?
Solution:  Like any other firm, banks understand the role of leverage in increasing ROE.  Bank managers believe that long-term profit maximization can best be achieved if their banks are highly leveraged.  Regulators are more concerned about the risk of bank failures in general than the profits of an individual bank. Their overriding concern is protecting the economy from widespread bank distress.
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