CH19-Long Term Investments Flashcards Preview

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Flashcards in CH19-Long Term Investments Deck (23)
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1
Q

Key issues to consider when determining capital market investment objectives

A
  1. Risk tolerance
  2. Return objectives
  3. Liquidity needs
  4. Time horizons or future funding needs
  5. Tax issues
  6. Asset/liability matching
  7. Legal or regulatory factors
2
Q

What is a bond’s market price?

A

PV of coupon payments + PV of par value

= CF year 1 ÷ (1 + k)1
+ CF year 2 ÷ (1 + k)2
+ CF year 3 ÷ (1 + k)3
+ … + Cn ÷ (1 + k)n

Where:
n=CF year
k = Opportunity cost or required rate of return

3
Q

What is YTM?

A

Yield To Maturity = CFs discounted at market’s required rate of return, which is the interest rate the market is demanding over the remaining life of the bond

4
Q

When a bond pays semiannual coupons, how do you adjust the coupon payments and the required rate of return?

A

Multiply the number of coupon payments by 2.
Divide coupon payment $ amount by 2.
Divide required rate of return by 2.

5
Q

Define YTC and Bond Call Provision

A

Yield To Call. Bond Call Provision=issuer redeem bonds prior to maturity. YTC uses call date instead of maturity date.

6
Q

What is YTW?

A

Yield To Worst = where all the possible YTC values are determined and the lowest of the potential values is the YTW

7
Q

What is the Gordon Growth Model AKA Dividend Discount Model?

A

An absolute or intrinsic valuation model used to Price Common Stock
= Dt(1 + g) ÷ (k – g)
where Dt is current dividend, g is growth rate, and k is market rate

8
Q

Formula for PV of a Stream of Payments

same as valuation of capital market securities
(same as market price of bond–>coupon+par)

A

= CF year 1 ÷ (1 + k)1
+ CF year 2 ÷ (1 + k)2
+ CF year 3 ÷ (1 + k)3
+ … + Cn ÷ (1 + k)n

Where:
n=CF year
k = Opportunity cost or required rate of return

9
Q

ABC is issuing preferred stock at $40.00 par value with dividend rate at 5.5%. What would the price be of the new preferred stock if the market requires 6.5% return?

A

Step 1 = Calc Pref. Stock Dividend
Step 2 = Calc Pref. Stock Price

Annual Preferred Stock Dividend = Preferred Stock Dividend Rate * Par Value

Annual Preferred Stock Dividend = 5.5% * $40 = $2.20

Price of Preferred Stock = Annual Preferred Stock Dividend / Required Rate of Return

Price of Preferred Stock = $2.20 ÷ 6.5% = $33.85

10
Q

When should the Gordon Growth Model be used?

2 conditions

A

When Both:

  1. k>g required return exceeds dividend growth rate
  2. dividend growth rate is expected to be constant in perpetuity
11
Q

T/F: bonds with longer durations are more sensitive to changes in interest rates

A

True

12
Q

4 steps to calculation duration. Duration=bonds’ weighted average time to maturity

A
  1. Calculate the present value of each annual cash flow generated by the bond.
  2. Multiply the values from Step 1 by the year in which the cash flow occurs.
  3. Divide each product from Step 2 by the bond price.
  4. Sum the values from Step 3.
13
Q

formula to Approximate % Change in Bond Price =

A

-Duration X Change in Interest Rate

14
Q

2 Factors that affect bond duration

A
  1. Time to Maturity
    (shorter maturity bonds have less price risk)
  2. Coupon Rate
    (bonds with larger coupon rates have shorter durations and less price risk)
15
Q

What is the duration of a zero-coupon bond?

A

zero-coupon bond’s duration equals maturity of the bond

16
Q

shape of the yield curve

A

convexity
Convexity illustrates the difference between duration and the yield curve is greater for larger changes in interest rates

17
Q

How to calculate Annual Preferred Stock Dividend?

A

Preferred Stock Dividend Rate * Par Value

18
Q

How to calculate Price of Preferred Stock?

A

Annual Preferred Stock Dividend
/
Required Rate of Return

19
Q

How to calculate Price of Common Stock?

A

= Dt(1 + g) ÷ (k – g)

where Dt is current dividend, g is growth rate, and k is market rate

20
Q

What is the primary purpose of Securities Lending?

A

to allow the borrower to hedge or short-sell securities that it does not own, in anticipation of the value of the security Declining

21
Q

What is a good use of standard deviation when determining the risk of an investment in common stock?

A

Helps develop bands around an INDIVIDUAL stock’s expected value

22
Q

Standard deviation =

A
  • average deviation from the expected value.

- measure variability in returns of an INDIVIDUAL stock

23
Q

Steps for determining optimal asset allocation

A
  1. Risk Tolerance
  2. Return Objective
  3. Liquidity needs
  4. company’s approach to short term investments