TVM
Why is a dollar today worth more than a dollar tomorrow?
Compound interest, Default Risk, Inflation
What securities are traded in financial markets?
Equities, Fixed Income, Derivatives
What is the main financial goal of a company?
Increase shareholder value (i.e. share price appreciation)
Explain diversification.
Combining stocks that are not perfectly positively correlated to reduce portfolio risk
What are the 3 main financial statements?
Balance Sheet, Income Statement, and the Statement of Cash Flows
What are the 5 major components of TVM?
PV, FV, I, N, and PMT
What are the two largest US exchanges?
NYSE and Nasdaq
What is capital budgeting?
The analysis of potential additions to FA; long-term decisions that involve large expenditures
Define risk and its role in finance
Risk - the chance that some unfavorable event will occur
Risk in finance - high risk, high reward; investors need to be compensated for taking on higher risk
What is the P/E ratio?
A market value ratio that tells us what investors think about the firm and its future prospects; higher P/E = higher value (or overvaluation)
Differentiate compounding vs discounting
Compounding: PV to FV
Discounting: FV to PV
What are some features or characteristics of common stock?
Voting rights, dividends, riskier than bonds, hedge against inflation
Define sunk costs and opportunity costs
Sunk costs - expenses that have been incurred and cannot be recovered
Opportunity costs - alternative investment returns that the firm could earn
Explain risk aversion
Investors do not like risk and need to be incentivized to take on more risk
What is the most important variable used in forecasting?
Sales
Explain the Rule of 72
Used to estimate the number of years required to double the invested money at a given annual rate of return
Explain intrinsic value of stocks
estimated "true" value
NPV - PV of discounted future CFs
IRR - discount rate that makes NPV=0; outflow=inflows
What is the risk measure used in the CAPM?
Beta
Explain the Efficient Market Hypothesis (EMH)
Securities are rarely, if ever, substantially mispriced in the marketplace.
No security analysis is capable of consistently finding mispriced securities more frequently than might be expected by random chance.
If APY is 12% and interest is compounded quarterly, is the EAR greater than, less than, or equal to 12%?
Greater
What are some features or characteristics of fixed income?
Less risky than equities, have fixed coupon payments, annuity plus final pmt, traded in OTC markets, debt obligation
Explain agency costs.
Conflict between managers and shareholders or debtholders and shareholders that reduce shareholder value
What is the beta of the market? What are some examples of market risk?
One
Supply & demand, wars or geopolitical conflicts, government fiscal or monetary policies, natural disasters, (de)regulation, inflation/deflation, technological changes
Describe the steps of the DCF model
1. Find dividends/FCFs in future years
2. Find horizon/terminal value at terminal year
3. Find NPV: intrinsic stock price today