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CORPORATE FINANCE EXAM FULLY SOLVED #13
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CORPORATE FINANCE EXAM FULLY SOLVED #13
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CORPORATE FINANCE EXAM FULLY SOLVED #13Valuation principle - correct answer State that we can use current market prices to
determine the value today of the costs and benefits associated with a decision
Net present value rule - correct answer The main tool of project evaluation where we
weigh the costs and benefits at different points in time and apply this information to
decisions
Time value of money - correct answer The difference in value between money today
and money in the future i.e. Investment
Discount rate - correct answer The risk-free interest-rate
NPV decision rule - correct answer When making an investment decision take the
alternative with the highest NPV. Choosing this alternative is equivalent to receiving it's
NPV in cash today
Accept projects - correct answer With positive NPV
Reject projects - correct answer With negative NPV
Arbitrage - correct answer The practice of buying and selling equivalent goods in
different markets to take advantage of a price difference
Normal market - correct answer A competitive market in which there are no arbitrage
opportunities
Law of one price - correct answer If equivalent investment opportunities trade
simultaneously in different competitive markets they must trade for the same price in all
markets
Financial security - correct answer An investment opportunity that trades in a financial
market
Separation principle - correct answer separate the firms investment decision from its
financing choice
Portfolio - correct answer A collection of securities
Value additivity - correct answer Because security C is equivalent to the portfolio of A
and B, by the law of one price they must have the same price
Stream of cash flows - correct answer A series of $ that last several periods
Timeline - correct answer Represents a stream of cash flows
,Net present value - correct answer Present value of benefits minus the present value of
costs
Perpetuity - correct answer A stream of equal cash flows that occurrs at regular
intervals and lasts forever, such as a British government bond which is called a consol
Annuity - correct answer A stream of equal cash flows paid at regular intervals that ends
after a fixed number of payments
Internal rate of return (IRR) - correct answer The interest rate that sets the net present
value of the cash flows equal to zero, the interest rate that equates the present value
and cash flow's of an investment opportunity
Compound annual growth rate (CAGR) - correct answer When looking at an investment
and converting it to an equivalent one year return so they can compare just two cash
flows but assuming that the amount compounds at regular intervals
Effective annual rate (EAR) - correct answer Indicates the actual amount of interest that
will be earned at the end of one year
Annual percentage rate (APR) - correct answer Indicates the amount of simple interest
earned in one year without the effect of compounding - usually less than what you will
actually earn
Continuous compounding - correct answer Compound the interest every instant
Amortizing loans - correct answer Each month you pay interest on the loan plus some of
the loan balance
Adjustable rate mortgage (ARM) - correct answer Interest rates that are not constant
over the life of the loan which results in recalculations based on the laws, current
outstanding balance, the new interest-rate, and the remaining life of the loan
Nominal interest rate - correct answer Interest rates that are quoted by financial
institutions which indicate the rate at which money will grow if invested for a certain time
period
Real interest rate - correct answer The rate of growth of your purchasing power after
adjusting for inflation is determined by this rate
Term structure - correct answer Regarding interest rates, the relationship between the
investment term and the interest-rate
Yield curve - correct answer Used to plot on a graph, the term structure which
corresponds the rate with the amount of time
, Federal funds rate - correct answer The rate at which banks can borrow cash reserves
on an overnight basis which is determined by the Federal Reserve
After-tax interest-rate - correct answer The reduced amount of interest the investor can
keep
Opportunity cost of capital - correct answer The best available expected return offered
in the market on an investment of comparable risk and term to the cash flow being
discounted
Mid year convention - correct answer Pretend that all cash flows for the year arrive in
the middle of the year
Bond certificate - correct answer Describes the terms of the bond including amounts
and dates of all payments to be made
Maturity date - correct answer The final repayment date of the bond
Coupon - correct answer The promised interest payments of a bond
Face value - correct answer The nominal amount used to compute the interest
payments also known as the principal
Zero coupon bond - correct answer Does not make coupon payment instead pays out
the face value on the maturity date, which always trades at a discount and are also
known as pure discount bonds
Yield to maturity (YTM) - correct answer The IRR of an investment in a bond which
basically is the discount rate that sets the present value of the promised bond payments
equal to the current market price of the bond
Spot interest-rate's - correct answer Default free zero coupon yield to maturity
Treasury bills - correct answer US government bonds with a maturity of up to one year
which are zero coupon bond
Zero coupon yield curve - correct answer Risk-free interest-rate for different maturities
Coupon bonds - correct answer Face value is paid at maturity but in addition to these
bonds make regular coupon interest payments
Treasury notes - correct answer A coupon security currently traded in financial markets
with maturity from 1 to 10 years
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