Topic Questions

Bond Valuation

Cash flows: coupon payment, par value and call price, for annual and semi-annual bonds

Who pays whom what?

Calculate value at various market rates, for annual and semi-annual bonds

Par, premium, discount

PV of interest differentials

Interest rate risk (price risk) v. reinvestment rate risk (income risk)

Calculate value at various dates (till maturity), for annual and semi-annual bonds

Price-yield relationships

Calculate yield to maturity, current yield, capital gains yield, yield to call for annual and semiannual bonds

Interest Rates Interest rate model ("layer-cake"): risk-free rate + risk premium

Determinants of real risk-free rate, nominal risk-free rate (Fisher Effect)

Determinants of risk premium (spread): default risk, (il)liquidity, maturity

Term structure/yield curve

Theories: market segmentation, pure expectations, liquidity preference

Forecasting interest rates

Stock Valuation

Distinguish common and preferred stock

What are common shareholders actually buying?

"Constant" dividend growth (Gordon) model : assumptions, applicability

 For constant (positive, zero, negative) growth common stock, calculate value of share and expected dividend yield, capital gains yield and total return

For non-constant growth common stock, calculate value of share today

Preferred stock: calculate value, expected return

Equilibrium: What conditions must hold? What happens if they do not?

Cost of Capital

Role of Weighted Average Cost of Capital (WACC)/Marginal Cost of Capital (MCC): investor's required returns => firm's cost => minimum acceptable return on new investment

MCC is supply curve of new capital

Target capital structure: meaning

Calculate component costs: debt (after-tax), preferred, common (retained earnings & new shares)

Calculate breakpoint(s)

Calculate WACC(s)

Limitations: "other things unchanged," particularly risk