Finance Glossary

Symbol	Term
$r$	Interest rate
$PV$	Present value
$FV$	Future value
$C$	Cash flow
$n$	Number of periods

Time Value of Money

Future value of a cash flow:

$$F{V}_n=C\times (1+r{)}^n$$

Present value of a cash flow:

$$PV=\frac{C}{(1+r{)}^n}$$

Interest Rate vs. Discount Rate vs. Cost of Capital

• “Interest rate” is used to mean a quoted rate in the market.
• “Discount rate” is the appropriate rate for discounting a given cash flow, matched to the frequency of the cash flow.
• “Cost of capital” to indicate the rate of return on an investment of similar risk.

Chapter 6 - Bonds

Bond Calculation Questions

• Use coupon rate to calculate PMT:

$$\text{PMT}=\frac{\text{Coupon Rate}\times \text{Par Value}}{\text{\# of payments per year}}$$

• Make sure to multiply $N$ by number of payments per year
• I/Y is yield to maturity divided by number of payments per year
• FV is par value
• PV is price paid

Premium/Par/Discount

• Premium/Above par: Bond price > Face Value, or Coupon rate > YTM
• At par: Bond value = Face Value, or Coupon Rate = YTM
• Discount/Below par: Bond price < Face Value, or Coupon Rate < YTM

Sensitivity

Longer maturity = sensitive Low coupon = sensitive

• Why is low/no coupon sensitive? A larger portion of the cash flows to be received in the future will result in larger changes due to compounding

Market rate rises → Price falls → YTM rises to match market Market rate falls → Price rises → YTM falls to match market

Credit Spread

Credit spread = Bond yield - treasury yield

Chapter 7 - Stock

• Reinvsting earnings: $g=\text{Retention rate}\times \text{Return on enw investments}$

Chapter 9 - Capital Budgeting

• Free cash flows = Earnings + Depreciation - Capital Expenditures - Change in NWC
  • Earnings here is incremental earnings or unlevered net income
• Net working capital (NWC) = Current Assets - Current Liabilities

Incremental earnings approach:

$$\begin{array}{rl}\text{Incremental FCF}& =(\text{Revenues}-\text{Costs}-\text{Depreciation})(1-t_c)\\ & +\text{ Depreciation}\\ & -\text{ Net Capital Expenditures}\\ & -\Delta \text{NWC}\end{array}$$

Tax shield approach:

$$\begin{array}{rl}\text{Incremental FCF}& =(\text{Revenues}-\text{Costs})(1-t_c)\\ & +t_c\times \text{Depreciation}\\ & -\text{ Net Capital Expenditures}\\ & -\Delta \text{NWC}\end{array}$$

After-tax cash flow from asset sale:

$$\text{Sale Price}-(t_c)\times (\text{Capital gain/loss})$$

where capital gain/loss is sale price - salvage value.

• Savage value = purchase price - accumulated depreciation

Chapter 12 Systematic Risk

Beta

• Beta ($\beta$) is the is the expected percentage change in the return of a security for a 1% change in the market’s return. -Beta for HP = 1.4, Market excess return was -2.5 → HP excess return was $1.4\cdot -2.5=-3.5$

• Excess return = Return - Market portfolio return

SML

• $y$-intercept = risk-free rate
• $m$ = market risk premium
• above SML → underpriced (we should buy)
• below SML → overpriced (we should sell)