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Questions and Answers
A bond can be considered attractive to investors if its stated interest rate is lower than the market expectations.
A bond can be considered attractive to investors if its stated interest rate is lower than the market expectations.
False
The realized return on a bond typically aligns with the expected return for fixed income securities.
The realized return on a bond typically aligns with the expected return for fixed income securities.
True
A bond's market price is always higher than its face value when issued at a premium.
A bond's market price is always higher than its face value when issued at a premium.
True
The bond discount reflects the difference between the face value and the market price when the price is above the face value.
The bond discount reflects the difference between the face value and the market price when the price is above the face value.
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A long-term debt obligation typically matures in a period spanning over 20 years.
A long-term debt obligation typically matures in a period spanning over 20 years.
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The bond discount rate is the interest used to price bonds during present valuation calculations.
The bond discount rate is the interest used to price bonds during present valuation calculations.
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Long-term debts are often utilized to acquire capital assets like vehicles and machinery.
Long-term debts are often utilized to acquire capital assets like vehicles and machinery.
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The expected return of a bond can differ from its realized return under normal circumstances.
The expected return of a bond can differ from its realized return under normal circumstances.
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Equity financing involves borrowing money that must be repaid with interest.
Equity financing involves borrowing money that must be repaid with interest.
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One disadvantage of equity financing is the dilution of ownership and operational control.
One disadvantage of equity financing is the dilution of ownership and operational control.
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Debt financing provides access to business contacts and management expertise.
Debt financing provides access to business contacts and management expertise.
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Warrants are typically included in offerings of equity units as part of the investment.
Warrants are typically included in offerings of equity units as part of the investment.
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The major sources of equity financing do not include crowdfunding.
The major sources of equity financing do not include crowdfunding.
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Positive shareholders' equity indicates a company's liabilities exceed its assets.
Positive shareholders' equity indicates a company's liabilities exceed its assets.
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Retained earnings are included as a component of shareholders' equity.
Retained earnings are included as a component of shareholders' equity.
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A primary characteristic of debt financing is a lack of repayment obligation.
A primary characteristic of debt financing is a lack of repayment obligation.
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Venture capitalists generally seek slow-growing businesses with low market potential.
Venture capitalists generally seek slow-growing businesses with low market potential.
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Equity financing can come from public offerings or personal connections like friends and family.
Equity financing can come from public offerings or personal connections like friends and family.
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A startup typically requires only one round of equity financing during its development.
A startup typically requires only one round of equity financing during its development.
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Investors in IPOs typically expect more control over the company compared to venture capitalists.
Investors in IPOs typically expect more control over the company compared to venture capitalists.
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The initial public offering (IPO) is considered a later stage of development for a company.
The initial public offering (IPO) is considered a later stage of development for a company.
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Convertible preferred stock is an example of a debt instrument used in equity financing.
Convertible preferred stock is an example of a debt instrument used in equity financing.
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A rights offering is a type of equity financing option available after an IPO.
A rights offering is a type of equity financing option available after an IPO.
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Professional investors typically provide insights and connections to help businesses grow.
Professional investors typically provide insights and connections to help businesses grow.
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Study Notes
Time Value of Money
- Money today is worth more than the same amount in the future, due to potential earning capacity.
- An insurance company may accept lower premiums today knowing the future value of the money can be reinvested with interest.
- Time value of money is fundamental to financial planning.
Future Value
- Future value (FV) is the worth of an asset or investment at a certain future date, taking into account the expected return.
- Simple interest future value calculations are based on the formula: FV = PV + (PV x r x n).
- Future Value is critical in making informed decisions about investments and savings.
Future Value of Annuity
- Annuity is a fixed sum of money paid or received regularly.
- Annuities involve present-day deposits for future payments.
- Annuity value increases over time due to compounding interest.
Present Value
- Present value (PV) is the current worth of a future sum of money. Calculating PV involves discounting future cash flows.
- The present value of an annuity is the current value of future payments.
- Higher discount rates result in lower present values.
- Present Value calculations help in financial and investment decisions.
Factors Affecting Present Value
- Interest rates: Higher rates decrease present value.
- Payment amount and frequency: Higher payments and more frequent payments raise present value.
- Time to maturity: Longer time periods increase present value.
- Inflation: Inflation erodes the future value of an annuity.
Risk of Investment
- Risk exposure is the potential for uncertain outcomes, either positive or negative.
- Systematic risk (uncontrollable risk): is uncontrollable risk stemming from forces beyond the firm's control; e.g. country risk, currency risk, inflation risk.
- Unsystematic risk (controllable risk): Risks that can be controlled; e.g. principal risk, liquidity risk.
- Investors prefer higher returns (risk premium) for riskier assets in order to motivate them to take on the riskier investment.
Measuring Risk
- Alpha (α): Investment performance exceeding market expectations.
- Beta (β): relative volatility of an asset compared to the overall market. A beta greater than 1 indicates higher risk.
- R-squared (R²): proportion of a fund's variation that's due to variation in the benchmark.
- Sharpe ratio: Measures return in relation to risk.
- Standard Deviation: Measures price fluctuations from the average return.
Calculating Required Rate of Return (RRR)
- Required rate of return (RRR): Minimum return needed for investment or projects.
- Calculated using the dividend discount model (DDM) or capital asset pricing model (CAPM): factors in risk tolerance.
- RRR above cost of capital is suitable.
Debt Financing
- Long-term financing where the company borrows money to finance assets.
- Mortgages & bonds are sources.
- Bonds have maturity dates and pay interest.
Equity Financing
- Sale of company shares as a source of capital.
- Provides ownership rights and potential dividends.
- Share issuance (e.g., IPOs) is a popular method.
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Description
This quiz explores the essential concepts of the time value of money, including future value and present value calculations. Understand the importance of annuities and how compounding interest affects investment decisions. Test your knowledge on financial planning and the impact of time on money's value.
