<<

. 39
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(b) Why can EBITDA be a very “incomplete” and therefore often worse number than EBIT for valuation purposes?
Can you modify EBITDA to be better?



Q C.10 Compare two equal underlying ¬rms (projects). One, however, is levered. Which one has the higher P/E ratio?
Do you have to assume a risk-averse world, or will your analysis also hold just the same in a risk-neutral world?



Q C.11 If you believe that the underlying growth rate of GDP of 5% nominal (2.0% real) is also applicable to the
earnings of ¬rms in the stock market forever, and if the P/E ratio of the stock market is 20 (as it is in December 2004),
then what do you expect to be an appropriate expected rate of return on the stock market?



Q C.12 If the interest rate is 12% per annum, what is the rental equivalent of a machine that costs $50,000 upfront,
$2,000 per year in maintenance, and lasts for 10 years?




3·2. A Sample Final

Students were told that the ¬nal was 160 minutes for 24 questions. The number of points was provided for each
questions, and is noted at the beginning of each question.


Q C.13 (4p) Market Perfection Questions:

(a) What are the four conditions that make a market “perfect”?
(b) What kind of ambiguity happens if the market is not perfect? (You do not need to spell it out for each reason
why the market can be imperfect. You need to tell us what breaks generally.)



Q C.14 (12p) The following are all possible future outcomes, all equally likely:


Rate of Returns on
T-bond Market Project A Project B
Bad 5% “5% “10% $800
Medium 5% +10% “5% $1,000
Good 5% +25% +90% $15,000

(a) What are the risks and rewards of the projects in the ¬rst three data columns?
(b) What is the risk and reward of an investment of 20% in A and 80% in the market?
(c) What is correlation between project A and the market?
(d) What is the market beta of project A?
(e) If the CAPM (almost) held, is project A overpriced or underpriced?
(f) What is a fair price of project B if the CAPM holds?
(g) What are the rates of return for project B?



Q C.15 (3p) If the average rate of return in the market had a standard deviation of about 20% per year, then what
was its monthly standard deviation?



Q C.16 (4p) What is the de¬nition of an arbitrage opportunity? How does it di¬er from a great bet?



Q C.17 (2p) If the stock market is e¬cient, what kind of advantages does this carry for corporations?



Q C.18 (3p) Evaluate: If the market is e¬cient, all goods are fairly priced. Therefore, there are no gains to trade.
¬le=exam-sample.tex: LP
806 Chapter C. Sample Exams.

Q C.19 (4p) What are the two main kinds of owner rights for debt and equity?



Q C.20 (3p) Evaluate each in the context of an example that you make up.

(a) If a ¬rm increases its leverage, its cost of debt will generally increase (or at least not decrease).
(b) If a ¬rm increases its leverage, its cost of equity will generally increase (or at least not decrease).
(c) If a ¬rm increases its leverage, its cost of capital will generally increase (or at least not decrease).



Q C.21 (4p) What do the two M&M propositions say?



Q C.22 (6p) Name three deeper reasons that favor debt over equity as a value-maximizing claim. (In other words,
saying debt is cheaper than equity is not deep enough a reason.)



Q C.23 (6p) Name three deeper reasons that favor equity over debt as a value-maximizing claim.



Q C.24 (10p) A ¬rm consists of the following:


This Year, Value Next Year, expected
Revenues = $230

Cost = $200
=
Debt Today $100
Interest = $10
=
Equity Today $100
Taxes = $5
Net Income = $15



The cost is covered by the ¬nancing that debt and equity are providing.
If everything is fairly priced:

(a) What is the expected rate of return on equity?
(b) What is the expected rate of return on debt?
(c) What is the tax rate?
(d) What is the WACC?
(e) What is the total net payout to debt and equity investors?
(f) Using the WACC method, what is the project value?



Q C.25 (3p) From a pure tax perspective, what sort of clientele would you expect would be attracted by cash cow ¬rms,
and how would they do this?



Q C.26 (5p) Capital Structure Dynamics:

(a) What seems to be the main determinant in ¬rms™ debt-equity ratios?
(b) When do ¬rms typically issue public seasoned equity?
(c) As far as capital structure is concerned, is long-term debt net issuing or equity net issuing more important?
(d) In company™s debt balance, is there debt that is not created in the ¬nancial markets?
(e) How strong are the forces pulling towards an optimal capital structure?



Q C.27 (4p) What can ¬rms do to avoid liquidity problems?



Q C.28 (3p) What is the typical fee charged in M&A transactions?
¬le=exam-sample.tex: RP
807
Section 3·2. A Sample Final.

Q C.29 (4p) What is the pecking order? What is the ¬nancing pyramid? Does the pecking order hypothesis imply a
¬nancing pyramid?



Q C.30 (4p) What is the typical announcement response in a debt o¬ering? in an equity o¬ering? what does this
suggest about the market™s beliefs about capital in¬‚ows vs. out¬‚ows, and debt-equity ratio changes?



Q C.31 (5p) What legal temptations that do not maximize shareholder wealth do managers face?



Q C.32 (3p) When do companies have the strongest incentives to control agency problems? Why?



Q C.33 (3p) What considerations and caveats should ¬‚ow into the “Terminal Value” in a pro forma analysis?



Q C.34 (2p) What is the golden rule of ethics?



Q C.35 (2p) In the most common economic point of view, is it a seller™s fault if he misrepresents the good that is for
sale?



Q C.36 (4p) Is there a problem with averaging P/E ratios? If so, how can you avoid it?
¬le=exam-sample.tex: LP
808 Chapter C. Sample Exams.
“chapter done“ 809

Solutions and Exercises




a. Q&A: Answers


1.
(a) No Taxes. No opinion/information di¬erences. No Transaction costs. No big buyers/sellers.
(b) Project value is ambiguous because it depends on owner™s wealth.

2.
(a) The annual interest rate is 1.001252 ’ 1 = 6.43%. This comes to a 5-year rate of return of 36.5%. The
$200 would grow to $273.18.
(b) Still $200.
(c) Your interest rate is now 5.144%, because you have to pay taxes every year. Over 5 years, you will have
1.051445 ’ 1 = 28.5% rate of return, or $257.01. The in¬‚ation rate is 2.6% in¬‚ation per year. In real
terms, you will end up with $226.06 in 5 years. [rounding error may lead you to a number o¬ by a dollar
or so.]

3. (1 + r )9 = (1 + 100%) ’ r = 31/9 ’ 1 = 12.98%. Check: 1.12989 ≈ 3.
4.
(a) √ √
3
r2 = 1.25 ’ 1 = 11.80%, r3 = 1.40 ’ 1 = 11.87%
(b)
f1,2 = 1.25/1.1 ’ 1 = 13.64%, f2,3 = 1.4/1.25 ’ 1 = 12.00%

5. This project has no IRR!
C 1
6. Annuity: $500, 000 = 1’ ’ C = $3, 668.82.
(1 + 8%/12)30·12
8%/12
7.
(a) The expected project payo¬ is $124. At a price of $100, this is an expected 24% rate of return. In a
risk-neutral world, this will be the expected rate of return for all projects. The bank must expect to
receive $20 · 1.24 = $24.8. With 40% probability, the bank will get $10 million, with 60% probability it
will get what it was promised. The promise must therefore be $34.667 million. This represents a 73.33%
promised rate of return.
(b) The project payo¬ is still the same. The bank will receive $30 million [50% rate of return] with 60%
probability, $10 million with 40% probability. This gives the bank an expected payo¬ of $22 million”or
an expected rate of return of 10%. The project is ¬nanced by 20% debt, so to keep the project expected
rate of return at 24%, it must be that
20% · 10% + 80% · x = 24% x = 27.5%
So, you demand an unconditional expected rate of return of 27.5%.

8. Cash Flows: $100. $300-$0=$300. $500-(-$50)=$550. $0-(-$50)=$50.
9.
(a) The ¬nancier considers interest to be a distribution to investors, while the accountant considers it a
cost.
(b) Because it has absolutely no adjustment for capital expenditures. EBIT has at least an amortized version
therein. The alternative is to work with EBITDA - capexp.

10. Unlevered has higher P/E. See classnotes. You need risk-aversion, or else the P/E ratio will be the same.
11.
P /E = 1/(r ’ g) ’ 20 = 1/(r ’ 5%) r = 10%
12. The 10 years of maintenance are the equivalent of
$2, 000 1
· 1’ = $11, 300.4
1.1210
0.12
Add to this the cost of $50,000, and you have a total cost of $61,300. This comes to a rental equivalent of
x 1
· 1’ = $61, 300 ’ x = $10, 849
1.1210
0.12
810 “chapter done“

13.
(a) No Taxes. No opinion/information di¬erences. No Transaction costs. No big buyers/sellers.
(b) Project value is ambiguous because it depends on owner™s wealth.

14.
(a) T-bond: mean 5%, sd 0%. Market: 10%, 12.25%. A: 25%. 46.01%
(b) Returns are (“6%,7%,38%). So, the mean is 13%, the standard deviation is 18.5%.
(c) Cov(˜A , rM ) = 500%. Correlation(˜A , rM ) = 88.8%
r˜ r˜
(d) Cov(˜A , rM )/V (˜M )= 500/12.252 = 3.33.
r˜ ar r
(e) The CAPM prescribes 5% + 5% · 3.33 = 21.65%. The actual rate of return is 25%. Therefore, the price of
A is too low”it is underpriced.
(f) You need the certainty equivalence formula here. E (˜B ) = $5, 600. Cov(˜B , rM ) = $710 .
r r˜
V (˜M ) = 150%% = 0.015. E (˜M ) ’ rF = 5%. lambda= 3.33 .
ar r r
So, the value is
$5, 600 $710
Value(P ) = ’ 3.3 · = $5, 333 ’ $2, 253 = $3, 080
1 + 5% 1 + 5%
(g) This translates into rates of return of “74%, -68%, and +287%.

15. 20/ 12 ≈ 5.8%
16. A zero upfront investment, with no possibility of a cash out¬‚ow, and occasionally positive cash ¬‚ows. A
great bet may have a negative in the future, e.g., ’$5 in one state of the world, +$100, 000 in another state
of the world.
17. Rely on and learn from your own market prices. Rely on and learn from your competitors™ market prices.
Rely on and learn from input™s and output™s market prices. Cannot add value by doing things that investors
can do for themselves.
18. False. There is consumer and producer surplus. e.g., a gas station may have fair prices, but if you are out of
gas, having the ability to buy gas there is very useful to you.
19. Control rights (debt can force bankruptcy, equity votes management), and cash ¬‚ow rights (debt gets ¬rst
dib, equity gets remainder incl unlimited upside).
20. True. True. False.
21. [1] In a perfect market, the ¬nancing mix (debt/equity) of the company makes no di¬erence to its value. [2]
In a perfect market, the payout policy of the company makes no di¬erence to its value.
22. See Table 23.7
23. See Table 23.7
24.
(a) $100 ’ $115, so 15%.
(b) $100 ’ $110, so 10%.
(c) $20 in earnings. $5 in taxes. Thus, tax rate is 25%.
(d) 0.5 · 10% · (1 ’ 25%) + 0.5 · 15% = 22.5%/2 = 11.25%.
(e) It is not ’$200 + $225/1.1125 = $2.247! The reason is that the payouts have already taken care of the
taxes. so, you need to use the non-tax adjusted WACC, which is ’$200 + $225/1.125 = $0. Actually,
another way to see this is to just rely on the statement that everything is fairly priced”this means that
there is positive NPV value to be gained here.

25. Cash cows would be debt-¬nanced, have high interest payments, and be held by non-pro¬ts.
26.
(a) How their value has changed around, i.e., their recent stock prices.
(b) In M&A transactions.
(c) Long-Term debt.
(d) Yes, e.g., pension fund obligations.
(e) Not very strong. They are unlikely to be big enough to stop managers from maintaining lousy capital
structures if they so wish.

27. Match assets and liabilities. Obtain a credit line. Have more liquid investments. Have more equity and less
debt ¬nancing.
28. About 1% of deal value.
29. Pecking Order: ¬rms prefer issuing debt to equity. Financing pyramid: a lot of debt at the bottom, less equity
at the top. The pecking order does not imply a ¬nancing pyramid, perhaps most of all, because equity gains
in value over time.
¬le=appendix.tex: RP
811
Section a. Q&A: Answers.

30. Debt carries about a zero (or tiny negative) announcement event. Equity is a large negative announcement
event, “1.5% (dilution of >10%). Together, this implies that markets like capital payouts and higher leverage.
31. [Legal Bribes]. Empire building. Corporate perks. High executive pay. Entrenching. Friendship+Loyalty.
Employees. Perverse incentives (MBO). Any 5 are enough.
32. Before the company is originally sold, because by reducing future agency problems, the entrepreneur is
increasing the value of the ¬rm that she bene¬ts from immediately. Thus, it should be a great corporate
charter!
33. You

(All answers should be treated as suspect. They have only been sketched, and not been checked.)
812 “chapter done“
WEB CHAPTER A
Index

Index
last ¬le change: Jan 17, 2006 (21:07h)

last major edit: na




n/a



1·1. Main Index

• Please note that page numbers here can be o¬ by a couple of pages (most hopefully no more than 1 page).
This has to do both with infrequent updating of the index by myself, and with L TEX™s way of processing lines
A
and pages. Underline means frequent mention on the same page.
• Boldface of a page number (or range) means an important occurrence (or speci¬c de¬nition) of the phrase on
the particular page.
• underline of a page number (or range) means multiple occurrences.




813
Index


„, 550. Beardstown Ladies™ Common-Sense Investment Guide, 492.
Bearer bond, 799.
10-K, see Annual Report.
Before-tax expense, 130.
10-Q, see Quarterly Report.
1040, 128. Behavioral ¬nance, 116, 481, 609, 672.
401-K, 128. Benchmarking, CAPM, 469.
Berkshire-Hathaway, 491.
Beta, 319.
Absolute priority, 603.
Bid price, 124, 291, 478.
Absolute priority rule, 508, 603.
Bid-ask bounce, 488.
Accounting, 198, 207, 250, 255.
BLS, see Bureau of Labor Statistics.
Accounts payables, 215.
Bond, 12f, 58, 508.
Accounts receivables, 206, 215.
Bearer, 799.
Accruals, 206.
Callable, 512.
Acid-Test, 258.
Change of Interest Rate In¬‚uencing Price of, 66.
Acquirer, 500, 595.
Collar, 513.
Acquisition, 236, 693.
Collateral, 512.
Adjustable Rate Mortgage, 797.
Adjusted present value, 554“559, 561“564, 566“568, 571“574, Coupon, 513.
Covenant, 512.
583f, 614“616, 787.
CPI, 143.
ADR, 255, 296.
Duration, 513.
Adverse selection, 606.
Maturity, 513.
After-tax expense, 130.
Municipal, 134.
Agency, 176.
Puttable, 512.
Agency Bond, 797.
Secured, 512.
Alternative Minimum Tax, 130.
Seniority, 512.
American Airlines, 600.
Sinking Fund, 512.
American Depositary Receipt, 255, 296.
Subordinated, 512.
Ameritrade, 288.
Zero, 513.
Amortization, 210.
Bond covenant, 508, 512.
AMT, see Alternative Minimum Tax.
Bond duration, 513.
Annual Percentage Rate, 797.
Bond Market Data Bank, 797.
Annual quote, 21.
Bond maturity, 513.
Annual rate, compounded daily, 21.
Bond seniority, 512.
Annual Report, 199, 250.
Bond stripping, 513.
Annualization of Portfolio Risk, 374.
Book value, 205.
Annuity, 43.
Book-to-Market Ratio, 260, 475.
APR, 508, 603, 797.
Borrower, 13.
APT, 471“475.
Brownian motion, 488.
APV, see Adjusted present value.
Bubble, 429.
APV with personal taxes, 583.
Bureau of Labor Statistics, 138.
Arbitrage, 296, 445, 478, 530f, 533, 611f.
Business judgment rule, 717.
Arbitrage portfolio, 474.
Business Week, 0-vii.
Arbitrage Pricing Theory, 471.
Buy recommendation, 684.
Archipelago, 289.
Buy-and-hold, 126.
ARM Rate, 797.
Ask price, 124, 291, 478.
Asset, 569. Cadbury Schweppes, 244“246, 248, 253f, 256, 265f, 294“297,
Asset allocation, 374. 300, 303, 342f, 355.
Asset beta, 436. Calibration, 749.
Auction market, 288. Call, 517.
Audit, 178. Call option, 517.
Average, 84, 308. Callability, 512.
Average annualized rate, 55. Callable Bond, 797.
Average tax rate, 131. Capital Asset Pricing Model, 422.
Capital budgeting, 11.
Capital Expenditure, 236.
Balloon payment, 513.
Capital gain, 15, 131.
Bank, 609.
Capital loss, 15.
Bank Debt, 609.
Capital structure, 526.
Bank of England, 612.
CAPM, 0-iv, 8, 270, 285f, 325, 382, 392, 402, 405, 410,
Bank overdrafts, 215.
421“429, 431“433, 435, 438“443, 445“452,
Bankers Acceptances, 797.
454f, 457f, 461“472, 474, 476, 479f, 487, 494,
Indirect, 593.
Basis point, 16.
814
INDEX 815

499, 501, 537“539, 544“547, 567“569, 571, Covenants, 119.
743“745, 757. CPI, 138.
Capped, 513. CPI Bond, 143.
Car loan rate, 797. Credit line, 514.
Cash, 215. Credit Markets, 149, 797.
Cash Conversion Cycle, 259. Credit premium, 88.
Cash ¬‚ow, 12. Credit risk, 88.
Expected, 164. Credit Suisse First Boston, 290.
Most Likely, 164. Credit-card rate, 797.
Typical, 164. Crossing system, 289.
Cash ¬‚ow right, 700. CSFB, 290.
Cash ¬‚ow statement, 221. Cum dividend, 610.
Cumulative Normal Distribution Table, 326.
Cash In¬‚ow, see Cash ¬‚ow.
Current assets, 205, 258.
Cash Out¬‚ow, see Cash ¬‚ow.
Cash ratio, 258. Current liabilities, 205, 258.
Causation, 327. Current Ratio, 258.
CD, 797.
Certainty equivalence, 452. DAX, 298.
Certi¬cate of Deposit, 797. Dax Performance Index, 297.
Chairman of the Board, 709. Day trader, 126.
Change in working capital, 220. Days in inventory, 259.
Changes in Deferred Taxes, 219. Days of Inventories Outstanding, 259.
Changes in working capital, 222. Days of Payables Outstanding, 259.
Chapter 11, 508. Days of Receivables Outstanding, 259.
Chapter 7, 508. Days of Sales Outstanding, 259.
Chapter 11 Reorganization, 593. Debenture, 798.
Chapter 7 Liquidation, 593. Debt, 12.
Charles Schwab, 288. Debt capacity, 567.
Chase Manhattan Bank, 685. Debt Ratio, 257.
Citibank, 685. Debt-for-equity, 251.
Classical ¬nance, 116, 481. Debt-for-stock, 251.
Closed end fund discount, 296. Debt/Equity Ratio, 257.
Closed-end, 296. Default, 88.
CMO, 797. Default premium, 88, 99.
Coca Cola, 225“228, 232, 234, 244“248, 253f, 256, 265, Default risk, 88, 427.
277, 293“297, 300, 303, 342“344, 355, 565, Deferred Tax, 586.
739f, 743f, 746, 750. Deferred taxes, 220.
COGS, see Cost of goods sold. De¬ned bene¬t, 13.
Collared, 513. De¬ned contribution, 13.
Collateral, 119, 512. De¬‚ation, 138.
Collateralized Mortgage Obligation, 797. Depletion, 210.
Collateralized Trust Bond, 797. Depreciation, 206, 210.
Collection period, 259. Deviation from the mean, 308.
Commercial paper, 513, 797. Dilution, 514, 678.
Common equity, 509. Discount, 45.
Compartmentalization, 175. Discount bond, 582.
Competitive market, 114. Discount factor, 25.
Computer science, 155. Discount rate, 25, 798.
Con¬‚ict of interest, 700. Discounting, 25.
Conglomerates, 439. Diseconomies of scale, 156.
Consumer Credit, 797. Diversi¬cation, 359.
Consumer Price Index, 138. Dividend, 290.
Continuously compounded interest rate, 78. Dividend Payout Ratio, 260.
Control right, 700. Dividend reinvestment plan, 612.
Convertability, 512. Dividend yield, 15, 261, 611.
Convertible Bond, 797. Dividend-price ratio, 261.
Corporate board, 509, 700, 709. DJIA, 270.
Corporate charter, 526. Double taxation of dividends, 509.
Corporate governance, 178, 509, 699. Dow Jones, 298.
Corporate income tax, 207. Dow-Jones 30, 297f.
Corporate Income Tax Rate, 549, 569. Dow-Jones Industrial Average, 270.
Correlation, 318, 322, 328, 363, 377f, 387, 417, 810. DPO, 259.
Cost, 12. DRIP, 612.
Cost of capital, 24, 188, 536. Due diligence, 481.
Internally Generated vs External Funds, 648. Duration, 74.
Cost of goods sold, 209. Duration and Maturity, 258.
Coupon bond, 44, 513.
Coupon yield, 15. E-M, see E¬cient Market.
Covariance, 315, 317“320, 322, 328, 330, 332“335, 337“342, EAC, 162.
347, 350, 354f, 360“364, 377f, 382, 385, 387f, Earned income, 128.
394, 397, 400f, 404, 412, 415“419, 423, 434, Earnings, 209.
452“455, 459, 744, 793f, 810. Earnings before interest and taxes, 209.
816 INDEX

Earnings before interest and taxes, depreciation, and amor- Flow-to-equity, 561.
tization, 209. FNMA, 798.
Earnings dilution, 672. Forward interest rate, 70.
Earnings yield, 236. Forward rate, see Forward interest rate.
Forward transaction, 74.
EBIT, see Earnings before interest and taxes.
EBITDA, see Earnings before interest and taxes, deprecia- FreddieMac, 798.
FT, 0-vii.
tion, and amortization.
Ecaps, 646. FTSE, 298.
ECN, 289. Fund, 288, 296.
Economic rents, 733. Fund of funds, 393.
Economies of scale, 158, 739. Fundamental trading, 483.
EDGAR, 199. Funded debt, 513.
E¬ective annual rate, 21. Future value, 17.
E¬cient frontier, 384. Futures Contract, 479.
E¬cient Market, 115, 384, 477. Citrus, 479.
Electronic communications network, 289.
GAAP, 210.
Enterprise value, 13.
GDP, 14.
Entity value, 632.
GDP De¬‚ator, 138.
Entrepreneurial Finance, 442.
Equal-weighted, 298. General Obligation Bond, 798f.
Geometric average, 71.
Equipment Obligation, 798.
George Soros, 490.
Equity, 12, 96, 508.
Germany, 526.
Equity beta, 436.
GIC, 798.
Equity Premium, 423.
Glass-Steagall Act of 1933, 685.
Estate tax, 133, 612.
Eurobond, 798. GO Bond, 798f.
Gold, 370.
Event study, 495.
Goldman Sachs, 289.
Ex-ante, 527.
Good bet, 479.
Ex-dividend day, 610, 612.
GOP, 612.
Ex-post, 527.
Gordon growth model, 42.
Exchange o¬er, 651.
Government Agency & Similar Issues, 797.
Exchange-traded fund, 296.
Greedy algorithm, 154.
Expected cash ¬‚ow, 164.
Growing annuity, 47.
Expected interest rate, 99.
Growing perpetuity, 40.
Expected Rates of Return, 188.
Expected Value, 0-iii, 84“86, 89“91, 94f, 97“100, 102, Growth ¬rm, 345, 475.
107f, 136, 164, 167“174, 236“242, 247, 252, Guaranteed Investment Contract, 798.
265, 269, 277, 307f, 310, 317, 320, 331, 336f,
342f, 350, 354f, 360f, 364f, 372, 374, 382f, Hamada Equation, 559.
Hammurabi, 60.
385, 388f, 391, 394, 396“398, 400f, 403, 405“408,
Health care ¬rms, 345.
410“416, 418f, 423“425, 427, 429, 433f, 437“439,
441f, 449, 451“458, 462“464, 471“474, 476, Hedge, 76, 424.
Hedge fund, 296, 393.
487, 535“538, 542“544, 546f, 550, 552, 554“559,
563, 565, 567“569, 571“576, 578“581, 583f, Hedging, 440.
590f, 739, 743, 745“748, 750f, 757, 760“765, Heuristic, 154.
High-yield bond, 688, 798.
789, 791“794, 796, 800, 810.
Historical mean, 345.
Expense, 12, 206.
Hold up, 705.
After-Tax, 130.
Holding period, 14.
Before-Tax, 130.
Holding rate of return, 18.
Externality, 155.
Home Equity Loan, 798.
Factor, 471. Hostile takeover, 710.
Factor exposures, 472. Hurdle Rate, 188.
Factor loadings, 472. Hyperbola, 382.
Fair bet, 85. Hyperin¬‚ation, 138.
FannieMae, 798.
FASB, 210. I/B/E/S, 240.
Federal Funds Rate, 798. Independent, 155.
Federated Department Stores, 596. Index fund, 345, 370.
FHLMC, 798. Indirect bankruptcy cost, 593.
Fidelity, 370. Individual retirement account, 128.
Fiduciary obligation, 290. In¬‚ation, 138.
Financial reports, 199. Initial public o¬ering, 289, 651f.
Financial results, 199. Instinet, 289.
Financial Times, 0-vii. Insurance Company, 655.
Financial Times Stock Exchange, 298. Intangible Assets, 210.
Interaction, 155.
Financials, see Financial results.
Fire-sale, 594. Interest, 13.
Fitch, 688. Interest Coverage, 258.
Fixed income, 13. Interest forward, 74.
Fixed interest-rate debt, 513. Interest Only, 797.
Fixed rate mortgage loan, 43. Interest rate, 13.
Floating interest-rate debt, 513. Continuously Compounded, 78.
INDEX 817

Expected, 88. Market-maker, 288.
In¬‚uence on Bond Price, 66. Markets Diary, 797.
Promised, 88. Maturity, 13, 508.
Quoted, 88. MBO, 693.
Stated, 88. MBS, 298.
Interest Rates and Bonds, 797. Mean, 84, 308.
Internal Rate of Return, 185, 188. Mean reverting, 374.
Internal Revenue Service, 128, 582. Mean-variance e¬cient frontier, 384.
Inventories, 215. Medicare, 130, 133.
Inventory Turnover, 258. Mergent, 688.
Inverted, 61. Merrill Lynch, 288f.
Investment, 12. Microsoft, 6.
Investment grade, 120. Miller Debt and Taxes, 615.
Investment grade bond, 688, 798. Minimum variance portfolio, 390f.
Investment in Goodwill, 219. Modigliani-Miller, 528.
Investor psychology, 482. Momentum, 475, 484.
IO, 797. Money Rates, 150, 797.
IPO, 289. Money-market, 272.
IPO underpricing, 653. Money-Market Rate, 798.
IRA, 128. Money&Investing, 298.
Monopoly, 160.
IRR, see Internal Rate of Return.
Monte-Carlo simulation, 170, 390, 753.
IRS, see Internal Revenue Service.
Issue origination, 684. Moody™s, 119, 688.
Issue placement, 684. Moral Hazard, 617.
ITG, 289. Morgan Stanley, 298.
Mortgage, 43.
Jargon, 0-vi. Mortgage Bond, 798.
Jumbo Mortgage, 798. Motley Fool Investment Guide, 492.
Junior bond, 512. MSCI EAFE, 298.
Junk, 120. Muni, 134.
Junk Bond, 798. Muni bonds, see Municipal bond.
Municipal bond, 134, 798.
KKR, 649, 712. Mutual fund, 296, 370, 490.
Kohlberg, Kravis, Roberts, 649, 712. MVE, 384.

Law of one price, 6, 26, 478. N-year Mortgage Rate, 798.
Laws of Expectations, 791. NASD, 289.
Nasdaq, 288, 298, 484, 492.
LBO, see Leveraged Buyout.
Leasing, 569. Natural logarithm, 78.
Lehman Brothers, 298. Natural monopoly, 160.
Level-coupon bond, 44. Natural Resources, 210.
Leverage, 508. Negative interaction, 156.
Leveraged Buyout, 553, 693, 705, 712. Negotiated debt, 514.
Levered equity, 93, 96. Net Income, see Earnings.
Net income, 206.
LIBOR, see London Interbank O¬er Rate.
Li¬‚and, Burton, 509. Net issuance of debt, 222.
Limit order, 125, 288. Net operating losses, 569.
Limit order book, 288. Net present value, 26f, 62.
Limited liability, 96, 290, 509. Capital Budgeting Rule, 27.
Linear Regression, 320. Net return, 14.
Liquidity premium, 91, 127. New York Bond Exchange, 650.
Liquidnet, 289. New York Futures Exchange, 479.
Loan, 13. New York Mercantile Exchange, 479.
Credit Risk, 88. New York Stock Exchange, 288, 478.
Default Risk, 88. New York Times, 0-vii.
London Interbank O¬er Rate, 513, 798. Nikkei, 298.
Long bond, 14. No-recourse loan, 96.
Long-term accrual, 206. Noise trader, 480.
Long-Term Capital Management, 327. NOL, 569.
LTCM, 327. Nominal return, 139.
Non-cash items, 220.
M&A, 693. NYSE, 214, 288, 370, 478, 484.
M&M, see Modigliani-Miller. NYT, see New York Times.
Macaulay Duration, 75.
Management buyout, 693. On margin, 288.
Margin, 157. On the margin, 158.
Marginal tax rate, 131. On-the-run, 127.
Market beta, 347, 433. Open-ended, 296.
Market E¬ciency, 479. Operating activity net of investing activity, 222.
Market model, 347. Operating income, 209.
Market order, 125, 288. Operations research, 155.
Market Risk Premium, 423. Opportunity cost, 24, 124.
Market value, 475. Opportunity cost of capital, 422.
818 INDEX

Optimal capital structure, 527. Quick Ratio, 258.
Quoted interest rate, 88.
Ordinary equity, see Common equity.
Ordinary income, 128.
Random variable, 84, 307.
OTC, 289.
Random walk, 487.
Over-the-counter, 289, 650.
Rate of return, 14, 23.
Overcon¬dence, 175, 609.
Annualized, 56.
Overoptimism, 609.
Holding, 56.
promised, 97.
P-E ratio, see Price-earnings ratio.
Rate-indexed, 139.
P/E ratio, see Price-earnings ratio.
Par value, 44. Rational Finance, 481.
Parabola, 385. Real Estate Investment Trust, 345.
Real option, 165.
Past performance is no predictor of future performance,
491. Real return, 139.
Payables Turnover, 259. Realization, 84.
Payback rule, 189. Receivables Turnover, 258.
Payment for order ¬‚ow, 125. Redeem, 512.
Payo¬, 12. Reinvestment rate, 54.
Payo¬ table, 93. REIT, 345.
Relativism, 175.
Payout Ratio, 260f.
Payout Table, 72. Repo Rate, 799.
Reputation, 718.
PE Ratio, see Price-earnings ratio.
Pecking order, 607, 648. Research and Development, 566.
PepsiCo, 6, 10, 114, 124f, 196f, 200“203, 205, 208“210, Restated, 210.
214, 217, 219“223, 225, 228f, 231, 234, 238, Restaurant Failure Rate, 12, 175.
244, 246, 248, 253f, 256“259, 261, 265, 270, Retail broker, 288.
277, 283, 291“297, 300, 303, 324, 342“344, Return, 12, 14.
355, 363, 435, 478“480, 551, 565, 568, 585, Nominal, 139.
729, 731f, 734“747, 749f, 752“758, 760“765. Real, 139.
Percent, 14. Return on (Book) Assets, 259.
Perfect World, 525. Return on (Book) Equity, 260.
Growing, 40. Return on Sales, 259.
Perpetuity, 38. Revenue, 12, 206, 209.
Pink sheets, 289. Revenue Bond, 798f.
PO, 797. Reward, 86.
Pooling, 210. Rho, 318.
Portfolio, 294, 793. Rights o¬ering, 652.
Portfolio benchmarking, 469. Risk, 87.
POSIT, 289. Risk premium, 91.
Positive interaction, 156. Risk-neutral, 87.
Post audit, 178. ROA, 259.
PPI, 138. ROE, 260.
Preferred equity, 517. Round-trip, 123.
Premium, 45, 90. Round-trip transaction, 291.
Default, 90, 99. Rule 415, 652.
Risk, 91. Russell 2000, 298.
Time, 91.
S&P 500, 298.
Present value, 17, 23.
Sales, 209.
Present Value of Growth Opportunities, 237.
Sales tax, 133.
Price-earnings ratio, 235.
SallieMae, 799.
Primary shares, 652.
Sample mean, 345.
Prime broker, 288.
Sampling error, 327.
Prime rate, 513, 798.
Sarbanes-Oxley Act of 2002, 723.
Principal, 44, 513.
Savings Bond, 799.
Principal Only, 797.
Scenario analysis, 104, 170, 174.
Pro forma, 729f.
Score, 326.
Probability, 84“86, 88“90, 94“100, 107, 165, 427, 453,
Seasoned equity o¬ering, 290, 651.
459, 532, 592, 597, 601, 603, 606, 618f, 791f.
Probability distribution, 85. SEC, see Securities and Exchange Commission.
Second-best, 700.
Producer Price Index, 138.
Secondary shares, 652.
Pro¬t Margin, 259.
Secured bond, 512.
Pro¬tability index, 184.
Securities, 508.
Progressive Tax Rates, 128.
Securities and Exchange Commission, 508.
Project, 12.
Security, 512.
Project beta, 436.
Security markets line, 424.
Promised, 89f.
Sell recommendation, 684.
Promised interest rate, 88, 99.
Selling, general & administrative expenses, 209.
Promised rate of return, 97.
Semi-Strong Market E¬ciency, 483.
Proxy contest, 710.
Senior bond, 512.
Puttability, 512.
Sensitivity analysis, 104.
PVGO, see Present Value of Growth Opportunities.
SEO, 290.
Quarterly Report, 199, 250. Separation, 118.
INDEX 819

Separation of decisions, 35. Tracking error, 345.
Series E Bond, 799. Trade credit, 595.
Series H Bond, 799. Trading Places, 479.
Trailing twelve months, 251.
SG&A, see Selling, general & administrative expenses.
Share repurchase, 290. Tranche, 650.
Shareholder proposal, 711. Transaction cost, 291.
Shareholder wealth, 526. Treasuries, 14.
Shark repellant, 711. Treasury bill, 14.
Sharpe Ratio, 398. Treasury bond, 14.
Sharpe-ratio, 374. Treasury Bonds, Notes and Bills, 797.
Short sale, 72. Treasury In¬‚ation Protected Securities, 143.
Short-term accrual, 206. Treasury note, 14.
Shorting, 291. Treasury stock, 651.
Sigma, 318. Treasury STRIPS, 69.
Signal-to-noise ratio, 482f. TTM, see Trailing twelve months.
Sinking fund, 512. Tunneling, 716.
Small Business Administration, 175. Turnover, 258.
Social Security, 130, 133.
Solvent, 88. Underinvestment, 596.
Specialist, 288. Underwriter, 289, 684.
Speculative grade, 120. Unfunded debt, 513.
Spot interest rate, 70. Unit, 513, 595, 612.
Spot rate, 70. Unsolicited bid, 710.
Standard Deviation, 86, 100, 277, 309f, 314, 317“319, US Treasuries, 14, 58.
322, 328, 330, 344, 354f, 360“364, 372, 374, US Treasuries yield curve, 58.
377f, 382f, 385, 388f, 394, 396“398, 400f, Utilities, 345.
403, 408, 415“419, 453, 794, 796, 800.
Standard&Poors, 119, 688. Value, 484.
Stanley Toolworks, 570. Value ¬rm, 345, 475.
State, 510. Value-at-Risk, 367.
State table, 93. Value-weighted, 299.
State-contingent claim, 510. Vanguard, 345, 370.
Stated interest rate, 88. VaR, 367.
Stock, 12, 96, 508f. Variance, 309f, 314, 317“319, 328, 330, 333“335, 338“342,
Stock dividend, 612. 344, 347, 354f, 360“364, 372, 377f, 382, 385,
Stock shareholder, 509. 388, 394, 397, 401, 403f, 411“416, 418f, 423,
Stock split, 297, 612. 434, 452“455, 744, 790“794, 800f, 810.
Stockholder, 509. Venture Capital, 517.
Straight-line depreciation, 206. Volatility, 483.
Strategic option, 165. Voting rule, 526.
Strong buy, 684.
Strong Market E¬ciency, 484. WACC, 0-iii, 0-v, 137, 436f, 525, 534, 537“541, 543“547,
Strong sell, 684. 549, 554, 556“559, 563f, 566“569, 571“575,
Student Loan Marketing Association, 799. 583f, 590f, 614“616, 787.
Subordinated bond, 512. WACC with personal taxes, 583.
Sunk cost, 160. Wall Street Journal, 0-vii, 22, 58, 70, 122, 125, 134f, 138,
Supervisory Board, 526. 144, 296, 298, 457, 491, 570, 595, 688, 797.
Survivorship bias, 490. Warrant, 517f.
Switzerland, 569. Warren Bu¬ett, 490.
Synergies, 156. Waste Management, 207.
Weak Market E¬ciency, 483.
T-bill, 14. Weather, 479.
Tangency Portfolio, 399. Weighted average cost of capital, 534, 538, 554.
Tangible Assets, 210. Tax-Adjusted, 556.
Tax bracket, 130. Winner™s curse, 606.
Tax form, 128. Working capital, 215.
Tax payables, 207, 215. WSJ, see Wall Street Journal.
Tax-Exempt Bond, 799.
Tax-exempt institution, 128. Yankee Bond, 799.
Taxable income, 128. Yield, 14.
Technical analysis, 483, 490. Yield Comparisons, 149, 797.
Tender o¬er, 693, 710. Yield curve, 58.
Term structure of interest rates, 58. Flat, 61.
Terminal value, 731. Yield to Maturity, 68.
The Economist, 0-vii. Yield-to-Call, 68.
The Whiz Kid of Wall Street™s Investment Guide, 492. You get what you pay for, 65.
Theft, 600.
Time value of money, 17. Z-score, 326.
Times Interest Earned, 258. Zero bond, 44, 513.
TIPS, see Treasury In¬‚ation Protected Securities.
Total investing activity, 222.
Total operating activity, 222.
Total Return Index, 297.
820 INDEX

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