Finance

Annuity Payment

An annuity is a series of equal cash flows that occur after equal interval of time. If we know the interest rate and number of time periods, we can work out the annuity cash flow that corresponds to a specific present value and/or future value.

Time Value of Uneven Cash Flows

When a cash flow stream is uneven, the present value (PV) and/or future value (FV) of the stream are calculated by finding the PV or FV of each individual cash flow and adding them up.

Types of Interest Rates

An interest rate is a percentage which represents the cost of money as a percentage of initial principal. Interest rates differ depending on whether they are nominal or real, quoted or effective, annual or periodic and so on.

Nominal Interest Rate

Nominal interest rate is the interest rate which includes the effect of inflation. It approximately equals the sum of real interest rate and inflation rate.

Real Interest Rate

Real interest rate is the interest rate adjusted for the effect of inflation on maturity value of a loan or investment. It approximately equals nominal interest rate minus inflation rate.

Quoted vs Periodic Interest Rate

Quoted interest rate (also called nominal interest rate or annual percentage rate) is the non-compounded interest rate for a period of one year. It can be converted to periodic interest rate by dividing it with the number of compounding periods per year.

Number of Time Periods in TVM

In case of simple interest, number of time periods t equals total interest divided by product of PV and interest rate and in case of compound interest, number of periods can be calculated using NPER function or using a logarithm-based formula

Tax Shield

Depreciation tax shield represents reduction in tax outflows when tax laws allow deduction of depreciation expense from taxable income. Interest tax shield refers to the tax-saving advantage of debt form of capital.

Pro Forma Financial Statements

Proforma financial statements are financial statements which provide information about a company’s expected financial performance and financial position in future.

Primary Market & Secondary Market

A primary market is a market in which corporations sell their securities to investors for the first time. On the other hand, a secondary market is a market in which investors trade the securities already issued with each other.

Binomial Option Pricing Model

Binomial option pricing model is a risk-neutral model used to value path-dependent options such as American options. Under the binomial model, current value of an option equals the present value of the probability-weighted future payoffs from the options.

Hedge Ratio

A hedge ratio is the ratio of exposure to a hedging instrument to the value of the hedged asset. A ratio of 1 or 100% means that the position is fully hedged and a ratio of 0 means it is not hedged at all.

Municipal Bonds

Municipal bonds (also called munis) are bonds issued by state or local governments. Most of municipal bonds are exempt from federal and state taxes. Their tax-equivalent yield equals tax-exempt yield divided by (1 - marginal tax rate).

Putable Bonds

Putable bonds are bonds which entitle the bondholder to return the bond to the issuer on specified dates before its maturity date. Putable bonds have an embedded put option.

Country risk premium is the incremental required return which results from the increased risk inherent in an investment in a foreign (developing) country. It is added to the requirement rate of return in a developed market to arrive at appropriate required return for an emerging market.

Cash flow adequacy ratio measures if cash flows generated from operating activities in a period are sufficient to pay off fixed asset purchases, made the payments due on debt and pay dividends. A cash flow of 1 or higher means that the company is able to meets its most pressing cash flow demands.

Loan to Value Ratio

Loan to value ratio (abbreviated as LTV ratio) is the ratio of the principal balance of the loan to the market value of the asset used to secure the loan. It is an important factor used by lenders in deciding whether to approve a loan or not.

Mutual Funds

Mutual funds are investment vehicles which pool funds from its unit-holders and invest them according to a specific investment style. Mutual fund types include: open-end vs closed-end, load funds vs no-load funds,

Altman Z-Score

Altman z-score is a statistic that measures the credit risk of a company. Companies with z-score of less than 1.81 are prone to bankruptcy. Z-score equals 1.2 times the working capital to total assets, 1.4 times retained earnings to total assets, 3.3 times EBIT to total assets, 0.6 times market capitalization to book value of liabilities and 1 time the total asset turnover.

Earnings Yield

Earnings yield is the ratio of earnings per share to current stock price. It measures dollars earned per \$100 dollars invested in a company at current stock price. Earnings yield is the reciprocal of the price to earnings (P/E) ratio and it is expressed as a percentage.

Activity Ratios

Activity ratios (also called efficiency ratios and asset-utilization ratios) are financial ratios which measure how successfully a company is utilizing it assets. Important efficiency ratios include total asset turnover ratio, working capital turnover ratio, inventory turnover ratio, receivables turnover ratio, days inventories outstanding, days sales outstanding, operating cycle, etc.

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