Discipline: Corporate Finance

1) Why time value of money is so important?

When a business chooses to invest money in a project -- such as an expansion, a strategic acquisition or just the
purchase of a new piece of equipment -- it may be years before that project begins producing a positive cash flow.
The business needs to know whether those future cash flows are worth the upfront investment. That's why the time
value of money is so important to capital budgeting.
Time Value
Simply put, the time value of money is the idea that a particular sum of money in your hand today is worth more
than the same sum at some future date. For example, given the choice between receiving $1 today or $1 a year from
now, you should take the money today. You could invest that $1, and even if you only earned a 2 percent annual
return on your investment, you still would have $1.02 a year from now -- more than the $1 you'd have gotten if you
waited. If you didn't invest that $1 at all but simply spent it, you'd still be better off; because of inflation, the $1
usually will have more buying power today than in the future.
Discount Rate
An essential consideration in the time value of money is the discount rate. That's the rate a business uses to convert
future amounts into today's dollars. Multiple factors affect the discount rate, including the interest rate at which the
company can borrow money, the return the company could earn from investing money, the return demanded by the
company's own investors, inflation and the risk of the project itself. Setting a discount rate is as much an art as a
science, but it's critical that a company come up with a reasonably accurate figure. Using a rate that is way off
means making bad capital budgeting decisions.
Converting Values
To make capital budgeting decisions using the time value of money, a company first estimates all the cash flows
involved with the project, positive and negative. It then converts all of those cash flows into their present value -how much they're worth in today's dollars. Consider a project that requires a $100,000 investment today (a negative
cash flow) and will return $25,000 a year for the next five years (positive cash flows). On paper, it looks as if the
project produces a $25,000 profit. But those future cash flows must be converted to present value. If the company
uses a discount rate of 10 percent, the present value of those cash flows actually comes out to $94,769.67. That's less
than the $100,000 cost, so the project actually will lose money. However, if the company is using a discount rate of
7 percent, the present value is $102,504.94, meaning the project is profitable. This underscores the importance of
accuracy in setting a discount rate.

KEY POINTS
Money today is worth more than the same quantity of money in the future. You can invest a dollar today and receive
a return on your investment.
Loans, investments, and any other deal must be compared at a single point in time to determine if it's a good deal or
not.
The process of determining how much a sum of money is worth today is called discounting. It is done for most
major business transactions.
TERMS[ edit ]
interest rate
The percentage of an amount of money charged for its use per some period of time. It can also be thought of as the
cost of not having money for one period, or the amount paid on an investment per year.

discounting
The process of determining how much money paid/received in the future is worth today. You discount future values
of cash back to the present using the discount rate.
Why is the Time Value of Money Important?
The time value of money is a concept integral to all parts of business. A business does not want to know just what an
investment is worth todayit wants to know the total value of the investment. What is the investment worth in total?
Let's take a look at a couple of examples.
Suppose you are one of the lucky people to win the lottery. You are given two options on how to receive the money.
Option 1: Take $5,000,000 right now.
Option 2: Get paid $600,000 every year for the next 10 years.
In option 1, you get $5,000,000 and in option 2 you get $6,000,000. Option 2 may seem like the better bet because
you get an extra $1,000,000, but the time value of money theory says that since some of the money is paid to you in
the future, it is worth less. By figuring out how much option 2 is worth today (through a process called discounting),
you'll be able to make an apples-to-apples comparison between the two options. If option 2 turns out to be worth less
than $5,000,000 today, you should choose option 1, or vice versa.
Let's look at another example. Suppose you go to the bank and deposit $100. Bank 1 says that if you promise not to
withdraw the money for 5 years, they'll pay you an interest rate of 5% a year. Before you sign up, consider that there
is a cost to you for not having access to your money for 5 years. At the end of 5 years, Bank 1 will give you back
$128. But you also know that you can go to Bank 2 and get a guaranteed 6% interest rate, so your money is actually
worth 6% a year for every year you don't have it. Converting our present cash worth into future value using the two
different interest rates offered by Banks 1 and 2, we see that putting our money in Bank 1 gives us roughly $128 in 5
years, while Bank 2's interest rate gives $134. Between these two options, Bank 2 is the better deal for maximizing
future value.
Compound Interest
In this formula, your deposit ($100) is PV, i is the interest rate (5% for Bank 1, 6% for Bank 2), t is time (5 years),
and FV is the future value.

Why Is the Time Value of Money So Important in Capital Budgeting Decisions?

The time value of money is important in capital budgeting decisions because it allows small-business owners to
adjust cash flows for the passage of time. This process, known as discounting to present value, allows for the
preference of dollars received today over dollars received tomorrow. Understanding some common capital
budgeting techniques that use the time value of money can help you understand why this concept is so important in
capital budgeting decisions.
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Net Present Value
The net present value method uses the time value of money to determine whether a project is profitable, even after
adjusting for the time value of money. To perform this test, a small-business owner would first determine the cash

inflows and outflows required for the project. Once identified, these figures are adjusted to present value and their
difference is determined.
If the project's net present value is greater than or equal to zero, the project is acceptable, as it provides a return
greater than or equal to the company's acceptable rate of return. If the owner does not use the time value of money to
discount cash inflows and outflows, projects with a long time horizon or in periods of a high discount rate could be
mispriced, and the owner could make an unprofitable decision.
Internal Rate of Return
The internal rate of return method applies the net present value method in reverse. This method finds the discount
rate, given the undiscounted cash flows of the project, which results in a net present value of zero. The zero point
represents the break-even point of project profitability.
To apply this method, a manager divides the investment required by a project by the net annual cash inflow the
project is expected to produce. This calculation yields the internal rate of return factor. This factor can be looked up
in a net present value table to discern the appropriate internal rate of return. This internal rate of return is then
compared with the company's minimum acceptable rate of return. If the project promises a higher return, it is
accepted.
Total Cost Approach
The total cost approach allows small-business owners to evaluate multiple projects at one time. In this method, the
manager adjusts all cash inflows and outflows for each competing alternative and then compares them. All projects
with positive net present values are acceptable; however, the project with the greatest net present value is the most
profitable. This method can be time-consuming, because costs that do not differ across competing projects are
calculated, even though they are irrelevant.
Project Profitability Index
When funds available for projects are limited, a small-business owner can calculate the project profitability index, or
PPI, to determine which project is preferred. By dividing the net present value of a project by the investment
preferred, the owner is calculating a value of net present value obtained per dollar invested. This is known as the
PPI. Higher project PPI values imply more desirable projects.

Understanding The Time Value Of Money

Congratulations!!! You have won a cash prize! You have two payment options: A - Receive $10,000 now OR B
- Receive $10,000 in three years. Which option would you choose?
What Is Time Value?
If you're like most people, you would choose to receive the $10,000 now. After all, three years is a long time to wait.
Why would any rational person defer payment into the future when he or she could have the same amount of money
now? For most of us, taking the money in the present is just plain instinctive. So at the most basic level, the time
value of money demonstrates that, all things being equal, it is better to have money now rather than later.

But why is this? A $100 bill has the same value as a $100 bill one year from now, doesn't it? Actually, although the
bill is the same, you can do much more with the money if you have it now because over time you can earn
more interest on your money.
Back to our example: by receiving $10,000 today, you are poised to increase the future value of your money by
investing and gaining interest over a period of time. For Option B, you don't have time on your side, and the
payment received in three years would be your future value. To illustrate, we have provided a timeline:

If you are choosing Option A, your future value will be $10,000 plus any interest acquired over the three years. The
future value for Option B, on the other hand, would only be $10,000. So how can you calculate exactly how
much more Option A is worth, compared to Option B? Let's take a look.
Future Value Basics
If you choose Option A and invest the total amount at a simple annual rate of 4.5%, the future value of your
investment at the end of the first year is $10,450, which of course is calculated by multiplying the principal amount
of $10,000 by the interest rate of 4.5% and then adding the interest gained to the principal amount:
Future value of investment at end of first year:
= ($10,000 x 0.045) + $10,000
= $10,450
You can also calculate the total amount of a one-year investment with a simple manipulation of the above equation:

Original equation: ($10,000 x 0.045) + $10,000 = $10,450

Manipulation: $10,000 x [(1 x 0.045) + 1] = $10,450

Final equation: $10,000 x (0.045 + 1) = $10,450

The manipulated equation above is simply a removal of the like-variable $10,000 (the principal amount) by dividing
the entire original equation by $10,000.
If the $10,450 left in your investment account at the end of the first year is left untouched and you invested it at
4.5% for another year, how much would you have? To calculate this, you would take the $10,450 and multiply it
again by 1.045 (0.045 +1). At the end of two years, you would have $10,920:
Future value of investment at end of second year:
= $10,450 x (1+0.045)
= $10,920.25

The above calculation, then, is equivalent to the following equation:

Future Value = $10,000 x (1+0.045)(1+0.045)
Think back to math class and the rule of exponents, which states that the multiplication of like terms is equivalent to
adding their exponents. In the above equation, the two like terms are (1+0.045), and the exponent on each is equal to
1. Therefore, the equation can be represented as the following:

We can see that the exponent is equal to the number of years for which the money is earning interest in an
investment. So, the equation for calculating the three-year future value of the investment would look like this:

This calculation shows us that we don't need to calculate the future value after the first year, then the second year,
then the third year, and so on. If you know how many years you would like to hold a present amount of money in an
investment, the future value of that amount is calculated by the following equation:

Present Value Basics

If you received $10,000 today, the present value would of course be $10,000 because present value is what your
investment gives you now if you were to spend it today. If $10,000 were to be received in a year, the present value
of the amount would not be $10,000 because you do not have it in your hand now, in the present. To find the present
value of the $10,000 you will receive in the future, you need to pretend that the $10,000 is the total future value of
an amount that you invested today. In other words, to find the present value of the future $10,000, we need to find
out how much we would have to invest today in order to receive that $10,000 in the future.
To calculate present value, or the amount that we would have to invest today, you must subtract the (hypothetical)
accumulated interest from the $10,000. To achieve this, we can discount the future payment amount ($10,000) by
the interest rate for the period. In essence, all you are doing is rearranging the future value equation above so that
you may solve for P. The above future value equation can be rewritten by replacing the P variable with present
value (PV) and manipulated as follows:

Let's walk backwards from the $10,000 offered in Option B. Remember, the $10,000 to be received in three years is
really the same as the future value of an investment. If today we were at the two-year mark, we would discount the
payment back one year. At the two-year mark, the present value of the $10,000 to be received in one year is
represented as the following:
Present value of future payment of $10,000 at end of year two:

Note that if today we were at the one-year mark, the above $9,569.38 would be considered the future value of our
investment one year from now.
Continuing on, at the end of the first year we would be expecting to receive the payment of $10,000 in two years. At
an interest rate of 4.5%, the calculation for the present value of a $10,000 payment expected in two years would be
the following:
Present value of $10,000 in one year:

Of course, because of the rule of exponents, we don't have to calculate the future value of the investment every year
counting back from the $10,000 investment at the third year. We could put the equation more concisely and use the
$10,000 as FV. So, here is how you can calculate today's present value of the $10,000 expected from a three-year
investment earning 4.5%:

So the present value of a future payment of $10,000 is worth $8,762.97 today if interest rates are 4.5% per year. In
other words, choosing Option B is like taking $8,762.97 now and then investing it for three years. The equations
above illustrate that Option A is better not only because it offers you money right now but because it offers you
$1,237.03 ($10,000 - $8,762.97) more in cash! Furthermore, if you invest the $10,000 that you receive from Option
A, your choice gives you a future value that is $1,411.66 ($11,411.66 - $10,000) greater than the future value of
Option B.

Present Value of a Future Payment

Let's add a little spice to our investment knowledge. What if the payment in three years is more than the amount
you'd receive today? Say you could receive either $15,000 today or $18,000 in four years. Which would you
choose? The decision is now more difficult. If you choose to receive $15,000 today and invest the entire amount,
you may actually end up with an amount of cash in four years that is less than $18,000. You could find the future
value of $15,000, but since we are always living in the present, let's find the present value of $18,000 if interest rates
are currently 4%. Remember that the equation for present value is the following:

In the equation above, all we are doing is discounting the future value of an investment. Using the numbers above,
the present value of an $18,000 payment in four years would be calculated as the following:

From the above calculation we now know our choice is between receiving $15,000 or $15,386.48 today. Of course
we should choose to postpone payment for four years!
The Bottom Line
These calculations demonstrate that time literally is money - the value of the money you have now is not the same as
it will be in the future and vice versa. So, it is important to know how to calculate the time value of money so that
you can distinguish between the worth of investments that offer you returns at different times.

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2. How do dividends and interest expense differ?

Dividends are a distribution of a corporation's earnings to its stockholders. Dividends are not an expense of the
corporation and, therefore, dividends do not reduce the corporation's net income or its taxable income. When a
dividend of $100,000 is declared and paid, the corporation's cash is reduced by $100,000 and its retained
earnings (part of stockholders' equity) is reduced by $100,000.
Interest on bonds and other debt is an expense of the corporation. The interest expense will reduce the corporation's
net income and its taxable income. When interest expense occurs and is paid, the corporation's cash is reduced by
the interest payment, but some cash will be saved by the reduction in income taxes. The corporation's retained
earnings will also be reduced by less than the amount of interest expense. For example, if a corporation has an
incremental tax rate of 40%, interest expense of $100,000 will result in $40,000 less in income tax expense and
income tax payments. This means that an interest payment of $100,000 will reduce the corporation's cash and
retained earnings by the net amount of $60,000 ($100,000 of interest minus $40,000 of tax savings).
Since interest is formally promised to the lenders, accountants must accrue interest expense and the related
liability Interest Payable. If the payment for interest is not made, the corporation will face legal consequences.
Dividends on common stock are not legally required. Therefore, if the corporation does not declare a dividend there
is no liability for the omitted dividends.

-Dividend payment is a distributed profit to the shareholders and Interest Payment is Interest paid on borrowed
money (to the bondholders)
-Interest Payment is tax deductible whereas dividends are not tax deductible.

Dividends are for investors and interests are for creditors.

Dividend is the portion of the profit distributing among shareholders of the company after tax and interest. But
interest is the amount paying to the debenture holders, bank and other financial institutions provided the funds to the
company.
Dividends are paid to investors while interests is paid to creditors.
Interest is taxable while dividend is not.
Interest is fixed rate but dividend is flactuate based on the company earnings
Dividends are related to profit against share holders.
Interest is related to loans/borrowings.

Dividend is paid to the shareholder of the company. It is distribution of profit to tha owner of the company. Interest
is the obligation of the company for the loan or deposits taken by the company.

3. What does beta measure? How do we use beta in CAPM (Capital Asset Pricing Model)?
Beta- This volatility measure is supposed to give you some sense of how far the fund will fall if the market takes a
dive and how high the fund will rise if the bull starts to climb. A fund with a beta greater than 1 is considered more
volatile than the market; less than 1 means less volatile.
So say your fund gets a beta of 1.15 -- it has a history of fluctuating 15% more than the S&P. If the market is up, the
fund should outperform by 15%. If the market heads lower, the fund should fall by 15% more.
Problem: For funds that don't correlate well to the S&P, beta just doesn't tell you much.
In finance, the capital asset pricing model (CAPM) is used to determine a theoretically appropriate required rate of
return of anasset, if that asset is to be added to an already well-diversified portfolio, given that asset's nondiversifiable risk. The model takes into account the asset's sensitivity to non-diversifiable risk (also known
as systematic risk or market risk), often represented by the quantity beta () in the financial industry, as well as
the expected return of the market and the expected return of a theoretical risk-free asset. CAPM suggests that an
investors cost of equity capital is determined by beta.
Formula
The CAPM is a model for pricing an individual security or portfolio. For individual securities, we make use of
the security market line(SML) and its relation to expected return and systematic risk (beta) to show how the market
must price individual securities in relation to their security risk class. The SML enables us to calculate the rewardto-risk ratio for any security in relation to that of the overall market. Therefore, when the expected rate of return for
any security is deflated by its beta coefficient, the reward-to-risk ratio for any individual security in the market is
equal to the market reward-to-risk ratio, thus:

The market reward-to-risk ratio is effectively the market risk premium and by rearranging the above equation
and solving for

, we obtain the capital asset pricing model (CAPM).

where:

is the expected return on the capital asset

is the risk-free rate of interest such as interest arising from government bonds
(the beta) is the sensitivity of the expected excess asset returns to the expected excess market

returns, or also

is the expected return of the market

is sometimes known as the market premium (the difference between the expected
market rate of return and the risk-free rate of return).

is also known as the risk premium

Restated, in terms of risk premium, we find that:

which states that the individual risk premium equals the market premium times .
Note 1: the expected market rate of return is usually estimated by measuring the arithmetic average of
the historical returns on a market portfolio (e.g. S&P 500).
Note 2: the risk free rate of return used for determining the risk premium is usually the arithmetic
average of historical risk free rates of return and not the current risk free rate of return.
For the full derivation see Modern portfolio theory.
4. Contrast the calculation of future (terminal) value with the calculation of present value. What is the
difference?
In finance, the terminal value (continuing value or horizon value) of a security is the present value at a future point
in time of all future cash flows when we expect stable growth rate forever. It is most often used in multistage discounted cash flow analysis, and allows for the limitation of cash flow projections to a several-year period.
Forecasting results beyond such a period is impractical and exposes such projections to a variety of risks limiting
their validity, primarily the great uncertainty involved in predicting industry and macroeconomic conditions beyond
a few years.
Thus, the terminal value allows for the inclusion of the value of future cash flows occurring beyond a several-year
projection period while satisfactorily mitigating many of the problems of valuing such cash flows. The terminal
value is calculated in accordance with a stream of projected future free cash flows in discounted cash flow analysis.
For whole-company valuation purposes, there are two methodologies used to calculate the Terminal Value.
In economics, present value, also known as present discounted value, is the value of an expected income stream
determined as of the date of valuation. The present value is always less than or equal to the future value because

money has interest-earning potential, a characteristic referred to as the time value of money, except during times of
negative interest rates, when the present value will be greater than the future value.[1] Time value can be described
with the simplified phrase, A dollar today is worth more than a dollar tomorrow. Here, 'worth more' means that its
value is greater. A dollar today is worth more than a dollar tomorrow because the dollar can be invested and earn a
day's worth of interest, making the total accumulate to a value more than a dollar by tomorrow. Interest can be
compared to rent.[2] Just as rent is paid to a landlord by a tenant, without the ownership of the asset being transferred,
interest is paid to a lender by a borrower who gains access to the money for a time before paying it back. By letting
the borrower have access to the money, the lender has sacrificed the exchange value of this money, and is
compensated for it in the form of interest. The initial amount of the borrowed funds (the present value) is less than
the total amount of money paid to the lender.

5.Contrast the objective of maximizing earnings with that of maximizing wealth.

When maximizing earnings, you are focusing on a flow; when maximizing wealth, you are focusing on a stock.
While maximizing one does not mean you are unconcerned about the other, there will be a difference of emphasis.
(It is possible for earnings maximization to ignore wealth; it is not possible for wealth maximization to ignore
earnings).
Earnings is more focused on short term standard of living. I want to earn as much as I can so I can buy as much as I
want. In the extreme, I don't save at all (i.e., I do not build up any wealth). I'm enjoying life now, but if anything
happens to my earnings stream, I am in trouble.
Maximizing wealth trades some of that standard of living for security. I may not enjoy as high a standard of living
now, but I will be able to maintain my current standard of living longer.
For example, let's say our earnings maximizer earns $100,000 a year and spends it all. He is enjoying a very high
standard of living. Our wealth maximizer makes $50,000, but spends only $30,000. His standard of living is much
lower, but for every year he earns $50,000, he can maintain his standard of living for 1.67 years. For the earnings
maximizer, the ratio is 1:1. The wealth maximizer still cares about earnings, because the more he earns the more he
can save. He, however, at two ways to reach his goal: earn more or spend less. The earnings maximizer can only
earn more.

6. Explain differences between Eurobonds, zero coupon bonds, and junk bonds.
Eurobonds, foreign bonds, and domestic bonds of different countries differ in terminology, in the way interest is
computed, and in features. We do not address these differences, because that would require a separate book.
Eurobond A bond issue sold internationally outside the country in whose currency the bond is denominated.
A zero-coupon bond makes no periodic interest payments but
instead is sold at a deep discount from its face value. Why buy a bond that pays no
interest? The answer lies in the fact that the buyer of such a bond does receive a return.
This return consists of the gradual increase (or appreciation) in the value of the security from
its original, below-face-value purchase price until it is redeemed at face value on its maturity
date.
The valuation equation for a zero-coupon bond is a truncated version of that used for a
normal interest-paying bond. The present value of interest payments component is lopped
off, and we are left with value being determined solely by the present value of principal
payment at maturity, or

Suppose that Espinosa Enterprises issues a zero-coupon bond having a 10-year maturity

and a $1,000 face value. If your required return is 12 percent, then

Using Table II in the Appendix, we find that the present value interest factor for a single
payment 10 periods in the future at 12 percent is 0.322. Therefore:
V $1,000(0.322)

$322

If you could purchase this bond for $322 and redeem it 10 years later for $1,000, your initial
investment would thus provide you with a 12 percent compound annual rate of return.
Zero-coupon bond A bond that pays no interest but sells at a deep discount from its face value; it provides
compensation to investors in the form of price appreciation.
A bond is a security that pays a stated amount of interest to the investor, period after period,
until it is finally retired by the issuing company.
During the 1980s an active market developed for non-investment-grade bonds. These are
bonds with a rating of Ba (Moodys) or less, and they are called junk or high-yield bonds.
The market for junk bonds was fostered by the investment banking firm of Drexel Burnham
Lambert, which dominated this market until Drexels demise in 1990. A number of companies
used the market to raise billions of dollars, displacing what was previously bank and
private placement financing. In addition, junk bonds were used in acquisitions and leveraged
buyouts (topics taken up in Chapter 23).
Principal investors in junk bonds include pension funds, high-yield bond mutual funds,
and some individuals who invest directly. A secondary market of sorts exists, but in any kind
of financial panic or flight to quality by investors in the bond markets, such liquidity dries
up. In the late 1980s, bonds issued in connection with highly levered transactions (leveraged
buyouts) began to experience difficulty, and many issues defaulted. Investors lost confidence,
and there was a sharp drop in new issues. The market recovered after the early 1990s, particularly
for higher-quality issues. Although junk bonds are a viable means of financing for
some companies, it must be recognized that there are windows of opportunity. In an unstable
market, few investors are to be found.
Junk bond A high-risk, high-yield (often unsecured) bond rated below investment grade.

7. Explain how an interest rate is just a price.

Interest rate is just like price, is determined by the supply and demand.
When many people apply for loans, banks will tend to increase the interest rate to slow down the applications
because banks cannot lend unlimitedly.
When very few people apply for loans, banks will tend to decrease the rate to attract more customers.
Of coz, these must be governed by the central bank, and not simple let the banks do whatever they want.

8. Explain the difference between a secured corporate bond and an unsecured corporate bond.
A bond is a debt security commonly issued by government agencies as well as large corporations. Regardless of the
issuing entity, all securities fall into two overarching categories: secured and unsecured bonds. Investors thinking
about buying bonds need to understand the risks, rewards, advantages, and disadvantages of these securities.

In this article, we're going to talk about the differences between secured and unsecured bonds. As part of that
explanation, we'll also provide some practical examples for each type of security. We'll then talk about their pros
and cons; finishing up with a discussion of the factors to consider before purchasing a bond.
Secured Bonds
When a bond is backed by a specific asset, it is termed a secured bond. Typical assets include cash or physical
property, such as plant equipment or machinery. A secured bond tells the investor that something of value will be
available to bondholders in the event the issuer cannot pay the interest owed, or repay the principal balance.
Secured Bond Examples
A government agency may decide to build a new bridge to span a waterway and connect two cities. That agency
may issue bonds to help finance the construction of that bridge. These bonds could be secured by the toll charges
collected from motorists traveling across the bridge. In this example, the bond would be secured by a future
revenue stream (cash). This type of bond is oftentimes referred to as a revenue bond.
Companies can also purchase real estate or other mortgageable property. When doing so, the company may decide
to use the real estate as collateral. This is accomplished through a mortgage bond. If the company defaults on this
security, the bondholders can collect a share of the money they're owed by foreclosing on the property.
Mortgage Bonds
This category can be further subdivided into junior and senior debt, also referred to as a first mortgage. If the issuer
of the bond is forced to liquidate their real estate holdings, the holders of senior debt (first mortgages) are paid
before the holders of junior debt.
Unsecured Bonds
An unsecured bond, also referred to as a debenture, is not backed by an asset of any kind. If bankruptcy occurs,
repayment is not guaranteed by a future revenue stream, equipment, or property. An unsecured bond is only backed
by the full faith and credit of the issuing institution.
Unsecured Bond Examples
U.S. Treasury securities such as bills, notes, and bonds are good examples of unsecured debt. The only guarantee of
repayment is the trust that investors have in the federal government. Although unpopular with taxpayers, the federal
government always has the option of raising income taxes to meet its financial obligations.
An income bond is another example of an unsecured bond. These securities are issued by large corporations, and
the payment of interest is contingent upon sufficient earnings. Also known as an adjustment bond, this last type of
security is frequently issued by companies attempting to maintain their operations while seeking bankruptcy
protection.
Risk of Repayment
Generally, secured bonds are considered safer investments than unsecured bonds. If the company begins to struggle
financially, the asset used as collateral can be sold to help the company meet its financial obligations. Therefore,
investors are willing to accept a lower rate of interest on secured bonds.
If a company liquidates its assets in a bankruptcy proceeding, the holders of unsecured debt have no real claim to
money owed. There isn't an asset the bankruptcy trustee can sell to help repay these bondholders. While secured

debt can provide the investor with a greater sense of safety, it should not be the ultimate measure of protection
against default.
Credit Ratings
Bond ratings were specifically developed to help investors understand the relative risk involved with the purchase of
these securities. These ratings are an independent entity's assessment of the borrower's ability to meet all of their
financial commitments. Currently, there are three credit agencies that set the standards for quality ratings: Moody's,
Standard and Poor's, and Fitch Ratings.
Each agency uses roughly ten different credit ratings, or grades, that range from Investment Grade to In Default. A
company's credit rating is perhaps the single most important factor used to determine the appropriate interest rate, or
yield.
Bond Features
In addition to the ratings assigned to a bond, investors should also consider the features offered. For example, bonds
can be callable, which allow the issuer to repay the bond's face amount before its maturity date. Zero coupon bonds
do not pay periodic interest; rather they are sold at a discount to face value.
Before making a purchase decision, it's important for an investor to consider all of the above factors. For example, a
secured bond that is of junk quality is a much riskier investment than an unsecured bond that is considered
investment grade. While high-quality zero coupon bonds are useless to investors seeking a periodic stream of
income.
Secured Vs. Unsecured Corporate Bond
If you're invested in a company that fails, whether your bond is secured or unsecured will play a pivotal role in
whether you ever see your money again. When a company issues a bond, it is either secured or unsecured. By
knowing the advantages and disadvantages of each type of bond, you can balance returns and risk in a way that
complements--and potentially improves--your investment strategy.
Corporate Bonds
When you purchase a bond, you are giving a company your money to borrow for a certain period of time. In
exchange, the company agrees to pay you interest on specific dates, at a prescribed rate, until the bond matures.
When the bond matures, or comes due, you are paid back the face value of the bond. The ability of the company to
meet these obligations varies according to its financial strength.
Secured Bonds
Financial strength is not always easy to predict. Sometimes even large and apparently strong companies fail.
Secured bonds alleviate some of this risk, because the bond is backed by a specific asset or revenue stream. If the
company becomes financially strapped, the secured bondholders have first access to that asset, or to revenue
provided by the specific asset. If this occurs, investors are able to collect at least a portion of what they are owed
Pros and Cons
As a secured bondholder you are less at risk of losing your investment than unsecured bondholders are. This is the
main advantage of a secured bond--safety. The downside is that returns are also generally lower, because there is
less risk to you. Another question to consider is what the bonds are secured by: Secured bonds may be backed by the

revenue stream of the project the bonds were issued in order to finance. While this provides some security, there is
no guarantee the project will produce the expected revenue, and if that project fails, bond holders may still face
some losses.
Unsecured Bonds
If you believe in the corporation's ability to meet its obligation to you, you may opt to invest in an unsecured bond.
These bonds are not backed by anything but your trust and the company's commitment to pay. In the event a
corporation goes bankrupt, there are no specific assets that can be sold to repay the bondholders. This additional risk
usually means you will receive a higher interest rate than you would if you held a secured corporate bond.
Pros and Cons
In the bond market, a higher risk usually means a higher return. Since the bond is not secured--and you face
potential sizable losses if the company goes bankrupt--you receive a higher return from the company for lending it
money. If a company is stable, has a long history of meeting its financial obligations and has a good credit rating, the
additional risk may be worth the higher return. The return and risk on a unsecured bond can vary greatly, from lowrisk and low return to high-risk and high return. Do some research on the company before buying its bond to make
sure you feel confident it can meet its obligation to you.

DEFINITION of 'Secured Bond'

A type of bond that is secured by the issuer's pledge of a specific asset, which is a form of collateral on the loan. In
the event of a default, the bond issuer passes title of the asset or the money that has been set aside onto the
bondholders. Secured bonds can also be secured with a revenue stream that comes from the project that the bond
issue was used to finance.

INVESTOPEDIA EXPLAINS 'Secured Bond'

Because of the pledge of an asset, secured bonds are seen as less risky than unsecured bonds, and they generally
provide lower returns than unsecured bonds. Securing a bond with the pledge of an asset is also a way for the bond
issuer to lower its interest payments. This means that secured bonds provide investors with a lower return than
unsecured bonds because even in the event of default, investors will be compensated at least somewhat for their
investment. Some types of secured bonds are mortgage bonds and equipment trust certificates.
Debentures are unsecured bonds, which means that bondholders have nothing but the corporation's promise that
interest payments will be made on time, or made at all. This promise is often called "full faith and credit."
Unsecured Corporate Bonds (Debentures)
Debentures are not backed by equipment, securities portfolios, mortgages on real estate, or any other specific assets.
Instead of guaranteed collateral, debenture-holders are secured in their principal investment by the general credit of
the issuer. Thus, while secured bondholders have priority over debenture-holders in the event of default or
bankruptcy, debenture-holders have the same priority as other general creditors, such as banks, insurance companies
and other financial institutions, and greater priority than shareholders of common or preferred stock. Debentures
usually offer higher yields than secured bonds, which is the expected trade-off for increased risk to the principal
investment.
Companies sometimes issue debentures because they don't have enough assets to collateralize into a secured bond
issue, or have already collateralized all their assets for secured bonds. Other companies are so successful and
established that debenture-holders can trust them to repay their debts with future revenue, leaving specific assets
free for financing in the future. The US government is the biggest issuer of debentures, but these instruments will be
discussed in further articles.

Secured Vs. Unsecured Corporate Bonds

Corporations often borrow funds by issuing corporate bonds. Investors lend a company funds by purchasing the
corporate bonds issued and become creditors for the corporation. The same company can issue different types of
bonds simultaneously. Some may be secured, or senior bonds, and others may be unsecured bonds, or debentures.
The degree of risk and level of earnings vary from one issue to another and do not necessarily depend on whether
the bonds are classified as secured or unsecured.
Secured Bonds
Bondholders of secured bonds hold a legal claim to particular assets of the issuer should the corporation default.
Different types of collateral can back secured bonds. For example, mortgage bonds are a type of secured bond in
which real estate assets provide the collateral for the issue. The proceeds a corporation receives from a mortgage
bond issue may be used to pay for the construction of new buildings, with the structures being built providing the
collateral for the issue.
Another example of a secured bond is an enhanced equipment trust certificate. A specialized form of secured bond
first used by railroads to finance the purchase of new equipment, EETCs are used by transportation companies to
pay for the lease and eventual purchase of equipment and supplies. The equipment provides the collateral until the
corporation pays bondholders in full.
Unsecured Bonds
Debentures are unsecured bonds and give the bondholder no legal claims on assets; no collateral backs the debt.
Since unsecured bonds are backed only by the corporation's promise to pay, the quality of the bonds is based on the
creditworthiness of the issuer. Should a corporation default on unsecured bonds, the bondholders cannot claim
property promised as collateral on other debts.
Earnings
Most corporate bonds are issued at a par or face value of $1,000 or $5,000, and they generally pay interest
semiannually. The indenture, the contract between the issuer and the bondholders, details the legal obligations of the
issuer to the bondholders. Corporations tend to issue more bonds when market interest rates are low. However, all
bonds carry some degree of interest rate risk regardless of the secured or unsecured provisions of the bond.
Quality and Yield
Comparing yields between an unsecured bond and a secured one is not relevant if the quality of the bonds is similar.
Comparative analysis based on the quality of different issues takes into consideration several factors that rating
agencies use to grade the issues. For example, bonds with only a slight chance of default are rated highest,
regardless of whether secured or unsecured, just as junk bonds are considered speculative grade and carry a high
risk. Thus, collateral tied to bonds affects yield only when the quality of the issue and the corporation behind it are
considered.

9. How do commercial banks obtain their funds?

The functions of a commercial bank - mainly to raise funds for deposits of deposit interest and their placement in the
credits of the loan interest. But there are other, versatile functions CB:

financial intermediaries who take funds of individuals and entities on terms of maturity, repayment and interest
payment (deposit interest that depositors receive current, term and savings accounts);
commercial banks to lend to businesses, organizations and individuals to contribute to the development of the
economy, structural changes in the economy;
implementing securities transactions, commercial banks contribute to the development of the stock market;
Commercial banks act as advisers to their customers for the individual banking, economic and stock transactions.
. Banks are businesses: they need to make money and they do this in a number of different ways.
Commercial and retails banks raise funds by lending money at a higher rate of interest than they borrow it. This
money is borrowed from other banks or from customers who deposit money with them. They also charge customers
fees for services to do with managing their accounts, and earn money from bank charges levied on overdrafts which
exceed agreed limits.
Investment banks earn fees from providing advice to large organisations coming to the City to issue stocks and
shares, and for underwriting these issues, as well as trading securities on the financial markets.

10. How does an investor receive a return from buying a bond?

11. How does standard deviation relate to the general concept of risk?
In statistics, the standard deviation (SD) (represented by the Greek letter sigma, ) is a measure that is used to
quantify the amount of variation or dispersion of a set of data values.[1] A standard deviation close to 0 indicates that
the data points tend to be very close to the mean (also called the expected value) of the set, while a high standard
deviation indicates that the data points are spread out over a wider range of values.
The standard deviation of a random variable, statistical population, data set, or probability distribution is the square
root of its variance. It is algebraically simpler, though in practice less robust, than the average absolute deviation.[2]
[3]

A useful property of the standard deviation is that, unlike the variance, it is expressed in the same units as the data.

There are also other measures of deviation from the norm, including mean absolute deviation, which provide
different mathematical properties from standard deviation.[4]
In addition to expressing the variability of a population, the standard deviation is commonly used to measure
confidence in statistical conclusions. For example, the margin of error in polling data is determined by calculating
the expected standard deviation in the results if the same poll were to be conducted multiple times. The reported
margin of error is typically about twice the standard deviationthe half-width of a 95 percent confidence interval.
In science, researchers commonly report the standard deviation of experimental data, and only effects that fall much
farther than two standard deviations away from what would have been expected are considered statistically
significantnormal random error or variation in the measurements is in this way distinguished from causal

variation. The standard deviation is also important in finance, where the standard deviation on the rate of return on
an investment is a measure of the volatility of the investment.

12. How is a bond like a loan? Explain.

A bond, like a loan, is issued for a fixed period of time, maturity, with the borrower typically agreeing to make fixed
interest payments at regular intervals using an interest rate, yield, on the amount borrowed, principal.
In finance, a bond is an instrument of indebtedness of the bond issuer to the holders. It is a debt security, under
which the issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay
them interest (the coupon) and/or to repay the principal at a later date, termed the maturity date.[1] Interest is usually
payable at fixed intervals (semiannual, annual, sometimes monthly). Very often the bond is negotiable, i.e. the
ownership of the instrument can be transferred in the secondary market. This means that once the transfer agents at
the bank medallion stamp the bond, it is highly liquid on the second market

13. If you invest the same amount in each of three accounts today, which account produces the highest future value
if the annual percentage rate is the same? Account A: annual compounding, Account B: quarterly compounding,
Account C: continuous compounding. Explain.

14. Is preferred stock a debt or equity instrument? Explain.

Preferred stock (also called preferred shares, preference shares or simply preferreds) is a type of stock which
may have any combination of features not possessed by common stock including properties of both an equity and a
debt instrument, and is generally considered a hybrid instrument. Preferreds are senior (i.e., higher ranking)
to common stock, but subordinate to bonds in terms of claim (or rights to their share of the assets of the company)
[1]

and may have priority over common stock (ordinary shares) in the payment of dividends and upon liquidation.

Terms of the preferred stock are described in the articles of association.

Similar to bonds, preferred stocks are rated by the major credit-rating companies. The rating for preferreds is
generally lower than for bonds because preferred dividends do not carry the same guarantees as interest payments
from bonds and because preferred-stock holders' claims are junior to those of all creditors.

15. Is there any relation between risk and return? Explain.

Generally, the higher the risk of an investment, the higher the potential return. There is no guarantee that you will
actually get a higher return by accepting more risk. Higher risk only increases the potential for higher returns you
could get a lower return or even lose money.

Some investments are riskier than others theres a greater chance you could lose some or all of your money. For

example, Canada Savings Bonds (CSBs) have very low risk because they are issued by the government of
Canada. GICs and bank deposits also carry low risk because they are backed by large financial institutions. With
GICs and deposits you also have the additional protection of deposit insurance on amounts up to $100,000 if your
financial institution goes bankrupt. With these low-risk investments you are unlikely to lose money. However,
they have a lower potential return than riskier investments and they may not keep pace with inflation.
Over the long-term, bonds have a potentially higher return than CSBs and GICs, but they also have more risks.
Their prices may drop if the issuer's creditworthiness declines or interest rates go up. If prices drop, you will incur a
loss.
Stocks have a potentially higher return than bonds over the long term, but they are also riskier. Bond investors are
creditors. As a bond investor, youre legally entitled to fixed amounts of interest and principal and are repaid in
priority if the company goes bankrupt. However, if the company is successful, you wont earn more than the fixed
amounts of interest and principal. Shareholders are owners. As a shareholder, if the company is unsuccessful, you
could lose all of your money. But if the company is successful, you could see higher dividends and a rising share
price.
Some investments, such as those sold on the exempt market are highly speculative and very risky. They should
only be purchased by investors who can afford to lose all of the money they have invested

16. What advantages and disadvantages are generally associated with the use of short-term debt? Discuss.

Short-term credits have both advantages and disadvantages. One of the main advantages, as we have said, the
flexibility: with a decrease in the financing needs of the company's short-term debt can be repaid. Another benefit cost reduction: in fact since the risk associated with short-term lending, lower than the long-term, lower and interest
rates. Thus, financing through short-term loans associated, usually with lower interest payments. In general, shortterm debt - it is more risky than long-term, for two reasons: first, the interest rates on short-term loans are subject to
large fluctuations, while interest rates on long-term loans are more predictable and less volatile; Second, the
maturity of short-term debt was only a few months. If the firm does not have the money to pay debts or to refinance
the loan, it can lead to bankruptcy.

17. What distinguishes a primary market from a secondary market?

Primary and Secondary Markets. Within money and capital markets there exist both
primary and secondary markets. A primary market is a new issues market. Here, funds
raised through the sale of new securities flow from the ultimate savers to the ultimate investors
in real assets. In a secondary market, existing securities are bought and sold. Transactions
in these already existing securities do not provide additional funds to finance capital investment.

(Note: On Figure 2.1 there is no line directly connecting the secondary market with the
investment sector.) An analogy can be made with the market for automobiles. The sale of
new cars provides cash to the auto manufacturers; the sale of used cars in the used-car market
does not. In a real sense, a secondary market is a used-car lot for securities.
The existence of used-car lots makes it easier for you to consider buying a new car because
you have a mechanism at hand to sell the car when you no longer want it. In a similar fashion,
the existence of a secondary market encourages the purchase of new securities by individuals
and institutions. With a viable secondary market, a purchaser of financial securities
achieves marketability. If the buyer needs to sell a security in the future, he or she will be
able to do so. Thus, the existence of a strong secondary market enhances the efficiency of the
primary market.
Primary market A market where new securities are bought and sold for the first time (a new issues market).
Secondary market A market for existing (used) securities rather than new issues.

The difference between a primary and a secondary market is that a primary market is one in which a stock is being
offerred directly from a company to investors for the first time. This happens most commonly during an initial
public offer.
In contrast to this, a secondary market is a market in which investors are buying stocks from and selling stocks to
one another. These are stocks that have already been issued by the firm and sold to some investor on the primary
market. When that investor wishes to sell the stock, he or she does so by selling it to some other investor on the
secondary market.
The difference, then, is that primary markets involve stocks being sold for the first time by a firm directly to
investors while secondary markets involve investors dealing existing stocks with one another.

"Primary Market" refers to the initial offering of stocks or bonds to the buying public, as when a previously
privately-owned company decides to "go public" by issuing shares of its ownership, or stock, to the public. In the
case of Initial Public Offerings, or IPOs, the stock is sold to the public for the first time, and any subsequent transfer
of that stock constitutes what is known as the "secondary market."
The "Secondary Market," then, refers to the subsequent sell or transfer of stocks and bonds throughout the broader
public marketplace through designated exchanges, most prominently, the New York Stock Exchange and Nasdaq.
The stocks bought and sold through these exchanges are no longer in the 'hands' of the original issuing companies,
but, rather, are sold from public hands to public hands.
The primary market is direct from the company issuing a stock or bond to the buyer. The secondary market is after
the initial public offering.
What Is Primary Market?

The primary market is also known as new issues market. Here, the transaction is conducted between the issuer and
the buyer. In short, the primary market creates new securities and offers them to the public.
For instance, Initial Public Offering (IPO) is an offering of the primary market where a private company decides to
sell stocks to the public for the first time. An important point to remember here is that in the primary market,
securities are directly purchased from the issuer.

Capital or equity can be raised in primary market by any of the following four ways:
1. Public Issue

As the name suggests, public issue means selling securities to public at large, such as IPO. It is the most vital
method to sell financial securities.
2. Rights Issue

Whenever a company needs to raise supplementary equity capital, the shares have to be offered to present
shareholders on a pro-rata basis, which is known as theRights Issue.
3. Private Placement

This is about selling securities to restricted number of classy investors like frequent investors, venture capital funds,
mutual funds and banks comes under Private Placement.
4. Preferential Allotment

When a listed company issues equity shares to a selected number of investors at a price that may or may not be
pertaining to the market price is known asPreferential Allotment.
The primary market is also known as the New Issue Market (NIM) as it is the market for issuing long-term equity
capital. Since the companies issue securities directly to the investors, it is responsible to issue the security
certificates too. The creation of new securities facilitates growth within the economy.
What is Secondary Market?

In secondary market, the securities issued in the primary market are bought and sold. Here, you can buy a share
directly from a seller and the stock exchange or broker acts as an intermediary between two parties.
The secondary market is actually formed by another layer of investors who deal with primary market investor to buy
and sell financial securities such as bonds, futures and stocks. These dealings happen in the proverbial stock
exchange.
National Stock Exchange (NSE) and New York Stock Exchange (NYSE) are some popular stock exchanges.
Majorly, the trade happens between investors without any involvement with the company that issued the securities
in the primary market.
The secondary market is further divided into two kinds of market.

1. Auction Market

The auction market is a place where buyers and sellers convene at a place and announce the rate at which they are
willing to sell or buy securities. They offer either the bid or ask prices, publicly. Since all buyers and sellers are
convening at the same place, there is no need for investors to seek out profitable options. Everything is announced
publicly and interested investors can make their choice easily.
2. Dealer Market

In a dealer market, none of the parties convene at a common location. Instead, buying and selling of securities
happen through electronic networks which are usually fax machines, telephones or custom order-matching
machines.
Interested sellers deliver their offer through these mediums, which are then relayed over to the buyers through the
medium of dealers. The dealers possess an inventory of securities and earn their profit through the selling. A lot of
dealers operate within this market and therefore, a competition exists between them to deliver the best offer to their
investors. This makes them deliver the best price to the investors. An example of a dealer market is the NASDAQ.
The secondary markets are important for price discovery. The market operations are carried out on stock exchanges.
A variation to the dealer market is the OTC market. OTC stands for Over the Counter market. The concept came
into existence during the early 1920s period through Wall Street trading, which implied the prevalence of an
unorganized system of dealers who conducted trades via networks. Stock shops existed to buy and sell shares overthe-counter. In other words, these were unlisted stocks which were sold privately.
Over time, the notion of OTC underwent a change. These days the over-the-counter denotes those stocks which are
not traded over NYSE, NASDAQ or American Stock Exchange (AMEX). The over-the-counter implies those stocks
which are traded on the pink sheets or on over-the-counter bulletin boards (OTCBB). Pink sheets are a name given
to the daily list of stocks published with ask and bid prices by the National Quotation Bureau. The OTCBB service
is offered by the National Association of Securities Dealers (NASD) which accurately displays the last sale prices,
real time quotations and other volume information of over-the-counter securities.
Endnote

I hope the article clarified and made you understand the concepts of primary and secondary markets. Now you know
the importance of both primary and secondary markets.

It will also interest you to know that there is something called third markets andfourth markets but they are not
heard of publicly. In the third and fourth markets, transactions of high volume happen between the dealers and the
brokers, and large institutions using over-the-counter networks.
The third market caters to transactions between dealer/brokers and large institutions whereas the fourth market is
only about transactions between large institutions. The activities of these markets have little or no influence on the
workings of the usual stock trading by an average investor. Moreover, the transactions in these markets are always
of high volume.
If there are any queries on primary and secondary market or how the primary market is different from the secondary
market, share below.
A study on the primary vs. secondary market gives information on the various aspects of the capital market
trading. Both the primary market and secondary market are two types of capital market depending on the issuance of
securities.

18. What does beta measure? How do we use beta in CAPM (Capital Asset Pricing Model)?

In finance, the capital asset pricing model (CAPM) is used to determine a theoretically appropriate required rate of
return of anasset, if that asset is to be added to an already well-diversified portfolio, given that asset's nondiversifiable risk. The model takes into account the asset's sensitivity to non-diversifiable risk (also known
as systematic risk or market risk), often represented by the quantity beta () in the financial industry, as well as
the expected return of the market and the expected return of a theoretical risk-free asset. CAPM suggests that an
investors cost of equity capital is determined by beta.
The Formula
Sharpe found that the return on an individual stock, or a portfolio of stocks, should equal its cost of capital. The
standard formula remains the CAPM, which describes the relationship between risk and expected return.
Here is the formula:

CAPM's starting point is the risk-free rate - typically a 10-year government bond yield. To this is added a premium
that equity investors demand to compensate them for the extra risk they accept. This equity market premium consists
of the expected return from the market as a whole less the risk-free rate of return. The equity risk premium is
multiplied by a coefficient that Sharpe called "beta."
Beta
According to CAPM, beta is the only relevant measure of a stock's risk. It measures a stock's relative volatility - that
is, it shows how much the price of a particular stock jumps up and down compared with how much the stock market
as a whole jumps up and down. If a share price moves exactly in line with the market, then the stock's beta is 1. A
stock with a beta of 1.5 would rise by 15% if the market rose by 10%, and fall by 15% if the market fell by 10%.
(For further reading, see Beta: Gauging Price Fluctuations and Beta: Know The Risk.)

9. What is annuity? What distinguishes an ordinary annuity from an annuity due?

Annuities
In finance, an annuity is any series of equal payments that are made at regular intervals. Though the word "annuity"
comes from the Latin for "yearly," the periods between payments in an annuity can be just about anything -- years,
months, weeks; it doesn't matter as long as the interval is consistent. An annuity can also last for a short period -- say
a few months -- or for decades.
Ordinary Annuity
With an ordinary annuity, the payment comes at the end of the covered term. The typical home mortgage is an
example of an ordinary annuity. When you pay your mortgage on Sept. 1, for example, you're actually paying for the
use of your home (and the use of the lender's money) for August. You'll pay for September on Oct. 1, and so on.
Most annuities are ordinary annuities, which is why they're called "ordinary." Other common examples include
interest payments from bonds and payments on installment loans.
Annuity Due
In an annuity due, the payment comes at the beginning of the term. The most familiar application of the annuity due
is rent. When you pay apartment rent on Sept. 1, you're paying for the use of the apartment in September. Unlike
with a mortgage, when your first payment typically isn't due until after your first full month in the home, your first
rent payment is due when you move in. Insurance premiums are another common example of an annuity due; you
pay today for coverage in the future.
Comparison
In general, if you're the one making the payments, you're better off with an ordinary annuity. If you're the one
receiving the payments, you're better off with an annuity due. The reason lies in a basic principle of finance known
as the "time value of money": Because of inflation and the ability to earn interest on invested or banked money, a
sum of money today is worth more than the same sum in the future. The longer you can delay making your first
fixed payment, the less that payment costs you.
On the flip side, the earlier you can receive the first payment of an annuity, the more it's worth. Practically speaking,
though, once an annuity begins, the cash flows occur on the same schedule, and there's little noticeable difference
between an ordinary annuity and an annuity due.

20. What is the difference between a foreign bond and a Eurobond?

Eurobonds
In eurobonds, a person, or company, will borrow money from a lender in a currency different from the borrower's
local currency. For example, an American company might want to issue a bond in the Swiss bond market and have
the money borrowed in euros. The names say what money is connected to eurobonds. For example, euroyen is
denominated in Japanese yen, while the euroswiss is done with a Swiss franc.
Foreign Bonds
A foreign bond will always have a borrower seeking funding in a foreign bond market in the country's currency of
where that bond is issued. For example, it's considered a foreign bond if a French company is using yen in Japan.
These bonds have more colorful names connected to the country. Some of them are the Yankee (U.S.), Samurai
(Japan), Bulldog (Great Britain), Kangaroo (Australia), and Heidi bonds (Switzerland).
Tax Advantage
Both types can be a tax-friendly way for companies to raise money in different foreign markets. With a eurobond, a
company won't fall under the wrath of one countrys tax policy. This form of debt issuance allows for a potentially
low-cost way to raise money in the world bond market. The eurobond market allows investors to lend money in
overseas markets without being double-taxed by two countries.
Currency Risk
Both bonds carry a currency or exchange rate risk. It occurs in the holding of any investment in a currency different
from that of the lender's home country. Either the borrower or the lender needs to perform some sort of currency
exchange throughout the bonds life. These exchange rate movements can either be beneficial or detrimental to
either party, which brings on the risk.
What Is the Difference Between Eurobonds and Foreign Bonds?

A Eurobond is a bond that is issued by an international borrower and sold to investors in countries with
currencies other than the currency in which the bond is denominated. An example of a Eurobond is a dollardenominated bond issued by a U.S. company and sold to Japanese investors. A Eurobond is typically issued in
a single currency (frequently dollars) in many countries. By selling Eurobonds, many multinational companies
finance their global operations especially in the countries in which they are do business. Eurobonds are also a
source of intermediate and long-term financing of sovereign governments and supranationals (e.g., IMF, WB,
etc).
In contrast to a Eurobond, a foreign bond is a bond issued in a host countrys financial market, in the host
countrys currency, by a foreign borrower. This bond is subject to the regulations imposed on all securities
traded in the national market and sometimes to special regulations and disclosure requirements governing
foreign borrowers. Many of these issues have colorful nicknames such as:
Yankee bonds: dollar-denominated bonds which are issued by non-American borrowers in the U.S. market.
Samurai bonds: yen-denominated bonds which are issued by non-Japanese borrowers in the Japanese market.

Bulldog bonds: pound sterling-denominated bonds which are issued by non-British borrowers in the British
market.
Heidi bonds: franc-denominated bonds which are issued by non-Swiss borrowers in the Swiss market.
Rembrandt bonds: guilder (now euro)-denominated bonds which are issued by non-Dutch borrowers in the
Dutch market.
Matador bonds: peseta (now euro)-denominated bonds which are issued by non-Spanish borrowers in the
Spanish market.
For example, in the United States, Yankee bonds are registered with the Securities and Exchange
Commission (SEC), and like other U.S. bonds, their interest is paid semiannually. Sovereign government
issues or issues guaranteed by sovereign governments tend to denominate the Yankee bond market.

DEFINITION of 'Foreign Bond'

A bond that is issued in a domestic market by a foreign entity, in the domestic market's currency. A foreign bond is
most often issued by a foreign firm to raise capital in a domestic market that would be most interested in purchasing
the firm's debt. For foreign firms doing a large amount of business in the domestic market, issuing foreign bonds is a
common practice.
Types of foreign bonds include bulldog bonds, matilda bonds and samurai bonds.

INVESTOPEDIA EXPLAINS 'Foreign Bond'

Foreign bonds are regulated by the domestic market authorities and are usually given nicknames that refer to the
domestic market in which they are being offered.
Since investors in foreign bonds are usually the residents of the domestic country, investors find them attractive
because they can add foreign content to their portfolios, without the added exchange rate exposure.

A foreign bond has three characteristics:

The bond is either issued by a foreign entity (such as a government, municipality, or corporation).
The bond is traded on a foreign market.
and, The bond is denominated in a foreign currency.
Foreign bonds are subject to currency risks, as when you hold the bond it is denominated in a foreign currency. As
bonds take a specified time to mature, there is no guarentee of the return of the bond given the currency exchange
fluctuations.
A eurobond is a bond issued and traded in a country other than the one in which its currency is denominated. A
eurobond does not necessarily have to originate or end up in Europe although most debt instruments of this type are
issued by non-European entities to European investors. Meaning an entity can place a bond on the German exchange
denominated in American dollars.
Another difference is the composition of the underwriting syndicate. Eurobonds are underwritten by an international
syndicate and is not subject to the rules and regulations of any country. Foreign bonds, however, are underwritten in
the country of currency denomination, and are therefore subject to the regulations of that country.
International Bond Financing. The Eurocurrency market must be distinguished from the
Eurobond market. The latter market is a more traditional one, with underwriters placing
securities. Though a bond issue is denominated in a single currency, it is placed in multiple
countries. Once issued, it is traded over the counter in multiple countries and by a number
of security dealers. A Eurobond is different from a foreign bond, which is a bond issued by

a foreign government or corporation in a local market. A foreign bond is sold in a single

country and falls under the security regulations of that country. Foreign bonds have colorful
nicknames. For example, Yankee bonds are issued by non-Americans in the US market,
and Samurai bonds are issued by non-Japanese in the Japanese market. Eurobonds, foreign
bonds, and domestic bonds of different countries differ in terminology, in the way interest is
computed, and in features. We do not address these differences, because that would require a
separate book.

21.What is the purpose of stock market exchanges such as the New York Stock Exchange?
A stock market or equity market is the aggregation of buyers and sellers (a loose network of economic
transactions, not a physical facility or discrete entity) of stocks (also called shares); these may
include securities listed on a stock exchange as well as those only traded privately.

A stock exchange is a place or organization by which stock traders (people and companies) can trade stocks.
Companies may want to get their stock listed on a stock exchange. Other stocks may be traded "over the counter",
that is, through a dealer. A large company will usually have its stock listed on many exchanges across the world. [4]
Exchanges may also cover other types of security such as fixed interest securities or indeed derivatives.
'New York Stock Exchange - NYSE'
A stock exchange based in New York City, which is considered the largest equities-based exchange in the world
based on total market capitalization of its listed securities. Formerly run as a private organization, the NYSE became
a public entity in 2005 following the acquisition of electronic trading exchange Archipelago. The parent company of
the New York Stock Exchange is now called NYSE Euronext, following a merger with the European exchange in
2007.
Also known as the "Big Board", the NYSE relied for many years on floor trading only, using the open outcry
system. Today, more than half of all NYSE trades are conducted electronically, although floor traders are still used
to set pricing and deal in high volume institutional trading.

The origins of the exchange date all the way back to 1792. Because of its long operating history the NYSE is home
to the majority of the world's largest and best-known companies. Foreign-based corporations can list their shares on
the NYSE if they adhere to certain Securities and Exchange Commission (SEC) rules, known as listing standards.
The NYSE opens for trading Monday through Friday 9:30a.m. to 4:00p.m. (ET), closing early on rare occasions.
The market also shuts down during nine holidays throughout the year

22 .What is the role of a discount rate in decision-making?

Discount rate may refer to:

An interest rate (the term "discount" does not refer to the common meaning of the word, but to the meaning
in computations of present value)

The central bank's discount window interest rate

The annual effective discount rate, an alternative measure of interest rates to the standard Annual
Percentage Rate

in investment financing, discounted cash flow

theoretical or observed rates at which people discount future payoffs

in environmental economics, and more generally in assessing the general welfare impacts of
government policies, social discount rate (the basic mathematics is the same as discounted cash flow, but
the cash value of human lives etc. can only be crudely estimated)

Fees charged for accepting payments other than in banknotes and coins:

bankers' acceptance rates for accepting bankers' acceptances. If commission is included as well,
this is known as the all-in rate

Discount Rate under Merchant Account, the fees charged to merchants for accepting credit cards

23. Why is it difficult to value a callable bond?

Corporate bond issues often provide for a call provision, which gives the corporation the
option to buy back its bonds at a stated price (or series of stated prices) before their maturity.
However, not all bond issues are callable. Particularly in times of low interest rates some
corporations issue noncallable bonds. When a bond is callable, the call price is usually above
the par value of the bond and often decreases over time. Frequently, the call price in the first
year is established at 1 years interest above the face value of the bond. If the coupon rate is
14 percent, the initial call price may be 114 ($1,140 per $1,000 face value)
There are two types of call provision, according to when they can be exercised. The
security may be immediately callable, which simply means that the instrument may be bought
back by the issuer at the call price at any time. Alternatively, the call provision may be deferred
for a period of time. The most widely used deferred call periods are 5 years for public utility
bonds and 10 years for industrial bonds. During this deferment period, the investor is protected
from a call by the issuer. In recent years, virtually all issues of corporate bonds have
involved a deferred call as opposed to an immediate call feature.
The call provision gives the company flexibility in its financing. If interest rates should
decline significantly, it can call the bonds and refinance the issue at a lower interest cost. Thus
the company does not have to wait until the final maturity to refinance. In addition, the provision
may be advantageous to the company if it finds any of the protective covenants in the
bond indenture to be unduly restrictive.
Value of Call Privilege. Although the call privilege is beneficial to the issuing corporation,
it works to the detriment of investors. If interest rates fall and the bond issue is called, the
investors can invest in other bonds only at a sacrifice in yield to maturity. Consequently, the
call privilege usually does not come free to the borrower. Its cost, or value, is measured at
the time of bond issuance by the difference in yield on the callable bond and the yield that
would be necessary if the security were noncallable. This value is determined by supply and
demand forces in the market for callable securities.
One can think of the value of a callable bond as

where the noncallable bond is identical to the callable bond in all respects except for the
call feature. The greater the value of the call feature, the lower the value of the callable bond
relative to that of the noncallable one. The level and volatility of interest rates are key factors
giving value to the call feature.
If interest rates are high and expected to fall, the call feature is likely to have significant
value. Because the call price limits the upside potential in price movement, bondholders do
not realize the full benefit of a significant interest-rate decline. Just as the bondholders party

gets going, the bonds are called, and they can invest in other bonds only at a lower coupon
rate than the rate they currently enjoy. As a result, investors demand a significantly higher
yield (and lower price) on the callable bond than they do on the noncallable one. In contrast,
when interest rates are low and expected to rise, the threat of a call is negligible. As a result,
the yields on the two bonds (callable and noncallable) may be nearly the same. The volatility
of interest rates determines the magnitude of bond price movement. The greater the volatility,
the greater the magnitude of possible interest-rate decline. As with any option, the greater
the volatility of the associated asset, the more valuable the option. (See Chapter 21 and its
Appendix for elaboration on this principle.)
In the Appendix to this chapter, we explore how a company decides whether or not calling
its bonds will be a profitable undertaking. By refunding (replacing) the bonds with a
bond issue with a lower coupon, certain costs may be more than offset, and the call would
be worthwhile.

24. What is the best proxy to the value of shares: book value or market value? Explain.
Its a debatable matter. For companies which does not have readily available market value i.e. pvt. companies we can
accept the above statement in affirmative. But for companies that have their market value of equity available this
statement is wrong.</p> <p>Similarly in situations of NPV or Free Cash flow analysis where we need market value
of equity to calculate the discount rate preference is given to market values. However if market values are not
available then we can use book value as alternative.</p
A book value is usually all the time away from the market value of shares. this could not be one of the best methods
of the evaluations. this could be applied on all other fixed asets also because some of them has the same
criteria </p>