İŞLETME FİNANSI I

A bond is a type of debt security which means that it represents borrowing by the firm. However, rather than getting a loan from a bank or other financial institution, the bond allows the funds to be obtained from a large number of parties under common standardized terms. Bonds can usually only be issued by governments or large, well known firms. Bonds obligate the issuer to make specified payments to the bondholder on specified dates over a specified time period (maturity). These specified payments are in the form of coupon payments and par value.

Bonds can be issued by corporations or governments. They can be considered interest only loans because the issuer pays only coupon payments until maturity and the face value at maturity. Unlike amortized loans, the issuer does not pay any part of par value during the life of the bond. For the annual coupon paying bonds, the number of times that coupons are paid indicates maturity. Once the bond is issued, the maturity declines as time passes and coupon payments are made.

As also understood from the information given, the statements in the options II, III, IV, V and VI are correct, so the correct answer is E. The statement in the option I is not correct because of the fact that bonds can be issued by corporations or governments.

Bonds obligate the issuer to make specified payments to the bondholder on specified dates over a specified time period (maturity). These specified payments are in the form of coupon payments and par value. Par value (also called face value or nominal value) indicates how much the issuer will repay to the bondholder at maturity. Par value of Turkish bonds in general is 100 whereas US bonds typically have a par value of $1.000. The coupon rate of a bond determines the coupon (interest) payments. Coupon payments are the periodic payments received by bondholders until the bond matures. The annual coupon payment is equal to the coupon rate times the par value of the bond. Some bonds pay their coupons in more than one payment per year, such as semi-annually or quarterly. The coupon rate, maturity date and par value of the bond are specified in bond’s indenture. The indenture is a contract between issuer and bondholder specifying the characteristics of the bond.

As also understood from the information given, the statements in the options I, II, III and V are correct, so the correct answer is D. The statement in the option IV is not correct because of the fact that the coupon rate, maturity date and par value of the bond are specified in bond’s indenture.

Suppose that a bond pays coupons semi-annually and has a coupon rate of 15% with a maturity of 5 years. A bond investor is expected to receive 10 (2 x 5 years) coupon payments, each paying  7.5 (15/2) over the five-year period and receive par value after 10 periods.  Then, the value of this semi-annual coupon paying bond is   107,1888, so the correct answer is E.

When the market interest rate is equal to the coupon interest rate, bonds sell at their par value. When the market interest rate is below the coupon interest rate, bonds sell above their par value and they are called premium bonds. When the market interest rate exceeds the coupon interest rate, bonds sell below their par and are called discount bonds.

There is an inverse relationship between value of bonds and market interest rates. As market interest rates increase, the present value of future cash flows declines and the value of bond decreases. Conversely, if market interest rates decrease, the present value of future cash flows increases and the value of bond increases. It is important to note that market interest rates might change but there is no change in coupon interest rate.

As also understood from the information given, all of the statements in the options about interest rates and bond values are correct, so the correct answer is E.

Even though coupon interest rates are fixed, bond values still fluctuate with the changes in market interest rates. Bonds exhibit interest rate risk, which is the risk that the return from the bond will change according to changes in the interest rates. An increase in interest rates reduces bond values. However, the decline in value of long-term bonds is more than the decline in value of short–term bonds because a change in interest rates has only a modest impact on the present value of near-term cash flows but a greater impact on the present value of distant cash flows. Bonds with longer maturity have a higher sensitivity to changes in market interest rates and have higher interest rate risk.

Bonds carry reinvestment rate risk, which is the risk that cash flows received may not be able to be reinvested at the expected rates if market rates have changed. It is important when there is a decrease in market interest rates. When a bond investor makes a short-term bond investment, if market interest rates decline when this investment matures, the proceeds from short-term investment will be reinvested at a lower interest rate. Long-term bond investors face higher interest rate risk and will have a disadvantage when market interest rates increase whereas short-term bond investor faces higher reinvestment rate risk and will have a disadvantage when market interest rates decline.

As also understood from the information given, all of the statements in the options about bond investors are correct, so the correct answer is E.

Yield-to-maturity is the average rate of return that will be earned on a bond if it is bought at the market price and held until it matures. It is the discount rate that makes the present value of its future cash flows equal to its market price. It is like an internal rate of return of a bond.

Calculating yield-to-maturity of a bond selling at par is easy. It is equal to its coupon interest rate. For discount bonds, yield-to-maturity is greater than their coupon rate whereas yield-to-maturity of premium bonds is less than their coupon rate.

Yield-to-maturity has two components. The first one is the return you get from coupon payments, called current yield (annual coupon/current bond price). The second one is the return you get from the change in the value of bond, called capital gains yield ((p₁-p₀)/p₀).

As also understood from the information given, all of the statements in the options about yield-to- maturity are correct, so the correct answer is E.

Yield curve plots the relationship between bond yields and maturity. One can infer the future levels of interest rates by examining the shape of the yield curve. In general, yield curves are upward sloping because investors may require more yield to invest in longterm bonds. First, as maturity increases, uncertainty in investing long-term bonds is higher. Second, prices of long-term bonds fluctuate more with the changes in interest rates. Long-term bonds have higher interest rate risk. Upward sloping yield curve implies that short-term interest rates will increase in the future.

As also understood from the information given, the statements in the options I, II, III and IV are correct, so the correct answer is D. The statement in the option V is not correct because of the fact that upward sloping yield curve implies that short-term interest rates will increase in the future.

If you purchase stocks of a company, you become an owner of that company. As an owner, you have several rights. One of them is voting right. You have a right to vote in the shareholders’ meeting. Second, you have a right to receive dividends, if the corporation decides to distribute any. They will be cash flows you expect to get in investing in stocks. Third, you have pre-emptive right. If the company issues additional shares, you have a right to purchase your share of these shares (sometimes at a discount) before the new stocks are offered to the public in order to protect your initial share in the company. Fourth, the right to receive your share of the residual (Assets Liabilities) in case of dissolution of the company. Note that this residual may be significantly different from the accounting number as it will depend on market values and not accounting values.

As also understood from the information given, if you purchase stocks of a company you have all of the rights in the options, so the correct answer is E.

The cash flows that are associated with stocks are the dividends that the firm may pay and price that the investor receives when she sells the shares. Dividends are paid only after interest and other required payments are made to creditors and they are not fixed amounts; Dividends depend on the profitability, growth prospects, investment requirements and payout decisions of the company. As a result, their timing and quantities are uncertain and they are more risky than debt securities. In order to compensate for this greater risk, they need to offer greater expected returns in order to make them attractive to investors.

As also understood from the information given, dividends depend on all of  the factors in the options, so the correct answer is E.

Compared to bonds, there are uncertainties about cash flows of stocks and several assumptions have to be made. It can be assumed that the stocks of similar companies should be priced in a similar way because investors are prepared to pay similar price for each lira of assets or earnings. It is called valuation by comparables. The common ratios used as comparables are price-earnings (P/E) ratio, market value-to-book value (MV/BV) ratio, price-to-sales ratio, price-to-cash flows ratio and PEG, defined as the P/E ratio divided by the growth rate of earnings.

As also understood from the information given, all of the ratios given in the options are the common ratios used as comparables in the context of valuation by comparables, so the correct answer is E.

Bonds with longer maturity have a higher sensitivity to changes in market interest rates and have higher interest rate risk.

When a bond investor makes a short-term bond investment, if market interest rates decline when this investment matures, the proceeds from short-term investment will be reinvested at a lower interest rate. Thus, short-term bond investor faces higher reinvestment rate risk and will have a disadvantage when market interest rates decline.

An increase in interest rates reduces bond values. However,the decline in value of long-term bonds is more than the decline in value of short–term bonds because achange in interest rates has only a modest impact on the present value of near-term cash flows but a greater impact on the present value of distant cash flows. Therefore, long-term bonds have a higher sensitivity to
changes in market interest rates and have higher interest rate risk.

When the market's required rate of return for a particular bond is much less than its coupon rate, then this implies the market interest rates have declined and the value of the bond has increased. Hence, the bond is selling at a premium.

Upward sloping yield curve implies that short-term interest rates will increase in the future.

Lower rated companies have higher default risk and their bonds are required to provide very high yield in order to attract investors to invest in these bonds.

If the market price is greater than intrinsic value, then stock is overpriced in the
market.

Stocks that provide all or almost all of their returns from dividend yield are
referred to as income stocks.

2.5/50=5 % ; (55-50)/50 = 10 %

Cash flows available to the firm or to the shareholders after the company makes its capital expenditures are defined as free cash flows.