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122

What is a treasury bond?

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Treasury bonds are long-term debt securities. They pay interest semi-annually until maturity. At maturity, the investor is paid the face value of the bond. The long term Treasury will generally pay a higher interest rate than shorter Treasuries to compensate for the additional risks inherent in the longer maturity. Treasuries are relatively safe since they are backed by the U.S. government.

The price and interest rate of the Treasury bond is determined at auction where it is set at either par, premium, or discount to par. If the yield to maturity (YTM) is greater than the interest rate, the price of the bond will be issued at a discount. If the YTM is equal to the interest rate, the price will be equal to par. Finally, if the YTM is less than the interest rate, the Treasury bond price will be sold at a premium to par. In a single auction, a bidder can buy up to \(\$\)5 million in bonds by non-competitive bidding or up to 35 percent of the initial offering amount by competitive bidding. In addition, the bonds are sold in increments of $100 and the minimum purchase is \(\$\)100.

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123

What is savings bond?

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U.S. Savings bonds are non-marketable securities that earn interest for 30 years. Interest accumulates, and the investor receives everything when s/he redeems the savings bond. The bond can be redeemed after one year, but if they are sold before five years from the purchase date, the investor will lose the last three months' interest. 

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124

What is a 10-K for a public company

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A 10-K is a report filed by a publicly traded company annually about its financial performance. It is required by the U.S. Securities and Exchange Commission (SEC). A 10-K report includes its organizational structure, financial statements, executive compensation, earnings per share, subsidiaries, and other relevant data.

The report is required by the SEC to keep investors informed of a company's financial condition before they buy or sell shares in the corporation.

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125

What is an asset

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An asset is a resource that an individual, corporation owns with the expectation that it will provide a future value. An asset is a resource that can generate cash flow in the future. A corporation's assets are reported on its balance sheet.

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126

What is a balance sheet?

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A balance sheet reports a company's assets, liabilities and shareholders' equity at a given time point. It is a financial statement that provides a snapshot of what a company owns and owes, as well as the amount invested by shareholders. It is used with income statement and cash flows to conduct fundamental analysis or calculating financial ratios.


The balance sheet adheres to the following accounting equation:

Assets = Liabilities + Equity

Intuitively, a company has to pay for all the things it owns (assets) by either borrowing money (taking on liabilities) or taking it from investors (issuing shareholders' equity).


For example, if a company takes out a ten-year, \(\$\)100,000 loan from a bank, its assets will increase by \(\$\)100,000. Its liabilities will also increase by \(\$\)100,000, balancing the two sides of the equation. If the company takes \(\$\)80,000 from investors, its assets will increase by that amount, as will its shareholders' equity. 

A number of ratios can be derived from the balance sheet to assess how healthy a company is. These include the debt-to-equity ratio and the acid-test ratio, and many others. 

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127

What is capital asset pricing model?

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The Capital Asset Pricing Model (CAPM) describes the relationship between systematic risk and expected return for assets, particularly stocks. CAPM is widely used for pricing risky securities and calculating expected returns for assets given the risk of those assets and cost of capital.

The expected return of an asset given its risk is calculated as follows:                              \(ER = R_f+\beta\times (ER_m-R_f)\)

where \(ER\) = expected return, \(R_f\) = risk free rate, \(\beta\) = beta of the investment, and \(ER_m-R_f\) = market risk premium. The beta measures the risk of the investment relative to the market. If a stock has a beta of less than one, it is riskier than the market, If a stock has a beta of less than one, it is less riskier than the market.

The goal of the CAPM formula is to assess whether a stock is fairly valued when its risk and the time value of money are compared to its expected return. For example, consider a stock worth \(\$\)100 per share today that pays a 3% annual dividend. The stock has a beta of 1.2. Assume that the risk-free rate is 3% and market return is 7% per year. The expected return of the stock based on the CAPM formula is 7.8%=3%+1.2×(7%−3%).

The expected return of the CAPM formula is used to discount the expected dividends and capital appreciation of the stock over the expected holding period. If the discounted value of those future cash flows is equal to $100 then the CAPM formula indicates the stock is fairly valued relative to risk.

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171

What is debt service coverage ratio (DSCR)?

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The debt-service coverage ratio (DSCR) measures a reflects a company's ability to service its current debt obligations.

\(DSCR=\frac{ \textrm{Net Operating Income}}{\textrm{Total Debt Service}}\)

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