Saturday, October 27, 2012

Lesson-4 on Finance



Question: What is Option?

Answer:
Ø Option is a derivative security because value is derived from the value of another security.
Ø The right to buy or sell a firm’s common stock at a specified price for a stated period of time

 

Question: What is Call Option?

Answer:
A call option gives the buyer the right but not obligation to call the underlying instrument for delivery at a specified price (exercise price) & obligation to seller to sell the underlying instrument at the same price.

 

Question: What is Financial Leverage? Implications of Financial Leverage

Answer:
Ø Financial leverage involves changes in shareholders' income in response to changes in operating profits, resulting from financing a company's assets with debt or preferred stock
Ø Financial leverage is concerned with the relationship between operating profits and earnings per share.

Question: What is operating leverage?
Answer:
Ø Operating leverage is a measure of how sensitive net income is to percentage changes in sales.
Ø Operating leverage acts as a multiplier. If operating leverage is high, a small percentage increase in sales can produce a much larger percentage increase in net income.

Question: What is degree of operating leverage?
Answer:
The degree of operating leverage may be defined as  the percentage change in operating profit  resulting from a percentage changes in sales.

 

Question:  What is Put option?

Answer:
A put option gives the buyer the right but not obligation to put the underlying instrument for delivery at a specified price (exercise price) & obligation to seller to buy the underlying instrument at the same price.

Question: What is Future Contract?

Answer:
A commitment today to transact in the future, both parties have agreed to a deferred delivery at sales price that is currently determined with no funds having been exchanged.

Question: What is Zero Coupon Bond ?

Answer:
A zero-coupon bond is a bond bought at a price lower than its face value, with the face value repaid at the time of maturity. It does not make periodic interest payments, or have so-called "coupons,".

Question: What are the underlying assumption of Cost-Volume-Profit Analysis?
Answer:
CVP assumes the following:
  • Constant sales price;
  • Constant variable cost per unit;
  • Constant total fixed cost;
  • Constant sales mix;
  • Units sold equal units produced.

Question: What is cost of capital?
Answer:
Ø The cost of capital is the discount rate used for evaluating the desirability of the investment project.
Ø It is also know as the cutoff, or the target, or the hurdle rate. It is the minimum required rate of return on the investment project that keeps the present wealth of shareholders unchanged

Question:  What is weighted average cost of capital?
Answer:
The composite, or overall cost of capital is the weighted average of the cost of various sources of fund , weights being the proportion of each source of funds in the capital structure

Question:  What are the Different Method of Project Evaluation?
Answer:
1) Traditional Methods
a) Pay Back Period Method
b) Accounting Rate of Return
2) Discounted Cash  Flow Method
a) Net Present Value Method
b) Internal Rate of Return Method
c) Profitability Index Method

Question: What is Pay Back period in Finance?
Answer:
Payback period in business and economics refers to the period of time required for the return on an investment to "repay" the sum of the original investment

Question: What are the limitations  of  Pay back Period Method in evaluation of Project ?
Answer:
1) The payback period only considers revenue, does not consider profits.
2) It ignores any benefits that occur after the payback period. It does not measure total income.
3)  It ignores the time value of money. 
4) It is dependent on cash inflows which are hard to predict.

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