1) An option is a contract that gives its holder the right to buy or sell an asset at a
predetermined price within a specified period of time.
2) A line of credit can be either a formal or an informal agreement between a borrower
and a bank regarding the maximum amount of credit the bank will extend to the
borrower during some future period, assuming the borrower maintains its financial
strength.
3) Assets other than cash are expected to produce cash over time, but the amount of
cash they eventually produce could be higher or lower than the values at which these
assets are carried on the books.
4) Accruals are “free” capital in the sense that no explicit interest must normally be paid
on accrued liabilities.
5) You are considering 2 bonds that will be issued tomorrow. Both are rated triple B
(BBB, the lowest investment-grade rating), both mature in 20 years, both have a 10%
coupon, neither can be called except for sinking fund purposes, and both are offered to
you at their $1,000 par values. However, Bond SF has a sinking fund while Bond NSF
does not. Under the sinking fund, the company must call and pay off 5% of the bonds at
par each year. The yield curve at the time is upward sloping. The bond’s prices, being
equal, are probably not in equilibrium, as Bond SF, which has the sinking fund, would
generally be expected to have a higher yield than Bond NSF.
6) The text identifies three methods for estimating the cost of common stock from
reinvested earnings (not newly issued stock): the CAPM method, the DCF method, and
the bond-yield-plus-risk-premium method. However, only the CAPM method always
provides an accurate and reliable estimate.