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Finance Junior Core > 410 - Exam 1 > Flashcards

410 - Exam 1 Flashcards

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1
Q

Money market instruments

A

Subsector of the debt market

  • -instruments are highly liquid
  • -short term
  • -relatively low-risk
  • -used for lending and borrowing in the short term
  • -usually take place btwn fin. institutions and companies, rather than indiv.

most common instruments

  • -T-bills
  • -Certificates of deposit
  • -commercial paper
  • -bankers acce[tamce
  • -eurodollars
  • -repurchase agreements
  • -brokers calls
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2
Q

Money market instruments

1. T-Bills

A

short-term gov. securities issued at a discount and returning FV at maturity

  • -how gov. raises money by selling bills to public
  • -earnings based on discount and pmt. at maturity bc zero-cpns

purchased directly from treasury or on secondary mkt. from gov. securities dealer

  • -highly liquid mkt. - easily converted to cash, sold at low transaction costs, with low price risk
  • -exempt from state and local taxes
  • -proxy for risk-free rate
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3
Q

Money market instruments

2. CDs

A
  • -time deposit with a bank with a fixed maturity date and specified fixed interest rate
  • -time deposits may not be withdrawn on demand (so not very liquid) but if issued at > $100,000 can usually be sold to another investor if owner needs cash before maturity date
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4
Q

Money market instruments

3. Commercial paper

A

short-term debt instrument that is unsecured and most often issued by large companies seeking short-term funds

  • -debt notes issued directly to public and act as a substitute for borrowing directly from the bank
  • -does not have to be registered with SEC if < 270 days
  • -played huge role in financial crisis of 2007 - people lost trust in liquidity of firms and they couldn’t make short term pmts.
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5
Q

Money market instruments

4. Bankers acceptance

A
  • -similar to a check - starts as an order to a bank from a customer to pay a sum of money at a future date
  • -bank has responsibility for the liability and when accepted can be traded in secondary mkt
  • -considered very safe bc allow indiv. to substitute the banks credit standing for their own
  • -creditworthiness of one trader is unknown to other
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6
Q

Money market instruments

5. Eurodollars

A

dollar-denominated deposits in any foreign bank or foreign branches of American banks

  • -housed outside US so not under regulation of the Fed
  • -lower regulation so lower costs to issuer - but bc issued outside their home country, more risky bc not domestic
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7
Q

Money market instruments

  1. repos and reverses
    - -repurchase agreements
A

REPURCHASE AGREEMENTS
form of short-term borrowing where dealer sells securities on an overnight basis with agreement to buy those securities back the next day at a slightly higher price
–securities are collateral for the loan
–sometimes caled repos - sometimes havelonger terms of 30+ days
–safe bc of collateral

reverse repo - when dealer finds an investor holding a gov. security and buys them with agreement to sell back at specified price on future date

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8
Q

Money market instruments

7. Brokers calls

A

when an indiv. buys a stock on margin - they borrow a part of the funds from their broker who often borrowed the funds from a bank
–brokers call is the agreement from the broker with the bank to borrow funds, with stipulation that broker will repay bank immediately (on call) if bank requests it

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9
Q

Money market instruments

8. Federal funds

A
  • -banks maintain their own deposits at Fed reserve bank - Fed reserve system’s member banks must each maintain a min. balance in a reserve acct. with the Fed - any funds that bank holds with Fed are called Federal Funds
  • -at any given time, banks will have an excess balance of funds req. by regulation and others will have a shortage - in fed funds mkt. banks with excess funds lend to those with a shortage to keep them in line with regulation
  • -rate at which overnight loans are arranged is known as the federal funds rate!
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10
Q

The LIBOR mkt.

A

London Interbank Offer Rate (LIBOR) is the int. rate at which large banks in London are willing to lend money amongst themselves

  • -LIBOR has become premier short-term int. rate quoted in European money market
  • -also often serves as reference rate for other securities and transactions
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11
Q

The bond mkt.

A

longer-term borrowing or debt instruments

  • -often referred to as the debt, credit or fixed-income mkt.
  • -primarily includes gov.-isued securities and corp. debt securities
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12
Q

The bond mkt.

1. Treasury notes and bonds

A

debt instruments with maturities ranging from a few months up to 10 years for T-notes and from 10-30 years for T-bonds

  • -interest rate is YTM - accounts for both the cpn income and the diff. btwn bonds purchaase price and FV
  • -in US, issue inflation-protected T-bonds called TIPS (Treasury inflation protected securities) - amt. is adjusted in proportion to inc. in CPI - so lower risk
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13
Q

The bond mkt.

2. International bonds

A

Eurobonds
–bonds denominated in a currency other than that of the country in which it is issued - ex, yen-denominated bond issued in Mexico

often ppl prefer to issue bonds in foreign countries but in the currency of the investor
–Yankee bonds - dollar-denominated bonds sold in the US by a non-US issuer

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14
Q

The bond mkt.

3. Municipal bonds

A

issued by state and local gov. - exempt from fed. income taxation
–usually int. income is exempt from state and local taxation too

2 types of muni

  • -1. general obligation bonds that are backed by full faith and credit of issuing party
  • -2. revenue bonds that are issued to fin. specific projects and are backed by rev. from project or agency backing the project
  • -usually issued to finance projects like airports and hospitals

KEY FEATURE IS TAX EXEMPT STATUS

  • -lower yields bc of it
  • -so can compare -after-tax yields
  • -ex. YTM on treasury note = 3% with a 35% tax rate = .03*(1 - .35) = 1.95% –> compared to a tax-exempt municipal bonds at 2% - muni bond pays higher yield
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15
Q

The bond mkt.

4. Corporate bonds

A

usually semi-annual cpns. and return FV at maturity

  • -but have risk of default to consider when buy
  • -secured bonds have collateral backing in case of default
  • -unsecured bonds (debentures) have no collateral
  • -callable bonds have options attached - give firm option (not obligation) to repurcahse the bond from the holder at a call price
  • -convertible bonds - have option (not obligation) to convert bond into a stipulated number of shares of stock
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16
Q

The bond mkt.

5. Mortgages and mortgage-backed securities

A

mortgage - debt instrument secured by collateral in form of real estate property

mortgage-backed security - is a type of asset where collateral is a collection of mortgages
–an IB will buy a pool of mortgages then sell shares that will pay dividiends based on the CF from the mortgage pmts.

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17
Q

Equity securities

1. Common stock

A
  • -ownership shares in corp.
  • -ownership and option to vote in matters of corp. governance
  • -elect board of directors - who then select managers to run the firm

2 key features of CS

  • -1. residual claim - last in line to claim assets and income of corp. (especially in bankruptcy)
  • -2. limited liability - but in a failure of corp…most they can lose is their original investment - not their personal assets
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18
Q

Equity securities

2. ADRs

A

American Depository receipts (ADRs) - equity shares traded in US markets that represent ownership in a foreign company
–ex. BP Plc. (formerly British petroleum) trades on NYSE under ticker BP. ADRs - most common way for US investors to invest in and trade shares of foreign corp.

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19
Q

Markets

1. primary market

A

markets provide a way to find and match buyers and sellers - also provides a way to determine prices
–separated into 2 basic categories by levels of standardization and supported product diversity

–sellers include corp. and gov. that finance their activities by issuing securities to the public and private comp. that issue securuties to transform into public entities

an issue of securities by a company that is already public is called a SEASONED EQUITY OFFERING (SEO) - while newly issued securities called an IPO
–generally both work with an IB - called the UNDERWRITER

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20
Q

Markets

2. Secondary market

A

allows participants to buy and sell previously issued securities - called seasoned securities

  • -exchages use an auction-like mechanism to match buyers and selelrs and to determine the prices at which they trade
  • -used a computerized structure called an ORDER BOOK
  • -each order represents how many units of a security a buyer/seller is willing to trade immediately at a given price

BID - price someone is willingt o buy a security (on bottom of chart)
OFFER - price someone is willing to sell - also called an ASK (on top of chart)

Highest bid and lowest offer is called the TOP OF THE BOOK

orders come in as limit/stop orders and market orders

  • -limit orders - say quantity and the min./max. price they are wiling to transact
  • -market order instructs the exchange to buy or sell a specific quantity of a security at the presently available prices - no price limit - only quantity desired - the matches start with lowest offer for buy order and highest bid for sell order
  • -process called “Walking the book”
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21
Q

Markets

1. Brokered market

A

decentralizded, customized - BROKER matches buyers and sellers

  • -broker hired as an agent by a buyer or seller to find interested counterparty - prices set by negotiation
  • -broker takes commission
  • -specialization makes mkt. attractive
  • -most common to us is the housnig mkt.

very few access exchanges directly - almost always go through a broker

sometimes a broker must:

  1. INTERNALIZE - especially for small orders…the broker simply sells shares out of his own inventory at the inside offer price or buys them from you at the inside bid
  2. ROUTE TO AN EXCHANGE - if the market order is large - broker may trade directly to the exchange to walk up the order book until it is filled - limit orders will be added to order book (under your broker’s ID) to awai execution
  3. ENGAGE IN 3RD MKT. DEALER - off-ecxhange trading in listed securities - loose network of brokers and dealers who solicit trades by phone, email, or bloomberg terminals - OTC mkt. in listed securities only (NASDAQ used to be part of third mkt. - used to be a bulletin where dealers would post bids and offers - used to be a pure dealer market)
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22
Q

Markets

2. dealer mkt.

A

decentralized, inventory-driven, somewhat customized - participants trade directly with a dealer

  • -dealer maintains an inventory of securities and stands prepared to buy additional units from a seller or sell from its inventory to a buyer
  • -makes money by buying low and selling high
  • -buyer or seller trades directly with the dealer

also called “over the counter” (OTC) mkts. - most bonds and derivative contracts are in dealer markets
–largest mkt. by volume (Currency mkt.) is a dealer0intermediated mkt.

23
Q

Markets

3. Exchanges

A

centralized, standardized, auction-like - buyers and sellers engage directly

  • -stock market
  • -known central location where people come to trade
  • -listed stocks and some derivatives and bonds
24
Q

IPOs

A

interesting bc they tend to experience very high returns on the first day of trading

  • -average first day returns very high and peacked during dot-com boom in 1999 - Priceline.com had first day IPO return of 331% (IPO price $16 and closed at $69)
  • -now average first day return is btwn 10-20%
  • -interesting because investment banks are hired to determine the best price per share to help raise the most possible capital for their clients

compute money left on the table (MLOT)

  • -MLOT = (closing price - IPO price) * (Shared issued)
  • -MLOT represents additional money the firm could have raised had they been able to locate the investors willing to hold the stock at the closing price
  • -sometimes has been about $36B left on the table!!! why would they be ok with leaving that money!?!
  • -also so lucky for the certain investors who buy at the IPO price…vs. those who buy closer to closing price

so WHY?!

  • -usually sell shares at IPO price to investors on the book…those who showed interest during road show - usually the bank’s big clients - it is underpricing to the bank’s clients, friends and associates
  • -also another reason - the closing price of an IPO on first day of trading is the “true value” of the IPO since it is the value investors are actually willing to pay for the firm’s shares
  • -banks entice potential investors to be forthcoming about private information by implicitly offering the shares at a discounted price relative to the bank’s final estimate of true value - investors reveal how much they are willing to pay and those who offer to pay higher prices are more likely to get the shares - so allows investors to say how much they are willing to pay and enables underwrites (IB) to get info. on true value of shares during road show process

so IPO underpricing is a cost of issuing shares paid by the firm issuing them - investors reveal private info. regarding the true value of the shares - in turn they are paid for the info. hey provide by. being given the opp. to buy the shares at a disount and earn large first day returns

25
Q

firms often acquire short-term debt by issuing ___ to the public

A

commercial paper

26
Q

treasury notes have maturities ___ and treasury bonds have maturities ____

A
  1. notes - up to 10 years

2. bonds - 10-30 years

27
Q

the bid price of a treasury bond is ___

A

the price at which a dealer in treasury bills is willing to buy the bill

28
Q

the federal funds rate is ___

A

the rate banks charge each other for over night loans to meet reserve requirements

29
Q

a third mkt is a ____

A

loose network of brokers and dealers

30
Q

NASDAQ is a ___

A

hybrid exchange and dealer market

–used to be a pure dealer mkt. - almost a third mkt. - used to have to pick up the phone and call the broker

31
Q

which of the following market types consists of indiv. or firms that stand prepared to sell from or buy to add to an inventory of securities?

A

dealer mkt.

32
Q

All of the following are characteristics of hedge funds except:

A

funds are heavily regulated by SEC (NOT VERY REGULATED)

the ones that were true was: investors pay relatively high fees that depend on fund performance, inv. often not allowed to sell back shares for long periods of time, wide use of short-sells

33
Q

Trading activity incurs explicit and implicit costs

A

can’t control returns as an investor but can control your COSTS
–can reduce costs to inc. returns at zero risk!!

EXPLICIT TRADING COSTS

  • -brokerage commissions and exchange fees
  • -any trading cost known in advance with certainty

IPMLICIT TRADING COSTS

  • -don’t pay them separately…embedded in prices you receive - ever know until after the trade…and still not completely obvious
  • -the 2 main ones are market impact (Trading may move prices up for buyers and down for sellers) and slippage (opp. cost for incomplete execution (inability to buy or sell desired quantity at time planned) or delays)

can measure them by the bid-offer spread - get a sense of the cost of trading

34
Q

Bid-offer spread

A

measured as the diff. btwn the bid and offer prices at the top of the book

  • -larger bid-offer spreads signal higher trading costs and LESS mkt. liquidity
  • -often orders exceed the quantity available at top of the book and must then walk the book being filled at decreasingly favorable prices

effective spread is TWICE the diff. btwn the quantity-weighted average price and the midpoint (average) of the top of the book before the transaction

bid-offer spread is useful summary of statistic mkt. conditions..but does not reflect the entirety of what it costs to trade…2 types of implicit costs: market impact and slippage

35
Q

short sales

A

when you buy shares, they are held by a custodian or entity that acts as a safe keeper of your shares - like a bank for shares

  • -just like in a bank - the shares don’t just sit around - the custodian lends them out - borrow shares bc can have short sales
  • -short sales - transaction where someone borrows a security held in custody then sells it hoping to repurcahse it later at a LOWER price
  • -a short seller pays a borrow cost to rent the shares - securities lending is a source of revenue to custodian banks
36
Q

investment companies

A

financial intermediaries who invest on behalf of individuals who provide capital such as mutual funds, that represent imp. players with growing ownership stakes in fin. mkts.

benefits of investment comp. (Rather than buying indiv. securities directly)
1. CHEAP DIVERSIFICATION - brokers charge a fixed fee for services…so it can be costly for an indiv. investor to purchase a broad portfolio…but an investment company can spread this cost over many investors, which lowers the cost of diversification

  1. RECORD KEEPING AND ADMIN.
    - -inv. companies issue periodic status reports - keep track of capital gains, dividends, investments and redemptions
  2. PROFESSIONAL MGMT.
    - -teams of analysts and portfolio managers who do research and select securities in an attempt to provide superior performance
37
Q

NAV

A

investors buy shares in inv. companies and ownership is proportional to # shares purcahsed
–value of each share is called Net asset value (NAV)

= (mkt. value of assets - liabilities) / # shares outstanding

38
Q

Mutual funds

A

majority are OPEN END funds

  • -raise capital by issuing shares to the public
  • -use capital raised to buy a portfolio of fin. securities
  • -each share represents partial ownership of the assets owned by the fund
  • -can be actively or passively managed
  • -passively managed funds called INDEX FUNDS - replicate performance of an index or basket of securities

in these cases - investors buy and sell shares of open-ended funds directly from the investment company itself or from brokers authorized by inv. comp.
—ex. Charles Schwab is authorized broker for a variety of mutual fund companies

What price to pay for share of a mutual fund?

  • -all new orders during a given day pay the 4pm NAV
  • -when ordering, investors indicate dollar amt. they wish to buy or sell rather than # of shares…at 4pm the inv. comp. calculates the fund’s NAC (exluding order flow that day to avoid dilution effects) - then any buy or sell orders are executed at the 4pm NAV
  • -if buy orders > sell orders –the fund issues more shares of the fund, or if sell > buy the fund buys back the shares
  • -# shares outstanding for open-end mutual fund changes almost every trading day
39
Q

Exchange traded funds

A

ETF - like an index fund that trades like a stock

  • -inv. comp. raises capital by issuing shares - the capital is invested in a pool of assets and the shares represent a claim to CFs generated by the pool - shares then trade on an exchange like a stock
  • -so when you buy or sell an ETF you trade with another investor at real time prices (ADVANTAGE OVER INDEX FUNDS)
  • -ETFs can also be SHORTED and index funds can’t

value ETFs bc know what securities are in the pool of assets backing the shares - report holdings on a daily basis
–almost all passively managed - meaning track n index or basket of securities

price of ETF is closely held to the value of the actual basket through arbitrage activity or authorized participants (AP) - large fin. institutions who act as ETF sponsor
–price of ETF sponsors charge annual fees, but very small and similar to those of index fund - some even charge zero fees and make money by short selling

one ADVANTAGE OF INDEX OVER ETF is that when you trade index funds, you avoid all explicit trading costs and many implicit trading costs - if have no loads…pay no cost to a broker, don’t pay bid-offer spread, and don’t walk the book - simply buy the 4pm NAV

40
Q

hedge funds

A

inv. companies that raise capital using investment strategies that include derivatives, short positions and leverage
- -many try to follow market neutral strategies by going long and some short others
- -not subject to SEC regulation and open only to accredited investors with et worth over $1M

41
Q

closed end funds

A

funds that issue a fixed number of shares - ones the shares are issued they trade on exchanges like a stock

  • -# shares outstanding is fixed, but assest of close-end funds are generally actively managed by fund managers
  • -rep. very smal fraction of total equity ownership
42
Q

explain how potential for arbitrage activity makes ETFs advantageous to closed-end funds

A

ETFs can create and redeem shares throughout the day…which keeps the stock price aligned with the NAV of the portfolio

  • -closed-end funds are fixed at the IPO and cannot expand or contract based on market activity
  • -the closed end funds are often sold at a discount and cannot be adjusted
43
Q

what is a 12b-1 fee

A

in a mutual fund - ann expenses used to pay authorized brokers who enable investors to buy and sell the funds as well as marketing and distribution costs
–controversial bc sometimes charged without inv. knowledge (CHECK CLASS NOTES)

44
Q

hedge funds vs. mutual funds

A

Mutual funds
–buy publicly traded securities - little use of leverage or short sales (HEDGE - can also buy non-public securitires = wide use of leverage and short sales)

–mutual - hold broad mix of assets (HEDGE - holdings are often concentrated)

–mutual - low fees that do not depend on performance (HEDGE - High fees that depend on performance)

–mutual - investors can sell back shares at any time (HEDGE - investor money is locked up for long periods)

–mutual - heavy regulation (HEDGE - light regulation)

–mutual - relatively low initial investments (HEDGE - very high investments necessary)

45
Q

why does the intro. of a front end load cause the req. fund return to depend on the holding period?

A

front end load represents a fixed cost that is spread over more years the longer you hold the investment,
–the shorter you hold it, the higher fund return must be to make up the cost

46
Q

DDM models

A

also called “intrinsic value” or “theoretical price”

  • -help us see if the current price of a security is NOT the equilibrium price
  • -if Price less than PV - we get higher return than the rquired expected return - means as prices move towards its equilbirum, we get a higher return than other securities with similar risk
  • -DDM models do not tell us WHEN market prices will move back to equilibrium
  • -don’t invlude risk either
  • -relies on assumptions to estimate future dividends - using CAPM

DDM gives us the PV of future forecasted dividends as an eqution - tells us the price we should pay for a security if we want an effective return equal to the chosen discount rate

grodon growth - for K for rf use rate on other risk free assets - or risky assets use CAPM to estimate
–for growth - use company’s historical average growth rate in dividends, use an industry median or average growth rate, or use the SUSTAINABLE GROWTH RATE

SGR = b*ROE (ROE * PLOWBACK)
--b = plowback ratio, 1-b = payout ratio
47
Q

Bloomberg DDM

A

4 stages:

  1. first 2 years
  2. long-term growth stage
  3. transitional stage
  4. mature stage1
48
Q

the two fund separation theorem states the every indiv.’s optimal portfolio ___

A

os a combination of the asset with the MAX sharpe ratio and some measure of risk-free borrowing or lending

49
Q

Gross return of a portfolio

A

The weighted average of the gross returns for each individual asset in the portfolio where the weight in each asset is the fraction of investment equity invested in that asset

50
Q

Value weighted portfolio

A

Choose desired target portfolio weights

Does not require rebalancing
—find Mkt. cap then weights
—S&P 500 index

51
Q

Price weighted index

A

Dow Jones industrial average is most widely cited and influential price index
—Charles Dow creates first and posted average price of companies stock within it (not average return) every day

Price weighted - when buy equal number of shares of every security
—weight in each security depends on its price — higher share price = higher weight

SPLITS IMP HERE
—occurs when come. Cuts price of its shares outstanding in half and doubles the shares outstanding - gives 2 shares to current holders but value cut in half
—stock split has NO impact on value of an investors holdings

52
Q

Equally weighted portfolios

A

The amount of MONEY invested in each security is the same

—

53
Q

Portfolio tilting

A

One way to increase exposure of a portfolio to a SINGLE security
-tilt towards - borrow at rf rate to add weight to a security
—tilt away - sell shares of a security and invest in risk free bonds

Finance Junior Core (14 decks)

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