ch 9-12 - midterm to quiz 2 Flashcards
mortgage
a form of debt to finance a real estate investment
loan to value ratio
indicates the proportion of the property’s value that is financed by debt
prime mortgage
borrower meets traditional lending standards, higher credit rating
subprime mortgage
borrower does not qualify for a prime loan, lower credit rating
Alt-A mortgage
satisfies some but not all o the criteria for rime loans, but have lower risk than subprime
insured mortgage
loan is insured by FHA or VA
conventional mortgage
loan is not insured by FHA or VA but can be privately insured`
fixed rate mortgage
- interest rate is decided at closing and does not change
- exposes the holder to interest rate risk
amortizing fixed rate mortgages
- monthly payments aren token down by principal and interest
- during the early years, most of the payment reflects interest
adjustable rate mortgage
- the interest rate will change over the life of the loan
- rate starts lower than a fixed rate loan
balloon mortgage
fixed rate loan that is amortized over a conventional period, such as 30 years, and the final payment is typically dues after 5-10 years
graduated payment mortgage
can have a fixed or variable rate of interest but allows payments to be lower in the early years, progressively increase over the life of the loan
growing equity mortgage
higher payments than a conventional loan, but the additional payment is applied to the principal in order to pay off the loan quicker
reverse annuity mortgage
allows homeowners 62 or older to access the equity in their primary residence while continuing to live in their home
shared-appreciation mortgage
allow a home purchaser to obtain a mortgage at a below-market interest rate
second mortgages
- can be used in conjunction with the primary/first mortgage
- Home equity loan or HELOC
- Allows borrowing based on additional equity in the property
- Typically, shorter term and higher rate than the first mortgage
how to value mortgages
Price equals present values of cash flows plus a risk premium
mortgage risks
- repayment risk
- credit risk
- interest rate risk
common stock
- represents a proportionate share of ownership
- lowest seniority in the capital stack and last to be paid in bankruptcy
preferred stock
- has preference over CS in terms of dividend payouts
- primarily an income investment
- price is sensitive to interest rate changes
- senior to CS but subordinate to bonds
IPO process - prospectus
detailed information about the firm, including financial statements and a discussion of risks
IPO process - road show
Key employees in the firm visit institutional investors to attract buyers for the IPO
IPO process - offer price
the price the shares will be offered at the time of the IPO
IPO process - pricing and book building
The lead underwriter must determine the offer price at which the shares will be offered at the time of the IPO
IPO process - allocation of IPO shares
to expand the list of potential buyers the underwriter may form a syndicate of underwriters to sell the shares and determine who will be the ultimate buyers of the primary offering
IPO offer price
the price paid by the initial buyers of the primary offering
over allotment(green0shoe) option
- provides the underwriter the flexibility to allocate an additional 15% of firm’s shares for up to 30 days post IPO
- sold at the offer price not the market price
“lock up” provisions
Prevents the original owners/investors of the firm from selling their shares for a specified period
private equity
Generally, provides capital to more established companies or provides equity to companies or purchasing them outright
venture capital funds
- Form of PE investment for startups
- Generally, the VC makes an investment for an equity stake in the company
- Receives money from wealthy investors and pension funds that are willing to maintain the investment for a long-term period(5-10 years generally)
- Not allowed to withdraw their money before a specified deadlines
LBO
- acquisitions that require substantial amounts of borrowed funds
- PE firm uses the enterprise value and “leverages” it through making an equity investment and then using public/private financing
Special purpose acquisition company
- A shell company designed to take companies public without going through the traditional IPO process
- expedited process to go public
organized exchanges
Physical trading floor where traders execute transactions - most trades are executed electronically
floor brokers
execute orders either for clients or for their own account
floor brokers
execute orders either for clients or for their own account
board of directors
Approving strategy and financial plans as well as ensuring decisions are made in the best interest of investors, employees and the community
role of analysts
Monitor stocks, asses their value and publicize an opinion of the company and stock price
proxy contest
shareholders can exercise their right to vote and may engage in “proxy” contests to attempt to:
- change the composition of the board
- Limit salaries for management
- Improve transparency
- Change the bylaws
antitakeover amendments
may require that at least ⅔ of the shareholder votes approve a takeover
poison pills
special rights awarded to shareholders or specific managers on the occurrence of specified events
golden parachutes
specific large amounts of compensation to managers if they lose their jobs or change in control of the firm
fundemental analysis
a review of the financial characteristics of the firm and industry to produce a stock valuation
P/E ratio analysis
- investors forecast the future earnings
- Apply the mean ratio used for the industry to identify the price
- Value per share = expected EPS x mean industry P/E
what are the limitations of P/E ratio analysis?
- Earnings forecasts can differ
- P/E ratio for the industry/peer group is not obvious
- Stock buybacks can distort a firm’s earnings
dividend discount model
The price of the stock should reflect the PV of future dividends
what are the flaws of the dividend discount model?
- Assumes no changes in dividend in perpetuity
- Errors can be made in determining the dividend to be paid, the growth rate, and the RRR
- Errors are more pronounced for the firms that retain most of their earnings
Free cash flow model(for firms that do not pay dividends)
- Estimate the free cash flows that will result from operations
- Subtract existing liabilities to determine the value of the firm
- Divide the value of the firm by the number of shares to derive a value per share
how is the risk of a stock measured?
- Volatility of the stock? - what is the SD
- Volatility of a portfolio? - what is the SD
- How does the stock move in relation to the overall market? - what is the beta
- VaR measures statistical expectations for losses using designated confidence intervals
- Risk adjusted stock performance - Sharpe ratio
VIX
measures the market’s expectations for volatility over the next 30 days
beta
- A relative measure of how the stock move in relation to the overall market
- High beta stocks are expected to be relatively volatile because they are more sensitive to market returns over time
value at risk and stressed value at risk
- Statistical expectations for losses using designated CI(confidence interval)
- Utilizes a data set to determine statistical probabilities of potential losses within a CI
- Used widely by risk managers and regulators in combination with other risk management tools
- Applicable to many investments(fixed income) and a component of how capital requirements are calculated for many financial institutions
- But there are significant assumptions and limitations
Sharpe ratio
- The Sharpe index measures risk-adjusted returns when total variability is the most appropriate measure of risk
- Measures the excess return above the risk-free rate per unit of risk
floor brokers
- fulfill and execute orders on the floor of the stock exchange
- Small orders(<100,000 shares) are often entered into an electronic trading platform
designated market-makers
- can match buyers and sellers, or buy for themselves
- Stand ready to buy/sell designated stocks if there are no other investors
ask(offer)
the price a broker will sell a stock
bid
the price a broker will buy a stock
bid-ask spread
the difference between the ask and bid price, measured as a percentage of the ask price
long position
when you buy and hold equities or fixed income positions and will make money when the price goes up
short position
when you sell a stock you don’t own by borrowing it from your broker, executed when you think the stock is overpriced
loss profiles for long and short positions
- Losses from a long position are limited to the amount of money invested
- Losses for a short position are unlimited
short ratio
of shares sold short / total # of shares
short interest ratio
of shares sold short / average daily trading volume
market order
an order to buy/sell at the best possible price
limit order
specifies a minimum price to sell or a maximum price to buy
stop order
used to minimize losses or protect gains
margin return formula
R = (SP - INV - LOAN + D) / INV
what are the requirements for using leverage?
- there is a minimum portion of the equity investment that must be covered with cash(currently 50%)
- there is a minimum portion of the equity investment that the investors must maintain in the account(currently 30%)
margin calls
the more margin lending, the more exposed the stock market is to a potential crisis
insider trading
Illegal act in which corporate insiders buy/sell company stock based on privileged information
circuit breakers
restrictions on trading when stock prices or a stock index reaches a specified threshold level
trading haults
implemented when exchange believe investors need more time to receive/absorb material information
SEC
- Monitors stock exchanges and reporting by listed companies
- Requires listed companies to file registration info and financial reports
goals of the SEC
- Full disclosure of relevant information for the benefit of investors
- Prevent abuses that would give an unfair advantage to an investor(s)
goals of the SEC
- Full disclosure of relevant information for the benefit of investors
- Prevent abuses that would give an unfair advantage to an investor(s)
