CH13-ST investing and borrowing Flashcards
An investment report should illustrate the composition of a portfolio according to: (3 things)
- Maturity distribution
- Quality ratings
- Security classes
The purchase price an INVESTOR would pay for a T-bill is based on ____?
Ask Discount
What is a Bid Discount on a T-bill?
The discount at which the DEALER will purchase the T-bill
Both Bid and Ask Quotes are based on a ### day year basis?
360 day year basis because they are given in terms of a discount
What is the key difference in the determination of a Money Market Yield (MMY) and the Bond Equivalent Yield (BEY)?
MMY is based on 360-day year, while the BEY is based on a 365-day year.
i.e. Day-Count Convention
What is holding period yield and how calculated?
HPY=return earned by investor during the period the investment is held.
HPY=(Cash Rx’d at Maturity - Amount Invested) / Amount Invested
How to convert MMY to BEY?
MMY * (365/360) = BEY
How to convert BEY to MMY?
BEY * (360/365) = MMY
What is nominal yield?
Coupon rate of a bond.
What is Yield Curve?
Plot of yields to maturity on the same investment instrument as of a specific date
What type of yield quoting convention is needed to compare investments held for different time periods?
An annualized return, like BEY or MMY
BEY is based on 365
MMY is based on 360
How to find discount rate when given:
$100,000 182-day T-bill sold for $96,982
FIRST:
Dollar Discount = Par Value - Purchase Price
SECOND:
Discount Rate = (Dollar Discount / Par Value) * (360 / Days to Maturity)
100,000 - 96,982 = 3,018 Dollar Discount
(3,018 / 100k) * (360 / 182) = 0.05969 = 5.97%
inverted yield curve means
Downward sloping
Investors prefer LT securities
Issuers prefer ST borrowing
Expect recession
Any organization’s investment reporting should illustrate the composition of a portfolio according to:
- maturity distribution
- quality ratings
- security classes
T/F: third-party custodians are often required for investors using outsourced investment management
True
Keeping securities at the institution from which they were purchased is considered somewhat more risky than using a fee-based, third-party custodian because there may be a potential for fraud
Define Active Investment Strategy
AKA Total Return Strategy: pursues enhanced returns by capturing capital gains that may arise on longer-dated maturities
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Define Buy and Hold Strategy for investments
goal of capital preservation by purchasing securities that can be held to maturity, eliminating price risk.
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Define Tax Based Strategy for investments
goal of minimizing income taxes on investment return
pg405
What is the most important tool an investment manager possess to protect the organization from investment risks?
Diversification
4 Diversification approaches for investments:
- Allocate by asset type or among a variety of investment management firms
- Hold a percentage of foreign instruments so the company can minimize the impact of specific currency movements
- Limit investments in issues from the same organization
- Limit investment from specific issuers and/or instruments in order to limit concentration risk
Define Price Risk
an INCREASE in interest RATES causes the bond value to decrease if SOLD PRIOR to maturity
- investor demand decreases
- a component of interest rate risk
Define Reinvestment Risk
after market interest rates drop, the proceeds from a maturing investment will be reinvested at a lower rate.
-a component of interest rate risk
exposure horizon within an investment policy is a function of
organization’s risk philosophy and the total interest rate exposure already present
Portfolio performance should be evaluated against ______
benchmarks based on permitted investment vehicles, such as:
US Treasury securities,
30-day commercial paper,
market segment indices
When should a security holding be considered impaired and a write-down taken?
When the organization’s valuation and impairment policies indicate to do so
formula for
Annual Interest Rate =
(Interest Paid + Fee on the unused portion) / used portion of the line
[ (Average borrowing * All-in rate) + (Unused portion * Commitment Fee) ] / used portion
formula for
Interest Paid =
Average borrowing * All-in rate
formula for
Fee on the unused portion =
Unused portion * Commitment Fee
3 basic cost components for lines of credit
- all-in rate of interest
- commitment fees (for used and unused balances)
- upfront and arranger fees on loan syndication
What type of commercial paper (CP) issuance specifies that the face value be in amounts higher than $250,000, has a maximum maturity of 397 days, and no restrictions on how the proceeds may be used?
4(2) Commercial Paper
T/F: Revolving credit lines can be carried as long-term liabilities on the balance sheet
True
Committed or Uncommitted:
terms are for one year and the bank can cancel the line of credit at any time
Uncommitted
Underlying cost of debt formula (r) =
r = Real Risk Free rate + Inflation prem. + Default prem. + Liquidity prem. + Maturity prem.
Rate demanded by Lenders, investors, or savers
Real Risk-Free Rate
What is assumed to be True when determining components of interest rates?
- US Treasuries are perceived to be risk-free, with no default risk
- US Treasuries are highly liquid and thus have no liquidity risk
- Both corporate and municipal bonds have default and liquidity risk
- Maturity risk increases with the issue’s time to maturity
What rate of return is the basis for all other borrowing rates?
real risk-free rate
