CH13-ST investing and borrowing

Question 1

An investment report should illustrate the composition of a portfolio according to: (3 things)

Answer 1

1. Maturity distribution
2. Quality ratings
3. Security classes

Question 2

The purchase price an INVESTOR would pay for a T-bill is based on ____?

Answer 2

Ask Discount

Question 3

What is a Bid Discount on a T-bill?

Answer 3

The discount at which the DEALER will purchase the T-bill

Question 4

Both Bid and Ask Quotes are based on a ### day year basis?

Answer 4

360 day year basis because they are given in terms of a discount

Question 5

What is the key difference in the determination of a Money Market Yield (MMY) and the Bond Equivalent Yield (BEY)?

Answer 5

MMY is based on 360-day year, while the BEY is based on a 365-day year.
i.e. Day-Count Convention

Question 6

What is holding period yield and how calculated?

Answer 6

HPY=return earned by investor during the period the investment is held.

HPY=(Cash Rx’d at Maturity - Amount Invested) / Amount Invested

Question 7

How to convert MMY to BEY?

Answer 7

MMY * (365/360) = BEY

Question 8

How to convert BEY to MMY?

Answer 8

BEY * (360/365) = MMY

Question 9

What is nominal yield?

Answer 9

Coupon rate of a bond.

Question 10

What is Yield Curve?

Answer 10

Plot of yields to maturity on the same investment instrument as of a specific date

Question 11

What type of yield quoting convention is needed to compare investments held for different time periods?

Answer 11

An annualized return, like BEY or MMY
BEY is based on 365
MMY is based on 360

Question 12

How to find discount rate when given:

$100,000 182-day T-bill sold for $96,982

Answer 12

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%

Question 13

inverted yield curve means

Answer 13

Downward sloping
Investors prefer LT securities
Issuers prefer ST borrowing

Question 14

Any organization’s investment reporting should illustrate the composition of a portfolio according to:

Answer 14

• maturity distribution
• quality ratings
• security classes

Question 15

T/F: third-party custodians are often required for investors using outsourced investment management

Answer 15

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

Question 16

Define Active Investment Strategy

Answer 16

AKA Total Return Strategy: pursues enhanced returns by capturing capital gains that may arise on longer-dated maturities
pg404

Question 17

Define Buy and Hold Strategy for investments

Answer 17

goal of capital preservation by purchasing securities that can be held to maturity, eliminating price risk.
pg404

Question 18

Define Tax Based Strategy for investments

Answer 18

goal of minimizing income taxes on investment return

pg405

Question 19

What is the most important tool an investment manager possess to protect the organization from investment risks?

Answer 19

Diversification

Question 20

4 Diversification approaches for investments:

Answer 20

• 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

Question 21

Define Price Risk

Answer 21

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

Question 22

Define Reinvestment Risk

Answer 22

after market interest rates drop, the proceeds from a maturing investment will be reinvested at a lower rate.
-a component of interest rate risk

Question 23

exposure horizon within an investment policy is a function of

Answer 23

organization’s risk philosophy and the total interest rate exposure already present

Question 24

Portfolio performance should be evaluated against ______

Answer 24

benchmarks based on permitted investment vehicles, such as:
US Treasury securities,
30-day commercial paper,
market segment indices

Question 25

When should a security holding be considered impaired and a write-down taken?

Answer 25

When the organization’s valuation and impairment policies indicate to do so

Question 26

formula for

Annual Interest Rate =

Answer 26

(Interest Paid + Fee on the unused portion) / used portion of the line

[ (Average borrowing * All-in rate) + (Unused portion * Commitment Fee) ] / used portion

Question 27

formula for

Interest Paid =

Answer 27

Average borrowing * All-in rate

Question 28

formula for

Fee on the unused portion =

Answer 28

Unused portion * Commitment Fee

Question 29

3 basic cost components for lines of credit

Answer 29

1. all-in rate of interest
2. commitment fees (for used and unused balances)
3. upfront and arranger fees on loan syndication

Question 30

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?

Answer 30

4(2) Commercial Paper

Question 31

T/F: Revolving credit lines can be carried as long-term liabilities on the balance sheet

Answer 31

True

Question 32

Committed or Uncommitted:

terms are for one year and the bank can cancel the line of credit at any time

Answer 32

Uncommitted

Question 33

Underlying cost of debt formula (r) =

Answer 33

r = Real Risk Free rate + Inflation prem. + Default prem. + Liquidity prem. + Maturity prem.

Question 34

Rate demanded by Lenders, investors, or savers

Answer 34

Real Risk-Free Rate

Question 35

What is assumed to be True when determining components of interest rates?

Answer 35

• 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

Question 36

What rate of return is the basis for all other borrowing rates?

Answer 36

real risk-free rate