CH2 Flashcards
What is the money market?
Subsector of the fixed-income market
Characterized by short-term, highly liquid, low-risk instruments, often with large denominations.
What is a Treasury Bill?
Government issued asset that matures within 52 weeks max
T-Bills are a key instrument in the money market.
What is the bank discount rate formula for T-bills? (assume it’s a 10k $ bill)
Where P = market price of the T-bill and n = number of days to maturity.
What are Certificates of Deposit (CDs)?
Any, $100,000 or more marketable financial asset. Note that first $250,000 FDIC insured
CDs are time deposits with specific maturities.
What is a Banker’s Acceptance?
- Purchaser authorizes a bank to pay a seller for goods at a later date
- When purchaser’s bank “accepts” draft, it becomes contingent liability of the bank (and marketable)
This instrument is used in international trade.
What are Repurchase Agreements (RPs)?
- Short-term sale of securities + promise to repurchase at higher price
- Collateralised loan
- Many RPs are overnight
RPs are used for liquidity management.
What is the Broker’s call?
- Applies for investors buying stock on margin
Loan may be “called in” by broker
This rate is crucial for margin trading.
What is the Federal Funds rate?
Trading in reserves held at the Federal Reserve
Key interest rate for the economy
It influences overall economic conditions.
What is LIBOR?
- Rate at which large banks in London (and elsewhere) lend to each other
- Base rate for many loans and derivatives
LIBOR has been widely used until its phase-out.
What are factors influencing quoted yields on money market instruments?
- Par value vs. investment value
- 360 vs. 365 days assumed in a year (366 leap year)
- Simple vs. compound interest
These factors complicate yield comparisons.
What is the Bond Equivalent Yield (BEY)?
- Cannot simply compare T-bills directly to bonds
- Adjusted bank discount rate to make it comparable
BEY allows for a standard comparison between different fixed-income securities.
What are Treasury Inflation Protected Securities (TIPS)?
- Principal adjusted for changes in the Consumer Price Index
TIPS provide protection against inflation.
What are municipal bonds?
Issuer: State and local governments
Differ from treasuries and agencies in terms of risk
Types: G.O. vs. revenue
Taxation: r tax exempt = r taxable × (1 - tax rate)
Municipal bonds often provide tax advantages.
What is the formula for calculating equivalent taxable yields?
This formula is used to compare the yields of tax-exempt and taxable investments.
What are the two categories of corporate bonds?
- Investment grade
- Speculative grade
What are Mortgage-Backed Securities backed by?
- A pool of mortgages with ‘pass-through’ of monthly payments
These securities cover defaults on the underlying mortgages.
What types of mortgages are included in mortgage-backed securities pools since 2006?
- Alt-A mortgages
- Subprime mortgages
What are the characteristics of common stock?
- Residual claim
- Limited liability
What are the characteristics of preferred stock?
- Priority over common
- Fixed dividends
- Nonvoting
What is the tax treatment of preferred stock dividends?
Corporate tax exclusions on 70% of dividends earned
What is a derivative asset?
A security with a payoff that depends on the price of other securities
What is a call option?
The right to buy an asset at a specified price on or before a specified expiration date
What is a put option?
The right to sell an asset at a specified exercise price on or before a specified expiration date
What is a futures contract?
True or False: A contract seller in a futures contract is called the long position.
False (they have a short position)
