Concepts Flashcards
What are the three portfolio parameters that has to be adressed in setting up a portfolio?
- Asset allocation
- Strategic allocation: Choice between different asset classes (bonds, stocks, derivatives etc.)
- Tactical allocation: Deviation from weights invested in different asset classes compared to strategic allocation - Choice of portfolio management
- Active portfolio management: Actively searching for “undervalued” assets
- Passive portfolio management: Buy-and-hold approach - Security selection (choice of security within an asset class)
What are the broad categories of “Players” on the financial markets? Main parameters of them?
Companies:
- Are net borrowers
- Raise capital in the security markets (usually common stock and bonds) to invest in real assets.
Households
− Are net savers
Governments
− Can be net savers (e.g., Norway, Singapore) or net borrowers (which is usually the case)
− Borrow funds to invest in infrastructure (streets, bridges, universities etc.)
Financial intermediaries
− They role is to match supply and demand of capital
Financial intermediaries perform a transformation function with respect to?
Liquidity
Maturity
Size
Risk
Financial assets: What is “Money market”? Who invests in them?
- Short-term (
Who issue bonds?
− Governments or related agencies (government bonds, municipal bonds…)
− Companies (corporate bonds)
− Special purpose vehicles (asset backed securities)
Common stock, what are the two main characteristics?
− Residual claim: Holders receive what is left over in the firm after every other claim is settled
− Limited liability: Holders are not liable with their personal wealth for the firm’s obligation
Preferred stock, what is its similarities to debt?
- Holder receives a fixed payment each year → Bond with infinite maturity
- Holder has no voting right
- Are sometimes also callable or convertible (Which bonds also can be if an option is attached)
Preferred stock, what is its similarities to equity? What are its differences to common stock?
Similarities
- The board of directors can decide whether to pay a dividend or not
- Costs for dividends are not deductible on firm level (as are interest payments)
Differences:
- If not: Dividend usually accumulates
- No dividend can be paid out to common stock holders until cumulated divided to preferred stock is paid out
How does equity indices differ?
Weighting of components:
- Price-weighted index (DJIA)
- Value-weighted index (S&P500)
- Equally-weighted index
Treatment of dividends
- Price index (DJIA, FTSE100)
- Performance index, also known as total return index (DAX30)
Asymmetric derivatives, examples and parameters
Call and Put options
- Gives the buyer the right to buy (call) or sell (put) an asset
- For a predefined price (exercise price)
- At a or before a predefined date
- The buyer of the option has the right, but not the obligation to exercise the option
Symmetric derivatives, examples and parameters
Futures and swaps
- Buyer (long) and seller (short) agree to exchange an asset
- For a predefined price
- At a predefined date
Underwriter
Usually investment bank(s), help an issuing firm preparing the prospectus, marketing the securities, and they also track the stock or the bond after the issue
Seasoned equity offering
A subsequent offering of equity by a firm
Public offering
Firms that offer securities to the general public
Private placement
Securities offering sold to a few institutional investors
Direct search markets
− Seller and buyers search each other individually
− Least organized market, sporadic participation, nonstandard goods
− Example: WG-gesucht.de
Brokered markets
− Brokers offer search services to buyers and sellers to find each other
− Example: Primary stock and bond markets, real estate market
Dealer markets
− Dealers buy assets on their own account and resell them at higher prices (the “spread”)
− Requires market activity
− Example: Some bond and equity markets
Auction markets
− Buyers and sellers meet at one place and trade; most integrated form of trading
− Example: Most stock and bond markets, derivative markets trade as continuous auctions
Market orders
− Buy or sell order that is executed immediately at the current market price
− In securities that are rarely traded (“low liquidity”) these trades can be expensive since the price is determined on the market
What is price-contingent orders? Advantage and disadvantage?
− Limit orders:
Buy or sell order that is executed if the prices crosses a certain threshold
− Stop orders:
Similar to limit orders, but aim at preventing losses
− Disadvantage: Questionable whether order will (ever) be executed (immediacy)
− Advantage: Transaction price known beforehand
What happens if investors post limit orders?
They get cumulated in a limit order book where the current limit orders are visible (Order book depth)
Buying on margin
When purchasing securities, investors usually have access to debt financing for the purchase transaction (usually offered by the broker)
− The buyer has to provide the margin
− The broker lends the remainder to the investor and charges him interest and fees; the securities bought serves as collateral for the loan
Short sales, what is it and how does it work in practice?
An asset is sold before it is bought and it allows investors to participate in declining asset prices
In practice, an investor would ask his broker to sell a security short. The broker would lend the security owned by another client to the investor, who would sell it. The position is closed when the investor returns the security to the broker by buying it back on the market.