Deck 3 - Equity, Fixed Income, Derivatives, Alternatives and Portfolio Management Flashcards
Main functions of the financial system?
- Allow entities to save, borrow, issue equity capital, manage risk, exchange assets, and utilize information
- Determine the return that equates aggregate savings and borrowing.
- Allocate capital efficiently
What is the leverage ratio?
It is the value of the asset divided by the value of the equity position
What is the margin call price?
Margin call price = Initial price ((1-initial margin)/(1-maintenance margin))
What is the difference between execution, validity, and clearing instructions?
Execution - how to trade - market and limit orders
Validity - when an order can be filled - day orders, gtc
Clearing - how to settle a trade
What are the sign of well-functioning financial system?
Complete markets, operational efficiency, informational efficiency, allocational efficiency
What are the objectives of market regulations
- Protect unsophisticated investors
- Establish minimum standards of competency
- Prevent insider trading
- Promote common financial reporting
- Require minimum levels of capital
What is the difference between a price index and total return index
Price uses only the price change and total return includes the price and income (dividends) from the index
What is the difference between a price-weighted, equal-weighted, market cap and fundamental weighted
Price - arithmetic mean of prices. Divisor must be adjusted for stock split
Equal - Same weight to each
Market - Based on the proportion of the total market value
Fundamental - Weights that are independent
Market Capitalization weighted index formula?
(Current total market value of index stocks/base year total market value of index stocks) x base year index value
Equal-weighted index formula?
(1+average percentage change in index stocks) x initial index value
What is the differences between fixed-income and the equity universe?
Fixed-income can be classified by issuer, collateral, coupon, maturity, credit risk, and inflation protection.
It has a much broader universe and higher turnover. Depend on dealers and are illiquid. Can be difficult to replicate
What are global depository receipts?
Issued outside the US and outside the issuer’s home country
What are american depository receipts?
Denominated in US Dollars and are traded on US exchanges
What are global registered shares?
Common shares of a firm that trade in different currencies on different stock exchanges
What is accounting ROE?
It is calculated as the firm’s net income/book value of common equity.
What is the firm’s cost of equity?
The minimum rate of return investors require. It is reflected in the market price.
What are porter’s five forces?
- Rivalry among existing competitors
- Threat of entry
- Threat of substitutes
- Power of buyers
- Power of suppliers
What are the stages of firm growth
- Embryonic
- Growth
- Shakeout
- Mature
- Decline
What is the dividend payment chronology?
- Declaration date
- Ex-dividend date - first day a share of stock trades without the dividend
- Holder-of-record date - date on which share owners who will receive the dividend are identified
- Payment date - the date the dividend checks are sent
What are advantages of discounted cash flows
- Easy to calculate
- Widely accepted and can be used for many firms
What is the FCFE model useful for
Free Cash flow to Equity for firms that do not pay a dividend
What is the Gordon growth model useful for
Stable, mature, non-cyclical firms
What is the disadvantages of discounted cash flow models?
Inputs must be forecast
Estimates are very sensitive to inputs
Required return on equity must be greater than the growth rate
Firm must pay dividends
What are the advantages of price multiples?
Often useful for predicting stock returns
Widely used by analysts
Can be used to calculate over time and between industries
Can be used when it is independent of the value
What are the disadvantages of price multiples?
Very sensitive to inputs, may not be comparable, bad for certain economic conditions, may appear overvalued by comparable method, market value of debt is hard to find
What are advantages of asset-based models?
Can provide floor values, has to have short-term assets, useful for public firms
What are the disadvantages of asset-based models?
Market values of assets can be difficult to obtain
What is the Gordon growth model?
Assumes growth rate is constant. V0 = D1/(ke-gc)
where g = b x ROE
b = earnings retention rate = 1 - dividend payout rate
What is the P/E ratio formula
P0/E1 = (D1/E1)/(k-g)
What is the Enterprise Value formula?
EV = Market value of common and preferred stock + market value of debt - cash and short-term investments if you are doing a multiple then divide by EBITDA
What is a bond with an amortizing structure and what is a sinking fund?
Amortizing structure - repays part of its principal at each payment date
Sinking fund - provision requires the issuer to retire a portion of a bond at specific time periods
What kind of bonds are more sensitive to change?
More sensitive to changes in YTM for bonds with lower coupon rates and longer maturities and less sensitive to changes in YTM for bonds with high coupon rates and shorter maturities
What is the no-arbitrage price?
It is the addition of the cash flow at the time divided by spot rate raised to the period
What is the true yield and current yield
When delayed by weekends or holidays and current yield is the coupon payments / price
What is special about a special purpose entity and a servicer?
It buys financial assets from the seller and issues ABS
Servicer carries out collections and other responsibilities related to the financial assets could be the same as the seller
Sequential pay CMOS
All scheduled principal payments and prepayments are paid to each tranche. The first has the most contraction risk and the last tranche to be paid principal has the most extension risk
What is the difference between prepayment, contraction, and extension risk?
Prepayment - overall uncertainty about timing
Contraction - risk that the loan will be repaid more rapidly
Extension - risk that the loan will be repaid more slowly
Macaulay duration
Weighted average number of coupon periods until a bond’s scheduled cash flows
What is modified duration and approximate modified duration
A percentage change in a bond’s price that would result from a 1% change in YTM.
Approximate modified duration =
(V- – V+) / 2 x V0 x ∆YTM
What is the effective duration
A percentage change in a bond’s price that would result from a 1% change in benchmark yield.
Effective duration =
(V- – V+) / 2 x V0 x ∆curve
What is key rate duration
The measure of the price sensitivity of a bond or a bond portfolio to a change in the sport rate for a specific maturity
How to calculate portfolio duration?
Weighted average number of periods until cash flows will be received using the portfolio’s IRR. OR
Percentage change in portfolio value for a 1% change in yield, only for parallel shifts of the yield curve
What is the money duration of a bond?
Money duration = annual modified duration x full price of bond position
What is the Price Value of a Basis Point?
The change in value of a bond expressed in currency units, for a change in YTM of one basis point or 0.01%
PVBP = [(V- – V+) / 2] x dirty price x 0.0001
What is the effectivity convexity of a bond?
The curvature of a bond’s price-yield relationship with options
Approximate Effective Convexity = (V- + V+ - 2V0) / ((∆curve)^2)V0
What is the formula for percentage change in full bond price?
%∆ full bond price = -annual modified duration(∆YTM) + 1/2 annual convexity (∆YTM)^2