definitions Flashcards
Basis Risk
the impact of interest rate changes on the price of futures contracts
Security Market Line
depicts the relationship between a security’s expected return and market beta
‘Gearing’
the ratio of debt to equity
American option
An option that can be exercised any time prior to and at expiration
Weak-form efficiency
Share prices fully reflect all information contained in past price movements
Ex-rights price
The new share price after a rights issue
Standard deviation
the square root of the average squared differences from the mean
Equity
The amount of cash shareholders have put into the business
Net Working Capital (NWC)
Current operating capital minus current operating liabilities
Net Debt
short term debt + long term debt - cash
Speculative Grade Bond
S&P credit rating below BBB-
Junk Grade Bond
S&P credit rating below BBB-
Non-investment Grade Bond
S&P credit rating below BBB-
Investment Grade Bond
S&P credit rating of AAA to BBB-
YTM
The discount rate that sets the present value of the promised bond payments equal to the current market price of the bond
Is the coupon rate expressed as a simple or effective interest rate?
simple interest rate (non compounded)
Idiosyncratic risk
exclusive to the firm and measures variation in the firms returns (also called diversifiable risk)
volatility
Standard deviation of a firms returns
Covariance
For 2 stocks it is the product of the deviations of their returns form their means. Positive if the 2 stocks move together, negative if the move oppositely.
Portfolio Weight (x_i)
The fraction of the total investment in the portfolio held in each individual investment of the portfolio .
Inefficient Portfolio
Where its possible to find another portfolio thats better both in terms of expected return and volatility
Efficient Frontier
Highest possible expected return for a given level of volatilty
Short position stock sales
Sell a stock today that you don’t own with the obligation to buy it back in the future
Excess Portfolio Return
Portfolio return minus the risk free rate of return
Sharpe Ratio
the ratio of portfolio excess return to portfolio volatility.
Optimal ratio is tangent to the efficient frontier.
Equity cost of capital
the best expected return available in the market on investments with similar risks
Perfect Capital Market
- Competitive market prices
- No taxes or transaction costs assosciated with security trading
- Financing decisions don’t affect cash flows
Unlevered equity
Equity in a firm that has no debt
Homemade leverage
If investors prefer a different capital structure to the one chosen by the the firm they can borrow\lend on their own to achieve the same result.
Enterprise Value
Enterprise Value = market value of equity + debt - cash
EBIT
Earnings before interest and taxes
liabilities
A firms obligations to its creditors
Leveraged Recapitalisation
When a firm repurchases a significant amount of shares by borrowing money
M&M proposition 1 on the value of a firm
the total market value of a firm is equal to the market value of a firms assets
Reinvestment risk
Reinvestment risk is the risk that future coupons from a bond will not be reinvested at the prevailing interest rate from when the bond was initially purchased.
When is reinvestment risk greater?
Name a fixed-income instrument that has no reinvestment risk?
Reinvestment risk is more likely when interest rates are declining and affects the yield to maturity of a bond, which is calculated on the premise that all future coupon payments will be reinvested at the interest rate in effect when the bond was first purchased. Zero-coupon bonds are the only fixed-income instruments to have no reinvestment risk since they have no interim coupon payments.
