definitions

Question 1

Basis Risk

Answer 1

the impact of interest rate changes on the price of futures contracts

Question 2

Security Market Line

Answer 2

depicts the relationship between a security’s expected return and market beta

Question 3

‘Gearing’

Answer 3

the ratio of debt to equity

Question 4

American option

Answer 4

An option that can be exercised any time prior to and at expiration

Question 5

Weak-form efficiency

Answer 5

Share prices fully reflect all information contained in past price movements

Question 6

Ex-rights price

Answer 6

The new share price after a rights issue

Question 7

Standard deviation

Answer 7

the square root of the average squared differences from the mean

Question 8

Equity

Answer 8

The amount of cash shareholders have put into the business

Question 9

Net Working Capital (NWC)

Answer 9

Current operating capital minus current operating liabilities

Question 10

Net Debt

Answer 10

short term debt + long term debt - cash

Question 11

Speculative Grade Bond

Answer 11

S&P credit rating below BBB-

Question 12

Junk Grade Bond

Answer 12

S&P credit rating below BBB-

Question 13

Non-investment Grade Bond

Answer 13

S&P credit rating below BBB-

Question 14

Investment Grade Bond

Answer 14

S&P credit rating of AAA to BBB-

Question 15

YTM

Answer 15

The discount rate that sets the present value of the promised bond payments equal to the current market price of the bond

Question 16

Is the coupon rate expressed as a simple or effective interest rate?

Answer 16

simple interest rate (non compounded)

Question 17

Idiosyncratic risk

Answer 17

exclusive to the firm and measures variation in the firms returns (also called diversifiable risk)

Question 18

volatility

Answer 18

Standard deviation of a firms returns

Question 19

Covariance

Answer 19

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.

Question 20

Portfolio Weight (x_i)

Answer 20

The fraction of the total investment in the portfolio held in each individual investment of the portfolio .

Question 21

Inefficient Portfolio

Answer 21

Where its possible to find another portfolio thats better both in terms of expected return and volatility

Question 22

Efficient Frontier

Answer 22

Highest possible expected return for a given level of volatilty

Question 23

Short position stock sales

Answer 23

Sell a stock today that you don’t own with the obligation to buy it back in the future

Question 24

Excess Portfolio Return

Answer 24

Portfolio return minus the risk free rate of return

Question 25

Sharpe Ratio

Answer 25

the ratio of portfolio excess return to portfolio volatility.
Optimal ratio is tangent to the efficient frontier.

Question 26

Equity cost of capital

Answer 26

the best expected return available in the market on investments with similar risks

Question 27

Perfect Capital Market

Answer 27

1. Competitive market prices
2. No taxes or transaction costs assosciated with security trading
3. Financing decisions don’t affect cash flows

Question 28

Unlevered equity

Answer 28

Equity in a firm that has no debt

Question 29

Homemade leverage

Answer 29

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.

Question 30

Enterprise Value

Answer 30

Enterprise Value = market value of equity + debt - cash

Question 31

EBIT

Answer 31

Earnings before interest and taxes

Question 32

liabilities

Answer 32

A firms obligations to its creditors

Question 33

Leveraged Recapitalisation

Answer 33

When a firm repurchases a significant amount of shares by borrowing money

Question 34

M&M proposition 1 on the value of a firm

Answer 34

the total market value of a firm is equal to the market value of a firms assets

Question 35

Reinvestment risk

Answer 35

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.

Question 36

When is reinvestment risk greater?

Name a fixed-income instrument that has no reinvestment risk?

Answer 36

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.