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Financial Strategy > Exam 2 > Flashcards

Exam 2 Flashcards

1
Q

Par value

A

Amount of debt borrowed to be repaid; face value.

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2
Q

Coupon Rate

A

The interest rate used to compute the bond’s interest payment each year. Listed as a percentage of par value, the actual payments usually are paid twice per year.

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3
Q

Bond Price

A

The bond’s market price reported as a percentage of par value.

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4
Q

How to calculate semi-annual interest payment on a bond:

A

(Coupon rate * face value) / 2

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5
Q

What is the safest FI investment in the world?

A

Treasury bonds

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6
Q

Difference between treasury notes and treasury bonds?

A

Notes have a maturity of 1-10 years and bonds have maturity of 10-30 years

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7
Q

Are interest payments on muni bonds taxed?

A

No - not at federal or state level

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8
Q

Difference between general obligation and revenue muni bonds?

A

General obligation bonds benefit everyone and are repaid using tax revenues. Revenue bonds only benefit specific groups and are repaid from user fees.

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9
Q

Treasury Inflation-Protected Securities

A

TIPS are U.S. government bonds where the par value changes with inflation.

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10
Q

Agency bonds

A

Bonds issued by U.S. government agencies. (Freddie Mac, Fannie Mae, Sallie Mae). Also thought to be very safe, but potentially have a higher return than T-bonds

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11
Q

Mortgage-backed securities

A

Securities that represent a claim against the cash flows from a pool of mortgage loans.

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12
Q

Asset-backed securities

A

Debt securities whose payments originate from other loans, such as credit card debt, auto loans, and home equity loans; one of the fastest growing areas of the financial services sector

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13
Q

Convertible bond

A

A debt security that can be converted to shares of stock or another type of security.

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14
Q

Premium Bond

A

A bond selling for greater than its par value.

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15
Q

Bid price

A

Price at which investors can sell the bond

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16
Q

Discount bond

A

A bond selling for lower than its par value.

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17
Q

Factors that determine coupon rate

A

The amount of uncertainty about whether the company will be able to make all the payments.

The term of the loan.

The level of interest rates in the overall economy at the time.

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18
Q

Zero coupon bond

A

A bond that does not make interest payments but generally sells at a deep discount and then pays the par value at the maturity date.

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19
Q

Present value of the bond =

A

PV of interest payments + PV of par value

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20
Q

Interest rates and bond prices are ___ related

A

inversely

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21
Q

Interest rate risk

A

during periods when interest rates change substantially (and quickly), bondholders experience distinct gains and losses in their bond inventories.

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22
Q

Reinvestment rate risk

A

The chance that future interest payments will have to be reinvested at a lower interest rate

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23
Q

how to calculate capital gain on a bond with changing interest rate

A

PV of bond in the future - PV of the bond currently

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24
Q

Which bond characteristics have the highest interest rate risk?

A

Longer maturities and lower coupons

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25
Q

Current yield

A

Return from interest payments; computed as the annual interest payment divided by the current bond price.

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26
Q

Why doesn’t current yield calculate total expected return?

A

Because it does not account for any capital gains or losses that will occur from purchasing the bond at a discount or premium to par.

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27
Q

Yield to maturity

A

The total return the bond offers if purchased at the current price and held to maturity.

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28
Q

Bond prices and bond yields have a ___ relationship

A

inverse

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29
Q

Interest rates and bond yields have a ___ relationship

A

Direct

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30
Q

Call Premium

A

One year of interest payments

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31
Q

Price of a callable bond =

A

PV of interest payments to call date + PV of call price

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32
Q

Difference between YTM and YTC calculation

A

YTC assumes that the investor will receive the par value and call premium at the earliest call date

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33
Q

Yield to call

A

The total return that the bond offers if purchased at the current price and held until the bond is called

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34
Q

taxable equivalent yield

A

Modification of a municipal bond’s yield to maturity used to compare muni bond yields to taxable bond yields

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35
Q

Equivalent taxable yield formula =

A

Muni yield / (1 - tax rate)

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36
Q

In what scenario are the coupon rate, current yield, and yield to maturity all the same?

A

When the bond trades at par value

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37
Q

If a bond is priced at a premium, current yield and YTM will be ___ than coupon rate

A

Lower

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38
Q

If a bond is priced at a discount, current yield and YTM will be ___ than coupon rate

A

Higher

39
Q

YTM is ___ than current yield in a premium bond

A

Higher

40
Q

Bond issuers are likely to call a bond when interest rates are ____

A

Low

41
Q

Credit quality risk

A

chance that the issuer will not make timely interest payments or even default.

42
Q

Bond rating

A

A grade of credit quality as reported by credit rating agencies.

43
Q

Investment grade

A

High credit quality corporate bonds.

44
Q

Junk bonds

A

Low credit quality corporate bonds, also called speculative bonds or high-yield bonds

45
Q

Unsecured corporate bonds

A

Corporate debt not secured by collateral such as land, buildings, or equipment.

46
Q

Debentures

A

Unsecured corporate bonds

47
Q

Senior bonds

A

Older bonds that carry a higher claim to the issuer’s assets.

48
Q

Mortgage bonds

A

Bonds secured with real estate as collateral.

49
Q

Equipment trust certificates

A

Bonds secured with factory and equipment as collateral.

50
Q

High-yield bonds

A

Bonds with low credit quality that offer a high yield to maturity, also called junk bonds.

51
Q

Formula: interest payment on TIPS

A

[1/2 * TIPS percent * current CPI/issued CPI] * 1,000

52
Q

Formula: capital gain of a TIPS

A

[(end CPI/issued CPI) * 1,000] - [(beg CPI/issued CPI) * 1,000]

53
Q

Residual claimants

A

Ownership of cash flows and value after other claimants are paid.

54
Q

Dow Jones DJIA

A

A popular index of 30 large, industry-leading firms.

55
Q

S&P 500

A

stock index of 500 large companies

56
Q

NASDAQ

A

A technology-firm weighted index of stocks listed on the NASDAQ Stock Exchange.

57
Q

What do each of the 3 stock indexes measure by?

A

DJIA: avg stock price
S&P 500: market cap
NASDAQ: market cap

58
Q

Difference between the bid and ask price (stocks):

A

cost to the investor, profit for the market maker

59
Q

Ask

A

The quoted price investors are likely to pay when they buy stock.

60
Q

Bid

A

The quoted price investors are likely to receive when they sell stock.

61
Q

Today’s value of a stock held for 1 year =

A

PV of next year’s dividend and price

Formula = (D1 + P1) / (1 + i)

62
Q

Today’s value of a stock held for multiple years =

A

D1 / (1+i) + D2 / (1+i)^2 +…+ (Dn + Pn) / (1 + i)n

*can also do this in a financial calculator by calculating the PV of each years’ dividends and summing the answers at the end

63
Q

PV using Constant growth (Gordon) model =

A

Next year’s dividend / (discount rate - growth rate)

OR

Current dividend * (1 + growth rate) / (discount rate - growth rate)

64
Q

Preferred stock

A

A hybrid security that has characteristics of both long-term debt and common stock.

65
Q

Dividend yield

A

Last four quarters of dividend income expressed as a percentage of the current stock price.

66
Q

Interest rates and preferred stock prices are ___ related

A

inversely

67
Q

Expected return using Constant Growth model =

A

Dividend / stock price + capital gain

OR

Dividend yield + capital gain

68
Q

Variable growth rate

A

A valuation technique used when a firm’s current growth rate is expected to change some time in the future.

69
Q

Relative value

A

A stock’s priceyness measured relative to other stocks.

70
Q

P/E Ratio

A

Current stock price divided by four quarters of earnings per share.

71
Q

What types of firms should investors be concerned about?

A

Firms with high P/E ratios and single-digit growth rates

72
Q

Value stocks

A

Companies considered to be temporarily undervalued; usually have low P/E ratios and high expected growth rates

73
Q

P/E Ratio Model =

A

P/E ratio * EPS * ((1 + g)^n)

74
Q

Future stock price =

A

Future P/E ratio * Future EPS

75
Q

FV formula =

A

FV = PV(1 + g)^n

76
Q

Dollar return =

A

Capital gain or loss + Income

OR

(ending value - beginning value) + Income

77
Q

Geometric mean return =

A

Sum of all years: [(1 + % return as a decimal) ^ 1/n] - 1

78
Q

Standard deviation =

A

A measure of past return volatility, or risk, of an investment.

Formula = Square root [sum (return - average return)^2] / (n - 1)

79
Q

Coefficient of variation =

A

Relative measure of risk vs reward (smaller = better)

Formula = Standard deviation / average return

80
Q

Modern portfolio theory

A

A concept and procedure for combining securities into a portfolio to minimize risk.

81
Q

Correlation

A

A measurement of the co-movement between two variables that ranges between −1 and +1.

82
Q

What does a correlation of +1 mean?

A

returns from two different securities move perfectly in sync

83
Q

What type of correlation do investors seeking diversification look for?

A

Low or negative

84
Q

Expected return

A

Sum of (each return * probability of that return)

85
Q

Required return using CAPM =

A

Risk-free rate + Return premium

OR

Risk-free rate + Beta * Market risk premium

86
Q

Risk premium

A

The portion of the required return that represents the reward for taking risk.

Formula = Beta * Market Risk Premium

OR

Beta * (Market Return - Risk Free Rate)

87
Q

Market risk premium

A

The return on the market portfolio minus the risk-free rate. Risk premiums for specific firms are based on the market risk premium.

88
Q

Capital market line (CML)

A

The line on a graph of return and risk (standard deviation) from the risk-free rate through the market portfolio; offers the highest exp. return for any level of risk

89
Q

Market portfolio

A

In theory, the market portfolio is the combination of securities that places the portfolio on the efficient frontier and on a line tangent from the risk-free rate. In practice, the S&P 500 Index is used to proxy for the market portfolio

90
Q

Beta

A

A measure of the sensitivity of a stock or portfolio to market risk.

91
Q

Security Market Line (SML)

A

Similar to the capital market line except risk is characterized by beta instead of standard deviation

92
Q

Portfolio Beta =

A

Sum of the beta of each stock * its weight in the portfolio

93
Q

Conditions for an efficient market:

A

Many buyers and sellers, no prohibitively high barriers to entry, free and readily available information to all participants, low trading or transaction costs

94
Q

Required Return using Constant Growth model =

A

(D1 / P0) + g

Financial Strategy (2 decks)

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