Exam 2

Question 1

a. Indenture

Answer 1

i. Defined the contract between issuer and holder

Question 2

b. Sinking fund

Answer 2

i. Indenture calling for issuer to periodically repurchase some proportion of outstanding bonds before maturity

Question 3

c. Subordination clause

Answer 3

i. Restrictions on additional borrowing stipulating senior bondholders paid first in event of bankruptcy

Question 4

d. Collateral

Answer 4

i. Specific asset pledged against possible default

Question 5

e. Debenture

Answer 5

i. Bond not backed by specific collateral

Question 6

a. Standard & Poor’s

Answer 6

i. Very High Quality: AAA, AA
ii. High Quality: A, BBB
iii. Speculative: BB, B
iv. Very Poor: CCC. D

Question 7

b. Moody’s

Answer 7

i. Very High Quality: Aaa, Aa
ii. High Quality: A, Baa
iii. Speculative: Ba, B
iv. Very Poor: Caa. C

Question 8

a. Bond Value=

Answer 8

Present value of coupons + Present par value

Question 9

b. Bond Price =

Answer 9

Coupon*1-(1+r)^-T/r + Future Value *(1+r)^-T

Question 10

3. Bond Pricing Criteria

Answer 10

d. Prices fall as market interest rates rise
e. Interest rate fluctuations are primary source of bond market risk
f. Bonds with longer maturities more sensitive to fluctuation in interest rate

Question 11

a. Zero Coupon bond

Answer 11

i. Pays no coupons, sells at discount, provides only payment of par value at maturity
ii. Carries no coupons, provides all return in form of price appreciation

Question 12

b. Separate Trading of Registered Interest and Principal of Securities (STRIPS

Answer 12

i. Oversees creation of zero-coupon bonds from coupons bearing notes and bonds

Question 13

a. Random Walk

Answer 13

i. Notion that price changes are random
ii. Past movement cannot predict future movement
iii. All stocks are independent of each other
iv. Technical analysis undependable
v. Investment advisors add little to no value
vi. Fundamental analysis undependable

Question 14

a. Arbitrage Pricing Theory (APT)

Answer 14

ii. Arbitrage: Relative mispricing creates riskless profit
iii. Risk-return relationships from no arbitrage considerations in large capital markets
iv. Rp= rf+Bp(rm-rf)+ep

Question 15

b. CAPM: Capital Asset Pricing Model

Answer 15

i. Use Security Market Line (SML) as benchmark for fair return on risky asset
ii. CAPM is false based on validity of its assumptions
1. Useful predictor of expected returns
2. Untestable as a theory
3. Principles still valid
a. Investors should diversify
b. Systematic risk is the risk that matters
c. Well diversified risky portfolio can be suitable for wide range of investors

Question 16

a. Technical Analysis

Answer 16

i. Research of recurrent/predictable price patterns and proxies for buy/sell pressure in market
ii. Resistance level
1. Unlikely for stock/index to rise above
iii. Support Level
1. Unlikely for stock/index to fall below

Question 17

b. Fundamental Analysis

Answer 17

i. Research on determinant of stock value, i.e., earnings, dividend prospects, future interest rate expectations and firm risk
ii. Assumes stock price equal to discounted value of expected future cash flow

Question 18

13. Exchange Rate Considerations

Answer 18

a. Rate at which domestic currency can be converted into foreign currency
b. Interest rate differentials
c. Country’s economic performance
d. Inflation

Question 19

16. LEI (Lead Economic Indicators)

Answer 19

a. Average weekly production hours
b. Initial unemployment claims
c. Manufacturers new orders
d. Institute of Supply Management Index of New Orders
e. New orders for nondefense capital goods
f. New private housing units authorized by local building permits
g. Yield curve: Spread between the 10-year T-bond and federal funds rate
h. Stick prices, common 500 stocks
i. Money supply (M2) growth rate
j. Index of consumer expectations for business conditions

Question 20

17. Macroeconomic Events/Criteria

Answer 20

a. Inflation
b. Fiscal policy
c. Employment levels
d. National income
e. International trade

Question 21

18. Calculate Current Price/Current Yield

Answer 21

a. Current Yield = Annual Coupon / Bond Price