Brainscape's Knowledge GenomeTM

Browse over 1 million classes created by top students, professors, publishers, and experts.


See full index

Year 2 Economics Term 1 > FE - Lecture 4 onwards > Flashcards

FE - Lecture 4 onwards Flashcards

1
Q

Bonds: Maturity

A

> 1 year

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

Bonds: Straight (plain vanilla/ bullet) bond

A

–Pays off regular (usually semi-annual), fixed coupons until maturity (MAY HAVE TO ASSUME THIS IS SOME QUESTIONS)
–Return of principal on maturity date

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

Bonds: Coupon payment terms:

A

–zero-coupon (sold at discount)
–amount of the coupon changes over time
•variable rate bonds (linked to current interest rates)
•index-linked bonds (linked to index –inflation)
•income bonds (pay coupon only if company income is sufficient)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

Bonds: Redemption terms

A

–1 redemption date (standard)
–double-dated bonds : range of possible redemption dates
–callable/puttablebonds: redemption date chosen by issuer/ holder
–convertible bonds: can be converted into other types of bonds/equity
–perpetual bonds: no redemption date (consols)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

Bonds: Issuer

A

–government = gilts
–local authorities (secured on the revenues of the local authority, but not guaranteed by government)
–corporate bonds

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

Bonds: Corporate bonds

A

–Debentures: secured
•fixed-charge: specific assets chargeable in case of default
•floating-charge:general charge on all assets (below fixed-charge)
•different classes ranked as either senior orjunior
–Mezzanine debt
•finance mainly management buy-outs
•different degrees of seniority (usually above equity but below senior secured debt)
–Unsecured debt: loan stock

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

Bonds: Currency

A

–Domestic bonds: issued in £ in the UK;
–Foreign bonds (bulldogs): issued in £ by foreign issuers
–Eurobonds = issued and/or traded in the UK in a foreign currency

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

Bonds: Default (credit) risk

A

–Credit ratings: Moody’s and Standard & Poor’s

–Junk bonds

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

Credit rating for bonds:

A

AAA,AA,A,BBB - Investment Grade

BB,B,CCC,CC,C,CI,R,SD,D,NR - non-investment grade (junk bonds)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

What is a console?

A

A bond with no maturity.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

What is yield? and its problem?

A

return you get on a bind. Doesn’t account for capital gains or losses to maturity

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

Term structure for a term to maturity equal to t?

A

A set of yields to maturity, at a given time, on bonds of different maturities.
A plot of the term structures is called the yield curve.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

YTM?

A

Yield to maturity. The most commonly used yield measure. A money weighted rate of return (IRR). The discount rate that makes current price = present value.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

Annual spot yield for a term to maturity equal to t?

A

rst, is the yield on a zero-coupon bond of maturity t,.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

Why is evaluating shares difficult?

A

–Dividends and earnings unknown
–No maturity date
–Risky

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

The two types of stock and their properties?

A

•Common stock (or equity)
–Variable dividend payments
•Preferred stock
–Fixed dividend payments
–Similar to bonds
–But dividend payment not guaranteed and holders cannot declare the firm insolvent if it fails to pay
–Cumulative: all unpaid dividends cumulate and are paid when earnings are sufficient
–Participating: fixed rate of dividend+ right to participate in further share of profits

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
17
Q

Profit loss account?

A

operating revenue - operating costs = operating profit, - interest payments on bonds and loans = profit before tax, - corporation tax = profit after tax, - dividends = retained earnings.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
18
Q

EPS?

A

Earnings per share = (profit after tax - dividends of preferred shares)/ # of ordinary shares.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
19
Q

PE ratio?

A

How much investors have to pay for £1 of earnings.

P/E Ration = Earnings per share/ dividends per share.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
20
Q

Net dividend yield?

A

Dividends per share/ price per share.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
21
Q

Problems with the dividend valuation model?

A

implicit assumption that the discount rate is constant.

Not operational: expectations of dividends into an infinite future.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
22
Q

What is the principal agent problem?

A

Owner(principle) and manager (agent) can have conflicting interests.
Agency Costs: costs of monitoring the management.
Flotation costs: costs of having to raise new funds frequently.
Agency costs down when external funds are being attained due to more scrutiny.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
23
Q

How does the dividend link in with the principal agent problem?

A

payment of dividend represents the tradeoff between flotation costs and agency costs. The optimal minimises costs.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
24
Q

What is signalling?

A

A dividend policy to signal to the market the firms prospects. Manager may hide how the firm is doing though. to avoid this, pay is often linked to how this.
The penalty of a false positive signal must be greater than the penalty for a true bad signal.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
25
Q

Capital structure decision: Debt (bank debt, bonds, commercial paper)

A
  • Fixed claim
  • Tax-deductible
  • High priority in bankruptcy
  • Fixed maturity
  • No management control
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
26
Q

Capital structure decision: Equity (owner’s capital, venture capital, common stock)

A
  • Residual claim
  • Not tax-deductible
  • Low priority in bankruptcy
  • ‘Infinite’ maturity
  • Management control
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
27
Q

Capital structure decision: Hybrid securities

A

They possess some characteristics of debt and some of equity. Examples:
•Convertible debt
•Preferred stock

28
Q

What are the 5 different stages of a firms life cycle and the financing decision at each stage?

A

1.Start-up:
–Owner’s equity. Perhaps bank debt
2.Expansion:
–Owner’s equity and venture capital. Some firms will become public (IPO)
3.High growth:
–Additional equity issues. Perhaps issuance of convertible debt
4.Mature growth:
–Internal financing and corporate debt
5.Decline:
–Internal financing. Debt retiring and stock buy-back

29
Q

Debt to capital ratio?

A

–Debt to Capital Ratio = Debt / (Debt + Equity)

30
Q

Debt to capital ratio: Debt

A

•Debt includes all interest bearing liabilities, short term as well as long term

31
Q

Debt to capital ratio: Equity

A

•Equity can be defined either in accounting terms (as book value of equity) or in market value terms (based upon the current price). (The resulting debt ratios can be very different)

32
Q

Benefits of Debt? Tax

A

Tax Benefit: When you borrow money, you are allowed to deduct interest expenses from your income
If you make a profit x, but have debt y, you only pay tax on x - y. As a result it it may be beneficial to be in debt. The interest payment on debt is payed of slightly by the fall in tax. This can only happen up to a point though. Once debt increases, it becomes more expensive, so they will need to use a new method. This may mean changing the base for the company so you pay tax in a place with lower coorperation tax rate.

33
Q

Benefits of debt? Discipline to management

A

If you are a manager of a firm with no debt, and you generate high income and cash flows each year, you may tend to become complacent
•Complacency can lead to inefficiency and investing in poor projects
•There is little or no cost borne by the managers
•Forcing such a firm to borrow money can reduce complacency
•The managers now have to ensure that the investments they make will earn at least enough return to cover the interest expenses
•The cost of not doing so is bankruptcy and the loss of such a job

34
Q

Costs of debt? Bankruptcy cost

A

Bankruptcy Cost
•The expected bankruptcy cost is a function of two variables
1.The cost of going bankrupt
2.The probability of bankruptcy

•Observation:Other things being equal, the greater the bankruptcy cost and/or probability of bankruptcy, the less debt the firm can afford to use

35
Q

Cost of debt? Loss of future financing flexibility

A
  • When a firm borrows up to its capacity, it loses the flexibility of financing future projects with debt
  • Observation:Other things equal, the more uncertain a firm is about its future financing requirements and projects, the less debt the firm will use for financing current projects
36
Q

The Miller-Modigliani Theorem

A

•In an environment with no taxes, default risk or agency costs, capital structure is irrelevant and the value of a firm is independent of its debt ratio

37
Q

Implications of The Miller-Modigliani Theorem

A

–Leverage is irrelevant. A firm’s value will be determined by its project cash flows
–The cost of capital of the firm will not change with leverage. As a firm increases its leverage, the cost of equity will increase just enough to offset any gains to the leverage

38
Q

freely convertible currencies?

A

holders can exchange without any restrictio

39
Q

Partially convertible currencies?

A

central bank imposes certain restrictions
•Ex: on capital transactions; maximum amount that can be exchanged, maximum fluctuation range …
There can also be partially convertible currencies.

40
Q

Direct Quotation?

A

price of foreign currency in terms of domestic currency

41
Q

Indirect quotation

A

Price of domestic currency in units of a foreign currency

42
Q

Forward FX rates?

A

delivery date > 2 business days ( settlement date for spot transactions).
Rates: quoted as premiums or discounts with respect to spot rates.

43
Q

Forward premium?

A

Fwd bid < fwd offer. Premium is added to the spot price

44
Q

Forward discount?

A

Fwd bid > fwd offer.

Discount is subtracted from the spot price.

45
Q

Exchange rate risk?

A

risk that adverse movement in the exchange rate will reduce the return from an investment.

46
Q

Other risks on the FX market?

A
  • Transaction costs:Investing in foreign markets can entail higher costs
  • Double taxation: Taxes due both in domestic and foreign country, or higher taxes in foreign countries
  • Political risk:Risk of expropriation (ex. Repsolin Argentina), revolution (ex. Libya), or simply default (again, Argentina), etc.
  • Transaction risk:Risk arising from invoicing in a foreign currency
  • Translation risk:Risk to the balance sheet from having assets and/ or liabilities denominated in a foreign currency
47
Q

Solution to FX market risks??

A

Hedging using forward currency transactions

48
Q

What does PPP allow us to do?

A

calculate the fair exchange rate independent of knowing whether the other rates are equilibrium ones.

49
Q

law of one price?

A

A freely traded product should have the same price everywhere (expressed in units of the same currency)

50
Q

Is PPP long or short run?

A

Long run exchange rate behaviour

51
Q

covered interest rate parity?

A

nominal interest rates are hedged (covered) for exchange rate risk will be equal in all countries.

52
Q

Forward contracts?

A

an agreement to buy or sell and asset at a certain future time for a certain price. Taylor made contracts with no money being exchanged till delivery.
Seller gains if spot price < forward price. buyer gains if forward price > spot price. The greater the difference, the greater the incentive for the counterpart to default.

53
Q

Negatives of forwards?

A
  1. Cannot be cancelled without mutual agreement (not very liquid)
  2. Obligations of one counterparty cannot be transferred to a third party (not marketable)
  3. Counterparty may default (credit risk)
54
Q

Long vs short position

A 
Long= agreement to buy the asset
Short= agreement to sell the underlying asset
55
Q

Futures contracts?

A

Similar to forward contracts but traded on an exchange.

Liffe, CBOT,CME

56
Q

what do futures contracts offer?

A

standardised agreements
more liquid
No default risk as a clearing house guarantees fulfilment of contracts.

57
Q

Initial margin?

A

The down payment made by the counterparties to cover any losses at the end of trading
•Initial margin is usually calculated by taking the worst probable loss that the position could sustain
•It can be paid in either cash or collateral

58
Q

Variation margin

A 
The additional (top-up) payment that has to be made if the level of the margin account falls below a specific threshold (maintenance margin).  Also known as margin call, and this is paid at the end of everyday if needed. (market to market).
Reduces credit risk
59
Q

Clearing houses?

A

Intermediaries to futures transactions

60
Q

Limit up and limit down?

A

price of a future lies between a band around the settlement price (from the day previous). Movement above or below this band causes the market to close until the next day making contracts completely illiquid till market reopen.

61
Q

Basis?

A

Basis = Futures price - spot price

62
Q

relationship between futures and spot price

A

as delivery month is approaches, futures price converges to spot price

63
Q

Basis > 0 or < 0

A

Contagion: basis > 0
Backwardation: basis < 0

64
Q

Financial futures contracts?

A

Settles in cash (no physical delivery)

65
Q

4 types of financial futures contracts?

A 
1.Short-term interest rate contracts
•Sterling, Euribor, Eurodollar
•Average daily volume: 1.7 million contracts approx.
•17 designated market makers
•LCH.ClearnetLtd (the clearing house)
2.Long-term interest rate contracts
3.Stock index contracts
4.Currency contracts

Year 2 Economics Term 1 (4 decks)

Brainscape helps you reach your goals faster, through stronger study habits.
© 2024 Bold Learning Solutions. Terms and Conditions