final

Question 1

Bond

Answer 1

Promise to repay a specified amount of money in the future. Involves two steps: The borrower issues a bond to the lender for some amount of cash.; The borrower has to pay interest and return the money in the end.

Question 2

Coupon

Answer 2

interest amount paid, usually made on the semiannual basis

Question 3

Principal/ Face value/ par value/ nominal value -

Answer 3

money which will be repaid in the end of the term

Question 4

Callable -

Answer 4

bond that the issuer can demand to repurchase at a set price (usually after a grace period). A call provision is valuable to issuer, costly to investor.

Question 5

Puttable bond –

Answer 5

bond that you [as investor] can exchange for cash before maturity

Question 6

ordinary bond

Answer 6

is the most basic type of bond without any special features such as options to convert into shares, be called back by the issuer, or be sold back to the issuer before maturity.

Question 7

interest rates of bonds

Answer 7

Callable bonds usually offer higher interest rates to compensate for the risk that the issuer might redeem them early.

Puttable bonds typically have lower rates because they provide more security to investors, allowing them to sell the bond back early.

Ordinary bonds generally have interest rates between those of callable and puttable bonds, reflecting their more straightforward, risk-average nature.

Question 8

Junk or high yield bond

Answer 8

like any bond, a junk bond is an investment in debt. A company or a government raises a sum of money by issuing IOUs stating the amount it is borrowing (the principal), the date it will return your money (maturity date), and the interest rate (coupon) it will pay you on the borrowed money. The interest rate is the profit the investor will make for lending the money.

Question 9

Convertible bond:

Answer 9

• A convertible bond is a fixed-income corporate debt security that yields interest payments but can be converted into a predetermined number of common stock or equity shares.
• Bond that is convertible into common stock at a set ratio. Gives an option to investor, lower int. rate for issuer

Question 10

Treasury Inflation-Protected Securities (TIPS)

Answer 10

are marketable Treasury securities whose principal and interest payments are adjusted for inflation.

Treasury Inflation-Protected Securities (TIPS) are a type of U.S. Treasury bond designed to help protect investors from inflation. The principal value of TIPS increases with inflation and decreases with deflation, as measured by the Consumer Price Index (CPI). When TIPS mature, you are paid the adjusted principal or original principal, whichever is greater. This means that if inflation occurs, the principal increases, and the interest payments, which are calculated based on the adjusted principal, also increase

Question 11

“Junk bond”

Answer 11

• bond that is rated below investment grade.

Question 12

Floating-rate bonds

Answer 12

coupon rate will change depending on what is happening (inflation rate, unemployment rate)

Question 13

Indenture -

Answer 13

is a legal contract between a bond issuer and the bondholders that outlines the specific terms of the bond, such as payment schedules, interest rates, and conditions for repayment.

Question 14

Debenture -

Answer 14

type of a bond that does not have any collateral (usually a junk bond)

Question 15

Classify bonds according to the issuer

Answer 15

Government (sovereign) bonds
- US Treasury bonds
- Govt agency bonds
- State and Municipal bonds

Corporate bonds

Question 16

classify bonds maturity

Answer 16

If government: treasury bills (year), notes(1-10years), bonds(10years+)

If corporate: commercial paper (less than 1 year), bond(1year+)

Question 17

Accrued interest

Answer 17

– the idea that if a bond is purchased between coupon payments, the buyer must pay the seller the accrued (accumulated) interest – the proportional share of the upcoming coupon payment

Question 18

know the 3 factors that impact bond prices

Answer 18

What influences and how bond prices:
● Interest rates - inverse relationship
● Inflation - if inflation up, bond price down.
● Changes in the probability of default – situation in the company

Bond prices are influenced by several key factors, each affecting how bonds are valued in the market. Interest rates have an inverse relationship with bond prices; when interest rates rise, bond prices typically fall, and vice versa. This occurs because newer bonds might be issued with higher yields when interest rates increase, making older bonds with lower yields less attractive unless their prices adjust downward. Inflation also affects bond prices negatively. If inflation expectations rise, the real return on bonds decreases, leading investors to demand higher yields, which translates into lower bond prices. Lastly, changes in the probability of default significantly impact bond prices. If a bond issuer’s financial health deteriorates, indicating a higher risk of default, the market will demand higher yields for the increased risk, lowering the bond’s price. This is especially critical in corporate bonds, where shifts in the issuer’s creditworthiness directly reflect in bond valuations. Each of these factors dynamically interacts with market sentiments and economic indicators to influence bond investment decisions.

Question 19

Know the 2 factors that influence volatility of bond prices

Answer 19

● Maturity length.
● Size of coupon

The volatility of bond prices, or how much bond prices fluctuate over time, is primarily influenced by two factors: maturity length and the size of the coupon. Firstly, the length of maturity plays a significant role; generally, longer-maturity bonds are more sensitive to changes in interest rates, making them more volatile. This is because the longer the period until a bond’s maturity, the greater the uncertainty and the higher the risk that changes in the market interest rates will impact the bond’s price. Secondly, the size of the coupon also affects bond price volatility. Bonds with lower coupon rates tend to be more volatile than those with higher coupons. Lower coupon bonds have smaller interest payments, which make their total returns more sensitive to changes in the market price of the bond, thus increasing volatility. Both factors are crucial in determining the risk and return profile of bonds, affecting decisions by investors depending on their risk tolerance and investment strategy.

Question 20

The coupon yield -

Answer 20

A bond’s coupon rate is the rate of interest it pays annually, while its yield is the rate of return it generates. A bond’s coupon rate is expressed as a percentage of its par value. The par value is simply the face value of the bond or the value of the bond as stated by the issuing entity.

Question 21

Current yield

Answer 21

the current yield is a measure of the bond’s yield based on its current price, rather than its original face value. The current yield of a bond is calculated by dividing the annual coupon payment by the bond’s current market value.

Question 22

YTM

Answer 22

Yield to maturity is the total return anticipated on a bond if it is held until it matures, including all remaining coupon payments and any gain or loss if the bond was purchased at a discount or premium to its face value.

Question 23

In the auction market

Answer 23

all individuals and institutions that want to trade securities will congregate in one area and announce the prices at which they are willing to buy and sell. These are referred to as bid and ask prices. The idea is that an efficient market should prevail by bringing together all parties and having them publicly declare their prices. Thus, theoretically, the best price of a good need not be sought out because the convergence of buyers and sellers will cause mutually-agreeable prices to emerge. The best example of an auction market is the NYSE.

Question 24

a dealer market

Answer 24

does not require parties to converge in a central location. The dealers hold an inventory of the security in which they “make a market”. The dealers then stand ready to buy or sell with market participants. These dealers earn profits through the spread between the prices at which they buy and sell securities. An example of a dealer market is the Nasdaq, in which the dealers, who are known as market makers, provide firm bid and ask prices at which they are willing to buy and sell a security. The theory is that competition between dealers will provide the best possible price for investors.

Question 25

Limit order -

Answer 25

An order to execute a transaction only at a specified price (the limit) or better. A limit order to buy would be at the limit or lower and a limit order to sell would be at the limit or higher.

Question 26

Market order -

Answer 26

is a buy or sell order to be executed by the broker immediately at current market prices. As long as there are willing sellers and buyers, a market order will be filled.

Question 27

Stop loss

Answer 27

• A market order that trades after a certain level, which you specify, has been reached. It may be time-limited as well, as with a Day Order or Good-Till-Cancelled Order. A stop order guarantees execution but not price.

Question 28

Blue chip

Answer 28

• A safe investment that generally attracts conservative investors

Question 29

Penny stock

Answer 29

• A penny stock is often defined as a stock that sells for $1 or less per share (or in some cases, less than $5 per share).

Question 30

Defensive Stock -

Answer 30

Defensive stocks come from companies that provide consistent dividends and stable earnings regardless of the state of the overall stock market or economy. They are called “defensive” because they tend to perform well even when the economy slows down. Examples include companies in industries like utilities, healthcare, and consumer staples—sectors where demand does not drop significantly even in a recession.

Question 31

Cyclical Stock -

Answer 31

Cyclical stocks are those that are heavily influenced by macroeconomic changes. Their performance is closely tied to the economic cycle of expansion and recession. When the economy is doing well, these stocks tend to perform exceptionally well; conversely, during a downturn, they often perform poorly. Industries such as travel, automotive, and luxury goods are typical examples of cyclical sectors.

Question 32

A growth stock -

Answer 32

refers to shares of a company that are expected to grow at a significantly higher rate compared to the overall market or its industry peers. These stocks typically do not pay dividends because the companies often reinvest earnings to accelerate growth in the short to medium term.

Question 33

Be able to distinguish between various dividend dates (e.g. declaration date)

Answer 33

1.Declaration Date: The company announces it will pay a dividend and sets the record and payment dates.
2. Record Date: The company checks its records to confirm who owns the stock and thus, who will receive the dividend.
3. Ex-Dividend Date: The cutoff date to buy the stock and still receive the dividend; set one or two business days before the record date.
4. Payment Date: The day the dividend is actually paid to the shareholders on record.

Question 34

Stock dividend -

Answer 34

A stock dividend involves issuing additional shares to shareholders instead of cash. It rewards shareholders without reducing the company’s cash reserves.

Question 34

Stock split

Answer 34

• A stock split increases the number of shares a shareholder owns, but the market value of the total shares remains the same. This is typically done to make the stock more affordable.

Question 35

American Depository receipts ADR

Answer 35

• American depositary receipts (ADRs) are negotiable certificates issued by a U.S. depositary bank representing a specified number of shares—usually one share—of a foreign company’s stock. The ADR trades on U.S. stock markets as any domestic shares would. ADRs offer U.S. investors a way to purchase stock in overseas companies that would not otherwise be available.

Question 36

Be able to explain the motivation behind the short selling as well as list the steps in short selling.

Answer 36

Short selling is a financial strategy used by investors who believe that the price of a stock is going to decline. The motivation behind this tactic is to profit from the anticipated decrease in the stock’s price. Essentially, the investor aims to sell high and buy low in reverse order. The process involves several steps. First, the investor borrows shares of the stock they expect to fall in price from a brokerage and then sells these borrowed shares at the current market price. Next, they wait for the stock price to drop. Once the price falls, the investor buys back the same number of shares at the lower price. These shares are then returned to the brokerage to close out the loan, and the investor keeps the difference between the sale price and the buyback price as profit, minus any fees or interest charged by the brokerage for the share loan. This strategy, while potentially lucrative, involves significant risks, as a stock’s price could unexpectedly increase instead, leading to potential losses.

Question 37

short selling -

Answer 37

profit from stock depreciation in price - risky
● Borrow the stock from the broker
● sell
● wait for the stock price to go down
● buy back the stock at the lower price
● return the stock to the broker (minus funding fee)

Question 38

Define a mutual fund

Answer 38

A mutual fund is a company that brings together money from many people (and other companies) and invests it in stocks, bonds or other assets.

Question 39

Open-end investment funds –

Answer 39

as many shares as demand will bear. Shares are bought directly from the company or intermediary.

Question 40

Closed-end –

Answer 40

fixed number of shares traded in the secondary market,

Question 41

Load fee

Answer 41

paid to acquire the fund
Management fee (annual)

Question 42

Expense ratio –

Answer 42

how much is deducted in total from NAV on an annual basis.
Consists of:
● Management fee
● Distribution
● Fund expenses
○ Custody
○ Brokerage
○ Accounting

Question 43

Know the advantages and disadvantages of investing into a mutual fund

Answer 43

Diversification
* Professional management
* Reduced transaction costs
* Liquidity
* Flexibility (wide choice)
* Additional services (mainly US, EU)

Underperformance
Costs and fees
Taxation
Risks:
Value loss
Systemic risk

Question 44

Know the advantages and disadvantages of investing into a mutual fund

Answer 44

Mutual funds offer a variety of advantages and disadvantages that cater to different types of investors. Advantages include diversification, which spreads risk across a variety of investments to mitigate losses; professional management, where expert fund managers make investment decisions; reduced transaction costs due to economies of scale; liquidity, allowing investors to quickly convert shares into cash; and flexibility, offering a wide range of fund types and investment strategies. Additional services such as automatic reinvestment of earnings or systematic investment plans are also common, especially in the US and EU markets. However, mutual funds also have drawbacks such as the potential for underperformance, where they may not achieve returns as high as the market average. Costs and fees associated with management and administration can also reduce the net gain for investors. Risks include value loss, where the value of the fund decreases due to market volatility; systemic risk, where failures in one part of the financial system affect the whole; and taxation, which can erode returns depending on the investor’s tax situation. Thus, while mutual funds are a useful tool for achieving diversified investment, they require careful consideration of their benefits and risks.

Question 45

Call –

Answer 45

right to buy

Question 46

Put –

Answer 46

right to sell

Question 47

American -

Answer 47

the option can be exercised at any time before expiration or maturity

Question 48

European -

Answer 48

the option can only be exercised on the expiration or maturity date

Question 49

Premium:

Answer 49

this is the price paid by the buyer to the seller to acquire the rights granted by the option. The premium is influenced by several factors, including the current price of the underlying asset, the strike price, the time remaining until expiration, and the volatility of the underlying asset.

Question 50

Exercise Price (or Strike Price):

Answer 50

This is the price at which the holder of an option can buy (in the case of a call option) or sell (in the case of a put option) the underlying asset when choosing to exercise the option. This price is fixed and agreed upon when the option is purchased.

Question 51

Moneyness:

Answer 51

In the Money - exercise of the option would be profitable
● Call: market price>exercise price
● Put: exercise price>market price
Out of the Money - exercise of the option would not be profitable
● Call: market price<exercise price
● Put: exercise price<market price
At the Money - exercise price and asset price are equal