Final Exam Flashcards
what was the first stock market and who created it
Amsterdam Stock Exchange; Dutch East India Company
what was the purpose of this stock market
to fund trade expeditions across the sea to Asia from Amsterdam
what is a bond yield? be able to explain how yield is affected by price and why
the return that the invesor can earn from holding a bond until maturity
how do zero-coupon rate bonds work?
they are sold at a discount of the face value and do not pay interest rate. the investors profits are face value at maturity - discounted price investor paid for the bond
how do you estimate risks of bonds
consider factors like credit risk, interest rate risk, inflation risk, and liquidity risk
what is credit risk
when the issuer will not be able to make principal and interest payments
what is interest rate risk
changes in interest rates (lower interest rates is bad for investor)
what is inflation risk
if inflation rises, the fixed payments you receive from the bond will not have the same purchasing power in the future.
what is liquidity risk
when the bondholder will not be able to bond easily without selling at a discount
less liquid =
bad; harder to sell, may even have to discount
what is the key concept of municipal bonds?
tax ememption from federal income taxes (benefitting high earners in large tax brackets)
What are the three types of municipal bonds?
general obligation, revenue, and private activity
what are general obligation bonds
bonds backed by full faith due to municipalities taxing power
what are revenue bonds
bonds repaid from revenue generated from the specific project that they finance. ex: toll roads
what are private activity bonds?
bonds issued by municipalities that attract private investment for projects that benefit the public. ex: hospitals
how does the Federal Reserve manage short term yields
with the federal funds rate
How does the federal funds rate work
it is the interest rate at whcih banks lend reserves to other banks. this rate influences other interest rates, such as mortgage, loans, and savings rates. a higher rate slow down inflation do to less spending and borrowing of money. lower rates lead to economic activity and growth
how does the Fed manage long term yields
quantitive easing and forward guidance
what is quantitive easing and forward guidance
QE is when the Fed buys lots of finacial assets, increasing the money supply and lowering interest rates. It also encourages borrowing and investing.
Forward guidance is the transparency of the Fed of future policy intentions to help investors makae sound decisions.
future value tells you
how much future investments will grow over time
when to use present value formula
to find current value of a sum of money that you will receive or pay in the future
when to use the present value annuity formula
when the problem provides a series of payments at equal intervals
when to use net present value formula
to calculate the difference between the present value of cash inflows and outflows over a period of time
what is a discount rate
difference between the bond’s face value and its current market price
what is the internal rate of return
it is the discount rate that makes the net percentage value of all cash flows equal to its current market price
What happens to the IRR when a bond is purchased at a discount?
IRR increases. This is because the investor earns a higher yield on the investment, meaning higher return, which leads to an increase in IRR due to its formula.
