Finance Topic 6 Flashcards

1
Q

bonds

A

means by which companies and gov raise/borrow money
form of debt finance

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

bond holders

A

lenders & investors

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

principal amount

A

amount borrowed
nominal value/par value
since recorded on bond agreement document
face value of bond

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

coupons

A

in return for lending = inv in bond receive regular interest payment of a fixed size

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

size of regular coupon

A

defined by annual % rate applied to nominal amount of bond

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

fixed income securities

A

since coupon lvl doesnt vary
bonds are often called ….

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

irredeemable/perpeutal bond

A

unless above = investors are repaid principal amount (some amount calculated by reference to principal amount) at end of agreed lending period (maturity/redemption)

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

value of bond

A

price of any fixed income security = depends on size & timing of coupon payments and time remaining to maturity

value of bond = sum of present values of remaining coupons and principal repayment
(discounting at investors required rate of return)

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

relationship between coupon rate & required return
and current value and redemption amount

A

higher coupon rate = higher price/value of bond
(coupon rate & bond price = +ve associated)

higher req return = lower price/value of bond
(req return and bond price = -ve associated = inverse/non linear relationship)

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

bond price and required return diagram,

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

2 key impactors on interest rate sensitivity of value

A

= price risk
1. term to maturity (longer = greater % change in bond price following change in interest rate/req return)
2. size of coupon (bonds paying lower show higher % change in bond price following change in interest rate/req return) -> lower coupon = greater sensitivity to bond changes

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

price changes

A

required return changes
price risk = sensitivity of value to changes in discount rate

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

coupon factors

A

lower coupon implies = higher interest rate sensitivity (price risk)
longer maturity = implies higher interest rate sensitivity

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

naive bond investing strategy

A

-investor believes interest rates will rise
- invest in lesser interest rate sensitive bonds (shorter maturity & higher coupon payment)

-investor believes interest rates will fall
- invest in greater interest rate sensitive bonds (longer maturity and lower coupon payment)

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

bond yields

A

yields - often quoted for bonds
key measure = gross redemption yield (yield to maturity or total return)

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

GRY

A

gross redemption yield
represents return an investor would make if held bond to maturity
IRR of cash flows associated with bond from investor/lender perspective

17
Q

conditions to hold for GRY

A
  1. bond is actually to be held to maturity
    (any sale prior = give proceeds subject to mkt conditions at Time of sale)
  2. GRY assumes all coupon amounts received can be reinvested at gRY rate (may not be the case, re-investment risk)
  3. regular coupon payments
18
Q

re-investment risk

A

having cash flows coming out of bond dont know the market conditions

19
Q

shares returns arithmetic return equation

A

rise in value = contributes to equity investors return

20
Q

rule of the return

A

returns can never be less than -1
cant do anything worse than lose all your money which would be -1

21
Q

descriptive statistics

A
  1. returns
  2. deviations (historic return - expected return)
  3. deviations squared = variance
  4. product of deviations
  5. co-variance
  6. correlation
22
Q

correlation formulae

A

co variance of A & B divided by
std deviation of A x std deviation of B

23
Q

uncertainty and risk

A

actual future returns = uncertain = measures of risk quantify this
(different approaches) = no universal def of risk
-common approach = calculate amount of variation in possible returns around their mean value
-majority = adopt std dev of returns as measure of risk
-wider possible variation in share returns = lower chance actual return will be close to mean (expected) return higher std = higher risk

-std deviation of returns = measure of total risk for asset
beta = systematic risk

24
Q

portfolio theory

A

following parameters estimated
1. expected return of asset
2. risk for each asset (Std dev of return)
3. covariance of returns between each pair of assets

25
total risk vs systematic risk
26
risk free inv
positive return & no risk sovereign debt (gov bonds) of developed countries, strong economies = held nearly risk free, position open to criticism
27
expected return on portfolio
28
total risk
risk inherent in individual stock/security specific to particular company
29
systematic risk
risk inherent in overall mkt or particular segment of market
30
diversification
Markowitz space rho: +1 = perf positive correlation (form straight line) as rho decreases more shedding of risk bows to the left perf negative correlation = perfect smoothing
31
risk averse investor
doesnt seek to avoid all risk (health appreciation for level of risk vs return) - demand higher expected return to compensate for higher risk equivalent risk = chose highest expected return equivalent expected return = chose lowest risk
32
risk hating investor
seek to avoid all possible risk no care for return choose alternative with lowest risk (zero risk) mo matter what expected returns are available
33
price risk (interest rate risk)
potential for value of bond to fluctuate due to changes in interest rate existing bond with fixed coupon rate = less attractive to inv compared to newly issued bonds with higher coupon rate rising interest rate env -relevant for bonds with longer maturities, lower coupon rates, higher durations = more sensitive to interest rate changes affects value of bond in secondary market
34
reinvestment risk
potential uncertainty or risk associated with reinvesting periodic coupon payments /principal repayments from bond