Intro to Financial Instruments Flashcards
Money Market
-short tenor (up to 1 year)
-considered very low risk
(lowest risk asset you can invest in– all backed by trusted parties)
What is tenor?
how long until the instruments expire
What 5 aspects are involved in the money market?
- Treasury bills
- Certificates of deposit (CDs)
- Commercial paper
- Bankers acceptance
- Eurodollars
T-Bills
-backed by the full faith and credit of the United States government
-Tenor is 4, 13, 26, or 52 weeks
-interest is exempt from state and local taxes
Certificates of Deposit (CDs)
-time deposit with a bank
-insured by the FDIC up to $250,000 (United States government)
-can be purchased at any retail branch (contractually guaranteed)
Commercial Paper
-short term, unsecured debt
-maximum tenor of 270 days
what is the only loss in commercial paper?
the only loss is if the investment company is to file bankruptcy within the interim (fraud is one way)
How is commercial paper issued?
it is issued by either banks or large well-known companies
typically rated investment grade by a rating agency
Banker’s Acceptance
-typically related to international trade, a customer wants to make a purchase in the future
-a banker’s customer enters a contractual agreement to pay a sum in the near future (less than 6 months)
-the bank will then endorse the order, thus taking responsibility for the payment
-if the customer is unable to make the payment at maturity, the bank is contractually obligated to make the counterparty whole
Eurodollars
-US dollar denominated deposits at foreign banks or foreign branches of American banks
-the purpose of these accounts is to operate outside of the regulation of the Federal Reserve
What is fixed income?
Fixed income markets, also known as Credit Markets or the Bond Market is comprised of publicly traded debt
Coupon
semi annual payment made to the investor
Maturity Date
when the outstanding balance is due to the investor
Convenants
financial metrics which the Issuer must remain in compliance with
Collateral
assets that are transferred to the bond holders in the event of a liquidation
Credit risk
the risk that the Issuer of the bond defaults on its obligations
If the issuer defaults, …
the investor can potentially take a loss
Credit analysis is
making an estimate of the probability of default
What is the Issuer of Treasury Notes and Bonds?
the United States Government
-backed by the full faith and credit of the US government, and as such is considered risk free
Treasury Notes
maturity of between 1 and 10 years
Treasury Bonds
maturity of 10 years or greater
Two types of agency bonds:
Federal Government Agency Bonds
Government Sponsored Enterprise Bonds
Federal Government Agency Bonds are issued
by a Federal Government Agency including:
1. Federal Housing Administration
2. Small Business Administration
3. Government National Mortgage Association (“GNMA”)
The Government National Mortgage Association or GNMA is…
typically issued in connection with mortgage-backed securities (“MBS”)
Government Sponsored Enterprise Bonds are issued by
entities which provide a public service but are not part of the federal government
4 examples of Government Sponsored Enterprise Bonds include
- Federal National Mortgage Association (FNMA)
- Federal Home Loan Mortgage Corporation (FHLMC)
- Federal Farm Credit Banks Funding Corporation
- Federal Home Loan Bank
Which two government sponsored enterprise bonds are associated with Mortgage-backed securities?
Federal National Mortgage Association (FNMA)
Federal Home Loan Mortgage Corporation (FHLMC)
Municipal bonds are issued by
cities, states, counties, or other government entities
General Obligation Bond:
backed by the full faith and credit of the issuing entity
ex: NJ issues a general obligation bond. The investor will receive timely payment unless the state of NJ were to declare for Bankruptcy
Revenue Bond
issued in connection with a project which will generate revenue. The bondholders will receive timely payments if the project generates said revenue
Corporate bonds are issued by
corporations.
Investors will receive timely payments as long as the corporation does not default.
In the event of a default in corporate bonds,
In the event of a default, the investor’s loss will depend on where their debt is in the capital structure
-senior debt will take a lessor loss than subordinated/ unsecured debt
-the more senior a piece of debt is, the lower the yield
probability of default and loss upon default who gets what first*
Common Stock or Equity
investing in a minority ownership position int he issuing company
Price Appreciation
increases in the stock price between the time the investor purchases the shares, and when they sell said shares
Dividends
quarterly cash payments which the Company makes to its shareholders. Distributions are completely optional.
Public Corporation Structure
-CEO financial responsibility is to return money back to the shareholders (enrich shareholders not employees)
-CEO in company performing well, large portion of their compensation will be in stock
-Board of Directors report to the shareholders - represent the shareholders and are voted on by the shareholders
Equity Categories (2)
Size
Valuation
Market Capitalization
the aggregate value of the Company’s common stock
How do you calculate market capitalization?
share price * shares outstanding
Penny Stocks
very small market capitalizations. Share prices are less than $5
Micro Cap Stocks
Market cap between $50 MM and $300 MM
Small Cap Stocks
Market cap between $300 MM and $2Bn
Mid Cap Stocks
Market cap between $2Bn and $10Bn
Large Cap Stocks
market cap of greater than $10Bn
*typically larger companies are less volatile
Growth Stocks (Valuation)
stocks of companies that the market expects to realize meaningful growth in its cash flow generation going forward.
As a result, the Company’s stock is high relative to its current cash flow generation
*growing tech companies
This would result in a _______. How is this calculated?
high price/ earnings (P/E) ratio
(the price of the stock/ (net incomes/share outstanding)
Value Stocks
stocks which appear to be priced low relative to its cash flow generation.
The market is pricing in lower expected future growth, relative to growth stocks
Income Stocks
stocks which have consistently paid out a large dividend. These are typically well established companies
*walmart
Preferred Stock
-no voting rights
-not a controlling position
-scheduled dividends which must be paid out before any dividends on common stock can be paid out
-no maturity date: is outstanding as long as the company is operating
