Investments

Question 1

Describe bond duration

Answer 1

BOND DURATION
- Duration is the weighted average maturity of all cash flows.
- The bigger the duration, the more price sensitive or volatile the bond is to interest rate changes
- Duration is the moment in time the investor is immunized from interest rate risk and reinvestment rate risk.
- Modified Duration is a bond’s price sensitivity to changes in interest rates.
- A bond portfolio should have a duration equal to the investor’s time horizon to be effectively immunized.

Question 2

How is coupon rate calculated?

Answer 2

Coupon rate = annual coupon payment/par

Question 3

Formula for current yield?

Answer 3

CY = annual coupon payment/current price of the bond

Question 4

How do you calculate YTM? YTC?

Answer 4

Use TVM keys, solve for I/YR and multiply x2 for the annual YTM.
- PV = amount paid for the bond or current value
- FV = Par or $1000
- N = number of years (always multiply x2 because semiannual)
- PMT = coupon rate or interest rate x 1000 (always then divide that amount by 2 because semiannual)
- I/YR = ? (Calculate and multiply x2 for final answer)

YTC - use the exam same method except using years to call for N and call price for FV

Question 5

What is the property valuation formula? What is the Cap Rate formula? (Hint: div. yield formula)

Answer 5

Capitalized Value = net operating income (NOI)/Capitalization Rate
Capitalized Rate = NOI/Cost

Question 6

How is net operating income (NOI) calculated?

Answer 6

Simplified formula: Net Operating Income + Interest Expense + Depreciation Expense (full formula attached below)

Question 7

What variables make up the black/scholes pricing model?

Answer 7

Model used to price call options. Variables include:
- Current price of the underlying asset
- Time until expiration
- The risk-free rate of return
- Volatility of the underlying asset
Also remember: As strike price increases, option decreases

Question 8

Describe a straddle and it’s purpose

Answer 8

Investor either buys or sells a put and call option on the same stock. This is done when expecting volatility.

Question 9

Describe a collar and its purpose

Answer 9

Investor owns the stock and wants to protect downside risk without paying full cost of put option. Investor buys the put and sells a call just above the current stock price