Investments Flashcards
Liquidity & marketability
Personal checking account cannot be traded or sold so not marketable. It is liquid as it can quickly be turned into cash. A personal residence and stock in a privately owned corporation are illiquid but marketable. US Treasury bills are both liquid and marketable.
Repo rate vs repro margin
The percentage difference between repurchase price and borrowed amount. The repo margin or haircut is the % difference between the amount borrowed and the value of the collateral
Primary purchaser of negotiable cds
Institutional investors
Stock dividends taxation…only dividends paid in cash are reported as income.
Treasury bills taxation
Interest income from us treasury bills taxed federal level at ordinary income. No state tax!
Eurodollar CDs
Are obligations of NON-U.S. bank
Offer slightly higher yield than domestic CDs
Less liquid than domestic CDs
Used to settle international transactions
Private placement
Limited to 35 unaccepted investors, but available to unlimited number of accredited investors.
Series I bonds interest rate is a combo of fixed rate of return and semi-annual inflation adjusted return rate. Can be used ( like the EE bond) for higher education costs free of income tax ( phase out limits). Note: series HH bonds may not be used in this way.
Private activity bond
Has high credit risk
Preferred stocks value is based on prevailing interest rates. The value for a preferred stock is its dividend divided by prevailing interest rates.
GO bonds
Most secure of all muni debt
Backed by full faith and credit of issuer
Supported by taxes
Investment value of bond ( intrinsic value as a straight bond)
Using financial calculator: set at 2 periods per year. N Gold #, int/yr, Pmt, $1000 fv, solve for pv
The intrinsic value of a preferred stock formula
P= D÷r ( dividends divided by market interest rate)
To immunize a bond portfolio over a specific time horizon
Investors would match the average weighted duration of the bond portfolio to the investment horizon.
The interest on a public purpose bond is received tax-free. Only the capital gains realized on the sale is subject to income tax.
The downside of a convertible bond is the difference between current market value of the bond and it’s investment value
Revenue bonds are secured by
User fees
Series E bonds may no longer be exchanged for series HH bonds.
According to the unbiased expectation theory of interest rates
The current long-term rate is the average of today’s short-term rate and expected future short-term rates. Under this theory, an upward sloping yield curve indicates increasing inflation expectation.
The amount attributed to bond market discount is generally not included in income until the sale of the bond and then it is treated as interest income.
Disadvantage of investing in convertable bonds?
Yield to maturity tends to be lower than similar non-convertable bonds.
Portfolio immunization for bondholders
Protects them from interest rate risk and from reinvestment rate risk.
Regarding duration
A risk-averse investor should consider bonds with low durations. Aggressive investors should consider bonds with high duration when they think interest rates will go down and consider bonds with low durations when they think interest rates will rise.
Multisecter bonds invest in..
Multisect bonds typically purchase: us government bonds, high-yield corporate bonds, & foreign bonds.
A low coupon bond is more suseptible to price fluctuations. A long-term bond is more suseptible to price fluctuations.
All things being equal, a profitable company with a higher debt level will have a higher return on equity.
A daily limit of a commodity futures contract is the maximum
Price increase or decrease relative to the settlement price the previous day.
Revaluation/ devaluation
Devaluation- goes down
Revaluation- goes up
Zero-coupon bonds are not subject to reinvestment rate risk. However, they are subject to purchasing power, interest rate and default risk.
Covariance is the most important variable in minimizing the standard deviation in a portfolio.
Systemic or non-diversifiable risks are:
(PRIME) purchasing power risk, reinvestment rate risk, interest rate risk, market risk, exchange rate risk
Exchange rate risk is a type of systematic risk ( those risks that affect the entire market)
Skewness
Measures how far the median return is from the mean return in decimal terms.
Assets that lie above the security market line (SMLl) are undervalued because their expected returns are higher than the required return represented by the SML.
Efficient frontier in portfolio theory
Indicates the highest returns for given levels of risk.
Market indexes and averages
- Wilshire 5000 index is often used to measure the overall market in the U.S.
- Russel 2000 index is used to benchmark small cap companies
- The S& P 500 index is used by most professional investors as a benchmark for U.S. large cap equity investments.
- Averages and indexed are constructed to inform investors about changes in the market. Also serve as benchmarks
The S& P 500 index automatically adjusts for stock splits and dividends by focusing on market value instead of price.
Jensen alpha may be used by itself to judge an investment.
Jensen alpha tell us
The percentage a manager over- or under- performed based on the amount of risk taken.
Alpha
Is measured as the portfolio’s actual or realized return in excess ( or deficient to) the expected return calculated by the capital asset pricing model, CAPM.
When using a security market index to represent a market’s performance, the performance of that marker over time is best represented by…
The change in the index value.
Prof. Harry Markowitz’s Modern Portfolio Theory (MPT) uses standard deviation as a measure of portfolio risk.
Indifference curves, which represent the risk-reward trade-off that the investor is willing to make, will
- cross the efficient frontier in two locations
- life tangent to the efficient frontier
- will not intersect the efficient frontier
- the portfolio that lies at the point of tangency of an indifference curve and the efficient frontier is the optimal portfolio for the investor.
When using the CAPM model, an increase in beta will cause the risk premium to increase. The expected rate of return will increase.
The capital market line CML provides a direct relationship between the risk and return for a well- diversified portfolio. CML graphically depicts the relationship of risk and return. CML uses standard deviation as a risk measure.
Capital asset pricing model (CAPM)
= risk-free return + (market risk premium - risk-free return) beta coefficient of stock
The CAPM has two components:
1.) Stock risk premium
2.) Market risk premium
The CAPM accounts for the impact of systematic risk (as measured by beta) only and does not take into consideration unsystematic risks, which is assumed have been diversified away.
If CAPM is higher than the investor’s required rate of return, a positive investment decision is warranted.
Calculate standard deviation of a series of returns
Using Fin. Calculator: enter the number and the summation symbol, then gold #8 ( which is Sx Sy)
Current yield (CY)=
Annual interest ÷ market price
T-Bills have the lowest credit risk because they are issued by the US Treasury.
Eurodollar
A deposit in a foreign bank denominated in dollars ( example: a us dollar deposited into a Hong Kong bank)
Yankees bond
Dollar denominated bonds issued in the US by foreign banks and corporations. Registered with the SEC.
Municipal discount bonds must be acreted
Corporate discount bonds must be acreted
Zero coupon bonds must be acreted
Accretion generates phantom income and enables the bondholder to raise the basis accordingly
Treasury bills terms
3, 6, and 12 months
( a man came up with this - only a woman does 9 mo- no 9 mo term!)
When is an issuing corp. Most likely to call it’s bonds?
When bonds selling at a significant premium, newly issued are offered with lower coupons.
