Brainscape's Knowledge GenomeTM

Browse over 1 million classes created by top students, professors, publishers, and experts.


See full index

AQ > Investments > Flashcards

Investments Flashcards

1
Q

The 7 investment risks are? (Capital Markets Handbook)

A

COSMILL

  1. Credit Risk
  2. Operational or Transactional Risk
  3. Settlement Risk
  4. Market Risk
  5. Interconnection Risk
  6. Legal Risk
  7. Liquidity Risk
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

Credit Risk

A

Possibility of loss due to a counterparty’s or an issuer’s default or inability to meet contractual payment terms.

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

Operational or Transactional Risk

A

possibility that inadequate internal controls or procedures, human error, system failure, or fraud will cause losses

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

Settlement Risk

A

possibility of loss due to the delivery of funds or assets before receiving the instrument or proceeds specified in the contract from the counterparty, and the counterparty is subsequently unable or unwilling to perform.

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

Market Risk

A

Possibility that an instrument or portfolio will lose value due to a change in market conditions, the price of an underlying instrument, an index of financial instruments, changes in various interest rates, or other factors.

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

Interconnection Risk

A

possibility of decline in an instrument’s value due to changes in interest rates, indices, or values of other instruments that may or may not be held by the investor.

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

Legal Risk

A

possibility that legal action will preclude contractual performance by one of the parties to a transaction.

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

Liquidity Risk

A

possibility that an instrument cannot be obtained, closed out, or disposed of in a reasonable time frame without forfeiting economic value.

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

The 4 principal market risks are? (Capital Markets Handbook)

A
  1. Foreign Exchange risk
  2. Interest rate risk (primary source)
  3. Commodity-Price risk
  4. Equity-Price risk
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

What categories of securities are investment quality?

A

Moody’s – Aaa, Aa, A+ or A, Baa-1 or Baa

S&P’s - AAA, AA, A, BBB

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

What items should the investment policy address?

A
  • Investment goals
  • Authorized activities and instruments
  • Internal controls and independent review
  • Selecting broker/dealers
  • Risk limits
  • Risk and performance measurement
  • Reporting
  • Accounting and taxation
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

The total return for an individual bond consists of what?

A
  1. The change in the market value over the measurement period
  2. The coupon received
  3. The reinvestment interest on the cash flows received during the measurement period
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

PO Strip Characteristics

A

Rates decline, value increases as cash flow (Principal Pmts) is received sooner

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

IO Strip Characteristics

A

Rates decline, value decreases, More prepayments, less interest payments

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

Positive Convexity

A

Option Free Instrument

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

Negative Convexity

A

Embedded Options in Instrument

17
Q

CMO Residuals – What is the effect when rates change?

A

Rates Decline, Value Declines

Rates Increase, Value Increases

18
Q

What are deleveraged and leveraged notes?

A

Floating-rate instruments with coupon payments based on a specific point on the yield curve.

Deleveraged Note - coupon rate will adjust by a fraction of the change in the underlying index:
• Attractive when rates expected to remain stable or decrease
• Market risk increases as leverage factor approaches 1.0

Leveraged Note - coupon rate will adjust by a multiple of the change in the underlying index (LIBOR, COFI, CMT)
• Attractive when rates expected to increase

Examples of a deleveraged note and a leveraged note are below:

Deleveraged: .50 X 10-year CMT + 150 bps
Leveraged: 1.50 X 3-month LIBOR + 100 bps

19
Q

Define a CMO/REMIC and how is it slotted on the Call Report?

A

Mortgage derivative securities consisting of several classes secured by mortgage pass through securities or whole mortgage loans. Principal and Interest payments from underlying collateral are divided into separate payment streams that repay investors in the various classes at different rates.

CMO Slotting - CMOs are slotted based on their weighted average life, regardless of whether the security is fixed or floating.

20
Q

How do you slot callable securities on the Call Report?

A

Callable-fixed-rate debt securities - Generally slotted at maturity, and the call option is not reflected; by call date when called.

21
Q

What are some passive investment strategies?

A
  1. Indexing - assembling a portfolio closely resembling the risk and return characteristics of a preferred market index.
  2. Immunization - bond portfolio structured so that interest rate risk characteristics (Macaulay duration) match those of the liability stream. Referred to as duration matching and requires frequent calculation and rebalancing.
22
Q

What are some active investment strategies?

A
  1. Gains Trading - purchase and subsequent sale of a security at a profit after a short holding period.
  2. When-issued securities trading - buying and selling of securities in the period between the announcement of an offering and the issuance and payment date of the securities
  3. Pair-offs - An institution commits to purchase a security, but before the settlement date, the bank pairs-off the purchase with the sale of the same security
  4. Extended Settlement - Use of a securities trade settlement period in excess of the regular-way settlement period (US Gov’t/Agency – 1 day; Corporate/Municipal – 3 days; MBS- 60 days). This facilitates speculation.
  5. Repositioning Repurchase Agreement – Dealer allows bank that has entered into a when-issued or pair off that cannot be closed at a profit to hold its speculative position until the security can be sold at a gain.
  6. Short Sale - Sale of a security that is not owned
  7. Adjusted Trading - Sale of a security to a broker above the prevailing rate and the simultaneous purchase and booking of a different security, frequently a lower rated or quality issue at a price above its market value.
23
Q

What are the recognized nationally recognized statistical rating organizations (NRSROs):

A

1- Dominion Bond Rating Service, Ltd.
2- Moody’s Investors Service
3- Fitch, Inc.
4- Standard and Poor

24
Q

What are the types of interest rate risks created by using off-balance sheet derivatives?

A
  1. Repricing
  2. Basis
  3. Option
25
Q

What are some types of interest rate swaps (Purpose-contractual agreement between two counterparties to exchange payments at periodic intervals for a specific time on a notional amount)? * SOURCE: ALM SCHOOL MATERIALS

A
  • Basic – provides for the counterparties to exchange variable-rate cash flows based upon different market indices. These agreements can be used to reduce basis risk for a balance sheet that has rates on assets and liabilities tied to different indices or different maturities of the same index.
  • Amortizing – has a notional amount that declines (amortizes) over the life of the agreement and may be used to hedge amortizing assets or to replicate cash flows of mortgage products. Usually these are fixed at inception.
  • Accreting – has a notional principal that increases over the life of the agreement and could be used to hedge the increasing interest rate risk in a construction loan because the loan balance increases during the funding of a construction project.
  • Forward – is a swap that has not reached its effective date; allows an institution to initiate a swap with a delayed start. These swaps can be used to hedge debt refinancing or anticipated debt issuances. These are based on forward interest rates.
  • Swaptions – is a contract that combines an option and a swap whereby one party has an option (the right, not an obligation) to enter into an interest-rate swap or terminate an existing swap at some future date.
26
Q

How do you value Swaps?

A
  • Pay-fixed for variable swap = > Short position on fixed rate, Long position on floating rate
  • Value of the swap equals difference between the NPV of the pmt streams of the two sides
  • Typically use the Treasury curve at a point equal to maturity plus swap spread
  • Though NPV of fixed and floating initially same, likely changes over time
27
Q

What are some types of hedging strategies?

A
  • Caps
  • Floors
  • Corridors
  • Collars
28
Q

Caps

A

equivalent to series of put options.

When the underlying index exceeds the strike rate, the seller pays the difference on the notional amount.

29
Q

Floors

A

equivalent to a series of call options.

When the underlying index is less than the strike rate, the seller pays the difference on the notional amount.

30
Q

Corridors

A

strategy used to protect the buyer from a modest rate increase. A corridor is a combination of a long cap and a short cap. The cap is purchased to reduce exposure to rising rates. Another cap, with a higher strike rate, is sold to reduce the expense of the long cap.

31
Q

Collars

A

combination of a cap and a floor. An investor buys a cap and sells the floor to reduce the cost of the cap.

32
Q

What are some factors affecting price?

A
  • Proximity of the underlying index to the strike
  • Remaining term to maturity
  • Volatility of the underlying index
33
Q

What are some types of market risk/value modeling measures?

A
  • Delta – the change in the value of the option (cap or floor) resulting from a small change in the underlying cash instrument (similar to duration). Often used to determine how many contracts to purchase. Contracts with higher deltas will have greater price sensitivities to changes in the underlying instrument.
  • Gamma – the change in the delta given a change in the underlying index (similar to convexity). Gamma risk is at its greatest when the option as at-the-money.
  • Theta – the loss of a contract’s value due to the passage of time.
  • Vega – the change in an agreement’s price resulting from a change in the volatility of the underlying index. Vega is always positive because option values increase as volatility rises.
34
Q

What are futures and forward contracts?

A
  • Futures – standardized, exchange-traded contracts obligating one party to buy, and the other to sell, a specific asset for a fixed price at a future date. These contracts are traded on an organized exchange.
  • Forwards – a contract obligating one party to buy and the other to sell, a specific asset for a fixed price at a future date. These are bought and sold over-the-counter.
35
Q

What are some types of Rates and Yields?

A

• Forward Yields – derived from spot yields and indicate the market’s overall expectations for future level of rates and the entire yield curve.
• Implied Forward Rates – can give market participants important information about expectations of the direction of future rates.
• Forward Rates – critical in determining prices of many hedging instruments, e.g. derivatives, and can provide protection against future volatility in rates or prices.
• Option Adjusted Spread – investor can use either the a) spot rate or b) forward yields for this calculation.
This is a spread to help determine the relative value for a security that has embedded options, e.g. a MBS.

36
Q

What factors are included in valuing futures and forward contracts?

A
  • Prices move in the same direction as bonds, i.e. rising rates yields lower prices
  • Cash price is usually different from price in futures market, difference called basis
  • Factors affecting basis include a) cost of carry, b) economic factors, c) perception of rate movements, and d) volatility of interest rates.
  • Principal risk is that basis may change from time hedge is initiated until termination

AQ (6 decks)

Brainscape helps you reach your goals faster, through stronger study habits.
© 2024 Bold Learning Solutions. Terms and Conditions