Investments - Lect. 1-3 Flashcards
Real Assets are: (2 things)
(1) Assets used to produce goods and services and (2) Land, buildings, equipment, and human capital
Financial Asserts are: (2 things)
(1) Claims on real assets or the income generated by them and (2) Stocks, bonds, etc.
3 main types of financial assets?
(1) Fixed-income (debt) securities, (2) Common Stock / Equity and, (3) Derivative Securities
Which main type of financial asset: Payments are determined by formula and paid unless the
borrower is declared bankrupt
Fixed-income (debt) securities
Which main type of financial asset: Represents ownership share in the corporation; does not guarantee any payment
Common stock / Equity
Which main type of financial asset includes: Determined by the prices of other assets such as bond or stock prices
Derivative securities
Higher stock price implies:
Less shares of equity needed to raise funds for an investment and higher potential profits for current shareholders
________ of a company bear more risk but will get a higher reward than ________ of a company
Equityholders; Bondholders
“Top-Down” portfolio strategy:
Will look at asset allocation first (e.g. “I want 60% of my money in stocks and 40% of my money in bonds.”)
“Bottom-Up” portfolio strategy:
Will look at security allocation first (e.g. “I want to make sure to buy shares of Anheuser Busch Inbev because their stock is seriously undervalued!”)
Investor’s portfolio is:
The collection of investment assets s/he owns
What happens in “rebalancing” the portfolio?
Adjusting the weights in the portfolio by buying or selling assets
Markets are generally near-efficient, meaning that:
Prices reflected in the market are generally close to the best estimate of the true value of the asset given all relevant information
3 main groups in financial markets:
(1) Firms (2) Households and (3) Governments
The following are ________ __________s: Banks, insurance companies, investment companies, credit unions, etc.
Financial Intermediaries
3 Advantages of investing in financial intermediaries?
(1) Pool resources from many small borrowers, lend more to large borrowers,
(2) Lending to many borrowers = better diversification and (3) Can use economies of scale to assess and monitor risk
What large company needing equity can do:
Sell stocks or bonds, may hire investment bankers to underwrite the issuance
What smaller and younger firms needing equity can do:
Raise private equity through venture capital
Responsibilities of investment banker:
(1) Underwrite the issuance and (2) Handles the marketing of the security in the primary market, not the secondary market
Securities that make up the money market:
(1) Short-term, marketable, liquid, low risk debt securities and (2) Instruments are sometimes called cash equivalents
Securities that make up the capital market:
(1) Longer-term debt markets (bond markets), (2) Equity Markets, and (3) Derivative Markets
Money Market Treasury Bills:
Gov’t issued 0-coupon bond, maturities of 4, 13, 26, or 52 weeks, Minimum $100, usually $10,000, Income earned only taxes at federal level (not state or local), includes a bid-ask spread, bid yield and ask yield given reported using bank discount method w/360 days in a year.
Money Market Certificates of Deposit
Times deposit, interest and principal returned at end of fixed term (can’t withdraw earlier), in denominations larger than $100,000 are negotiable. Typically maturities of 3 months or less, and treated as bank deposits by the FDIC.
Money Market Commercial Paper
Short-term, unsecured debt issued by corporations for
working capital - Sometimes backed by bank line of credit - Has a liquid secondary market - Yields are determined by riskiness and maturity - financial firms recently started issuing asset-backed commercial paper
Difference between Domestic CDs and Eurodollar CDs?
Eurodollar CDs are less liquid and more risky, but offers higher yields.
Yields on Money Market Instruments?
Default-free T-bills are generally considered risk-free - Other MM instruments will carry more default risk and have higher yields that T-bills - Economic Crises and increased default risk among instruments cause yields relative to T-bills to increase.
Treasury Notes and Bonds: (3 things)
(1) Issued in increments of $100, most common is $1,000, (2) BOTH offer semiannual coupon payments, and (3)
Treasury Note maturity: > 1 year - 10 years
T-Bond maturities: 10 - 30 years
Eurobonds are:
Bonds sold in country A but denominated in currency of country B (ex: U.S. dollar-denominated bonds sold in Britain, or Japanese yen-denominated bonds sold in France)
Yankee Bonds are:
Dollar-denominated bonds sold in the U.S. by non-U.S. issuers
Municipal Bonds are:
(1) Issued by state and local gov’ts (2) Interest Income EXEMPT from taxation at federal, state, and local level within issuing state
Municipal Bonds - General Obligation bonds are backed by:
The “full faith and credit” of the issuer
Revenue bonds are issued to finance:
Particular projects
Compare returns on muni bonds to regular bonds - Formula to determine which return is greater:
If r(1 - t) < rm = MuniBond If r(1 - t) > rm = NormalBond
Formula: Equivalent before-tax yield to MuniBond given Tax Rate =
r = rm / (1 - t)
Formula: cutoff tax bracket where individuals are indifferent b/t muni and normal bonds
t = 1 - (rm / r)
Corporate bonds: Issued by? Borrowed from? Pmts? Risk and yields? Secured bonds vs. Unsecured bonds (Debentures)?
Issued by Private Firms to borrow $ directly from the public. Semi-annual payments, more risk and higher yields. Secured bonds have some form of collateral, while unsecured don’t.
Mortgages and Mortgage-Backed Securities are:
A claim in a pool of mortgages or an obligation that is secured by such a pool.
What is a call option?
A call option gives its holder the right, but not the
obligation, to purchase an asset for a specified price (exercise price or strike price) on a specified date
What is a put option?
A put option gives its holder the right, but not the obligation, to sell an asset for a specified price on a specified date
Entering a long position in an option costs a _____ that is paid to the short position of the option
Premium
What is a Futures Contract?
A contractual obligation to buy/sell an asset at a specified price upon a specified date. No premium paid to enter into contract by either side
Long position in a call option is; Long position in a futures contract is:
The right to buy; The obligation to buy
Long position in a put option is; Short position in a futures contract is:
The right to sell; The obligation to sell
What act created the PCAOB and what did it require?
Sarbanes-Oxley Act of 2002 - Required independent financial experts on firms board of directors audit committees. CEO and CFO must personally certify financial reports. Auditors may not provide other services to clients and board of directors must be composed of independent directors and hold regular meetings
Describe what insider trading is:
It is illegal for anyone to profit on information that is
held by officers, directors, or major stockholders but is not available to the public
3 signs insiders exploit their knowledge:
(1) Several convictions of insider traders (2) Firms that increase div will see increase in stock price before the announcement, and (3) Research on trades of insiders shows stocks tend to do better when insiders increase buying, poorer when insiders decrease selling
What does the Securities Act of 1933 and Securities Exchange Act of 1934 Require? Establish? Empowers who?
Require full disclosure of relevant information relating to the issue of new securities. 2) Established the SEC Securities and Exchange Commission to administer provisions. 3) Empowers SEC to regulate securities exchanges, OTC trading, brokers, and dealers
An investor can borrow someone else’s share of stock and sell it to a third investor; this is called a:
Short Sale
Full-Service Broker:
(1) Have a research staff, offer analyses and forecasts of general economic or industry conditions (2) Can also handle a discretionary account where they will buy/sell on an investor’s behalf without notifying the investor
Discount Broker:
(1) Buy and sell securities, hold them for safekeeping, offer
margin loans, facilitate short sales. (2) Generate no information for investors
Securities can be traded on either the:
Primary or secondary markets
A Primary Market is:
The security being issued is new and a portion of the money will go to the firm itself
A Secondary Market is:
The security is already outstanding and trades happen between investors; no new money reaches the firm
4 Characteristics of Privately held Firms:
1) Fewer obligations to release F/Ss to public, (2) MAX of 499 shareholders, (3) Can sell shares directly to investors through a private placement, and (4) B/c stock is much less liquid, price of shares will be lower than equivalent public company
4 Characteristics of Publicly Traded Companies:
1) Can issue through either an IPO or SEO (Seasoned Equity Offering), (2) Typically have syndicate of investment banks w/1 lead firm marketing the securities, (3) Must present a prospectus to the SEC: a registration statement, and (4) Firms can also register securities “on the shelf:” register the securities today, can sell them at various times to the public for the next two years
Price-contingent orders: If the price drops below a certain point, buy
Limit Buy Order
Price-contingent orders: If the price rises above a certain point, sell
Limit Sell Order
Price-contingent orders: If the price rises above a certain point, buy
Stop-Buy Order
Price-contingent orders: If the price drops below a certain point, sell
Stop-Loss Order
Market orders - Buy Order:
Buy the stock at the ask price
Market orders - Sell Order:
Sell the stock at the bid price
Difference b/t ask and bid price:
Bid-Ask Spread
4 Main types of trading securities markets, w/example for each:
(1) Direct Search Markets (Craigslist) (2) Brokered Markets (Real Estate Markets) (3) Dealer Markets (most bond markets) (4) Auction Markets (NYSE)
Main U.S. Markets: Lists around 3,000 firms and has three levels of subscribers: market makers, those that can see all bid-ask quotes, and those that can only see the best bid-ask quotes
NASDAQ
NYSE
New York Stock Exchange
ECNs - Electronic Communication Network:
(1) Post market and limit orders over computer networks, (2) Automatically matches orders that can be “crossed,” (3) Eliminates extra bid-ask spread incurred from a broker-dealer system. (4) List trades on other markets, so traders automatically send orders to exchange with best price. (EX: Direct Edge, BATS, NYSE Arca, etc.)
5 Characteristics of Common Stock?
(1) Typical rules allow one-share for one-vote @ annual meeting & a share of the financial benefits of ownership
(2) Vote is for board of governors, who ensure managers act in the interest of shareholders (3) Most shareholders will vote by proxy (4) Has a residual claim on assets and income (5) Shareholders have limited liability
2 Characteristics of Preferred Stock?
(1) Fixed income stream, no ownership rights, but no
contractual obligation to be paid (2) Issuing firm cannot deduct dividends paid (like it can with interest for bonds), but a corporation investing in another corporation’s preferred stock can exclude 70% of dividends received in computation of taxable income
