Quiz 1 Jargon

Question 1

Liquidity

Answer 1

A measure of cash and other assets that are available to quickly meet financial obligations

Question 2

Securitization

Answer 2

Pooling of certain types of assets so they can be repackaged into interest-bearing financial vehicles and sold on a market

Question 3

Capital structure

Answer 3

The distribution of debt and equity that a bank has that makes up its finances

Question 4

Leverage

Answer 4

The level of borrowed money used as a funding source relative to the amount of equity the bank holds ie: the level of assets to equity in the case of banks because they fund loans using deposits

Question 5

Collateral

Answer 5

Backing a loan with an asset that can be converted for cash

Question 6

Priority

Answer 6

Which groups get paid out first

1) first lien — secured
2) second lien — secured
3) senior — secured
4) subordinate — unsecured
5) preferred equity
6) shareholders equity

Question 7

First lien debt

Answer 7

First person paid out by sale of the collateral and assets given a default

Question 8

Second lien

Answer 8

Second person to be paid out by asset sale and collateral given a default

Question 9

Debt — bonds

Answer 9

Debt security similar to an IOU, investors issue bonds to raise money from investors willing to lend them money for a set amount of time

Question 10

Equity

Answer 10

The value that would be returned to a company’s shareholders if all the assets were liquidated and all the debt was paid off

Question 11

Preferred equity

Answer 11

Different type of equity that represents ownership of a company and the right to claim income from the company’s operations. Get paid out more than regular equity holders

Question 12

Dividends

Answer 12

Money paid out to investors from business operations

Question 13

Interest — Coupon payments

Answer 13

A percentage paid out to an investor on a bond or security of debt based on the value of that debt

Question 14

Fire sale

Answer 14

When a bank sells its assets quickly to raise equity during a bank run

Question 15

Book equity — tangible book value of equity

Answer 15

Value of equity on the company’s balance sheet. Total assets minus total liabilities. Tells you the firms net asset value

Question 16

Market equity

Answer 16

The price of shares of the company traded on the stock exchange times the number of shares outstanding. Or in other words the market value of the company’s equity

Question 17

Market-to-book ratio

Answer 17

The value of the market value of equity relative to the book value of equity. Or the price per share * shares outstanding over the net asset value

Question 18

Return on assets

Answer 18

How profitable a company is relative to its total assets. Net income / total assets

Question 19

Return on equity

Answer 19

The profitability of a company relative to its level of equity. Net income / shareholders’ equity

Question 20

Net interest margin

Answer 20

The amount of cash earned or lost on loans and debt. Interest income - interest expense

Question 21

Delinquent loans

Answer 21

Borrower is behind on the interest payments on a loan

Question 22

Provision for loan losses

Answer 22

Capital deployed by banks to absorb losses on their loan portfolio

Question 23

Charge off

Answer 23

Debt that is deemed unlikely to be collected by the creditor but the debt is not necessarily forgiven or written off entirely. Similar to writing down an asset but it applies specifically to loans

Question 24

Cash flow

Answer 24

Total amount of money being transferred into and out of business

Question 25

Default and recovery

Answer 25

A borrow fails to repay the funds on a loan according to the loan agreement. Recovery is borrower liquidating it’s assets in order to repay investors. Think FTX going bankrupt

Question 26

Regulatory capital

Answer 26

Capital requirements for banks that helps them absorb losses on risk assets and falling prices and restricts leverage

Question 27

Tier 1 capital

Answer 27

Core capital on the banks reserves including shareholders equity and retained earnings

Question 28

Tier 2 capital

Answer 28

Supplementary capital that includes hybrid capital instruments , subordinated debt and loan-loss reserves

Question 29

Repurchase agreements (Repo transactions)

Answer 29

Collateralized overnight loans where 1 bank lends to another with an agreement to repurchase the collateralized loan at a higher price

Question 30

Haircut

Answer 30

The difference between the market value of the collateral and the price of the loan in a repo transaction

Question 31

Rehypothacate

Answer 31

Sell the original collateral from the first repo agreement in another repurchase agreement

Question 32

Principle agent problem

Answer 32

Conflict between depositors and the bank in they way they use the deposits

Question 33

Volatility index (VIX)

Answer 33

Measures the volatility in the market using future annualized volatility implied option market prices. Higher VIX indicates market is willing to pay higher prices for insurance. Based on the Black-Scholes model

Question 34

Implied option volatility

Answer 34

Annualized volatility given the other option inputs (calls and puts) and market price. Returns of call and put options on the S&P 500

Question 35

Realized volatility

Answer 35

Standard deviation of actual market returns — annualized returns of the S&P 500 at present time

Question 36

Procyclical Leverage

Answer 36

Banks enthusiastically respond to asset price appreciation and expand their balance sheet but overreact when prices depreciate and are forced to heavily de-lever by selling assets to raise equity which further decreases prices

Question 37

Marked-to-market balance sheet

Answer 37

Assets and liabilities on the balance sheet are marked to the fair value. Aims to provide a realistic appraisal of an institutions current financial situation

Question 38

Losses from credit risk

Answer 38

Probability of default * (1 - recovery rate), the losses incurred by a bank for lending to risky borrowers who have a higher probability of default

Question 39

Margin spiral

Answer 39

Rush by borrowers to withdraw their securities (draw down lines of credit) posted as collateral to a dealer

Question 40

Value at Risk (VaR)

Answer 40

Estimate of the probability of a potential loss in value X for over a period of time for a given confidence interval Y. Probability that an asset drops below a specific value over a given period

Question 41

Target federal funds rate

Answer 41

The interest rate the fed wants banks to lend at

Question 42

Effective federal funds rate

Answer 42

Interest rate banks actually lend at

Question 43

Open market operations

Answer 43

Tool the fed uses to align the effective fed funds rate with the target rate. Open market operations either add or drain reserves from the banking system

Question 44

Federal funds rate

Answer 44

Interest rate at which banks lend to each other overnight

Question 45

Fed funds

Answer 45

Immediately available reserve balances that depository institutions with accounts at the fed can access. Consists of short term borrowings of money funds and liabilities of depository institutions. Exempt from reserve requirements and price ceilings

Question 46

Why might banks be special?

Answer 46

1) provide transaction accounts for individuals and corporations
2) backup source of liquidity in times of economic stress
3) act as transmission for monetary policy

Question 47

How are banks treated as special?

Answer 47

1) access to the discount window at the federal reserve
2) take FDIC insured deposits
3) restrictions on competition
4) government regulation and supervision
5) capital and reserve requirements