Session 13&14&15 Flashcards
Primary market
The primary market is the part of the capital market that deals with issuing of new securities. Companies, governments or public sector institutions can obtain funds through the sale of a new stock or bond issues through primary market.
=!secondary market (sometimes exchange markets but mostly dealer markets)
Call market
A market in which trading in individual securities occurs at specific times as opposed to continuously. In a call market all orders to buy and sell a particular security are assembled at one time in order to determine a price at which most of the orders can be executed. The participants then move on to a different security. Call markets are frequently used in situations in which there are few securities and participants.
Continuous market
A continuous market can occur at any time as long as the market is open. Buyers and sellers are matched up on a continuous basis and the price is determined through an auction or through bid-ask quotes.
Long position
gains when asset values increase.
purchase stock or calls, sell puts, take long futures or forward positions
Short position
gains when asset values decrease.
sell short, sell/write calls, purchase puts, take short futures or forward positions)
Calls (call options)
right to buy
Puts (put options)
right to sell
Buying on margin
The purchase of an asset by paying the margin and borrowing the balance from a bank or broker. Buying on margin refers to the initial or down payment made to the broker for the asset being purchased. The collateral for the funds being borrowed is the marginable securities in the investor’s account. Before buying on margin, an investor needs to open a margin account with the broker. In the U.S., the amount of margin that must be paid for a security is regulated by the Federal Reserve Board.
Trading execution
How to trade:
market order
limit order
Trading validity
When to trade: good-till-canseled immediate-or-cansel = fill or kill day order stop order
Seasoned offering
An issue of additional securities from an established company whose securities already trade in the secondary market. A seasoned issue is also known as a “seasoned equity offering” or “follow-on offering.”
Quote driven market
An electronic stock exchange system in which prices are determined from bid and ask quotations made by market makers, dealers or specialists. In a quote driven market, also known as a price driven market, dealers fill orders from their own inventory or by matching them with other orders. A quote driven market is the opposite of an order driven market, which displays individual investors’ bid and ask prices and the number of shares they want to trade.
Order driven market
A financial market where all buyers and sellers display the prices at which they wish to buy or sell a particular security, as well as the amounts of the security desired to be bought or sold. This is the opposite of a quote driven market, which is one that only displays bids and asks of designated market makers and specialists for a specific security.
Rebalancing
The process of realigning the weightings of one’s portfolio of assets. Rebalancing involves periodically buying or selling assets in your portfolio to maintain your original desired level of asset allocation.
Stock split
Take, for example, a company with 100 shares of stock priced at $50 per share. The market capitalization is 100 × $50, or $5000. The company splits its stock 2-for-1. There are now 200 shares of stock and each shareholder holds twice as many shares. The price of each share is adjusted to $25. The market capitalization is 200 × $25 = $5000, the same as before the split. –> dilution does not occur.
Price weighted index
A stock index in which each stock influences the index in proportion to its price per share (represents a portfolio which includes an equal number of shares of each stock in the index). The value of the index is generated by adding the prices of each of the stocks in the index and dividing them by the total number of stocks. Stocks with a higher price will be given more weight this way and, therefore, will have a greater influence over the performance of the index.
Market cap weighted index
represents a portfolio that includes all the outstanding shares of each stock in the index
Price and outstanding shares today /
price and outstanding shares base year
beginning index value (100, 1000, …)
Risk adjusted return
Risk-adjusted return is a measure of the return on an investment relative to the risk of that investment, over a specific period.
it’s used to compare different investments with different returns and risks.
one of the calculation methods is Sharpe ratio:
portfolio return - risk free return /
portfolio standard deviation
Momentum investing (strategy)
This strategy looks to capture gains by riding “hot” stocks and selling “cold” ones. To participate in momentum investing, a trader will take a long position in an asset, which has shown an upward trending price, or short sell a security that has been in a downtrend. The basic idea is that once a trend is established, it is more likely to continue in that direction than to move against the trend.
Statutory voting
if you owned 50 shares and were voting on six board positions, you could cast 50 votes for each board member, for a total of 300 votes. You could not cast 20 votes for each of five board members and 200 for the sixth.
Cumulative voting
lets shareholders weight their votes toward particular candidates and improves minority shareholders’ chances of influencing voting outcomes. In cumulative voting, you are allowed to vote disproportionately, so if you own 50 shares and are voting on six board positions, you can cast 300 votes for one director and none for the five other directors.
Callable common stock
A security that represents ownership in a corporation that has voting rights, whose owners are last to be paid if the company liquidates and which is redeemable by the issuing corporation, at a predetermined price or at a premium to the current market price. Typically, callable common stock is issued for a subsidiary company by its parent company. The parent company reserves the right to buy back the shares of the subsidiary company, should it become strategically beneficial.
opposite: putable
Callable common stock
A type of preferred stock in which the issuer has the right to call in or redeem the stock at a preset price after a defined date.
opposite: putable
Leveraged buyout (LBO)
a private equity technique
uses debt to buy all outstanding stock of a firm
Management Buyout (MBO)
an LBO led by firm’s management
Private investment in public entity
A private investment firm’s, mutual fund’s or other qualified investors’ purchase of stock in a company at a discount to the current market value per share for the purpose of raising capital.
Depository receipts
a type of foreign investment.
A negotiable financial instrument issued by a bank to represent a foreign company’s publicly traded securities. A depository receipt trades on a local stock exchange, but a custodian bank in the foreign country holds the actual shares. Depository receipts can be sponsored or unsponsored depending on whether the company that issued the shares enters into an agreement with the custodian bank that issues the depository receipt.
For example, a firm based in Kenya looking to list shares in the United States through an ADR will pick a Kenyan bank to serve as a custodian of the firm’s shares. Once the bank is chosen, the firm will decide how many shares will be represented by the depository receipt, referred to as the depository receipt ratio, and will find an American broker willing to purchase the shares to be held by the custodian bank. Once the bank issues depository receipts, the American broker can sell those shares domestically.
Premium
Bond price > par value
Coupon rate
ANNUAL interest rate (frequency is not that much important, there’s no compounding and the annual sum would be constant)
Bond indenture (trust deed)
legal contract between issuer and bond holder, held by trustee.
it includes covenants
- debenture: an unsecured loan certificate issued by a company, backed by general credit rather than by specified assets.
Affirmative/negative covenants
A: actions that issuer must perform
N: restrictions on issuer actions that would disadvantage bondholders
Domestic/foreign bonds
National bond market
D: Domestic issuer and currency
F: Foreign issuer - Local currency (german firm registers with SEC and issue $ bonds in US)
N: market including trading of both issue types
Eurobonds
Usually, a eurobond is issued by an international syndicate and categorized according to the currency in which it is denominated. A eurodollar bond that is denominated in U.S. dollars and issued in Japan by an Australian company would be an example of a eurobond. The Australian company in this example could issue the eurodollar bond in any country other than the U.S.
**eurobonds are traded in eurobond markets not national markets, if a eurobond is at least traded in one domestic market, it’s named global bond.
Securitized bond
Issued by a special purpose entity(SPE)
firm sells assets to the SPE (bankuptcy remote)
these assets are the bond’s collateral and also asset cash flows make payments to bond holders.
this is mechanism to reduce borrowing costs by making the bondholder’s claim on a solid collateral which is bankruptcy remote.
*Assets like MBS, credit card receivables, business loans and automobile loans are used.
Covered bonds
like securitized bonds but they don’t sell to SPEs, the asset is still on company’s balance sheet but it’s segregated.
in this model, firm must augment assets whenever they are insufficient to support covered bonds (maybe due to value fall).
also in this type bondholders have recourse to the firm as well as the segregated financial assets. because they’re still related to the firm. so covered bonds are a bit stronger than securitized bonds.
Credit enhancement
Internal: overcollateralization/excess spread/tranches (waterfall structure)
External: bank guarantee/surety bond/letter of credit/cash collateral account
OID bonds
original issue discount bonds:
bonds issued with discount to par value, most extreme example is zero coupon bond
Fixed income cash flows
Fixed: Bullet Structure Partially amortizing Fully amortizing Sinking fund
Floating:
Floating rate notes(FRN): reference rate + fixed margin (could have a cap or floor)
Variable rate note: margin not fixed (e.g may change with the rate of the bond)
Inverse floater: coupon rate = X% - reference rate
Other terms:
Step up coupon: coupon rate (fixed or floating) increases on a schedule, likely the issuer calls the bond prior to step up unless rates are up or credit rating down (so the issuer cannot have a cheaper source of finance)
Credit linked coupon: coupon rate increases if credit rating decreases and vice versa.
Payment in kind: Issuer may make coupon payments by increasing principal amount.
Deferred (split) coupon: Coupon payments do not begin until a period after issuance, then the accrued coupon payment would be paid, and after that regular coupon payments until maturity.
Index linked bonds: coupon rate or principal changes based on value of an index (CPI, Equity indices like SP500 (usually zero coupon bonds!), commodity prices, …)
Inflation linked bonds(linkers):
(adjusted based on CPI)
Interest indexed: coupon rate adjusted
Capital indexed: principal value adjusted
Indexed annuity bonds: fully amortizing, payments adjusted
Principal protected: pay original face value if index decreases over life of bond
LIBOR
is a benchmark rate that some of the world’s leading banks charge each other for short-term loans. It stands for IntercontinentalExchange London Interbank Offered Rate and serves as the first step to calculating interest rates on various loans throughout the world.
Embedded options in bonds
Callable bonds
(*make whole provisions: calculate call price based on future cash flows)
Putable bonds
Convertible Bonds (bondholder decides)
Warrants (attaching stock options to the bond!)
Contingent convertibles (converts automatically if specific events like a fall in company equity percentage happen)
Fixed income classifications
Type of issuer: government/ corporate/ SPE(SPV)/ structured finance instruments
Credit Quality: Investment grade/high yield/speculative/junk
Maturities: Money market/capital market
Coupon structure: Fixed rate/floating rate
Geographic market: developed/emerging
Currency denomination: primarily dollar and euro
Index linking: inflation/equities/commodities
Taxable status:exempt/OID/interest paid net of tax
Primary markets for bonds
Public offering
Private placement
Shelf registration: register entire issue with regulators, issue bonds over time
Underwritten offering
Best effort offerings
Auctions: often used for government bonds (single price auctions)
Secondary market for bonds + trade settlement
Primarily over the counter trading (dealer market) and the bid-ask spread depends on issue’s liquidity.
trade settlement:
T+3: corporate bonds
T+1: government bonds
Same day (cash settlement): money market securities
*bonds are priced based on their value on the delivery date
Government debt
Soveregin bond: issued by national government in local currency or a foreign currency (higher ratings when in local currency, because they can simply print it if needed!)
Non sovereign government bonds: States, provinces, counties, cities (higher ratings when coupons are going to be paid from taxes, fees, etc than from the project earnings because it could be late, problems could come up, etc).
Agency debt
Quasi government bonds(agency bonds): issued by government sponsored entities (they could be guaranteed by the government or not)- like fannie mae
Supranational bonds: issued by multilateral agencies, like IMF or world bank
Corporate debt
Bank borrowing: Bilateral loans-Syndicated loans
Commercial papers (working capital financing-bridge financing): US CP(up to 270 days-traded based on discounts- Settlement in T+0) / Euro CP(up to 364 days-traded based on add-on interest basis-Settlement in T+2) **Rollover risk: the risk that new CP cannot be issued(sold) to pay for maturing paper-this can happen due to deteriorating credit of the company or systematic failure of the market) --> of a good credit ratings company's need backup lines of credit
Corporate bonds: Term maturity structure/Serial bond issue
Medium term notes(MTNs): not medium term and not notes:D
Issuer provides range of maturities, buyer specifies desired value and maturity through issuer’s agent.
Short term funding for banks
Customer deposits
Certificate of deposit
Negotiable CDs (large numbers-traded on secondary markets– a 1 million CD means we should pay 1M right now and receive 1M+interest at maturity)
Central bank funds market (loans from CB to meet reserve requirements– short term borrowing and lending among banks of their excess funds deposited with central banks)
Interbank funds (like CB funds- banks like it more because it doesn’t reveal their liquidity needs)
Repurchase agreements
Source of short term funding for bond dealers.
sell bond to counterparts and agree to repurchase it on repo date at a slightly higher price (repo rate)
Reverse repo
looking at repo from dealer’s perspective.
dealers needs a specific bond in his inventory so buys it and promises to sell it back at a defined price
Repo margin
= haircut
you are not going to be loaned the whole value of the bond (collateral) because of the risks
*repo margin: percentage difference between sale price and value of bond.
Repo margin and rate sensitivity
Bond credit, counterpart credit(seller of bonds), term of repo, securities supply
YTM assumes:
Held to maturity
All payments made
Coupon payments reinvested at YTM
Spot rates
a market discount rate for a single payment to be received in the future. (yields on zero coupon bonds are spot rates)
YTM is an average of spots, its just the IRR achieved when chipping in the current price!)
Accrued interest
accrued interest interest in the bond’s price that is being traded in between coupons.
30/360 method: usually for corporate bonds
actual/actual method: government bonds
Flat/full price
flat=clean=quoted–> does not include accrued interest.
full=invoice=dirty–> includes accrued interest
Matrix pricing
used to price bonds that are not frequently traded so no access to YTM.
uses YTMs of traded bonds of same credit quality to estimate bond YTM (ONLY the credit quality is important to be the same)
average of YTMs of bonds with same maturity or use linear interpolation to adjust for differences in maturities.
YTM for semiannual pay bonds
2*semiannual IRR
(not an EAY)
–> semi annual pricing uses YTM/2
Current yield
annual coupon payment/flat price
*current yield ignores movement toward par value(amortization)
Simple yield
(annual coupon payment +/- amortization) / flat price
- amortization: (discount or premium) / time to maturity
- assumes straight line amortization of premium or discount
Yield convention
Street convention: payments on scheduled dates
True yield: uses actual payment dates (differences can occur due to holidays and weekends)
Government equivalent yield: corporate bond yield restated based on 365 day year, used for calculating spread to benchmark government bond yield
Yield to call (YTC)
With discount bonds there’s no problem, we get to the par value sooner so higher yield.
Yield to first call: substitute the call price at the first call date for par and number of periods to the first call date for N
*Different YTCs can be calculated for each of a bond’s call dates
