Short Questions Flashcards
What is a Stock Market Index? What are the main ones?
Composite value of a group of secondary markets traded stocks. Index movements inform investors on the general state of the market. Historical analyses proves strong evidence of correlation between inidicies.
Europe-FTSE
US- Dow Jones
Asia-NIKKEI
What is meant by an Interest Rate Zero Collar Cost?
Combination of buying a cap and selling a floor. A borrower may wish to limit upside risk of interest rates increasing but is prepared to give up some benefits of interest rates decreasing. If the purchase of a cap is perfectly subsidized by the sale of the floor, its called a zero cost collar.
What is an Amortizing Loan
Where the principal of the loan is paid down over the life of the loan, according to the ammortising schedule typically through equal payments.
What is a syndicate loan?
Offered by as group of banks to clients with large scale and high risk requirements. Motivation for the syndicate is to distribute risk. One bank assumes the role of the and is responsible for important aspects of the loan such as: pricing, Organisation and agreement of conditions-One covers all banks. Eg syndicate loan given by JP Morgan to AT&T for $20 billion was split among 11 banks.
Factors considered when pricing a bond
Cost of funds
Operational Cost associated with serving the loan
Risk premium for default risk
Reasonable profit margin
Why might a lender enter a Repo Agreement
Holding excess cash
They have shorter maturities
Higher interest
How does a T-Bill work
Security issued by the US, essentially a loan. T-Bills have a future value eg $1000 but bought for $960 every bill has a maturity(when you get money back), the government pays you the FV (100) and you make 40(Discount Rate).
How extensively has the Irish government used short term T bills in the last 3 years?
Increments of £500 million every 2/3 months
Bid/Cover ranged from 2.69 to 4.98
Yields ranged from -0.22 to .2
Type of bids were competitive
What is meant by the Term Structure Rate of Interest Rates?
Relationship between maturity and yields for bonds - the yield curve. The term structure of interest rates compares the interest rates on securities assuming all characteristics (Default risk, Liquidity risk) except maturities are the same.
What is a forward rate?
Expected or implied rate of interest in a short term (one year) security starting at some point in the future. Determined from spot rates.
Translation exposure? And how to hedge?
The risk that a company equities assets and liabilities or income will change in value as a result of exchange rate change. Exposure may be given in terms of NBV = Foreign denominated assets - foreign denominated liabilities. To hedge - match denominated assets and liabilities so net exposure is reduced.
What is Transaction Exposure? And how to hedge?
The risk faced by companies involved in international trade, that currency exchange rates will change after entering into financial obligations. Can lead to big losses.
To hedge: Use FX forwards, futures or options.
The main foreign exchange trading activities preformed by financial institutions?.
- Purchase and sale of foreign currency to allow customer transactions.
- Purchase and sale of foreign currency to allow customers take financial positions in foreign ,markets
- Purchase and sale of foreign currency to hedge
- Purchase and sale of foreign currency for speculative purposes.
What is the purpose of backstop facility? Who supplies it? How is it priced?
Provides liquidity if the commercial paper issuer cannot refinance the commercial paper in the market because the investor demand reduces or disappears.
Its provided by the bank
Two elements to pricing:
(i) Commitment Fee - low fee expressed as a % of the amount committed by the bank to the issuer- paid regardless weather the facility is used.
(ii) Interest Margin - LIBOR much higher fees than (i) and charged on the amount borrowed by the issuer.
If the issuer for the bonds needs to avail of the backstop facility the demand for short term paper has reduced likely due to credit concerns.
Why might an investor prefer to invest in stock that had a history of paying low or zero dividends?
Tax position. Capital gains are treated more advantageously than dividend income.
May not need the cash flows - suits younger investors who aren’t reliant on dividends for income
What is meant by the YTM?
YTM is the interest rate an investor would earn by investing every coupon payment from the bond at a constant interest rate until the bond’s maturity date. The present value of all of these future cash flows equals the bond’s market price.
A callable bond gives the ____ the option to call the bond at a specified time in the future. A convertible bond gives the ____ the option to convert the bond into another security at a specified time in the future. A callable bond usually has a ____ yield than a regular (non callable) bond. A convertible bond usually has a ____ yield than a regular (non convertible) bond
Issuer
Investor
Higher
Lower
What is the difference between a secondary stock market and a stock market index? Give 2 examples of a secondary stock market and 2 examples of a stock market index.
A secondary stock market is the market which securities are traded after they are initially offered in the primary market. Most trading occurs in the secondary market. Seasoned securities are traded in the secondary market. The largest secondary stock markets by market capitalization are NY Stock Exchange, NASDAQ, Tokyo Stock Exchange and London Stock Exchange
A Stock Market Index is the composite value of a group of secondary market traded stocks . Movements in a stock market index provide investors with information on movements of a broader range of secondary market securities. The most common stock market indices would be the DJIA, S&P 500, NASDAQ Composite Index, FTSE 100, DAX, Nikkei 250
If an upward sloping yield curve is said to be flattening what is happening to rates at the short end and at the long end? Give an example of a country which has seen a flattening of their yield curve within the last year and mention approximate yield levels
Flattening - short term rates rising and long term rates falling - eg US yield curve -
Sept 2015 - 3 mo: 0.03% and 30 yr 2.88%
Spet 2016 - 3 mo: 0.29% and 30 yr 2.55%
GoFaster plc’s EUR3bn bond maturing in 2023 trades at a price of 28.7 cents. 3 months ago this bond traded at 13.0 cents.
Where is this bond trading relative to its par value? What was happening to the yield on the bond over the last 3 months – give a reason for why the yield may have changed.
Bond was trading at a deep discount to par. Yields decreased from 30% to 18.9% over the same period. Reasons: credit quality of company improved possibly due to upgrading of rating.
What is meant by the Fair Present Value of a Bond.
The Fair Present Value of a bond is the present value of the stream of cash flows it is expected to generate. The fair present value of a bond is calculated by discounting the bonds expected cash flows to the present using the required rate of return. The PV of the annuity is calculated and the PV of the principal payment at the end of the bonds term is calculated. They are added together to calculate the Fair Present Value of the bond.
Give an example of when a company would buy:
(i) An interest rate swap
(i) An interest rate swap
(iii) A credit default swap
(i) if theres increased volatility in the nature of interest rates
(ii) If one wishes to limit the upside risk of interest rates increasing but is prepared to give up the benefit of rates decreasing.
(iii) if the buyer of the swap wants to transfer the risk of the underlying debt instrument to the seller of the swap.
What is meant by the term “marking a swap to market”
MTM is a measure of the fair value of accounts that can change over time, such as asssets and liabilities. MTM aims to provide a realistic appraisal of an institution or companys current financial postion.
Exercise Price
the price per share at which the owner of a traded option is entitled to buy or sell an underlying security.
Options Premium
The price paid to acquire the option. The market determines the forces that influence the premium.
Put Option
Gives the buyer the right to sell the underlying security at a specificity price.
Intrinsic Value
The difference between the current trading price and the strike price. Only in the money options have intrinsic values. Out of the money no intrinsic value.
Time Value
An option is dependent on length of the time renaming to exercise the option, as well as volatility of the underlying market price the value of the option decreases as the expiration date approaches ( time decay)
Unbiased expectations theory?
Investor with a 4 year time horizon could buy: a current 4 year bond and hold to maturity or buy four successive one year bonds. In equilibrium the return on both should be equal. The shape of the curve is determined by the markets current expectations of future short term interests rates. If short term rates are expected to rise YC will be upward sloping.
Liquidity Premium Theory
An extension of UET. It states that long term security do not offer the same liquidity as short. Investors require a liquidity premium. Illiquidity increases exposure to future prices uncertainty and risk of capital loss.
What is a Bullet Repayment
A bullet repayment is a lump sum payment for the entirety of a loan amount paid at maturity. Loans with bullet repayments are also referred to as balloon loans, and are commonly used in mortgage and business loans to reduce monthly payments. The existence of a bullet repayment due at a loan’s maturity often necessitates advanced planning to have a refinancing facility in place, unless the borrowers have cash to pay off the lump sum.
What are the main activites undertaken by
Commercial Banks
- Offer savings/deposit accounts
2. Giving out loans
What are the main activites undertaken by
(i) Investment Banks
- Provide advisaory services to customers
- Assist in mergers and acquisitions
- Assist companies in arranging finance – bond issues
- Assist IPO’s
- Underwriting risk deals – buying securities and selling at profit
How do the type of assets on the balance sheet of a commercial bank differ from those of an investment bank?
IVB Assets = securities
IB raise capital via bonds
CB Assets = Loans
CB raise capital via shares
Portfolio Concentration Risk?
Not having a large % of your portfolio in one sector.
What factors will a bank consider when it is pricing a loan for a borrower. Discuss the components involved in assessing credit risk.
Credit Liquidity Interest Rate Risk Currency Operational Technological Solvnecy
What are the principal risks facing a financial institution?
Fraud
List and briefly summarize the main characteristics of the different Ordinary Life Insurance.
1.Term Life
Has no savings element
Individual’s beneficiaries receive payout in event of death during coverage period (stated death benefit)
- Whole Life
Provides cover for insured individual for entire period of person’s life - Endowment Life
Combines term insurance with savings element - Variable Life
One of newer innovations within insurance
Policyholder generally given choice of mutual funds within which to invest premium payments
What is insurance underwriting and how is it caused?
U/W risk exists when premiums are insufficient to cover:
(1) Claims/losses incurred from insuring risks
(2) Administrative expenses (legal, tax, etc.) incurred in providing insurance cover for risks
What is a Finance Company
Provide loan facilities to both individuals and businesses
Provide services such as:
- Consumer lending- Business lending- Mortgage financing
Raise funds to finance operations through short- and long-term debt
Differ from commercial banks in not accepting deposits
What are the primary differences between hedge funds and mutual funds?
Hedge Fund:
- Lightly regulated
- Only high wealth individuals
- More flexible
Mutual Funds
- Managed portfolio
- invested in less risky securities.
- Any investor
What are the characteristics of a “junk” bond and why would an investor purchase a junk bond?
- Non investment grade BB or Ba
- High yields
- high credit rating
In the Insurance market what is a Combined Ratio and what does it measure?
The combined ratio is the total of estimated claims expenses for a period plus overhead expressed as a percentage of earned premiums. A ratio below 100 percent represents a measure of profitability and the efficiency of an insurance firms underwriting efficiency.
How does a futures or options clearinghouse assist traders?
- Intermediary between buyers and sellers of financial instruments.
- The purpose to improve the efficiency and add stability
- Takes the opposite position of each side of a trade.
What is the difference between General Obligation and Revenue Bonds?
GOB = Municipal bonds backed by the state , no collateral
RB = Raise funds for revenue generating projects , state may not use taxes on default
In an Initial Public Offering (IPO) define what is meant by the terms Net Proceeds and Gross Proceeds
Gross Proceeds is the money received by the agent for his employer.
Net Proceeds is the gross proceeds minus the commission and other expenses
What is meant by the term “the pull to par” for a bond in the market.
Pull to Par is the effect in which the price of a bond converges to par value as time passes.
At maturity the price should equal its par
What is a Credit Default Swap
The buyer of pays a premium for insuring against a debt default.
The seller of a credit default swap receives monthly payments from the buyer.
If the debt instrument defaults they have to pay the agreed amount to the buyer of the credit default swap.
What is Bid/Cover?
Express the demand for security during offerings and auctions.
What is a Venture Capital firm and how does it operate?
A venture capitalist is an investor who either provides capital to startup ventures or supports small companies that wish to expand but do not have access to equities markets.
