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Spring term 2019 > Theory of Investments - Definitions > Flashcards

Theory of Investments - Definitions Flashcards

1
Q

What is a derivative security?

A

A security whose payoff depends on the value of other financial variables such as stock prices, interest rates, or exchange rates.

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2
Q

What is equity?

A

Ownership of a firm.

The net worth of a margin account.

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3
Q

What is asset allocation?

A

Choosing among broad asset classes such as stock versus bonds.

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4
Q

What is security analysis?

A

Determining correct value of a security on the marketplace.

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5
Q

What is a risk-return trade-off?

A

Investors must take on greater risk if they want higher expected returns.

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6
Q

Define ‘Passive Management’.

A

Buying a well-diversified portfolio to represent a broad-based market index without attempting to search out mispriced securities.

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7
Q

Define ‘Active Management’.

A

Attempts to achieve portfolio returns more than commensurate with risk, either by forecasting broad market trends or by identifying particular mispriced sectors of a market or securities in a market.

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8
Q

What are the key features of corporate bonds?

A

Contractual Obligation.
Fixed Payments (Typically)
Payment Preference: FIRST

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9
Q

What are the key features of preferred stock?

A

Perpetual Payments
Accumulated Dividends
Fixed Payments (Typically)
Payment Preference: SECOND

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10
Q

What are the key features of common stock?

A

Voting Rights (Typically)
Perpetual Payments
Payment Preference: THIRD

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11
Q

What is a financial intermediary?

A

An institution such as a bank, mutual fund, investment company, or insurance company that serves to connect the household and business sectors so households can invest and businesses can finance production.

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12
Q

What is the difference between the primary and the secondary market?

A

Primary Market - New issues of securities are offered to the public.
Secondary Market - Already existing securities are bought and sold on the exchanges, or in the OTC market.

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13
Q

Define ‘Venture Capital’.

A

Money invested to finance a new, not yet publicly-traded firm.

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14
Q

What is private equity?

A

Investment in a company that isn’t traded on the stock exchange.

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15
Q

Define ‘Securitisation’,

A

Pooling loans for various purposes into standardised securities backed by those loans, which can then be traded like any other security.

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16
Q

What is systematic risk?

A

Risk of break-down in the financial system, particularly due to spillover effects from one market to others.

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17
Q

How can systematic risk be limited?

A

Transparency that allows traders and investors to access the risk of their counter parties, capital requirements, frequent settlement of gains or losses, incentives to discourage excessive risk taking, and accurate and unbias analysis.

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18
Q

What is the main difference between money markets and capital markets?

A

Money Market - Includes short-term, highly liquid, and relatively low-risk debt instruments.
Capital Market - Includes long-term, relatively riskier securities.

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19
Q

What are the ask and the bid prices?

A

Ask Price - The price at which the dealer will SELL a security.
Bid Price - The price at which the dealer is willing to BUY a security.

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20
Q

Define ‘Bid-Ask Spread’,

A

The difference between a dealer’s bid and ask price.

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21
Q

What is a certificate of deposit?

A

A bank time deposit.

22
Q

What is a commercial paper?

A

A short-term unsecured debt issued by large corporations.

23
Q

What is are Eurodollars?

A

Dollar-denominated deposits at foreign banks or foreign branches of American banks.

24
Q

What are repurchase agreements? (REPOs)

A

Short-term, often overnight, sales of government securities with an agreement to repurchase the securities at a slightly higher price.
A reserve repo is a purchase with an agreement to resell at a specified price on a future date.

25
Q

What is the London Interbank Offered Rate (LIBOR)?

A

Rate that most creditworthy banks charge one another for large loans of Eurodollars in the London market.

26
Q

Define ‘Yield to Maturity’.

A

A measure of the average rate of return that will be earned on a bond if held to maturity.

27
Q

Define ‘Municipal Bonds’.

A

Tax-exempt bonds issued by state and local governments, generally to finance capital improvement projects.
General obligation bonds - backed by the general taxing power issuer.
Revenue bonds are backed by the proceeds from the project or agency they are issued to finance.

28
Q

What is the equivalent taxable yield offered by a municipal bond?

A

= rm/(1-t)

rm - municipal bond yield
t - investor’s tax bracket

29
Q

Explain what common stock is.

A

It’s the ownership share in a corporation. Each share entitles its owner to one vote on matters of corporate governance and to a prorated share of the dividends paid to shareholders. Stock, or equity, owners are the residual claimants on the income earned by the firm.

30
Q

Explain what preferred stock is.

A

It usually pays fixed dividends for the like of the firm; it is a perpetuity. A firm’s failure to pay dividends accumulate. Newer varieties of preferred stock include convertible and adjustable-rate issues.

31
Q

What is meant by ‘residual claim’?

A

Residual claim refers to the fact that shareholders are at the bottom of the list of claimants to assets of a corporation in the event of failure or bankruptcy.

32
Q

What is meant by ‘capital gains’?

A

The amount by which the sale of a security exceeds the purchase price.

33
Q

What is the price-earning ratio?

A

The ratio of a stock’s price to its earnings per share.

34
Q

What is the market-value-weighted-index?

A

An index of a group of securities computed by calculating a weighted average of returns of each security in the index, with weights proportional to outstanding market value.

35
Q

Define ‘index fund’.

A

A mutual fund holding shares in proportion to their representation in a market index such as the S&P 500.

36
Q

What are derivative assets?

A

They’re securities providing payoffs that depend on

37
Q

What is the difference between a call and a put option?

A

Call Option - The right to buy an asset at a specified exercise price on or before a specified expiration date.
Put Option - The right to sell an asset at a specified exercise price on or before a specified expiration date.

38
Q

What is meant by the exercise (strike) price?

A

The price set for calling (buying) and asset or putting (selling) an asset.

39
Q

What is a futures contract?

A

It obliges traders to purchase or sell an asset at an agreed-upon price on a specified future date. (Maturity date)
The long position is held by the trader who commits to purchase.
The short position is held by the trader who commits to sell.
Futures differ from forward contracts in their standardisation, exchange trading, margin requirements, and daily settling (Marking to market).

40
Q

What does the bid-ask spread depend on?

A

How frequently they are traded.

The higher the spread, the less frequent they’re traded.

41
Q

What is the difference between bullish and bearish?

A

Bullish expects prices to go UP

Bearish expects prices to go DOWN

42
Q

What is a mortgage backed security?

A

Either an ownership claim in a pool of mortgages or an obligation that is secured by such a pool.

43
Q

What is a market portfolio?

A

The portfolio for which each security is held in proportion to its market value.

44
Q

What is ‘Market Fund Theorem’?

A

A result associated with the CAPM, asserting that investors will choose to invest their entire risky portfolio in a market-index mutual fund.

45
Q

What is ‘ Market Price of Risk’?

A

A measure of the extra return, or risk premium, that investors demand to bear risk. The reward-to-risk ratio of the market portfolio.

46
Q

Define Beta.

A

Beta is the measure of the systematic risk of a security. The tendency of a security’s returns to respond to swings in the broad market.

47
Q

What is the expected return-beta (or mean-beta) relationship?

A

The implication of the CAPM that security risk premiums (expected excess returns) will be proportional to beta.

48
Q

What is meant by ‘Security Market Line (SML)’?

A

Graphical representation of the expected return-beta relationship of the CAPM

49
Q

Define Alpha.

A

The abnormal rate of return on a security in excess of what would be predicted by an equilibrium model like CAPM or APT.

50
Q

What are homogenous expectations?

A

The assumption that all investors use the same expected returns and covariance matrix of security returns as inputs in security analysis.

51
Q

What is a zero-beta portfolio?

A

The minimum-variance portfolio uncorrelated with a chose efficient portfolio.

52
Q

What is the difference between being liquid and illiquid?

A

Liquidity refers to the speed and ease with which an asset can be converted into cash. If something is illiquid, there is a difficulty, delay or cost in selling assets on a short notice without offering substantial price concessions.

Spring term 2019 (5 decks)

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