WEEK 2: Money Market Instruments, Fixed Income, and Equities

Question 1

real assets

Answer 1

assets used to produce goods and services (land, machinery, knowledge)

Question 2

financial assets

Answer 2

means that individuals hold claim to the real assets (stock, bonds, options)

Question 3

asset classes

Answer 3

1. money market (1 year or less), cash and cash equivalents
2. fixed income, equity, derivatives, real estate, alternative assets

Question 4

Asset Allocations and Sub-allocations

Answer 4

1. stocks (equities): large, mid, small cap stocks, foreign stocks and growth vs income
2. US government, municipal bonds, corporate bonds, foreign bonds, inflation-protected bonds
3. real estate, commodities, currencies, limited partnerships

Question 5

Cash and cash equivalents

Answer 5

cash, depository accounts (checking, NOW, savings, money market), liquid securities (certificate of deposit, T-bills, US savings bonds), brokerage accounts (asset management, money market), commercial paper, banker’s acceptance, eurodollars

Question 6

characteristics of cash equivalents

Answer 6

low risk, highly liquid, low return, provide assess to liquid assets for emergency or short-term operational (working capital) needs

Question 7

Checking/NOW Account

Answer 7

facilitate financial transactions, on-demand withdrawal, no interest or minimums

Question 8

Savings/Money Market Deposit account

Answer 8

higher interest than checking and NOW, subject to account minimums, some check writing restrictions, fees assessed

Question 9

certificate of deposit

Answer 9

fixed interest rate time deposit, any denomination, subject to minimum, FDIC-insured time deposits, pays fixed interest rate, early withdrawal penalties, brokered CDs are issued by banks to brokerage firms who de-bundle and sell to customers

Question 10

money market mutual funds

Answer 10

pooling of assets to purchase diversified portfolio of short-term debt securities with low credit risk, minimum opening and balance requirements, earns a market rate of interest, minimum level of volatility

Question 11

US Treasury Bills

Answer 11

federal debt, sold at discount to face value, actively traded in secondary market, min denomination is $100, interest is taxable at federal level, tax-exempt at state and local level

Question 12

commercial paper

Answer 12

short-term paper debt issued by a corporation to finance short-term operations: unsecured, short-term promissory note, issued to finance short-term need, discount to par value

Question 13

banker’s acceptance

Answer 13

agreement between a bank and company: bank guarantees to make the future payment, typically issued for short-term financing, bank’s credit replaces credit of the company, used to facilitate international trade, sold at discount to par value

Question 14

repurchase agreement

Answer 14

short-term agreement in which one party sells a security to another party with an agreement to repurchase at a specific date and price

Question 15

eurodollars

Answer 15

US dollar-denominated time deposits held in foreign banks, typically short-term

Question 16

federal funds

Answer 16

bank reserves held at Federal Reserve, to maintain reserve requirement, bank often borrow overnight from other banks

Question 17

taxation of money market instruments

Answer 17

ordinary income: interest
capital gain income: sale of asset

Question 18

bond categories

Answer 18

issuer (US gov, state and local), term structure, credit rating (investment grade, junk), cash flows (coupon paying, zero coupon)

Question 19

cash flows for coupon bonds

Answer 19

fixed income securities with maturities > 1 year. coupon bonds offer semi-annual or annual coupon payments + return of bond’s face value at maturity

Question 20

zero coupon bonds

Answer 20

receive par value at maturity

Question 21

fixed-income securities

Answer 21

US government bonds and agency securities (US treasury notes and bonds, TIPS, STRIPS, US savings bonds, US government agencies), mortgage-backed securities, guaranteed insurance contract (GICs), municipal bonds (general obligation, revenue bonds), corporate bonds (investment grade, junk), foreign bonds, promissory notes

Question 22

US treasury note

Answer 22

issued in terms of 2-10, multiple of $100, semi-annual interest payments, interest income is subject to federal tax, exempt at state and local elvel

Question 23

US treasury bond

Answer 23

same as treasury note, but issued in terms of 10-30 years

Question 24

US treasury inflated-protected services (TIPS)

Answer 24

pays fixed interest rate on adjusted principal, linked to moves in CPI, at maturity, investor gets inflation-adjusted principal

Question 25

STRIPS

Answer 25

zero coupon

Question 26

US Savings Bonds

Answer 26

zero coupon bonds, pays interest when redeemed/maturity, purchase from US treasury, can be redeemed early after one-year with penalty in first 5 years, interest deferred until redeemed
Series EE: discount to face value, issued at 50% to face with term 20 years
Series I: zero coupon with 1-30 year maturity, fixed rate of interest + variable inflation - rate adjustment
both tax exempt

Question 27

Mortgage-backed securities

Answer 27

pass-through securities, mortgage payments passed along to debt-holder, subject to prepayment risk
Centralized mortgage obligations (CMOs) are backed by a pool of mortgage loans divided into tranches.

Question 28

Guaranteed Investment Contract (GIC)

Answer 28

low risk, zero coupon, offered by insurance companies, guaranteed return of principal and interest at maturity, low rate of return, low volatility, low liquidity

Question 29

Municipal Bonds

Answer 29

debt issued by state and local governments
general obligation bonds - backed by taxing power of gov
revenue bonds - backed by specific project
public muni: tax exempt at fed level
interest is generally tax-exempt within home state

Question 30

Corporate Bonds

Answer 30

issued by US corporations, 1-30 years, interest rate based on market rate for similar debt securities

Question 31

Other bonds

Answer 31

yankee: debt obligation issued by foreign bank or company that is issued in US, interest and principal paid in US $
foreign: debt obligation issued by foreign government, bank, or company, interest and principal paid in local currency

Question 32

Callable bonds

Answer 32

company has “right” to recall bonds after a certain period, recalled if company can reissue debt at a lower cost in exchange for right (bondholder) receives higher yield than equivalent “straight bond” plus a call premium

Question 33

Puttable bonds

Answer 33

bond holder has right to sell bond back to issuer prior to maturity at predetermined price, lower YTM than straight bond, bondholder will sell bond back to issuer if rates increase

Question 34

Convertible Bonds

Answer 34

provide the bond holder with the right to convert the bond to common shares, if exercising right bondholder turns in the bond and receives stock, specifies conversion ratio, may have call provision, so issuer can force redemption

Question 35

Bond with a warrant

Answer 35

provide bondholder right to exercise warrant to buy common shares, if exercising bondholder keeps bond and buys shares, specifies per share purchase price, value of warrant is priced similarly to call option

Question 36

taxation of bonds

Answer 36

municipal: tax exempt at fed
coupon: interest
zero: accrued
discount bond: interest + amortized discount
premium bond: interest - amortized discount
TIPS: interest and semi-annual inflation adjustments
all: capital gain sale before maturity

Question 37

accrued interest

Answer 37

amount of interest that accumulates since last coupon payment

Question 38

common stock

Answer 38

ownership in the company: voting rights, right to dividends, limited liability, growth asset, high return, high volatility, stock liquidity

Question 39

dividends

Answer 39

companies pay out dividends quarterly or annually to existing shareholders.
income = cash dividend
declaration date, date of record, ex-dividend date, date of payment, payout (dividends per share/EPS), retention ratio (1-payout ratio), dividend yield (DPS/current price per share)

Question 40

stock splits

Answer 40

increases the number of shares owned by shareholders but decreases stock price, net value remains unchanged

Question 41

capital appreciation

Answer 41

appreciation = current market price - basis
total return = dividends + cap appreciation

Question 42

categories of stocks

Answer 42

market capitalization (#shares outstanding * current market price), geographical location, growth vs income, market cycle performance, sector vs industry

Question 43

stock rights

Answer 43

way for company to raise capital, offer existing shareholders the right to accumulate more shares

Question 44

stock warrants

Answer 44

offers the holder the right to buy (or sell) certain number of shares at a special price by a certain time (>5years). if issued the company issues new shares. if put warrant is redeemed, company buys back shares

Question 45

American Depository receipt

Answer 45

shares in foreign companies that can be purchased on our domestic exchange, represents shares held on deposit, direct ownership of foreign security in $, exchange risk

Question 46

sponsored vs unsponsored ADRs

Answer 46

sponsored: implemented by US depository bank in collaboration with foreign company
unsponsored: without collaboration, only trades over counter and demand driven by broker-dealer

Question 47

preferred stock

Answer 47

fixed dividend into perpetuity, preference over common, no voting rights, might be convertible, cumulative dividends must be paid before common can receive dividends, dividends can be skipped, no maturity debt