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55 Cards in this Set
- Front
- Back
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Define an "investment"
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Sacrifices something today for benefits in the future.
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Explain Financial Assets
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Financial Assets are claim to the income generated by real assets. There are three broad types:
1. Fixed income (Money Market Debt, Capital Market Debt) 2. Common Stocks/Equity 3. Derivatives |
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Discuss Financail Assets and Real Assets
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Real assets produces goods and services such as land, machines, knowledge. Financial asset are peces of papers or data entries. Financial Assets hold claims on the real assets. Invest in a company (F.A) -> the company uses the investment to raise profits among their real assets.
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Explain the Financial Markets
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Investors in the stock market decides which companies will live and die. Good prospect companies makes the investors bid up the stockprice and raises the value of the company. Other way around for weak companies. Capital flows to the company with the best prospect.
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Explain Agency Problems
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That managers hired by the shareholders will put their own interest infront of the shareholders. I.e. Empire building and private jets.
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Name 4 reasons why the Financial Markets are important
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1. Information Role: Market Prices reflect investors collective judgement.
2. Consumtion Timing: Investors can store their wealth in financial assets. 3. Allocation of risk: Investors can select securities consistent ith their tastes for risk. 4. Seperation of Ownership and Managemen: Investors do not have to participate in the day to day management of the firm. |
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Name some examples of financial markets related problems
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1. Brokers (Frauds etc.)
2. Credit Rating Agencies (CRA failed to rate sub-prime appropriately during the financial crisis 2008) 3. Fraud and Inapprtopriate auditing. 4. Manipulations. (I.e LIBOR manipulation scandal) 5. Agency problems. |
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Explain the Investment process
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Asset Allocation: (The Choice among broad asset classes such as safe and risky assets. A top down starts with asset allocation)
Security Selection: (The choice of securities to hold within each asset class which are choosen with security analysis. A bottom up starts with security selection) |
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Explain 2 types of Investment Managements
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1. Passive Management: (Highly diversified portfolios and no effort to outperfrom the market through security analysis.
2. Active Management: Attempt to outperform the market using security analysis and timing the performance of different asset classes. |
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What does the term "Markets are Competative" imply?
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That the Market is full of intelligent people, with backed up financial knowledge. You should not expect and "Free-lunches" securities as there are few or none securities that are so undervalued that they represent obvious gain.
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Explain Risk Return Trade Off
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The risk should give an expected return. Obvious return would mean that everybody would invest in that opportunity. Higher expected return comes with a higher risk. If the return seems to be higher than the risk there will be a rish for those securities adjusting them to the commensurate risk for the expected return.
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Name the Market Participants! (Players)
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1. Firms, net borrowers. (Raise capital to develope and generate real assets income)
2. Households, typically net savers. (Purshases securities issued by firms for an expected return) 3. Goverments can be borrowers or savers. (Borrows through T-bills, nots or bonds.) |
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Name additional Market Participants! (Intermediaries)
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Financial Intermediaries brings net savers and net borrowers togheter! Such as - banks, - Investment companies (gives small investors the benefit of investing large in i.e. mutual fund.) - Insurance Companies
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Explain the Market Partificpant = Investment Banker
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Handles the marketing of the security in the primary market, where new issues of securities are offered to the public. Later investors can trade earlier issued securities on the secondary market.
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Explain the Money Market
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The Money Market is a subsector of the fixed income market that are highly marketable and hence, liquid. Many of theses secuirites are traded in large denominations and are therefore out of reach for the regular investors. The Money Market has a very low risk ans is short-term. Individuals typically access the money market using mutual funds where investor's money is pooled.
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Explain briefly the components of the money market.
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- Repurchase agreements=(Repos are overnight loans organized as government securities sold to an investor)
- Certificates of Deposit=(CDs are time deposits with a bank where the bank pays the interest at the end of the fixed period. May not be withdrawn before matiruty) - Commercial Papers=(Short-term unsecured debt notes issued by a company instead of borrowing from the bank. High amounts making investors need to go via Money Market Mutul funds. Fairly safe. - Bankers Acceptances=(An order to a bank by a bank's customer to pay a sum of money on a future date, typically within 6 months. - Eurodollars=(U.S. dollar denominated time deposits in banks outside the USA.) - Brokers Calls=(Investors can but stocks on margin, borrow money. ) |
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Explain Treasury Bills
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TBills are the most marketable of all instruments and represent the simplest form of borrowing. Short-term government debt up to 1 year.
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Explain the Ask, Bid and Bid-Ask spread of T-Bills.
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The Ask price is the price you would have to pay to buy a T-Bill. The Bid price is the price you would get if you sold a T-Bill. The bid-asked spread is the difference between these two prices.
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How would you calculate the ask yield of a T-Bill with a Par Value of $10'000 that can be purchased for $9'999.57 and the maturity is 36 days.
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Price paid/Par Value -1 -> Annualize = (Discount x (360/Maturity days)) = Ask yield
Discount from the Par Value= (9'999.57/10'000)-1=0.000043= -0.0043% Annualized ask yield would be 0.0043% x (360/36)= 0.043% |
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How would you calculate the bid yield of a T-Bill with a Par Value of $10'000 that can be sold at 9'999.40 with a maturity of 36 days,
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Price paid/Par Value - 1 -> Annualize = Discount x (3607Maturity Days) = Bid yield
9'999.50/10'000 -1 = 0.00005 = - 0.0043% 0.005% x (#60/36) = 0.05% |
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What is the LIBOR market
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The rate at which the banks lend money to each other in London. Uses as an imprtant reference rate (2% above LIBOR)
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What does the Bond Market consist of?
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Treasury Notes and Bonds - Municipal Bonds - Corporate Bonds - Mortgages and Mortgage-Backed Securities - Inflation Protected Treasury Bonds - International Bonds
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Explain Treasy Notes and Treasury Bonds.
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T-Notes have a maturities up to 10 years. T-Bonds have maturities from 10-30 years. Interests are payed semi-anually called cuopon payments.
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Explain Bond Quotes - the percentage of Par.
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The price the Bond is traded for is typically expressed as a percentage of Par Value. Government bonds trade in 1/32 increments and Corporate Bonds trade at 1/8 increments. A T-Bond traded at 104.16 meaning that its trading for 104.16/32 = 104.5% of Par Value. Above 100 is called a Premium and below 100 is called that its traded at a Discount.
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Explain 2 types of Corporate Bonds.
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- Callable=(Gives the firm the right to repurchase the bond at a stipulated call price.
- Convertible=(Gives the holder the right to convert each bond to a stipulated numver of shares of stocks.) |
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Explain Mortgage-Backed Security.
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MBS is a way for Banks to free up cash and at the same time letting investors to buy into mortgages. Banks bundle up different mortgages and sell the stream of interest to i.e. an investment bank.
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Explain the Common Stock and its 2 typical characteristics.
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A common stock represents ownership shares in a company. EAch share gives one vote.
- Residual Claim=(Shareholders are last in line of all those that have claims on the company. The company can pay the residual as cash dividends or by investing the money in the company) - Limited liability=(The shareholders cannot lose more than their initial investment if the company goes bankrupt) |
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Explain the Preffered Stock
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Have similiarities to both equities and debt securities. Since it promises a fixed dividend payment each year. It does not grant any voting righs. The company is not obligated to pay the dividents, but it is cumulative and has to be paid before any other dividends are paid(to the common stock holders).
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What is an ADR? (American Depository receipts)
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Security of a non-US company listed on the U.S. stock exchanges that makes it easier for foreign firms to cope with U.S. security registration. For Example, Ericosson (ERIC) is listed as an ADR on NASDAQ.
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Explain the term Derivatives.
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Derivatives is an instrument where payoff depends on an underlying assets. It therefore derives from this asset. Often stocks or debts but also real assets.
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Briefly explain the derivative Options
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- Options=(*A call option gives its holder the right to purchase an asset for a specified price, called the excercise or strike price on or before a specified expiration date. *A put Option gives its holder the right to sell an asset for a specified strike price, on or before a specified expiraton date)
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Briefly explain the derivative Futures
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A futures contract calls for delivery of an asset at a specified delivery date for an agreed-upon future price. The trader taking the long position commits to purchase the asset and the trader that take the short position commits to sell the asset.
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Market Indexes: Explain the Price-weighted average
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The weight of each company in the index is proprtional to its share price exluding dividends. This index actually does not tell us very much, but it has a long tradition.(The Dow Jones Industrial Average) Stock splits must be compensated with a change divisor.
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How do you calculate the Price-Weighted Average?
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By taking the Initial Index Value and divide it with the amoun of stocks in the index = Po/Sa. Then calculating the Final Index Value after rises or decreases in the stockprice and divide by the amount of stocks= P1/Sa.
Take the initial value - final value/Initial value to get the percentage change in the index. Initial index value of Stock A and B = (25+100)/2=62.5 Final Value after market changes = (30+90)/2=60 Percentage change in Index = -2.5/62.5=-0.04 = -4% |
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How do you find the new divisor after a stock split in the Price-Weighted Average?
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Since the index change remains the same, we need to find a new divisor that results in the same index change but with the new stock price.
If the Initial Value of Stock A and B where before B got split in 2: (25+100)/2=62.5 we need to find the divisor that makes (25+50)/d=62.5 Simply take the adjusted stockprices (25+50) and divide by the old initial value before the split (62.5) (25+50)/62.5 = 1.2 is the new divisor. |
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What is the primary market?
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When firms raise capital they may choose to sell or float securities. These new issues of stocks, bonds or other securities typically are marketed to the public by investment bankers in what is called the primary market. The most common issue of stocks is the Initial public offering (IPO) and that is stocks that are issued by a formerly privately owned company that is going public.
Companies that already have floated equties offers seasoned equity offerings. |
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What is the Secondary Market?
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Investors trade previously issued securities among themself on the market. (Different types of securities and on different types of markets)
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Explain the 4 different types of markets!
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--Direct Search: A person search for a buyer/seller of a specific security/good. This is the least oragnized market.
--Brokered Markets: Brokers have specialized knowledge and offer services to buyers and sellers. I.e. Real Estate Markets, large block transactions, primary markets. -- Dealer Markets: Dealers specialized knowledge in various assets, purchase these assets and sells them later on. The bid-ask spread is the profit and for that the dealer decrease trades searchcost. --Auction Markets: The most integrated market. Typically stock markets with an advantage over the dealer market that investors need not to search for the best price between different dealers. |
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Explain the 4 different types of orders!
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--Market Order: Executed immeditatly. Trader recieves current market price (Sell at the bid and buy at the call)
-- (Price-contingent Orders) Limit Orders: Limit buy instructs the broker to buy at or below a specified price and limit sell instructs the broker to sell at or above a specified price. - Stop-Buy order: Gives the broker to buy when the price inceases above a specified price. - Stop-loss order: Gives the broker instructions to sell when the price falls below a certain level. |
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What is a Short-Sell?
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Basically you borrow a stock from a broker, sells it immediatly and waits for the price to decline to buy it back from the market and returns the stock = earns the difference. *Borrowing costs might be high *Potential losses are infinite.
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Explain "Investment Companies" and their 4 most obvious benefits.
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Investment companies pool funds of individual investors and thereby gives them the advantages of large scale investing: 1. Administration & Record keeping. 2. Diversification and divisibility 3. Professional Management. 4. Reduced transaction costs
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Explain Mutual Funds (!!)
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Mutual funds collects funds from invidual investors and provides benefits of large scale investing. Mutual funds can be passive and active ways of managing investors funds. Buys and sales of mutual funds are executed at the End-of-day NAV. They often come with/and front-end load and/or expense ratios. Each mutual fund has an investment policy.
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Name the different Mutual Fund investment policys.
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* Money Market Funds: Invest in money market securities such as CP, Rps or CoDs. Averege time tends to be around 1 month.
* Equity Funds: Invests primarely in stocks. Income funds focuses on dividend yield and Growth Funds on future capital gains.(Riskier) * Index Mutual Funds: The fund manager follows the benchmark index. (Low cost, low turnover) * Active Mutual Funds: Fund manager aims to beat the benchmark index. (Higher costs, high turnover, typically underperfoms the index) * Secor Funds * Bond Funds * Balanced funds. |
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Explain Close-End funds.
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A manager investment company that don't buy back the shares. Instead these funds are traded by the investors like stocks on the open markets. Therefore the prices can differ from NAV with premium and discounts.
Calculate P/D= (price-NAV)/NAV |
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Explain Hedge Funds
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Like Mutual Funds, Hedge Funds pool assets to be invested by a fund manager. Hedge Funds on the other hand are commonly structured as private partnerships and are thus subjected to a minimal SEC regulations. These funds often invest heavily in derivatives, short sales and uses leverage. (risky)
Calculate NAV= (Market value of assets - liabilities)/Shares outstanding |
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Explain Commingled Funds!
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Partnership of investors that pool funds. Works like an open-end mutual fund but it issues units instead of shares that can be bought to NAV.
"In securities, it is the mixing of customer-owned securities with brokerage-owned securities. " |
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What is the Portfolio Turnover?
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This is to measure the degree of management in a fund. It tells us how actively managed the portfolio is and measures the fraction of the portfolio that is replaced each year. (Higher turnover often results in higher expense ratio, fees)
Calculate Turnover = (Replaced Value)/Total Value |
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Explain the Active vs the Passive Portfolio Management
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The Active Management is based on that a specific type of management or analysis produce returns to beat the market. * It seeks to take advantage of the INEFFENCIES in the market and comes with higher costs for analysist and managers to do the research. *MARKET TIMING is a big component due to that actively managed portfolios belive that it is possible to anticipate the movement of market based factos such as economic conditions and interest rate trends.
Passive Management Portfolios: Is based on the believes that markets are EFFICIENT. That market returns cannot be surpassed regularly over time and that low-cost investmens held for the long-term will provide the best returns |
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Explain Skewness
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Skewness is when the distribution of events differs from the "Normal Distribution".
A positive means that the standard deviation OVERESTIMATES the risk and that there is a higher chance of extremely high positive deviations than negative ones. A negative skew means that the standard deviation underestimates the risk, there is a higher chance of extremely high negative deviations than positive ones. |
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Explain Kurtosis
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Kurtosis is used to describe the distribution of observed data around the mean. "Volatility of volatility".
A high kurtosis portrays a chart with fat tails (where observed outcomes strives far from the mean) and a low kurtosis portrays a chart with skinny tails and a distribution concentrated towards the mean. |
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Explain the Indifferent Curve
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Indifference curve describes the different risk-return combinations of which an investor achieves equal amount of utility.
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What is the Efficient Frontier?
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A combination of asset in a portfolio that has the best possible expected level of return for its level of risk. Does not include risk-free assets. NOT the highest return for the lowest risk but the optimal point of where each lever of risk is ecuated to the highest level of return.
The Efficient Frontier is based completely on the past. |
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What is the SML? (Security Market Line)
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It's the CAPM formula graphed. It shows the relationship between an asset's systematic risk and the required rate of return. Assets with greater risk are expected to provide higher rates of returns.
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What is the CML? (Capital Market Line)
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The CML consists of the combination of all risky and the risk-free assets using market values of the assets to determine the wieghts. The CML is like the SML but for a portfolio and is showing that for any give variance the rational investor will always choose the portfolios that will give her the greatest return.
Investing above it will is to risky and investing below it is leaving money on the table. The CML is a proxy of the efficient frontier where every RATIONAL investor will chose. Formula: rp=rf+SDp ((rm-rf)/SDm) |
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Explain the difference between the SML and CML
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SML uses beta as the measure of risk. This model can be used with individual stocks and portfolios.
CML uses the standard deviation as a measure of risk. It can only be used to determine well diversified portfolios. |
