10/11- Part 2 Flashcards Preview

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Flashcards in 10/11- Part 2 Deck (27):

Junk Bonds (High-Yield Bonds):


- highly speculative

- have low or below grade ratings (some may even be in default)

- typically offer very high yields because they are sold at a discount from their face value due to the very high risk


Global Bonds:

- Potentially  higher returns than U.S. bonds

- Interest rate trends in other countries may not follow U.S. rates

- Currency exchange rate can impact returns in U.S. dollars


Convertible Securities:

- Allows holder to convert the security into a specified number of shares of common stock

- Two Major types of convertible securities
       - convertible bonds
       - convertible preferred stock


Equity Kicker

- another name for the conversion feature that allows holder to convert the security into a specified number of shares of common stock, can "kick up" the potential return on the bond

     -Why would company do this? could lower the interest on a bond due to investors payoff, if company converts bond on stock they don't have to give bond value back causing no refund.


Bond Ratings:

- check out table 10.2 in the txt book, Moodys and S&P rate bonds based upon perceived risk of a bond; highest rated bonds are AAA; Junk Bonds start at Speculative issues and proceed downwards


Basic Bond Investing Strategy:

- if you expect interest rates to increase, buy short term bonds

- if you expect interest rates to decrease, buy long term non callable bonds
- this is why bonds have outperformed stocks over the past thirty years

- ladder bonds for protection against interest changes; stagger the maturities spread them out
- changes in interest rates are not as important if you intend to hold the bond to maturity


The Pricing of Bonds:

- bonds are priced according to the present value of their future cash flow streams.

- Bond Price= Present Value of the annuity of annual interest income+ present value of the bond's par value


Bond Duration:

- a measure of bond price volatility
- indicates how a bond will react in different interest rate environments
- average amount of time it takes to receive the interest and the principal
- if a bond has a duration of 6, then a 1% increase in interest rates will result roughly a 6% decline in bond value- 2% increase would cause a 12% decline- this all does not matter if you hold the bond to maturity
- if interest rates drop the opposite effect happens and the bond value would increase by 6%


The Concept of Duration:

- generally speaking, bond duration possesses the following properties:
       - bonds with higher coupon rates have shorter durations
       - bonds with longer maturities have longer durations
       - bonds with higher YTM lead to shorter durations
- bond duration is a better indicator than bond maturity of the impact of interest rates on bond price (price volatility).
       - if interest rates are going up you wanna hold bonds with shorter durations
       - if interest rates are going down, hold bonds with long durations


Characteristics of Preferred Stocks:

- Hybrid security- characteristics of both stocks and bonds
- like a bond in that it has a stated dividend and provides a fixed income
- trades just like a common stock (pricing)
- like a stock in that it has no fixed face value
- like a stock in the sense that default does not force bankruptcy
- potential for a price appreciation
- investment quality for the stock is rate like bonds


Advantages of using Preferred Stock:

- dividend income is highly predictable
- dividend yields are similar to yields on high credit quality bonds
- should pay slightly more due to the fact that the risk is slightly higher
- corporations are able to exclude 70% of preferred dividends from income taxes
- generally safe, not as safe as bonds because if a company goes bankrupt bondholder are the first to receive payments
- low unit cost


Disadvantages of Preferred Stock

- many preferred stock dividends do not qualify for the new preferential tax rate of 15%
- behave like a bond
       - if inflation and interest rates rise, the value of the preferred stock drops
       - if inflation and interest rates drop, the value rises
- investors don't participate in the capital gains that common stockholders receive.
- preferred stock doesn't have the safety of a bond


Valuing Preferred Stock

- value is a function of the dividend yield provided
- the lower the investment quality, the higher the yield.
- risk exposure of preferred stocks includes:
       - business risk
       - interest rate risk


Issue Characteristics of Preferred Stock

- Conversion feature at the desire of the stockholder not the company
- Cumulative provision- all past unpaid dividends must be paid before common stock dividends are paid


Key Measures of Preferred Stock:

-Dividend Yield= annual dividend income/ current market price of the preferred stock

- book value

- agency ratings

-ability of the company to cover the dividend


Investment Strategies using Preferred Stock:


- Two Major Strategies

    - going after higher levels of current income

    - seeking capital gains when market rates are falling


Why Choose a Mutual Fund?

- immediate diversification- money spread out through many companies
- liquidity- if you need some of the money its easy to sell part of the fund
- professional management- people who are watching the fund constantly
- continuous supervision- they do this everyday, help when your unavailable to view your portfolio
- easy record-keeping
- automatic reinvestment of dividends-
- easy to change investment strategies- sell out of one mutual fund and move the money into another


Close-End Funds

- limit the number of investors, limit the amount of money and people... Why limit investors? may have to depart from investment guidelines


Open-Ended Funds

- permit an unlimited amount of investors, will always find a place for money


Load Fund

- approx 5.5% up front fee charged at the time of the initial investment- will not receive the full fund due to the sales charge


Light Load Funds

- 2-3% up front fee charged at initial investment


No Load Fund

- no up front fee; still has an annual expense charge at a max of 3%


money market funds:

- a cash substitute- putting money in another account other than a bank

- highly liquid

- usually have check-writing privileges

- while they are low risk they are not risk free and there is the possibility of losing money, bc money market funds make short term loans to corporations

- maintain a constant Net Asset Value of $1

- type and average maturity of fund will determine the rate of return


Sector of Specialty Funds:

- focus on a special industry or investment vehicle; transportation, health care, computers software, internet etc.


Ethical or Social Responsible Funds:

- avoid the investment of the "four sins"

- smoking, drinking, gambling, pornography

- biblically responsible investments

- avoid 4 sins and anything that is involved with abortion and lifestyle issues


politically correct funds

- mutual fund that will look for company's that provide for gay and lesbian couples, exclude companies that don't provide those type of investments