Chapter 2: Asset Classes And Financial Instruments Flashcards
What are the three asset classes?
Fixed income, Equity and Derivatives
What is the money market?
It’s a sub-sector of the fixed-income market. (Short-term debt(debt securities), liquid (easy and quickly to sell, convert asset to cash w/o loss in value), low risk (and rate of return), often have large denominators (large cost - not in reach of smaller investors) ex. Issuer government treasury bills, companies
What are treasury bills? Why are they issued?
Issued by the government, when $ are needed.
How are treasury bills quoted in Canada?
Using the Bond Equivalent Yield (rBEY)
rBEY=((Face value - price)/price)*365/n (#of periods)
How are treasury bills quoted in US?
Bank Discount Yield (d)
D=((Face value - price)/price)*365/n (#of periods)
What is the effective annual rate and how is it calculated?
Term yield compounded at an annual rate
EAR = (Face value/Price)^365/n - 1
Calculate the price given time=6months, rBEY=0.16%, par value=1000
Formula: rBEY=((1000-P)/P)(365/n)
Two ways:
Rearrange formula:
rBEY/(365/n)=(1000-p)/p
P(rBEY/(365/n)=(1000-p)
P(rBEY/(365/n)+p=1000
P(rBEY/(365/n)+1)=1000
P=1000/(rBEY/(365/n)+1)
P=1000/(1+rBEY(n/365))
P=1000/(1+0.0016*(182/365)
P=1000/1.00079781
=$999.2
Or fill it in:
0.0016=((1000-p)/p)*(365/182)
0.0008=(1000-p)/p
0.0008p+p=1000
1.0008p=1000
P=1000/1.0008=$9992
Find the effective annual rate if t=6m, rBEY=3.94%, par value=$1000
EAR=(1000/P)^(365/n) -1
Step 1: Find P
P=1000/((1+rBEY)(n/365))
=1000/(1+0.0394(182/365))
=1000/1.01964603
=980.73
EAR=(1000/980.73)^(365/182)-1
=1.03979-1
=0.03979=3.979%
How does increasing interest rate manage inflation?
Cash in the market, encourages people to invest instead of spending, decreases liquidity in the market. (When interest rates are low it’s easier to get a loan and spend money)
What are bankers acceptances?
An order to a bank by a bank’s customer to pay a sum of money to the holder of the acceptance, at a future date (usually 6m). They are safe, can be traded in secondary markets, sold at a discount
What is CDOR? What is the main benchmark for CDOR?
Canadian Dealer Offered Rate - used to determine interest payments on the Canadian market on floating-rates (even if there is no money in the account, bank still pays amount - banker’s acceptance!) Bankers’ Acceptance rates (yields) are the main benchmark for CDOR.
What are Eurodollars or LIBOR? How are they different?
First happened in Europe but can any country, London Interbank Offered Rate. It’s a USD-denominated deposit at foreign bankers or foreign branches of American banks. The benchmark rate for Eurodollars is LIBOR. LIBOR - the rate that most creditworthy banks charge one another for large loans of eurodollars in the London market. It has become the premier short-term interest rate quoted in the European money market.
How many currencies and tenors is LIBOR produced in?
5 currencies (CHF,EUR,GBP,JPY,USD) and 7 tenors (overnight, 1w, 1m, 2m, 3m, 6m, 12m)
What are certificates of deposit?
Time deposits with banks, the bank pays principle and interest to the depositor at the end of the fixed term of the deposit, time deposits for smaller amounts are (GICs). CDs and GICs are not transferable in Canada
What happens when you Ceritificate of Deposit amount is greater than $100,000
You might be able to transfer it to another investor before maturity. It’s called Bearer Deposit Certificate (BDNs)
What is a commercial paper?
Short-term unsecured debt issued by large corporations, often back by a bank line of credit. Minimum denominations: $50,000 (not available to small investors directly), with maturities up to 1 year but usually 1 to 2 months. (Low risk - offered by highly reliable companies)
What are brokers’ Call Loans?
Individuals who buy stocks on margin (purchasing stock on a loan) borrow from their brokers. The brokers, in turn, sometimes borrow funds from a bank and agree to repay bank immediately (on call) if they bank requests it. The rate on these loans is related to the T-bill rates (low rates)
What are reverses and repos?
(Between dealers and investors, use government security as collateral for reverse/repos)
Repos (RPs): Short-term, often overnight, sales of government securities with an agreement to repurchase the securities at a slightly higher price.
Reverse repos: a purchase with an agreement to resell at a specified price on a future date
What is the Bank of Canada Overnight Rate?
Rate at which major Canadian Banks borrow and lend overnight, among themselves
What is the US Federal Funds Rate?
In the US, each bank is required to maintain a minimum balance with the federal reverse system (the Fed). Banks excess funds lend to those with shortage (usually overnight), at a rate called the Federal Funds rate
Yields on Money Market Instruments?
Low risk but not zero (government for ST), money market securities are not free of default risk, the risk premium on Canadian CDs over T-bills has often become greater during periods of financial crisis. The spread = rate on Credit Default - T-bill rate
What is the Bond Market?
Usually for 30 to 40 years. It’s a sub sector of the fixed income market. (Long term, a stream of cash flows determined by a specific formula, low risk (but not as low as money market), can be issues at par, discount or premium, can be callable (redeemable before maturity) - corporation can call it back after a # of years, call when the new rates in the market is lowered.
What is the current yield of a bond?
A bond’s annual coupon payment divided by its price.
Coupon/Bond price
What is yield to maturity (YTM)?
A measure of the average rate of return that will be earned on a bond if held to maturity. P0=PV of bonds cash flows
