Exam 2 Flashcards
(21 cards)
a. Indenture
i. Defined the contract between issuer and holder
b. Sinking fund
i. Indenture calling for issuer to periodically repurchase some proportion of outstanding bonds before maturity
c. Subordination clause
i. Restrictions on additional borrowing stipulating senior bondholders paid first in event of bankruptcy
d. Collateral
i. Specific asset pledged against possible default
e. Debenture
i. Bond not backed by specific collateral
a. Standard & Poor’s
i. Very High Quality: AAA, AA
ii. High Quality: A, BBB
iii. Speculative: BB, B
iv. Very Poor: CCC. D
b. Moody’s
i. Very High Quality: Aaa, Aa
ii. High Quality: A, Baa
iii. Speculative: Ba, B
iv. Very Poor: Caa. C
a. Bond Value=
Present value of coupons + Present par value
b. Bond Price =
Coupon*1-(1+r)^-T/r + Future Value *(1+r)^-T
- Bond Pricing Criteria
d. Prices fall as market interest rates rise
e. Interest rate fluctuations are primary source of bond market risk
f. Bonds with longer maturities more sensitive to fluctuation in interest rate
a. Zero Coupon bond
i. Pays no coupons, sells at discount, provides only payment of par value at maturity
ii. Carries no coupons, provides all return in form of price appreciation
b. Separate Trading of Registered Interest and Principal of Securities (STRIPS
i. Oversees creation of zero-coupon bonds from coupons bearing notes and bonds
a. Random Walk
i. Notion that price changes are random
ii. Past movement cannot predict future movement
iii. All stocks are independent of each other
iv. Technical analysis undependable
v. Investment advisors add little to no value
vi. Fundamental analysis undependable
a. Arbitrage Pricing Theory (APT)
ii. Arbitrage: Relative mispricing creates riskless profit
iii. Risk-return relationships from no arbitrage considerations in large capital markets
iv. Rp= rf+Bp(rm-rf)+ep
b. CAPM: Capital Asset Pricing Model
i. Use Security Market Line (SML) as benchmark for fair return on risky asset
ii. CAPM is false based on validity of its assumptions
1. Useful predictor of expected returns
2. Untestable as a theory
3. Principles still valid
a. Investors should diversify
b. Systematic risk is the risk that matters
c. Well diversified risky portfolio can be suitable for wide range of investors
a. Technical Analysis
i. Research of recurrent/predictable price patterns and proxies for buy/sell pressure in market
ii. Resistance level
1. Unlikely for stock/index to rise above
iii. Support Level
1. Unlikely for stock/index to fall below
b. Fundamental Analysis
i. Research on determinant of stock value, i.e., earnings, dividend prospects, future interest rate expectations and firm risk
ii. Assumes stock price equal to discounted value of expected future cash flow
- Exchange Rate Considerations
a. Rate at which domestic currency can be converted into foreign currency
b. Interest rate differentials
c. Country’s economic performance
d. Inflation
- LEI (Lead Economic Indicators)
a. Average weekly production hours
b. Initial unemployment claims
c. Manufacturers new orders
d. Institute of Supply Management Index of New Orders
e. New orders for nondefense capital goods
f. New private housing units authorized by local building permits
g. Yield curve: Spread between the 10-year T-bond and federal funds rate
h. Stick prices, common 500 stocks
i. Money supply (M2) growth rate
j. Index of consumer expectations for business conditions
- Macroeconomic Events/Criteria
a. Inflation
b. Fiscal policy
c. Employment levels
d. National income
e. International trade
- Calculate Current Price/Current Yield
a. Current Yield = Annual Coupon / Bond Price
