FIN 312- Exam 2 (section 12-15)

Question 1

Are issued by governments and corporations when they want to raise money.
- By buying you’re giving the issuer a loan, and they agree to pay you back the face value of the loan on a specific date and to pay you periodic interest payments along the way, usually twice a year

Answer 1

bond

Question 2

issuer, maturity, par value (or principal), coupon rate and frequency and currency denomination

Answer 2

The basic features of a bond include

Question 3

the amount the issuer agrees to pay to the bondholder when the bond matures

Answer 3

Bond’s principal

Question 4

is the interest rate that the issuer agrees to pay to the bondholder each year. It can be a fixed rate or a floating rate

Answer 4

Coupon rate

Question 5

the total rate of return that will have been earned by a bond when it makes all interest payments and repays the original principal

Answer 5

Yield to maturity

(it can be considered an estimate of the market’s expectation for the bond’s return)

Question 6

The issuer pays a ____ interest rate for a long-term bond; investors will potentially earn greater returns on longer-term bonds but will incur additional risks

Answer 6

higher

Question 7

Bonds can be bought and sold in the ______ after they are issued

Answer 7

“secondary market”

Question 8

A bond’s yield is the actual ___ ___ an investor can expect if the bond is held to maturity

Answer 8

annual return

Question 9

A bond’s price always moves in the opposite direction of its yield

If interest rates fall → older bonds become ____ because they were sold in a higher interest rate environment and therefore have ____ coupons

Answer 9

more valuable; higher
(talking about bonds)

Question 10

If interest rates rise → older bonds may become _____ bc their coupons are relatively low, and older bonds, therefore, trade at a _____

Answer 10

less valuable; “discount”
(talking about bonds)

Question 11

In the market, bond prices are quoted as a percent of the bond’s _____

Answer 11

face value (also can say par value)

Question 12

Rising interest rates → New bonds will pay investors ____ interest rates than old ones (old bonds drop in price)

Falling interest rates → ____ bonds pay higher interest rates than new bonds (old bonds tend to sell at a premium)

Answer 12

higher; Older

Question 13

a weighted average of the present value of a bond’s cash flow
- expressed in years

Answer 13

Duration

Question 14

The ____ ____ ___ can be calculated for an entire bond portfolio, based on the durations of the individual bonds in the portfolio

Answer 14

weighted average duration

Question 15

For zero-coupon bonds → maturity and duration are ____ (since there are no regular coupon payments and all cash flows occur at maturity)

Answer 15

equal

Question 16

a conservative investment strategy where the primary goal is to preserve capital and prevent loss in a portfolio
- offers interest at a set rate that is often higher than short-term savings rate

Answer 16

Capital preservation

Question 17

• capital preservation
• income
• diversification
• potential hedge against economic weakness or deflation
• capital appreciation

Answer 17

reasons why investors purchase bonds
(role of bonds in a portfolio)

Question 18

a collection of financial investments like stocks, bonds, commodities, cash, and cash equivalents

Answer 18

portfolio

Question 19

selling bonds after they have risen in price – and before maturity – investors can realize price appreciation

Answer 19

capital appreciation

(the difference between the purchase price and the selling price of an investment)

Question 20

Bond prices can rise for several reasons, including a drop in ____ and an improvement in the _________

Answer 20

interest rates; credit standing of the issuer

Question 21

• When the price of goods and services are rising (inflation) → a bond’s fixed income becomes ___ attractive
• Slower economic growth usually leads to lower inflation → makes bond income more attractive
• An economic _____ → typically bad for corporate profits and stock returns, adding to the attractiveness of bond income as a source of return
• _____ → bond income becomes even more attractive (bc bondholders can buy more with the same bond income)

Answer 21

less; slowdown; Deflation

Question 22

• government bonds
• corporate bonds
• Emerging market bonds
• Mortgage-backed and asset-backed securities

Answer 22

types of bonds

Question 23

• includes “Sovereign” debt
• sovereign bonds that are linked to inflation → treasury inflation-protected securities (TIPS)
• provides a “real” or inflation-adjusted return

Answer 23

government bonds

Question 24

some agency bonds are guaranteed by the central government, while others are not. Supranational organizations, like World Bank borrow in the bond market to finance public projects and/or development

Answer 24

Agency and “quasi-government” bonds
(type of gov bond)

Question 25

Whether provinces, states or cities borrow to finance a variety of projects (from bridgers to schools). - In the US Municipal bonds (munis) may enjoy a tax advantage over other bonds

Answer 25

Local government bonds (type of gov bond)

Question 26

corporations borrow money in the bond market to expand operations or fund new business ventures

Answer 26

Corporate bond

Question 27

- Investment Grade - Speculative-grade (junk) bonds

Answer 27

2 types of corporate bonds

Question 28

- Tend to be issued by newer companies, companies in particularly competitive or volatile sectors, or companies with troubling fundamentals

Answer 28

Speculative-grade bonds

Question 29

sovereign and corporate bonds issued by developing countries - Can help diversify an investment portfolio and can provide potentially attractive risk-adjusted returns

Answer 29

Emerging market bonds

Question 30

“securitization” in which the cash flows from various types of loans (mortgage payments, car payments or credit card payments) are bundled together and resold to investors as bonds (Largest sectors involving securitization)

Answer 30

Mortgage-backed and asset-backed securities

Question 31

Created from the mortgage payments of residential homeowners - are sensitive to changes in prevailing interest rates and can decline in value when interest rates rise

Answer 31

Mortgage-backed securities (MBS)

Question 32

created from car payments, cc payments, and other loans - similar loans are bundled together and packaged as a security that is then sold to investors - are usually “tranched” meaning that loans are bundled together into high-quality and lower-quality classes of securities

Answer 32

Asset-backed securities (ABS)

Question 33

german securities secured by mortgages - banks that make loans and package them into ..... keep those loans on their books

Answer 33

Pfandbriefe and covered bonds

Question 34

Include buying and holding bonds until maturity and investing in bond funds or portfolios that track bond indexes

Answer 34

Passive investment strategies

Question 35

try to outperform bond indexes, often by buying and selling bonds to take advantage of price movements

Answer 35

Active investment strategies

Question 36

To ____ _____ successfully over the long term, ____ ____ requires the ability to 1) Form opinions on the economy, the direction of interest rates and/or the credit environment 2) Trade bonds efficiently to express those views 3) Manage risk

Answer 36

outperform indexes; active investing

Question 37

- Credit analysis - Macroeconomic analysis - Sector rotation - Market analysis - Duration management - Yield curve positioning - roll down - Derivatives - Risk management

Answer 37

types of active strategies (Active managers can employ a number of different techniques to find bonds that could rise in price)

Question 38

uses a variety of strategies to maximize capital appreciation - Active bond portfolio managers seeking price appreciation try to buy undervalued bonds, hold them as they rise in price, and then sell them before maturity to realize the profits “buying low and selling high.”

Answer 38

Total return investing

Question 39

using fundamental, “bottom-up” ; bond prices may increase when a company brings in new and better management used to measure the issuer's ability to meet its debt obligations.

Answer 39

Credit analysis

Question 40

Portfolio managers use top-down analysis to find bonds that may rise in price due to economic conditions, a favorable interest rate environment or global growth patterns

Answer 40

Macroeconomic analysis

Question 41

based on their economic outlook, bond managers invest in certain sectors that have historically increased in price during a particular phase in the economic cycle and avoid those that have underperformed at that point.

Answer 41

Sector rotation (active strategy for bond investments)

Question 42

Portfolio managers can buy and sell bonds to take advantage of changes in supply and demand that cause price movements

Answer 42

Market analysis

Question 43

managers anticipating a rise in interest rates can attempt to protect bond portfolios from a negative price impact by shortening duration, possibly by selling some longer-term bonds and buying short-term bonds.

Answer 43

Duration management

Question 44

bond managers can use futures, options and derivatives to express a wide range of views, from the creditworthiness of a particular issuer to the direction of interest rates

Answer 44

Derivatives

Question 45

2 types of buy-and-hold approach (passive investment)

Answer 45

- bond ladder - barbell

Question 46

investors pay for bonds when they first invest and again when they need to reinvest their money at maturity

Answer 46

Buy-and-hold approach

Question 47

a bond portfolio is invested equally in bonds maturing periodically, usually every year or every other year

Answer 47

Bond ladder

Question 48

money is invested in a combination of short-term and long-term bonds; as short term bonds mature, investors can reinvest to take advantage of market opportunities while the long-term bonds provide attractive coupon rates pairing high-risk, high-return investments with lower-risk, lower-return investments in an attempt to reduce risk without diminishing overall return

Answer 48

Barbell

Question 49

1) Going from being a private business entirely funded by the owner to accessing the private equity markets (venture capital) 2) Going from private to public with an initial public offering 3) Public companies making seasoned offering of debt and equity

Answer 49

3 transitional periods (Financing choices across the business cycle)

Question 50

sources of funds

Answer 50

1) retained earnings 2) debt capital 3) equity capital

Question 51

earnings that company does not distribute among shareholders

Answer 51

Retained earnings

Question 52

borrowed funds that must be repaid at a later date

Answer 52

Debt capital

Question 53

investor get tiny stake of ownership in the company

Answer 53

Equity capital

Question 54

PROS: - reliable sources of funds - Less expensive - No dependency on 3rd party - Quick source CONS: - Company would have no/less money to distribute to owner

Answer 54

retained earnings

Question 55

PROS: - Most common source of finance - Taking debt is relatively easier - Less costly than other sources - Interest payment help in reducing the tax liability CONS: - If company can't make payments it may impact its reputation & even force it to go bankrupt

Answer 55

debt capital

Question 56

PROS: - No obligation to pay back CONS: - A company is expected to share the profits with the shareholders - May dilute company’s ownership control - Does not offer any tax benefit

Answer 56

equity capital

Question 57

the process of offering shares of a private corporation to the public in a new stock issuance

Answer 57

initial public offering (IPO)

Question 58

a group of investment banks and broker dealers (syndicate) that is responsible for selling shares of the IPO to institutional and individual investors

Answer 58

Lead underwrite

Question 59

In addition to IPOs, there are other types of equity new issue offerings for companies with stocks that are already publicly traded:

Answer 59

follow-on offering & secondary offering

Question 60

a fixed-income corporate debt security that yields interest payments but can be converted into a predetermined number of common stock or equity shares

Answer 60

convertible bonds

Question 61

for convertible bonds, if.... Value > nominal value = _____

Answer 61

convert bond to stock

Question 62

- international trade - licensing - franchising - joint ventures - Acquisition of existing operations - Establishing new for subsidiaries

Answer 62

6 most common methods firms use to conduct international business

Question 63

Minimal risk, minimal capital at risk, possible exit at low cost (a common method firms use to conduct international business)

Answer 63

international trade (a common method firms use to conduct international business)

Question 64

- No need of significant investment - Difficult to ensure quality control in the foreign production process (a common method firms use to conduct international business)

Answer 64

licensing

Question 65

A type of business where a trademark is licensed, the system for operating the business, or the appearance of the location - No major investment in foreign countries

Answer 65

franchising (a common method firms use to conduct international business)

Question 66

.... jointly owned and operated by two or more firms - Risk of sharing control and leadership

Answer 66

joint ventures (a common method firms use to conduct international business)

Question 67

- High returns possible, but also risk of large losses; large investments; smaller investments and risks for partial ...

Answer 67

Acquisition of existing operations (a common method firms use to conduct international business)

Question 68

- High returns possible, but also risks of large losses; tailoring usually requires time to market (need of time to gain market share)

Answer 68

Establishing new for subsidiaries (a common method firms use to conduct international business)

Question 69

category of cross-border investment in which an investor resident in one economy establishes a lasting interest in and a significant degree of influence over an enterprise resident in another economy

Answer 69

Direct foreign investment (FDI)

Question 70

MNCs commonly consider direct foreign investment because it can improve their ____ and enhance ____ ____

Answer 70

profitability; shareholder wealth

Question 71

- Attract new sources of demand - Enter profitable markets - React to trade restrictions - Exploit monopolistic advantages - Diversify internationally

Answer 71

Motives MNCs that are attempting to boost revenues

Question 72

- Use foreign factors of production - Use of foreign raw materials - Use foreign technology - React to exchange rate movements - Fully benefit from economies of scale

Answer 72

Motives MNCs that are trying to cut costs