Random questions Flashcards
1
Q
BEY
A
Först hitta FV (måste annualize innan då) de gör man genom att FV x (1-days/yr x DR)
2
Q
Calculate bonds price given a YTM on or between coupon dates
A
Example + formula
3
Q
Open interest derivatives
A
OI is the total number of outstanding contracts that are held by market participants at the end of each trading day. Open interest can never exceed the total trading volume.
4
Q
Olika namn för Flat price och Full price
A
5
Q
Vad ger hög/låg credit risk
A
Företagets leverage (Eg Debt/capital, Debt/ebitda etc)
6
Q
Equity Beta
A
The equity beta takes into account different levels of the company’s debt.
7
Q
Asset Beta
A
The asset beta is the beta of a company on the assumption that the company uses only equity financing.
8
Q
Beta estimation methods
A
For beta estimation, you can use either the market model regression of stock returns or the pure-play method.
9
Q
How to calculate Beta
A
10
Q
Sharpe ratio
A
11
Q
M2
A
12
Q
Treynors
A
13
Q
Jensens alpha
A
14
Q
Put call parity
A
CALL STRIKE - PUT STOCK
15
Q
Forward put call parity
A
Byter ut stocken mot F0T och discountar tillbaka, även X ska discountas.
16
Q
Degree of operating leverage (DOL)
A
DOL measures how sensitive a company’s operating income is to changes in product demand, as measured by unit sales. It is the ratio of the percentage change in operating income to the percentage change in units sold.
17
Q
Degree of Financial Leverage (DFL)
A
The degree of financial leverage (DFL) assists a company in quantifying its financial risk, i.e., the risk relating to how it finances its operations.
DFL refers to the sensitivity of the cash flows available to the owners of a company when operating income changes.
18
Q
Degree of Total Leverage (DTL)
A
If we combine a company’s degree of operating leverage with its degree of financial leverage, we get the degree of total leverage (DTL), which is a measure of the sensitivity of a company’s net income to changes in the number of units produced and sold.
19
Q
Contribution margin
A
Contribution margin is a business’s sales revenue less its variable costs. The resulting contribution dollars can be used to cover fixed costs (such as rent), and once those are covered, any excess is considered earnings.
20
Q
Relationship between yield curves
A
Par Yield Curve: Generally lower than the spot yield curve because it averages yields over multiple years.
Spot Yield Curve: Generally lower than the forward yield curve because it reflects current rates for zero-coupon bonds.
Forward Yield Curve: Reflects future expected interest rates and tends to be higher.
21
Q
Macdur
A
22
Q
Moddur
A
23
Q
PVPB
A
24
Q
mac d worksheet example
A
25
valuing using binomial
26
Hedge ratio with binomial model
H = (C+ – C-) / (S+ – S-)
With this hedge ratio, you can long H units of the shares to hedge against a short position in a call option. The hedge ratio works similarly for put options, just with a negative hedge ratio value.
27
Finding probabilities for binomial model
28
IF Taxable income is greater than Accounting profit, what happens?
29
IF Accounting profit is greater than Taxable income , what happens?
30
Leverage ratio
31
Margin call price
32
Justified P/E
33
Flexibility Option
Definition: Flexibility options allow companies to adapt their operations to changes in the market environment. This includes the ability to change prices, modify production levels, or switch to alternative inputs or outputs based on market conditions.
34
Sizing Option
Definition: Sizing options allow companies to alter the scale of their operations. This includes options to expand, contract, or abandon a project.
35
Aggregate demand
Aggregate demand is the total amount that households and businesses intend to spend
36
Fiscal Policy
Fiscal policy can boost overall demand through:
Decreasing corporation taxes stimulates business profits and expenditures.
Introducing new public expenditures for social welfare and infrastructure projects.
Reducing personal income tax resulting in increased disposable income.
Lowering sales taxes leads to decreased prices for consumers.
Note that the effectiveness of the Fiscal policies on aggregate demand, changes over time, and economy to economy.
37
Automatic Stabilizers
Automatic stabilizers are fiscal policies that automatically adjust tax rates and transfer payments in a manner that is intended to stabilize incomes, consumption, and business spending over the business cycle.
Note that automatic stabilizers work automatically, without the need for policymakers to identify shocks.
For instance, when the economy slows down and unemployment rises, the government’s spending on social insurance and unemployment benefits will increase. This will boost aggregate demand, helping to prevent the economy from contracting further.
38
How to find CAL?
The optimal portfolio will have the highest sharpe ratio
39
Defined Contribution Pension Plan
A Defined Contribution (DC) pension plan is an investment vehicle in which the amounts invested, or the contributions that the employee makes to the plan, are defined or specified, but the benefits are not predetermined. The objective of the pension plan is to accumulate wealth by investing a portion of wages while working to provide income during retirement. Unlike a Defined Benefit (DB) pension plan, where the retirement benefits are predetermined based on factors such as salary and years of service, a DC plan places the investment risk on the employee. The employee is responsible for ensuring that their contributions and investment growth are sufficient to provide the desired income upon retirement. The final retirement income in a DC plan depends on the contributions made, investment performance, and the choices made by the employee regarding investment options within the plan.
40
Defined Benefit Pension Plan
In a DB pension plan, the employer has an obligation to provide certain benefits to employees when they retire. The future benefit is specified or defined. The investment management of DB plans has to consider the timing of its future liabilities or cash flows by assessing the age of its plan members. If, for example, a DB pension plan has a lot of young members, the investment time horizon of the plan may be quite long. The plan investment manager may try to match the cash flow requirements of the plan with cash-flow-producing assets such as bonds. This checks the capacity of portfolio assets to offset portfolio liabilities.
41
Conflict between willingness and ability for risk
According to prudent investment principles, when there is a conflict between willingness and ability to take risk, the ability to take risk should be given more weight. This is because regardless of how willing someone is to take on risk, if they do not have the financial capacity to withstand potential losses, their overall risk tolerance should be considered lower.
42
Operating income
=EBIT
43
EBITDA
44
Soft Hurdle Rate
Definition: A soft hurdle rate is a minimum return that must be achieved before a performance fee is charged. However, once this rate is met, the performance fee is calculated on the entire return, not just the portion above the hurdle.
Example: Imagine an investment fund with a soft hurdle rate of 5%. If the fund earns a 10% return, the performance fee is calculated on the entire 10%, not just the 5% above the hurdle
45
Hard Hurdle Rate
Definition: A hard hurdle rate is a stricter version where the performance fee is only charged on the returns above the hurdle rate.
Example: Using the same 5% hurdle rate, if the fund earns 10%, the performance fee is only applied to the 5% return that exceeds the hurdle.
46
Clawback
Definition: A clawback is a provision that ensures investors can recover performance fees paid in earlier years if the fund underperforms in subsequent years.
Example: If an investor pays a performance fee in a year when the fund performs well but the fund performs poorly in later years, the clawback provision allows the investor to reclaim some of those fees to make up for the losses.
47
A well functioning financial system has what?
A well-functioning financial system has complete markets with effective financial intermediaries and financial instruments, allowing:
Investors to move money from the present to the future at a fair rate of return.
Borrowers to easily obtain capital.
Hedgers to offset risks.
Traders to easily exchange currencies and commodities.
48
Current yield
49
Futures vs forwards prices
If interest rates were constant, futures and forwards would have the same prices. The pricing differential between the two varies with the volatility of interest rates. Practically, the derivatives industry makes virtually no distinction between futures and forward prices.
Futures Contracts: These settle daily, meaning the gains or losses are calculated at the end of each trading day. Any gains are added to the margin account, and losses are deducted from it.
Reinvestment of Gains: Because of daily settlements, any increase in value can be immediately reinvested, which can affect the overall return on the investment.
Bra att veta del:
FUTURE IS POSITIVE
FORWARD IS NEGATIVE
Futures contracts can be either more or less expensive than forward contracts, depending on factors such as interest rates, cost of carry, and the ability to reinvest gains. Generally:
More Expensive: When interest rates are high, making the cost of maintaining margin accounts higher.
Less Expensive: When the opportunity to reinvest daily gains outweighs the cost of maintaining the margin account, typically in stable or low-interest-rate environments.
50
Pay off vs profit
51
Trade agreements in order
Trade agreements can be categorized by the degree of economic integration among the participants. Each type of agreement in the following list includes the provisions in the previous type of agreement, so that monetary union is the most integrated and includes all the provisions listed.
Free trade area: All barriers to import and export of goods and services among member countries are removed.
Customs union: In addition, all member countries adopt a common set of trade restrictions with non-members.
Common market: In addition, all barriers to the movement of labor and capital goods among member countries are removed.
Economic union: In addition, member countries establish common institutions and economic policy.
Monetary union: In addition, member countries adopt a single currency.
52
HHI meaning
The Herfindahl-Hirschman Index (HHI) is a measure of market concentration used to determine the competitiveness of an industry. It is calculated by summing the squares of the market shares of all firms within the industry. (The higher the number, the more concentrated it is.Ie more monopolistic)
53
Leading indicators
Leading indicators include share prices, average weekly hours worked in the manufacturing sector, or new orders for capital goods. The function of leading indicators is to predict the future movements of the economy.
54
Lagging indicators
Lagging indicators only change when the economy has started following a certain pattern. Even though they are more precise than leading indicators, they can only be seen after a large economic shift has occurred. They include unemployment rates, interest rates, gross national product (GNP), the balance of trade, consumer price index (CPI), and gross debt.
55
Coincident Indicators
Coincident indicators constitute elements such as gross domestic product (GDP), retail sales, and employment levels. They can be seen simultaneously as the size of the economy either expands or contracts.
56
Fiscal multiplier meaning
The fiscal multiplier measures the ratio of the change in equilibrium output to the change in autonomous spending that caused the change. If the multiplier is greater than one, it indicates that a change in government spending or taxation has a magnified effect on output. The opposite is true if the ratio is less than one. We’d expect a change in government spending or taxation to have no effect on the overall output when the multiplier is equal to zero.
57
SML
The Security Market Line (SML) is the graphical representation of the CAPM with beta reflecting systematic risk on the x-axis and expected return on the y-axis. The SML intersects the y-axis at the risk-free rate, and the slope of the line is the market risk premium, Rm – Rf.
58
Loss aversion
refers to the irrational dislike of losses in a portfolio. It manifests when an investor, despite recognizing a stock’s positive metrics and including it in their portfolio, impulsively sells it when it faces a downturn. Goals-based investing offers a solution to this bias by ensuring that the investor’s priorities remain the focus, thus discouraging them from deviating from their strategic asset allocation during market downturns. By clearly focusing on their goals, investors can mitigate the impact of loss aversion and make more rational investment decisions.
59
Illusion of control
refers to the erroneous belief that positive investment performance is primarily attributed to investors’ ability to influence events beyond what is realistically possible. This bias is often observed among risk-seeking investor types, particularly active accumulators. The illusion of control manifests in excessive trading and a failure to diversify the portfolio adequately. Investors under this bias overestimate their control over investment outcomes, leading to suboptimal decisions and increased risk exposure.
60
Mental accounting
refers to the tendency of investors to categorize their wealth into arbitrary compartments mentally. An example of mental accounting is when investors hold onto low-yielding government bonds received as a birthday gift while using high-interest credit cards. This bias can lead to suboptimal financial decisions since it overlooks the financial picture and focuses on individual categories in isolation. However, goals-based investing is designed to effectively address this bias by emphasizing the investor’s broader financial goals and priorities, encouraging a more holistic and rational approach to wealth management.
61
Representativeness bias
Representativeness bias refers to the tendency to classify new information based on past experiences and classifications. New information may resemble or seem representative of familiar elements already classified, but in reality, it can be very different. In these instances, the classification reflex can deceive, producing an incorrect understanding that biases all future thinking about the information. Base-rate neglect and sample-size neglect are two types of representativeness bias that apply to FMPs.
62
Framing bias
pertains to the tendency of investors to evaluate information based on how it is presented rather than its objective content. This bias can lead to different perceptions and decisions based on the framing of the information. For instance, consider the classic question of whether the glass is half-full or half-empty. An investor influenced by framing bias may be more inclined to focus on a situation’s negative aspect (half-empty) or the positive aspect (half-full), depending on how it is presented.
63
Availability bias
refers to the tendency of individuals to rely on information that is easily accessible or readily available. According to this theory, widely disseminated information is often given more credibility than information that requires effort. Ideally, the importance and credibility of information should not be solely determined by its availability. Instead, it should be evaluated based on its value and usefulness in making informed decisions.
64
Utility
Utility is a measure of relative satisfaction that an investor derives from different portfolios. We can generate a mathematical function to represent this utility that is a function of the portfolio’s expected return, the portfolio variance, and a measure of risk aversion.
65
Risk management process / framework
66
Diversification ratio
You want to think of the ratio as the percent volatility your portfolio has when compared to sticks within it. In this case the portfolio has 2/3 the volatility.
A lower ratio means lower correlations and better diversification
67
Empirical vs. Analytical Duration
Analytical Duration:
Definition: A theoretical measure calculated using a formula.
How It Works: Assumes bond prices change based on interest rates without considering real market conditions.
When Used: Good for stable, low-risk bonds like government bonds.
Empirical Duration:
Definition: A practical measure based on real market data and historical bond price movements.
How It Works: Considers how bond prices actually change in the real world, including factors like credit risk.
When Used: Better for riskier bonds like corporate bonds, especially in unstable markets.
68
Make-Whole Call
Definition: A feature in some bonds that lets the issuer repay the bond early, but with a penalty to make the investor "whole" (compensated for the early repayment).
How It Works: If the issuer wants to call the bond (repay it early), they have to pay the bondholder not just the face value, but also an additional amount to cover the interest the bondholder would miss out on.
69
Lock up period
This is the period after investment in which withdrawals may not be made. Hard lockups mean no redemption is possible, and soft lockups mean a penalty is assessed, although withdrawal is permitted.
70
Gates
Limits on withdrawal sizes.
71
Min max price of put option
72
Min max price of a call option
73
Call options reaction to rise in Interest rates
Goes up
74
Put options reaction to rise in Interest rates
Goes down
75
Different options for investing
76
Companies with high volatility has a preference for what type of capital?
77
Calculate covariance of a portfolio
Först få fram expected return, sen tar man deviations från dess expected return och har det weighted mot dess probability
78
Goals of central banks
79
Country behaviour
80
Bayes formula for updated investment information
81
EV of public company
82
SCL
Very similar to SML, its but used for determining excess return of an investment compared to market.
SCL is based on CAPM. Its slope is Beta, as it is comparing a certain investment to the market.
83
SML
SML is based on CAPM, it is a graphical representation of systematic risk and expected return. Its slope is E(rm-rf) as it is the market.
84
Portfolio variance
85
reverse repo
In a reverse repurchase agreement, a buyer purchases securities from a counterparty with the agreement to sell them back at a higher price at a later date
86
Time value of option
The portion of an option's price that exceeds its intrinsic value. It reflects the potential for the option to gain additional value before expiration due to the passage of time and the inherent uncertainty of future price movements.
87
The Intrinsic Value of the Option
Intrinsic Value: The difference between the underlying asset's current price and the option's strike price. It represents the actual value if the option were exercised immediately.
88
The Exercise Value of the Option
Another term for intrinsic value, referring to the value realized by exercising the option immediately.
89
Why real estate?
Real estate offers diversification because it doesn't perfectly track broader market trends.
It provides cash flow stability during economic shocks through long-term leases.
It offers income generation and potential for capital appreciation.
90
Payment-in-kind
(PIK) coupon bonds allow the issuer to pay interest in the form of additional amounts of the bond issue rather than to cash payments. As a result, such bonds are favored by issuers concerned with cash flow problems.
91
Deferred coupon bonds
Sometimes called split coupon bonds, pay no coupons for their first few years but later pay higher coupons. Such bonds are common in project financing.
92
Index-linked bonds
are linked to a specified index offering protection for the investors. Some common indices are the UK Retail Price Index (RPI) or the US Consumer Price Index (CPI). Indices are transparent and regularly published. In addition, governments usually issue inflation-linked bonds or linkers.
93
Credit-linked bonds
Have coupons that change in line with the bond’s credit rating.
94
Step-up coupon bonds
Either fixed or floating, have coupons that increase by specified margins at specified dates. Such bonds provide protection against rising interest rates.
95
Total return vs price return
price return, focusing solely on the appreciation or depreciation in stock prices, which is why dividends are not included in the calculation. If the question had asked for the total return, then dividends would be factored into the calculation.
96
Effective annual yield
𝐸𝐴𝑌 = (1 + 𝑃𝑒𝑟𝑖𝑜𝑑𝑖𝑐 𝑟𝑎𝑡𝑒)𝑚 − 1
97
BEY (example)
First find PV and then find HPY, to then calculate back the days
98
Duration properties, (What affects the duration)
Coupon Rate,
Explanation: Higher coupon rates result in larger, more frequent cash flows earlier in the bond's life, reducing the bond's duration since the present value of these payments is a larger proportion of the bond's total value, thus leading to an inverse relationship with duration.
Yield to Maturity,
Explanation: As yield increases, the present value of a bond's future cash flows decreases, which weights the cash flows more towards the earlier periods and reduces duration due to the time value of money, resulting in an inverse relationship.
Time-to-Maturity,
Explanation: A longer time to maturity typically means more cash flows are due further in the future, increasing a bond's sensitivity to interest rate changes, thus increasing duration, indicating a direct relationship.
Fraction of Current Coupon Period that has Elapsed,
Explanation: As more of the coupon period elapses, the remaining time until the next cash flow decreases, effectively reducing the time-weighted average of future cash flows and therefore decreasing the bond's duration, showing an inverse relationship.
99
Premium bonds vs Discount bonds in duration
Interest Rate Sensitivity: Discount bonds have higher duration than premium bonds for the same maturity, making them more sensitive to interest rate changes.
All else being equal, premium bonds have a shorter duration compared to discount bonds, which makes them less sensitive to interest rate changes.
100
Difference between inventory impairment and noncurrent assets.
101
Standard error
Standard Error is a measure of how much the values we observe in a sample are expected to differ from the true values in the whole population.
It tells us about the accuracy of our sample estimates.
102
Capital allocation pitfalls
Inertia
Source of Capital Bias
Failing to Consider Investment Alternatives or the Alternative States
Pushing Pet Projects
Basing Investment Decisions on EPS, Net Income, or ROE
Internal Forecasting Errors
103
How to calculate time weighted vs money weighted
Time= Geometric mean if many periods
Money= Cashflow sheet with to get IRR
104
Effective duration
105
Price value per basis point
106
Convexity
107
Standard devation of a portfolio
108
Difference between MBO and MBI
In a Management Buyout (MBO), the current management team buys the company and continues to manage it, whereas in a Management Buy-In (MBI), an external management team buys the company and replaces the existing management team.
109
What is a bullet structure in bond payments?
Periodic coupon interest payments are made over the life of the bond, and the principal value is paid with the final interest payment at maturity.
110
Q: Define an amortizing bond.
A bond where periodic payments include both interest and some repayment of principal, potentially fully paying off the principal by maturity
111
What is a floating-rate note (FRN)?
A bond with a coupon rate based on a reference rate like LIBOR, with possible adjustments reflecting the issuer's creditworthiness.
112
What is an inverse floater?
A bond with a coupon rate that increases when the reference rate decreases and decreases when the reference rate increases.
113
Explain what an index-linked bond is.
A bond with payments based on a published index, such as a commodity or equity index. Some may be principal-protected.
(principal protected means they cant pay less than par value)
114
Describe indexed-annuity bonds.
Fully amortizing bonds with periodic payments directly adjusted for inflation or deflation.
115
What is a capital-indexed bond?
A bond where the principal value is adjusted by the inflation rate, with an example being U.S. Treasury Inflation Protected Securities (TIPS).
116
What are deferred coupon (split coupon) bonds?
Bonds where regular coupon payments do not begin until a period of time after issuance.
117
What is a sinking fund provision?
A provision that requires periodic retirement of a portion of the bonds issued over the life of the bond. Bonds with this provision generally have less credit risk but greater reinvestment risk.
Periodic retirement of the bond refers to the process of gradually paying off the principal amount of the bond before its maturity date. This is typically done through a sinking fund provision, where the issuer sets aside funds over time to repurchase and retire (i.e., pay off) a portion of the outstanding bonds at regular intervals.
118
What are sovereign bonds, and what backs them?
Sovereign bonds are issued by national governments or their treasuries and are backed by the taxing power of the government.
119
What factors lead to higher ratings for sovereign bonds issued in local currency?
The ability of the sovereign to collect taxes and print local currency leads to higher ratings compared to sovereign debt issued in a developed economy's currency.
120
What are on-the-run bonds or benchmark bonds?
These are the most recently issued government securities of a particular maturity, which have the most active trading and most informative prices.
121
What are nonsovereign government bonds?
Nonsovereign government bonds are issued by states, provinces, counties, or entities created to fund specific projects like hospitals or airports. Payments may be supported by project revenues, general tax revenues, or special taxes/fees.
122
How do sovereign bonds compare to nonsovereign bonds in terms of yield?
Sovereign bonds typically trade with lower yields because their credit risk is perceived as lower than that of nonsovereign bonds.
123
What are agency bonds or quasi-government bonds?
These bonds are issued by entities created by national governments for specific purposes, such as financing small businesses or mortgage financing.
124
What are supranational bonds?
Supranational bonds are issued by supranational agencies, such as the World Bank, IMF, and Asian Development Bank.
125
What is a bilateral loan?
A bilateral loan involves only one bank lending to a corporation, typically with a LIBOR-based variable rate.
126
What is a syndicated loan?
A syndicated loan is funded by several banks, rather than just one.
127
What is commercial paper?
Commercial paper is short-term, unsecured debt issued by corporations, often used to fund working capital or as a temporary funding source before issuing long-term debt. It usually matures in about 90 days, with a maximum of 270 days to avoid SEC registration.
128
What is bridge financing?
Bridge financing is temporary debt used until permanent financing can be secured.
129
Why do corporations maintain backup lines of credit with banks?
To get an acceptable credit rating from rating services on their commercial paper.
130
What is Eurocommercial paper (ECP)?
ECP is issued in several countries with maturities up to 364 days, with rates quoted as add-on or discount yields.
131
What is a serial bond issue?
A bond issue where bonds have several maturity dates, allowing portions of the issue to be redeemed periodically.
132
How are corporate bonds categorized based on maturity?
Short-term (up to 5 years), medium-term (5 to 12 years), and long-term (more than 12 years).
133
What are structured financial instruments?
Securities designed to change the risk profile of an underlying debt security, often by combining it with a derivative. Examples include asset-backed securities and collateralized debt obligations.
134
What is a credit-linked note (CLN)?
A CLN is a bond with regular coupon payments, but its redemption value depends on whether a specific credit event occurs. If no credit event occurs, it is redeemed at par; if a credit event occurs, the redemption payment is lower.
135
What is a capital protected instrument?
A structured financial instrument that guarantees a minimum value at maturity, with potential upside gain. An example is a zero-coupon bond combined with a call option on a reference stock index.
136
What is a participation instrument?
An instrument with payments based on the value of an underlying interest rate, asset return, or index return. A floating-rate note, like one based on LIBOR, is an example.
137
What is the effective yield of a bond?
The effective yield is the compound return for a bond.
138
What is street convention in yield calculation?
It refers to yields calculated using the stated coupon payment dates, with payments made on the next business day if they fall on weekends or holidays.
139
What is the true yield?
A yield calculated using the actual coupon payment dates, which may be slightly lower than the street convention yield.
140
What happens when the quoted margin is less than the required margin for an FRN?
The FRN will sell at a discount if the credit quality decreases, and at a premium if the credit quality improves.
141
What is bond-equivalent yield?
An add-on yield based on a 365-day year, used for comparing money market securities.
142
discount rate vs add on yield
Discount rate is based on the face value, while add-on yield is based on the price you paid for the security.
In practical terms, the discount rate is commonly used for quoting returns on Treasury bills, while add-on yield is more often used for certificates of deposit and some types of commercial paper.
The discount rate provides a simpler comparison for instruments like T-bills, which are sold at a discount, as it standardizes the return based on the face value.
The add-on yield is more relevant for instruments where the interest is explicitly added to the initial investment, making it clearer for investors to understand their actual return on the investment.
143
What is a Collateralized Mortgage Obligation (CMO)?
A CMO is a security that is collateralized by residential mortgage-backed securities (RMBS) and structured into multiple tranches with different risk exposures.
144
What is a Planned Amortization Class (PAC) tranche?
A PAC tranche has reduced prepayment risk because support tranches absorb the variability in prepayments, maintaining a more predictable payment schedule within a specific range, known as the PAC's "initial collar."
145
What are Commercial Mortgage-Backed Securities (CMBS)?
CMBS are backed by income-producing real estate (like apartments, warehouses, and office buildings) and are evaluated based on the property’s loan-to-value (LTV) ratio and debt service coverage ratio.
146
What is a fixed-rate mortgage?
A fixed-rate mortgage has an interest rate that remains unchanged over the life of the loan.
147
What is an adjustable-rate mortgage (ARM)?
An ARM has an interest rate that can change over the life of the mortgage, often based on an index.
148
What is the difference between a non-recourse and a recourse loan?
In a non-recourse loan, the lender can only claim the property used as collateral, whereas in a recourse loan, the lender can claim other assets of the borrower if the property sale doesn't cover the loan amount.
149
What are Agency RMBS?
Agency RMBS are issued by government agencies like GNMA, FNMA, and FHLMC, with GNMA securities backed by the full faith and credit of the U.S. government.
150
What is the conditional prepayment rate (CPR)?
CPR is an annualized measure of prepayments on mortgage-backed securities, indicating the speed at which loans are prepaid compared to a benchmark.
151
What are credit enhancements in ABS?
Credit enhancements are measures, either internal or external, that improve the credit quality of asset-backed securities, such as third-party guarantees or overcollateralization.
152
What is a Collateralized Debt Obligation (CDO)?
A CDO is a structured security backed by a pool of debt obligations that is managed by a collateral manager.
153
What are some types of CDOs?
Collateralized Bond Obligations (CBOs): Backed by corporate and emerging market debt.
Collateralized Loan Obligations (CLOs): Backed by leveraged bank loans.
Structured Finance CDOs: Backed by residential or commercial mortgage-backed securities (MBS), asset-backed securities (ABS), or other CDOs.
Synthetic CDOs: Backed by credit default swaps on structured securities.
154
Q: What are the three classes of bonds (tranches) issued by CDOs?
Senior Bonds: These are the highest priority tranches with the least risk.
Mezzanine Bonds: These have medium priority and risk.
Subordinated Bonds (Equity or Residual Tranche): These are the lowest priority tranches and carry the highest risk, with returns more similar to equity investments.
155
What does a positive duration gap indicate?
A positive duration gap (Macaulay duration greater than the investment horizon) exposes the investor to market price risk from increasing interest rates.
156
What does a negative duration gap indicate?
A negative duration gap (Macaulay duration less than the investment horizon) exposes the investor to reinvestment risk from decreasing interest rates.
157
How does a higher yield to maturity (YTM) affect interest rate risk?
Interest rate risk is less with a higher YTM because the price-yield relationship is convex, meaning at lower yields, the price is more sensitive to a given change in yield.
At higher yields, the bond is already priced in such a way that investors feel they’re getting a fair deal, so small changes in interest rates don’t make them as eager to buy or sell.
158
What is key rate duration?
Key rate duration measures the sensitivity of a bond or portfolio to changes in interest rates at a specific maturity, assuming other spot rates remain constant.
It helps assess the impact of nonparallel shifts in the yield curve, which duration alone may not adequately measure.
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Covered bonds
Covered bonds are like asset-backed securitites (ABS) but with dual recourse—to both the asset pool and the issuing financial institution. Recall that in an ABS, the financial institution to which the loan originates transfers the securitized assets to a bankruptcy-remote legal entity. However, in the case of covered bonds, the cover pool (pool of assets) is retained on the financial institution’s balance sheet, with the covered bondholders given top priority claim.
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Declaration Date
The declaration date is the day on which a company issues a statement declaring its intent to pay a dividend. On the said date, the company also announces the holder-of-record date and the payment date.
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Ex-Dividend Date
The ex-dividend date, otherwise known as the ex-date, is the first business day on which a share will trade without its dividend. As a result, investors who owned shares before and on the ex-dividend date will receive a dividend once it is paid, while investors who acquire shares on or after the ex-dividend date will not have the benefit of receiving dividend.
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Holder-of-Record Date
The holder-of-record date, or simply the record date, as determined by a company, is the business day on which a shareholder that is listed in the company’s records is deemed to have ownership of the company’s shares for the purpose of deciding who can and who cannot receive a dividend when paid.
The record date is typically one or two business days after the ex-date.
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Payment Date
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Value at risk
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Return generating models
Multifactor Model: Estimates expected returns using multiple risk factors, such as GDP growth, inflation, firm size, and earnings. The return on a security is the sum of factor sensitivities (betas) multiplied by the expected value of each factor.
Market Model: A single-factor model where the expected return on a security is based on the market return. The model uses the CAPM formula.
where i is the sensitivity of the asset's return to the market return. (AKA single index)
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Swaps och forwards
Both are zero at inition- and swaps can be seen as multiple OFF THE MARKET forwards (ie, same price per payment)
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What affects yield spreads?
Gov bonds= = Real risk-free interest rate + Expected inflation rate + Maturity premium
Corp bonds= Credit Cycle: Improved credit conditions narrow spreads, while a weakening cycle widens them.
Economic Conditions: Weak economies widen spreads as investors demand higher risk premiums; strong economies narrow spreads due to lower perceived risk.
Funding Availability: Low availability of market-making capital widens spreads; sufficient capital narrows them.
Issuer's Financial Performance: Positive news narrows spreads by increasing bond demand; negative news widens spreads due to increased perceived risk.
Market Supply and Demand: High supply with low demand widens spreads; high demand narrows spreads.
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Sustainable growth rate
retention rate × ROE
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Market cap formula
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Primary methods of private debt
There are four primary methods of private debt investing: Direct lending, mezzanine loans, venture debt, and distressed debt.
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Exit strategies for private equity
Trade sale.
Initial public offerings.
Recapitalization.
Secondary scales.
Liquidation or write-off.
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Corporate governance benfits and risks
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Bond prices and interest rates
Bond prices have an inverse relationship with interest rates. This means that when interest rates go up, bond prices go down and when interest rates go down, bond prices go up.
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Call and put option prices and interest rates
Higher Interest Rates:
Call Options: Become more expensive because borrowing money to buy stocks is more costly, making call options a more attractive alternative.
Put Options: Become cheaper because the cost of holding stocks goes up, and fewer people want to buy protection against stock price drops.
So, in easy terms, higher interest rates make call options pricier and put options cheaper because of how they affect the costs and decisions around buying and holding stocks.
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Calculate the forward rate
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real exchange rate calculation
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Approximate real exchange rate
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Bond prices and yield changes
Inverse relationship in general, but-
The convexity of the price-yield relationship causes the bond's price to increase more when yields fall than it decreases when yields rise by the same amount.
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Forwards or futures to sell in a declining inflationary environment
If the investor sells a futures contract and commodity prices fall (as expected), they would profit. However, since futures are marked-to-market daily, any gains or losses would be settled each day. If interest rates are falling (as they would if inflation falls), the gains on the futures contract would be invested at a lower interest rate, reducing the overall profit.
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Risk neutrality
Dont even consider risk- Just thinking about return
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I- Spread
Definition: The I-spread, or Interpolated Spread, measures the difference between the yield of a credit instrument (like a corporate bond) and the yield of an interest rate swap with a similar maturity.
Purpose: It's used to understand how much additional yield a bond is offering over the swap rate, which is often considered a proxy for a risk-free rate.
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Z-Spread
Definition: The Z-spread is the constant spread that, when added to the spot rate curve (the zero-coupon Treasury curve), makes the present value of the bond's cash flows equal to its current market price.
Purpose: The Z-spread accounts for the entire yield curve and provides a more precise measure of the credit spread by considering the bond’s entire cash flow structure.
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G-spread
Definition: The G-spread is the difference between the yield on a corporate bond and the yield on a government bond of similar maturity.
Purpose: It provides a straightforward measure of how much extra yield an investor earns for taking on credit risk relative to a government bond, which is typically considered the risk-free benchmark.
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Equity-related hedge fund strategies
Primarily concentrate on equity markets, with most of their risk profiles tied to equity-related risks. The primary strategies within this equity-related category, which will be explored further, include long/short equity, dedicated short bias, and equity market neutral.
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Event-driven hedge fund strategies
Center around corporate events, encompassing governance events, mergers and acquisitions, bankruptcies, and other pivotal occurrences within corporations. The central risk for these strategies is event risk, where unforeseen events can adversely affect a company or security. Such unexpected events may involve unanticipated corporate reorganizations, unsuccessful mergers, credit rating downgrades, or bankruptcies. The most prevalent event-driven hedge fund strategies, merger arbitrage, and distressed securities will be thoroughly examined.
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Relative value hedge fund strategies
Center on assessing the relative valuation between two or more securities. These strategies frequently entail exposure to credit and liquidity risks, as the valuation variances they aim to capitalize on often stem from differences in credit quality and liquidity among various securities. The two primary relative value hedge fund strategies to be explored in more detail are fixed-income arbitrage and convertible bond arbitrage.
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Opportunistic hedge fund strategies
Adopt a top-down perspective, concentrating on a diversified opportunity set, often with a macroeconomic orientation. The risks associated with opportunistic hedge fund strategies hinge on the specific opportunity set they target and may fluctuate over time and across various asset classes. The two prevalent opportunistic hedge fund strategies covered in greater depth are global macro and managed futures.
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Specialist hedge fund strategies
Center on distinctive or specialized opportunities, frequently demanding specific expertise or market knowledge. These strategies may encounter distinctive risks from particular market sectors, specialized securities, or esoteric financial instruments. Two specialized strategies involving options (volatility strategies) and reinsurance will be investigated more comprehensively.
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Multi-manager hedge fund strategies
These are centered around constructing a diversified portfolio comprising various hedge fund strategies. Managers within this category employ their expertise to blend diverse strategies and make dynamic reallocations over time. The two prevalent types of multi-manager hedge funds, multi-strategy, and fund-of-funds, will be examined in more detail.
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Type 1 and type 2 errors
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Competetive vs non competetive bids
Competitive Bid:
You set the price you’re willing to pay.
Risk: You might not get any bonds if your price is too low.
Non-Competitive Bid:
You agree to pay whatever price is set in the auction.
Benefit: You’re guaranteed to get the bonds.
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Calculate min max for Call option
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Calculate min max for Put option
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