Section 2 - Cash and Fixed Interest Securities Flashcards

Question

what happens on the bond secondary market

Answer 1

o Used for subsequent trading after issue o Three sterling markets; Government sector, Corporate sector, Sterling loans to foreign borrowers

Answer 2

o Eurobond market (international bonds)

Answer 3

* Redemption yield is more accurate as considers income and gain/loss at maturity * If redemption yield is less than interest yield there will be a capital loss at maturity * However, this ignores tax * No CGT on gilts and most corporate bonds for individual investors.

Answer 4

* Interest Rate - when interest rates fall capital values rise and vice versa * Liquidity - trade infrequently * Inflation - erodes capital values (bond prices tend to fall if rate of inflation is speeding up) * Currency - exchange rate movements for global bonds * Default o Issuer may not pay interest or capital at maturity (Governments are most secure due to creditworthiness and ability to raise money to pay debt) o Credit ratings: investment grade (S&P BBB- or higher /Moody’s Baa3 or higher) o Sub-investment grade (junk bond) (volatile) * Market/Systematic Risk - economic factors or government actions

Answer 5

Rising positive curve, higher yields for longer terms

Answer 6

Income similar for long & short term If economic factors are stable and no radical changes to expected inflation or interest rates

Answer 7

Yields on longer-term bonds are less than short-term bonds Caused by supply and demand or when investors expect short- term increases to interest rates but lower long-term rates

Answer 8

Less than 7 years

Answer 9

7 - 15 years

Answer 10

Over 15 years

Answer 11

* Interest & capital repayment adjusted with inflation (using RPI) * Lower yields than conventional stock * Profits on disposal are CGT exempt but interest is taxable

Answer 12

* Sale & repurchase agreement * One party agrees to sell gilts to another party * With a formal agreement to repurchase equivalent securities at an agreed price on a specified future date * Transfer of assets - but operates as form of short-term lending * Bank of England uses repo market to influence interest rates

Answer 13

* Separating conventional gilts into interest (coupon) and redemption payments * Which are then traded in their own right * A 5-year gilt can be stripped to make 11 separate securities (5 x 2 coupon payments + 1 redemption payment = 11)

Answer 14

* Allows companies to borrow money for long periods at fixed rate of interest o Greater risk than gilts so higher yields o Prices typically more volatile o Liquidity issues for lower quality bonds o Wider spread on buying & selling prices o Credit ratings can change/affect prices

Answer 15

Charge on certain assets of the company

Answer 16

Higher yield due to higher risk Holders rank alongside other creditors in liquidation

Answer 17

* Written acknowledgement of debt * Established by trust deed * Fixed - charged over specific asset * Floating - general charge over company asset

Answer 18

* Offers holders the option of converting to ordinary shares * Conversion dates and rates are specified. * In the event of conversion CGT is chargeable

Answer 19

* Securities paying rate of interest linked to money market rate e.g. LIBOR * Rate expressed in basis points above LIBOR’s 6-month average * Interest normally paid half yearly or yearly

Answer 20

* Issued by building societies * Perpetual subordinated bonds (PSBs) originally issued by building societies that have now converted to banks o Issuer has no obligation to redeem (they are undated) o Particularly sensitive to interest rates o Do not qualify for compensation under FSCS o Rank behind all other creditors in the event of liquidation o Interest payable is non-cumulative o Interest is paid gross half yearly o Exempt from CGT

Answer 21

* A £50 bonus is added for every £200 saved - up to a maximum of £3,000

Answer 22

* Treasury bills

Answer 23

* This is where the buyer receives the full 6 months’ interest

Answer 24

* Because it considers income as well as the gain or loss at maturity

Answer 25

* This is a general charge over any of the company’s assets (as opposed to fixed)

Answer 26

Future Value (FV) = Present value PV x (1 +r)n You should be putting this into a single line on your scientific calculator. £45,000 x (1 + 0.06) ^ 3 = £53,595.72 This is a £3,595.72 surplus.

Answer 27

This uses a variation of the future value calculation used in Question 1. It can be quickly manipulated using algebra – for more information on how this is done, please refer to the Investment Calculations video or check the example below. The easiest way to do this calculation is simply to remember the manipulated formula. If you do this enough, it’s like second nature: n √ (FV / PV) – 1 = r The √ in the formula is not the “normal” square root key on your calculator. You are looking for the “nth root”, not the “square root”. On your calculator it should look like “x√” So for this calculation, we do the following: 5 √ (£1,000 / £712.99) – 1 = 0.07, or 7%

Answer 28

In order to calculate the value of each annual mortgage payment (P), the annuity formula must be used with the following numbers: r = 5.45% (which when written as a decimal = 0.0545) n = 25 (years) A = £200,000 1 − ( 1 + 𝑟 ) −𝑛 𝑃 𝑟 = 𝐴 This may look scary, but it’s not. It’s just an extended version of the FV calculation used in Question 1. So let’s work through it. 1 – ( 1 + 0.0545 ) ^-25 = 0.735 And we know r is 0.0545 So 0.735 / 0.0545 = 13.48 At this point, we know that P x 13.48 = £200,000. We can use algebra to easily flip this around: £200,000 / 13.48 = P = £14,837.20 (Your answer may be slightly different depending on how you round – show your workings in the exam and always show your final answer to 2DP.)

Answer 29

Using algebra, we can take the following steps: FV = PV ( 1 + r ) ^n £1,000 = £712.99 ( 1 + r ) ^5 £1,000 / £712.99 = ( 1 + r ) ^5 1.4 = ( 1 + r ) ^5 5 √ 1.4 = 1 + r 1.07 = 1 + r 1.07 – 1 = r 0.7 = r Why not go back through this calculation now you know the answer? For example, take the third row of the calculation: £1,000 / £712.99 = ( 1 + r ) ^5 We can now confirm: £1,000 / £712.99 = 1.4. But we can also confirm ( 1 + 0.07 ) ^ 5 also = 1.4.

Answer 30

The manual way £10,000 ( 1 + 0.05 ) = £10,500 - £2,000 = £8,500 £8,500 ( 1 + 0.05 ) = £8,925 - £2,000 = £6,925 £6,925 ( 1 + 0.05 ) = £7,271 - £2,000 = £5,271.25 The formulaic way First, we need to calculate the PV of the £2,000pa annuity. The formula is detailed in the previous question. 1 – ( 1 + 0.05 ) ^-3 = 0.136162 / 0.05 = 2.7232 X £2,000 = A = £5,446.50 We now need to work out how much the remainder (£10,000 less the PV annuity) is worth when compounded over 3 years at 5%: £10,000 - £5,446.50 = £4,553.50 £4,553.50 ( 1 + 0.05 ) ^n = £5,271.25

Answer 31

Using pounds and pence We know that an AER of 26% means that if we start by owing £100 at the start of the year, we’ll end up owing £126 at the end of the year. As such, we can use a simple r calculation: 12 √ (£126 / £100) – 1 = 0.0194, or 1.94% Without using pounds and pence Using the following formula: n √ (1 + APR) – 1 = r This is a variation of the r formula we used above, but we’re using percentages and rates rather than pounds and pence. 12 √ ( 1 + 0.26 ) – 1 = 0.0194, or 1.94%

Answer 32

APR = (1 + monthly rate)12 -1 If the annual percentage rate was already known, the monthly rate would be calculated by using the following formula: Monthly rate = 12√1+APR - 1

Answer 33

APR = (1 + 0.06/12)12 – 1 = 6.17% [2 decimal places, always!]

Answer 34

a) Every 3 months (quarterly) = [(1+0.04/4)4 – 1] x100% = 4.06% b) Monthly return = [(1+ 0.04/12)12 – 1] = 4.07%

Answer 35

The money markets are the market for short-term credit, loans and deposits with an original maturity of less than one year. Institutions can borrow funds if they have a cash flow problem, or deposit funds if they have a surplus. Deposits range from overnight to 12 months. These funds may either be in the form of a straightforward cash deposit or loan, or an instrument such as a bill or a certificate of deposit.

Answer 36

the inter-bank market

Answer 37

The inter-bank market is a market where two-way prices are made between participating banks banks raise the shortfalls and lay off the surpluses generated in each period by their customers' activities (normally unsecured and for amounts in excess of £500k).

Answer 38

The two-way price will be made up of a BID (to buy) rate, which is the rate the bank will pay for deposits received, and an OFFER (offering/selling) rate, which is the rate the bank charges for loans made. The bid rate is always lower than the offer. The difference between the two is called the SPREAD.

Answer 39

they charge a margin on selling/buying (using their platform – which could be anything from eBay to Betfair to Cofunds to Standard Life; they charge a spread or margin on each transaction for ‘trading’ using their platform.

Answer 40

Treasury Bills

Answer 41

Through the DMO at weekly auctions T-bills are issued at a discount and redeemed at their face value, or par; there is no coupon. The DMO (Debt management office) issues T-bills every Friday. Interested parties submit a price, and if they are successful they pay the price they submitted; this is called a competitive auction. T-bills may be purchased from the DMO at issue and redeemed at the end of the redemption period. Alternatively it is possible to buy (or sell) them second hand on the money markets.

Answer 42

one month, three months or six months (usually a minimum of £500,000 nominal purchase).

Answer 43

DMO issues a 91day T-bill with face value £100k (100k is the final return) Investor pays 98.5k (initial investment cost) Investor holds bill to redemption Receives £100k (and £1.5k in growth over the 91 days, from the initial investment) This would be the equivalent of receiving £1.5k ‘interest’ every 91 days (on an initial deposit of £98.5k); this is 365/91 x 1.5k/98.5k = 6.11% pa This is a ‘simple’ method. A more accurate method could be to apply the AER formulae over the period to get an annualised comparable figure. In this case, it would be compounded 365/91 times per annum.

Answer 44

corporate unsecured short dated debt is called Commercial Paper (CP) and have typical maturities of between 30 and 90 days. All of these money market transactions are done via the money markets – effectively trading paper as cash equivalent, but written on their own terms.

Answer 45

Money Market Funds (MMFs) are collective investments which invest primarily in cash and short-term debt such as treasury bills, certificates of deposit, and commercial paper. They allow private investors to access these wholesale assets and, given the size of the collective investment, the potential for a higher interest rate.

Answer 46

Yes, commercial paper is considered very low risk because of the credit worthiness of the issuer and the short-term nature of the debt (typically under 1 year).

Answer 47

A CD is issued when an investor places some money for a given term with a bank at an agreed interest rate (usually linked to the LIBOR/SONIA rate, but with a discount because they are ‘tradable’); they represent a deposit (not a loan), pay interest (at end of term) and typical maturities range between one and three months.

Answer 48

S & P, Moody’s & Fitch

Answer 49

CDS (credit default swap) rates are the cost of insuring a bank debt default by using credit default swap. Most major UK banks have CDS rates of between 100 and 300 bips. Any higher would indicate the market considers there to be higher risk of default

Answer 50

The transfer and settlement of most money market instruments take place through the Central money markets Office (CMO) system run by CREST.

Answer 51

credit risk, inflation risk and interest rate risk and there maybe also currency risk where they are issued as non- sterling denominated.

Answer 52

Inflation risk is the risk of money losing value as inflation increases. But in recent time, deflation has been the concern

Answer 53

Deflation is described as: A decrease in the price level of goods and services, or when the annual inflation rate is below 0%. With deflation, interest payments become more expensive in real terms over time. The loan value, in effect, increases. The value of the interest increases in real terms. Maturity value is greater in real terms. Fixed interest prices pushed up. Individuals defer purchases (as the price is expected to be lower in the future) reducing turnover and profit for companies and downward pressure on share price.

Answer 54

Fall in demand/reduction in economic activity. Greater tendency to save/borrow less. Debt increases in value

Answer 55

Debt securities are financial instruments that give the owners’ rights to interest and repayment of capital on loans made to governments and companies. They are more commonly known as bonds and can have redemption periods of up to 30 years (pension fund demand has led to a call for 50 year issues and recent 55 year bond issues were quickly over-subscribed by £12billion).

Answer 56

Companies and governments need cash to operate and cash income does not always cover their cash expenditure. Both must raise additional ‘capital’ to fund shortfalls. Capital is usually categorised into debt and equity Debt involves borrowing money with a firm commitment to repay both the capital and associated interest; governments cannot raise equity capital, therefore debt is their only option. UK Government gilts and Treasury bills (dealt with under Topic 2) are issued by the DMO (Debt Management Office)

Answer 57

The gilt-edged market makers (GEMMs) are market makers who set up and deal in the primary markets for gilts (via DMO) in the UK Government debt securities. Gilt-edged securities form a large part (@ 65%) of national debt, with the remaining (35%) being funded by NS&I, short-term borrowing from the Bank of England and overseas borrowings.

Answer 58

Gilts are auctioned (offered for sale) on regular dates by DMO Non-competitive bids Successful non-competitive bids are accepted in full at the weighted average price at which competitive bids have been accepted. Syndicated offerings This is where the DMO appoints a group of banks to manage the sale of the gilt on its behalf.

Answer 59

Competitive bids must be for one amount at one price and bonds are sold to those whose competitive bids are at or above the lowest price the DMO is prepared to accept. The result is that not all gilts are sold at the same price.

Answer 60

Successful non-competitive bids are accepted in full at the weighted average price at which competitive bids have been accepted.

Answer 61

In a TAP the DMO passes the gilts onto GEMMs who issue them directly into the secondary market; initially the gilts are still issued to GEMMs, who tender prices to the DMO.

Answer 62

Shorts <7 years to redemption, Medium 7-15 and Long >15 Nominal (par) value (=£100 on redemption) Interest rate (coupon described as an annual % of nominal value £100 paid semi-annual 6 months apart and paid gross of income tax) Redemption date (year £100 capital is repaid) with undated/irredeemable gilts effectively being cashed in by the government at any time.

Answer 63

Index-linked bonds have coupons AND redemption values which are linked to the UK Retail Price Index (RPI) or CPI – depending on the index being used or being issued by HM Government (these calculations can be very complicated and you will never get asked to calculate one, but you do need to understand that both the coupon and par value are index- linked).

Answer 64

The break-even inflation rate is the rate of inflation that gives the same real net redemption yield for an index-linked gilt and a comparison conventional gilt of similar maturity for investors of a given tax rate (ie. BRT, HRT or ART). ABOVE the break-even rate the index-linked gilt gives the better return. BELOW the break-even rate the conventional gilt provides the better return

Answer 65

STRIPS stands for ‘Separate Trading of Registered Interest and Principal of Securities’. These gilts can be stripped into their coupons and final redemption amount, both traded separately. These individual parts are both registered securities. Each strip forms the equivalent of a zero-coupon bond. It will trade at a discount to its face value, with the size of the discount being determined by prevailing interest rates and time. Only those gilts that have been designated by the DMO as ‘strippable’ are eligible for the STRIPS market (not all gilts are eligible).

Answer 66

The key feature of a ‘Zero’ is that it has a fixed maturity date with a fixed return (dependant on the cost on investment and final ‘par’ value return). The rate at which the assets have to grow annually to provide the redemption price at the maturity date is called the ‘hurdle rate’. This can be positive or negative.

Answer 67

The general features of overseas government bonds and the markets they trade in vary from country to country – but, effectively all operate on the same basic principles.

Answer 68

Gilts issued through the Treasury by DMO (including repo market) *Sterling loans to foreign borrowers *Eurobond market which deals with foreign currency loans to UK and foreign governments and companies, this allows institutions who receive earnings in foreign currencies to keep the income in that currency

Answer 69

Eurobond market which deals with foreign currency loans to UK and foreign governments and companies, this allows institutions who receive earnings in foreign currencies to keep the income in that currency

Answer 70

A repurchase agreement (also known as a repo or sale and repurchase agreement) allows a borrower to use a financial security (gilt) as collateral for a cash loan at a fixed rate of interest. The analogy of the pawn broker is a good one here – the pawn broker will ‘lend’ money against the collateral of the goods and return them at some point in the future.

Answer 71

A gilt repo is a contract in which the seller of gilts (in this case the DMO, who are selling gilt- edged debt/bonds) agree to sell and buy back at a future specified time and price (which could be very short time scale). Here, the gilt repo is a means of borrowing, using the gilt as security (accessing the gilt capital for a fixed period – where the gilt capital is secure). A repo contract is where the borrower (in the gilt market this would be DMO), agrees immediately (part of the same contact) to sell the security (gilt) to a lender and also agrees to buy the same security from the same lender at a fixed price at some later date.

Answer 72

The advantage of the gilt repos is that holders (of the gilt) are able to raise finance (cash) against the security of the gilts and potentially accessing cheap short-term finance.

Answer 73

Eurobonds are international bond issues outside any particular jurisdiction. For example, a US dollar Eurobond could be issued anywhere in the world, except for the US. As such, a better name for it might be an international bond. They are a way for an organisation to issue debt without being restricted to their own domestic market. They are generally issued via a syndicate of international banks

Answer 74

Corporate bonds are debt securities where the issuing company promises to repay the capital (at end of term) and interest to the holders throughout the term. The method commonly used for issuing corporate bonds is a PLACING. This takes very much the same form as a placing in equity issues, with underwriting of corporate bond issues common. The description of a corporate bond is very much like a gilt with interest fixed or variable rate and terms of redemption (and provisions for early repayment/demand for early repayment or convertibility) is set out within the terms of issue.

Answer 75

A domestic bond refers to one in which the nationality of the issuer, the denomination of the bond and the country of issue are the same. For example, a sterling denominated bond issued in London by a UK company.

Answer 76

A foreign bond is one in which the nationality of the issuer is different to that of the denomination of the bond and the country of issue, for example, a sterling bond issued in London by a US company (known as BULLDOGS on the UK market).

Answer 77

* Credit / default risk: non-payment of interest or capital at redemption * Economic risk: different countries = different economies = different risks (Greece versus Germany?) * Foreign exchange / currency risk: negative currency exchange movements * Interest rate risk: the inverse relationship between bond prices and interest rates * Liquidity risk: is it possible to sell a specific amount, at the price you want and at the time you want to? * Political risk: political instability can be a major factor (Venezuela?)

Answer 78

An international bond (EUROBOND) is a security where the denomination of the bond and the country of issue are all different. For example, a company issuing dollar bonds in Paris and Tokyo, or a company issuing yen bonds in Frankfurt and Dublin Eurobonds are issued in the currency and country where the issuer finds it cheapest to raise the finance, and then swapped into the currency the issuer wants.

Answer 79

A debenture is a document which acknowledges a company's indebtedness to a third party, and in particular to secured debt instruments. That is, secured corporate bonds would be called debentures – secured on defined assets

Answer 80

the term loan stock refers to unsecured corporate bonds (but, maybe guaranteed in some other way).

Answer 81

An asset-backed security (ABS) is a financial instrument secured by a pool of assets such as property or loans. They are issued by companies specially created for the purpose and are a separate legal entity from the original owner of the underlying assets. This leaves them unaffected by any bankruptcy risk in the original owner. Cash flows from the pool of underlying assets (e.g. rental income or mortgage income) are distributed on a pro-rata basis to the holders of the ABS. This is called a securitisation

Answer 82

A mortgage backed security (MBS) is a securitised pool of underlying home loans. They are used by retail banks to securitise the cash flows from mortgages that would otherwise be receivable over, normally, a 25 year term.

Answer 83

* Credit risk: interest payments and repayment of the bond may not be made * Market risk: inverse relationship between bond prices and interest rates * Inflation risk: real value of bond coupon & redemption repayment * Liquidity risk: bonds not easily traded * Exchange rate risk: bonds denominated in different currencies

Answer 84

Credit risk Credit rating agencies make an assessment when first issued (and throughout the term of the bond) and are divided into Investment Grade (various grades) or Non-Investment Grade (junk bonds). For example, using S&P ratings, anything less than a BBB is junk. (I suspect that a farming co-operative offering a fruit box as a coupon, could be put into the category of ‘junk bonds? These type of bond/debt arrangements are now, apparently, very popular with start-ups and SME’s looking for investment) Market risk The income/coupon from a bond remains unchanged throughout the term. Yields vary to reflect interest rates rising or falling by a fall or rise in its capital value (par=100). (Fruit boxes could also be susceptible to a number of other, as yet unquantifiable biological risks as well….!) Volatility/Sensitivity Bond prices will not all change by the same amount when interest rates or yields change – they are all made up of different coupons and terms. The measure used to calculate how sensitive the bond is to changes in interest rates or yield, is known as duration or modified duration (see more on that in the next section).

Answer 85

Interest rate risk/duration risk Reinvestment risk Default risk Downgrade risk Systematic risk Liquidity risk Political risk

Answer 86

Flat yield £3.75 / £151.64 = 2.47% x 0.6 = 1.48% GRY £51.64 loss on redemption / 33 years = 1.56% /£151.64 = 1.03% 1.48 – 1.03 = 0.45%

Answer 87

- The amount of time - In years - Required to regain the cost of a fixed interest security - Taking into account flat yield/coupon - And return of capital on redemption - For every 1% movement in interest rates (up or down) the bond value will move by the value of its modified duration in the opposite direction. - The higher a bond’s duration, the more sensitive it is to interest rate changes. - However, due to convexity, duration is likely to underestimate rises in value and overestimate falls in value.

Answer 88

- It would reduce the value of the bond - By 12.5 / 10 = 1.25% - From £132.50 by £1.65625 down to £130.84.

Answer 89

When interest rates rise, the prices of fixed interest bonds, such as gilts, will fall – this is your see-saw correlation effect. When interest rates rise (or fall), the prices of longer- dated gilts, will fall (or rise) by a greater proportion, as defined by your modified duration calc.

Answer 90

This is the risk that as one gilt matures, you can’t reinvest back into another gilt giving the same rate of interest due to changes in the market and interest rates. This is of particular concern to investors relying on income who have gotten used to a certain level of income and can now no longer continue that level of income without taking on more risk.

Answer 91

This is the risk that the government defaults on either its coupon to you, or on the return of capital at maturity. This is a very low risk with gilts. However, the UK was downgraded to an AA credit rating after the Brexit vote by S&P, and some governments such as Russia, Greece, and Argentina have defaulted in the past.

Answer 92

This is the risk that the UK’s credit rating is downgraded, which could increase yields on existing bonds as investors demand a higher return for the higher perceived default risk. The UK was downgraded to AA by S&P shortly after the Brexit vote, following by Fitch and Moody’s, although it should be noted that impact was minimal in the markets on these occasions.

Answer 93

This is the risk of a global crisis causing most/all asset classes to fall together, with converging correlation coefficients (trying saying that three times fast!) such as we saw in 2008. However, it’s important to note that UK gilts were fairly stable during the crisis, while corporate bonds tanked.

Answer 94

The possibility that an investor may not be able to buy or sell an investment as and when desired or in sufficient quantities.

Answer 95

A change in government policy could reduce the real return on gilts, for example, by the removal of the personal savings allowance, or an increase in income tax.

Answer 96

Conventional gilts pay interest and redemption of the nominal capital in fixed amounts of pounds. These payments are eroded in terms of purchasing power by inflation over the holding period to maturity. If the government expands the money supply with continued QE, this could be a longer term risk.

Answer 97

Flat yield £3.75 / £151.64 = 2.47% x 0.6 = 1.48% GRY £51.64 loss on redemption / 33 years = 1.56% /£151.64 = 1.03% 1.48 – 1.03 = 0.45%

Answer 98

- The amount of time - In years - Required to regain the cost of a fixed interest security - Taking into account flat yield/coupon - And return of capital on redemption - For every 1% movement in interest rates (up or down) the bond value will move by the value of its modified duration in the opposite direction. - The higher a bond’s duration, the more sensitive it is to interest rate changes. - However, due to convexity, duration is likely to underestimate rises in value and overestimate falls in value

Answer 99

- It would reduce the value of the bond - By 12.5 / 10 = 1.25% - From £132.50 by £1.65625 down to £130.84.

Answer 100

1. Fixed price: a fixed price is stated and offered on that basis (sometimes this initial price is set low to encourage take up) 2. Tender: investors make bids and applications with the highest bids accepted (and normally all purchased at same price) 3. Placing: similar to an offer, but where the shares are only offered to selected investors (pension funds, investment houses)

Answer 101

I’m going to use Gordon’s Growth Model (GGM) to calculate the share prices, which is a method of share valuation using dividend flows. The following formula is used: So in the case of the above: 6p / (0.10 – 0.07) = 200p If I were a value manager, I would buy/hold because the current share price suggests the shares are undervalued. Other valuation methods are also tested. You will also need to understand how to calculate share price based on net asset value (NAV) and Earnings Growth (PEG ratio). You need to have an awareness of the Shareholder Value model, but as far as I’m aware, you don’t need to know how to calculate this.

Answer 102

5p / (0.15 – 0.12) = 166.67p If I were a value investment manager, I might sell this share because it’s currently priced at 200p and GGM is suggesting its value is only 166.67p, and thus is overvalued.

Answer 103

- It assumes constant growth in dividend per share, which is rare for companies. - It bases the valuation on dividend flow, which therefore renders it less useful for valuing smaller “growth” oriented stocks. - If the required return is less than the dividend growth rate, the result is a negative value - If the required return is equal to the divided growth rate, the model also collapses due to the share value being theoretically infinite. On my Casio fx-82MS, it says “Math Error”

Answer 104

Straight AER calculations: Account A: (1+ 0.061 / 4)^4 – 1 = 6.24% Account B: (1+ 0.06 / 12)^12 – 1 = 6.17% The quarterly account (Account A) therefore delivers the stronger returns in this case.

Answer 105

- Duration represents the time it takes - In years - For a bond investor to recover their initial investment - Taking into account coupon/interest payments - And the capital repayment on redemption - It is used as a measure of the bond’s sensitivity to interest rates, - For every 1% change in interest rates, bond prices will move the opposite way by the amount of their Modified Duration. - The formula is as follows: Macaulay duration Modified Duration = (1 + GRY) - Due to convexity, Modified Duration will tend to underestimate rises in value and overestimate falls in value.

Section 2 - Cash and Fixed Interest Securities Flashcards

(130 cards)