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FIN 3504 Chapter 2
Investments Analysis - Exam 1
30
Finance
Undergraduate 4
02/10/2010

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Term
Financial Security Types
Definition
- Money market (cash)
- Bonds (fixed income)
- Stocks (equities)
- Derivatives
Term
Money Markets
Definition
- Short-term (< 1 year maturity)
- Little or no default risk
- Very liquid / marketable
- Subsector of the debt market
- Many trade in large denominations and are out of reach of individual investors
Term
U.S. Treasurer Bills
Definition
- $1,000 and up
- 28, 91, 182 days (1,3,6 months)
- State and local tax exemption
- Short-term government securities issue at a discount from face value and returning the face amount at maturity
- Most marketable of all money market instruments
- Highly liquid
Term
Certificates of Deposit (CDs)
Definition
- FDIC insurance (up to $100K)
- Secondary market trading (>$100K)
- Time deposit
- bank time deposit
- May not be withdrawn on demand
- Bank pays interest and principal to the depositor only at the end of the fixed term of the CD
- Short-term are highly marketable, but maturities of 3 months or more have less market
Term
Commercial Paper
Definition
- Less than 270 Days (avoid SEC registration)
- Secondary market trading
- Short-term unsecured debt issued by large corporations
- Considered a fairly safe asset because a firm's condition presumable can be monitored and predicted over such a short term
- Very liquid - trades in secondary markets
Term
Banker's acceptance
Definition
- an order to a bank by a customer to pay a sum of money at a future date
- Usually within 6 months
Term
Eurodollars
Definition
- $US-denominated foreign deposit
- Dollar-denominated deposits at foreign banks or foreign branches of American banks
- Most are for large sums
- Usually less than 6 months
Term
Repos / Reverse Repos
Definition
- Typically overnight
- Repo: sell securities w/ agreement to buy back (borrow)
- Reverse repo: buy securities w/ agreement to sell back (lend)
- Repurchase agreements
- Short-term sales of government securities with an agreement to repurchase the securities at a higher price
- Reverse repo - dealer finds an investor holding government securities and buys them with an agreement to resell them at a specified higher price on a future date
Term
Fed Funds
Definition
- Overnight loan between banks
- Funds in the accounts of commercial banks at the Federal Reserve Bank
Term
LIBOR
Definition
- London Interbank Offer Rate
- Lending rate between large British banks
- Quoted in dollars and other currencies
- 1,3,6,12 month
- Widely used as a reference rate (swaps, ARMs, etc.)
- Become the premier short-term interest rate quoted in the European money market
- Reference rate
Term
U.S. Federal Agency Debt
Definition
- Mortgages: GNMA and FHLB
- Quasi-agency: FNMA and FHLMC
- SLMC privatized over 1997-2004 to become Sallie Mae
Term
International Bonds
Definition
- Sovereign debt
- Eurobond - different currency than country in which issued
- Other bonds are issued in foreign country and currency - Yankee bond: issued in US in $US by non-US issuer
Term
Municipal Bonds
Definition
- Munis
- Issued by state and local governments
- Revenue vs. general obligation bonds
- Interest free from federal taxation (and state/locale of issue)
- Tax-exempt bonds issued by state and local governments
- Capital gains taxes must be paid if the bonds mature or are sold for more than the investor's purchase price
- General obligation bonds - backed by the "full faith and credit" of the issuer
- Revenue bonds - issued to finance particular projects and are backed either by the revenues from that project or by the municipal agency operating the project (riskier than general obligation bonds)
- Industrial development bond - revenue bond that is issued to finance commercial enterprises, such as the construction of a factory that can be operated by a private firm
Term
Corporate Bonds
Definition
- Typically structured like treasuries
- Most commonly: subordinated debentures (general obligation)
- Default risk concerns
- Other features: call provisions, convertibility, etc.
- Long-term debt issued by private corporations typically paying semi-annual coupons and returning the face value of the bond at maturity
Term
Asset Backed Securities (ABS)
Definition
- Pool of financial assets used to back new security (great flexibility on structure)
- Mortgage-backed securites (MBS) most common
Term
Common Stock
Definition
- Limited rights (voting rights at annual meetings and possibly other major issues, pro rata share of dividends)
- Residual claim (equity = assets - liabilities; going concern vs. liquidation value)
- Limited liability
- Double taxation of dividends
- Preferential tax treatment of capital gains
- Ownership shares in a publicly held corporation; shareholders have voting rights and may receive dividends
- Elect a board of directors to control the corporation - select managers to run the corporation on a daily basis
- Residual claim - stockholders are the last in line of all those who have a claim on the assets and income of the corporation
- Limited liability - the most shareholders can lose in event of the failure of the corporation is their original investment
Term
Preferred Stock
Definition
- Defined dividends (no guarantee, cumulative - must be paid before any common stock dividends)
- No voting rights
- Held only by other corporations (70% dividend exclusion rule)
- Nonvoting shares in a corporation, usually paying a fixed stream of dividends
Term
Depository Receipts
Definition
- ADRs trade foreign shares on US exchanges
- Not common now that foreign markets are more accessible
Term
Contingent Claims
Definition
- Value derivers from changes in the value of the underlying asset
- Used to manage risk
- Used to speculate (leveraged investment)
- Three major types (options, futures/forwards, swaps)
- A security with a payoff that depends on the prices of other securities
Term
Options
Definition
- Call Option - the rights to buy an asset at a specified price on or before a specified expiration date
- Put option - the right to sell an asset at a specified exercise price on or before a specified expiration date
- fixed exercise or strike price
- Specific quantity or volume of asset (contract size)
- Maturity / expiration date
- Used to speculate or to manage risk (calls gain in value as prices rise, puts gain in value as prices fall)
Term
Futures/Forwards
Definition
- Promise to buy/sell an asset at a future date (long position - promise to buy, short position - promise to sell)
- Fixed price
- Specific quantity or volume of asset (contract size)
- Maturity / Expiration date
- Used to speculate or to manage risk (long positions gain in value as prices risk, short positions gain in value as prices fall)
- Exchange traded
- Forwards are over-the-counter (OTC) or broker/dealer market
- Obliges traders to purchase or sell an asset at an agreed-upon price at a specified future date
Term
(market) value-weighted
Definition
- Most indexes
- Based on market cap (# shares x price per share)
- S&P 500: 500 large corporations
- Wilshire 5000: all NYSE, AMEX and NASDAQ (actively traded)
Term
Dow Jones Industrial Average (DJIA)
Definition
- Holdover from ancient times (1896)
- Price-weighted index
Term
equally-weighted index
Definition
- Matches many investor's behavior (split money evenly across investments)
- Problem with rebalancing
Term
Indexes/Indices
Definition
- try to capture/represent a market
- some capture a large part of the market and some only a small part
- competing indexes
- attempt to define and track some segment of the securities market
- most are value-weighted
Term
price-weighted indexes
Definition
- worse way to measure markets than value-weighted indexes
- created in 1896, only knew the price each stock traded at
Term
Lehman Brothers
Definition
- Fixed income
- Government
- Corporate
- ABS
- now known as Barclays Capital Aggregate Index
Term
MSCI
Definition
- Morgan Stanley Capital International
- World index
- EAFE (Europe, Australia, Far East)
Term
Treasury Notes or Bonds
Definition
Debt obligations of the federal government with original maturities of one year or more
Term
Price-weighted average
Definition
An average computed by adding the prices of the stocks and dividing by a "divisor"
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