a reward to risk ratio that looks at systematic risk only
What is Jensen's Alpha?
the excess return above or below the security market line. A measure of how much the portfolio beat the market
What is a discount rate?
the interest rate that the FED offers to commercial banks for overnight reserve loans
What is the federal funds rate?
The interest rate that banks charge each other for overnight loans of $1 million or more
What is a U.S. treasury bill?
A short term U.S. government debt instrument issues by the U.S. treasury
What is LIBOR?
The london interbank offered rate- the interest rate that international banks charge one another for overnight eurodollar loans.
What are eurodollars?
U.S. dollar dominated deposits in banks outside the United States
What is interest rate risk?
long term prices are much more sensitive to interst rate changes than short term bonds.
What does the modern term structure theory suggest?
that nominal interest rate is equal to the real interest rate + the inflation premium + the risk premium
What is the importance of Return on equity?
1.)higher ROE may reflect higher margin
2.)higher ROE may reflect higher asset turnover
3.)higher ROE results in higher sustainable growth rate
What is the yield to maturity of a bond?
-the discount rate that equates the todays bond price with the present value of the future cash flows of the bond
-it is the promised yield as long as there is no change in bond price or as long as the bond is held to maturity
What are the 3 basic relationships between bond price and their yield described by Malkiel's theorems?
1.) bond prices and bond yield move in opposite directions, (yield increases, price decreases)
2.) longer term bonds are more sensitive to changes in yield than shorter term bonds
3.) lower coupon bonds are more sensitive to changes in yield than higher coupon bonds
What does macaulay duration measure?
the sensitivity of a bond price to change in bond yields, (two bonds with the same duration do not nessesarily have the same maturity but the do have about the same price sensitivity to a change in bond yield)
What is reinvestment risk?
the need to reinvest bond coupons at the future interest rates that are not known in advance
What is price risk?
the risk the bond prices will decrease.
What can duration matching do?
it can immunize a dedicated portfolio
What is duration matching?
matching the duration of the portfolio to its target date. Thus the impacts of price and reinvestment risk almost offset.
What happens to interest rates after a portfolio is immunized?
changes in interest rate will have minimal impact on the target date value of the portfolio
What is a call provision?
it allows the issuer to buy back all or part of its outstanding bonds at a specified call price sometime before the bonds mature
What is a put provision?
grants bondholders the right to sell their bonds back to the issuer at a specified price, usually its par value.
What are sinking funds?
an account that is used to provide scheduled redemptions of outstanding debts. provides security for bondholders and sometimes they can recieve their pricipal back before maturity
What is convertable provision?
it allows a bondholder the right to exchange each bond for a designated number of common shares
What are senority provisions?
the bonds that were issued first have claim to the issuers assets first
What is VaR and what does it assume?
value at risk-
it evaluates the probability of significant loss, a measure of investment risk. Assume fixed time horizon and specified probability.
When does price risk arise?
in dedicated portfolios when the target date value of a bond is not known with certainty.
What is the difference between long term and short term bonds?
Long term bonds have more interest rate risk due to their longer maturity length