Investment Midterm - From HW
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The price at which a dealer is willing to pay to purchase a security.
The price at which a dealer will sell a security.
Debt obligations of the federal government that make semiannual coupon payments and are issued at or near par value.
Ownership shares in a firm.
Ownership in a firm. Also, the net worth of a margin account.
Mutual fund holding shares in proportion to their representation in a market index such as the S&P 500.
The amount by which the sale price of a security exceeds the purchase price.
Yield to maturity
A measure of the average rate of return that will be earned on a bond if held to maturity.
Par value / principle
The face value of the bond.
A bond's interest payments per dollar of par value.
Default risk (The possibility that a bond issuer will default, by failing to repay principal and interest in a timely manner. Bonds issued by the federal government, for the most part, are immune from default (if the government needs money it can just print more). Bonds issued by corporations are more likely to be defaulted on, since companies often go bankrupt. Municipalities occasionally default as well, although it is much less common.
Investment grade bonds
Bond rated BBB and above or Baa and above. Lower-rated bonds are classified as speculative-grade or junk bonds.
Speculative-grade (junk or high-yield) bonds
Bond rated Ba or lower by Moody's, or BB or lower by Standard & Poor's, or an unrated bond.
A differential in promised yield that compensates the investor for the risk inherent in purchasing a corporate bond that entails some risk of default.
term structure of interest rates
the pattern of interest rates appropriate for disconting cash flows of various maturities
pure yield curve
refers to the curve for stripped, or zero-coupon, treasuries
on-the-run yield curve
refers to the plot of yield as a function of maturity for recently issued coupon bonds selling at or near par value
- the yield to maturity on zero-coupon bonds
- meaning the rate that prevails today for a time period corresponding to zero's maturity
- the current interest rate appropriate for discounting a cash flow of some given maturity
- the short rate for a given interval refers to the interest rate for that interval available at different points in time
- a one-period interest rate
forward interest rate
- rate of interest for a future period that would equate the total return of a long-term bond with that of a strategy of rolling over shorter-term bonds. the forward rate is inferred from the term structure
- the interest rate (f) that would need to prevail in the second year to make the long- and short-term investments equally attractive, ignoring risk
- compensates short-term investors for the uncertainty about the price at which they will be able to sell their long-term bonds at the end of the year
- forward rate minus expected future short interest rate
- equals the weighted average of the times until each coupon payment or principal payment made by the bond with weights proportional to the present value of the payment
- effective maturity of bond
- Macaulay's duration divided by 1+yield to maturity
- measures interest rate sensitivity of bond
- the curvature of the price-yield relationship of a bond
- can be quantified as the rate of change of the slope of the price-yield curve
immunization techniques refer to strategies used by such investors to shield their overall financial status from exposure to interest rate fluctuations
- realigning the proportions of assets in a portfolio as needed
- as interest rates adn asset durations change, a manager must rebalance the portfolio of fixed-income assets continually to realign its duration with the duration of the obligation
- asset durations will change solely because of the passage of time even if interest rates do not change
- research to predict stock value that focuses on such determinants as earnings and dividends prospects, expectations for future interest rates, and risk evaluation of the firm
- consider the business environment in which the firm operates
- the recurring pattern of recession adn recovery
- the economy recurrently experiences periods of expansion and contraction, although the length and depth of those cycles can be irregular
industries with above-average sensitivity to the state of the economy
- industries that have little sensitivity to the business cycle
- industries that produce goods for which sales and profits are least sensitive to the state of the economy
degree of operating leverage DOL
percentage change in profit for a 1% change in sales
shift the portfolio more heavily into industry or sector groups that are expected to outperform based on one's assessment of the state of the business cycle (macroeconomic forecasts)
industry life cycle
- start-up state - extremely rapid growth
- consolidation state - growth that is less rapid, but still faster than that of general economy
- maturity stage - growth no faster than the general economy
- stage of relative decline - grows less rapidly than the rest of the economy, or actually shrinks
- net amount that could be realized by selling the assets of a firm after paying the debt
- represent amount of money that could be realized by breaking up the firm, selling its assets, repaying its debt and distributing the remainder to the shareholders
- if the market price of equity drops below liquidation value, the firm becomes attractive as a takeover target, which could lead to liquidation after taken over
intrinsic value V0
present value of all cash payments to the investor in the stock, including dividends as well as proceeds from the ultimate sale of the stock, discounted at the appropriate risk-adjusted interest rate, k
dividend discount model (DDM)
a formula stating that the intrinsic value of a firm is the present value of all expected future dividends
plowback ratio / earnings retention ratio
- the proportion of the firm
- s earnings that is reinvested in the business (and not paid out as dividends).
- the plowback ratio equals 1 minus the dividend payout ratio
present value of growth opportunities (PVGO) / net present value / NPV
net present value of a firm's future investments
price-earnings multiple / price-earning ratio / P/E multiple
the ratio of a stock's price ot its earnings per share
a financial statement showing a firm's revenues and expenses during a specified period
an accounting statement of a firm's financial position at a specified time
statement of cash flows
a financial statement showing a firm's cash receipts and cash payments during a specified period
the real flow of cash that a firm could pay out forever in the absence of any change in the firm's productive capacity
return on equity (ROE)
an accounting ratio of net profits divided by equity
return on assets (ROA)
a profitability ratio; earnings before interest and taxes divided by total assets
return on sales (ROS) / profit margin
the ratio of operating profits per dollar of sales (EBIT divided by sales)
times interest earned
ratio of profits to interest expense
a ratio representing the ability of the firm to pay off its current liabilities by liquidating current assets (current assets/current liabilities)
net asset value (NAV)
the value of each share expressed as assets minus liabilities on a per-share basis
open-end (mutual) fund
a fund that issues or redeems its own shares at their net asset value (NAV)
a private investment pool, open to institutional or wealthy investors, that is largely exempt from SEC regulation and can pursue more speculative policies than mutual funds
high water mark
the previous value of a portfolio that must be reattained before a hedge fund can charge incentive fees
exchange-traded fund (ETFs)
offshoots of mutual funds that allow investors to trade portfolios of securities just as they do share of stock
effective-annual rate (EAR)
interest rate is annualized using compound rather than simple interest
- an expected return in excess of that on risk-free securities
- the premium provides compensation for the risk of an investment
A risk-averse investor will consider risky portfolios only if they provide compensation for risk via a risk premium
a risk-neutral investor finds the level fo risk irrelevant and considers only the expected return of risk prospects
a risk lover is willing to accept lower expected returns on prospects with higher amount of risk
an asset with a certain rate of return; often taken to be short-term t-bills
the interest rate that can be earned with certainty
bell-shaped probability distribution that characterizes many natural phenomena
spreading a portfolio over many investments to avoid excess exposure to any one source of risk
systematic risk / market risk
risk factors common to the whole economy, nondiversifiable risk
firm-specific risk / diversifiable risk
risk attributable to firm-specific risk, or nonmarket risk
graph of the lowest possible portfolio variance that is attainable for a given portfolio expected return
the portfolio of risky assets with lowest variance
portfolio opportunity set
the expected return - standard deviation pairs of all portfolios that can be constructed from a given set of assets
ratio of excess return to portfolio standard deviation
optimal risky portfolio
an investor's best combination of risky assets to be mixed with safe assets to form the complete portfolio
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