3120 Exam 2 Notes - PDF

APTER 6 UNDERSTANDING FINANCIAL MARKETS financial markets the arenas throughwhich ends now two major dimensions primary marketsmarkets in which corporations raise anas through newissues of securities investment banksbanks thathe...

APTER 6 UNDERSTANDING FINANCIAL MARKETS financial markets the arenas throughwhich ends now two major dimensions primary marketsmarkets in which corporations raise anas through newissues of securities investment banksbanks thathelp companies and governments raise capital arrangemost primary market transac tor businesses commercial banks depository institutions whose major assets are loans and major liabilities are deposits corporations or government entities often have a new project or expanded productionneeds but donot na enough capital these entities sellthe new financial instrument issues to initial and suppliers in exchange to the capital required investment banks intermediate between issuing parties and demanders and investors fund suppliers primary market financial instruments include stock issues from firms ininally goingpublic initial public p I securities ma a firms may issue additional bones or stocks as primary market secondary markets markets that trade financial instruments once they are issued NYSE NASDAQ markets exist for stocks bonds as wellas instruments backed by mortgages foreign exchange suturessoph is a centralized marketplacesaving search costs often uses securities brokers provides liquidity and diversification forinvestors provide security valuation into issuers tradingvolume of shares of a security that are simultaneously bought and sold during a givenperiod each buyer and seller contract w exchange's clearinghouse whichthen matches sell and buyorders for each transaction Both money capital markets deal in debt securities capital mancets also dealin equity but the marketsdiffe withrespect to when the securities come are moneymarketstrade debt securities instruments w maturities lessthan oneyear agents w excess shortterm funds can iena or supply to economic agents who need or demand short anas suppliers of anas buymoney market instruments demanders of anassell them avenationsof secondary market prices are usually quite small less risky than longterm investments money market securities treasury bill snow term us government obligations federal funds shortterm anas transferred between financial institutions typically a day repurchase agreements repo agreements involving security sales from one party to another with the promise to reverse the transactionat a specified date andprice usually discounted commercial paper shortterm unsecured promissory notes that companies issueto raiseshortterm cash negotiable certificate of deposit bankissuedtime deposits thatspecify an interest rate maturity date that are negotiable traded on an exchange 100000 banker acceptances Bas bankguaranteed time drafts payable to a vendor ofgoods  capital markets tradedebt and eaving instruments w maturities greaterthan oneyear longer maturities result in wider price fivanations than money market instruments size of market depends on 1 number of securities issued 2 market prices of those securities CAPITAL market instruments treasury notes andbonds us treasury longterm obligations issued to finance the national debt pay for other federal government expenditures us government agency bonds longterm debtsecurities conaterized by a pool of assets and insured by agenc ot us government state local gov't bonds debtsecurities issued by state local governments usually tocover capital longterm improvements mortgages longterm loans issued to individuals or businesses to purchase homes pieces of land or other realesta mortgage backed securities longtermdebt securities that offer expected principal and interest payments as conateral these securities made upof many mortgages are gathered into a pool andare thus promised principal b by andinterest cashflows corporate bonds longterm debt securities issued by corporations corporate stocks longterm equity securities issued by public corporations stock shares represent fundamental conor ownership claims ost companies operateglobally events movements in foreign markets affect profitability performance reign exchange markets mancets trade currencies for immediate spot or some are stated delivery reign exchange risk arises from the unknown valueat which foreign currency cashflows can be convened into us donaus erivative security financial security ex wives contract option contract or mortgage backed securities w a value that is linked to another undenying security such as a stock traded in capital mancets generally feature high leverage traders can beusers of derivative contracts or dealers that act as counterparties in customer trades forfeesused for hedging speculating riskiest financial security mancet nancial institutions perform the essential unction of channeling funds from those w surplus tends to those w shortages o funds allow fin markets to function by providing the least costly and most efficient ways to channel tends to and from these markets spread risk among mancer participants Intiffinainsa institutions we would have direct transfers of fundsfrom suppliers tousers directflow of equity deb curities nancial intermediaries indirectly transfer funds to vitimate and users as an alternative indirectway for investors to nanneltends to users is aggregation of funds from and suppliers resolves problems relegated monitors have greater incentive to connect into monitor the enduser's actions  asset transformers is purchase financial claims that and users issue and finance the purchase by selling financial claims to household investors as deposits insurance policies or other secondary securities AWAY FROM RISK MANAGEMENT regulatory changes in the 1980s 1990s increased systemic risk of the financial system shift in the banking model from that of originate hold to originate distribute originate hold when banks take shortterm sources of funds and use them to fund longer term loans originate distribute when banks originatewarehouse loans and then quickly sell them bank loan sales have increased dramatically over the last several decades RESTRATES nominalinterestrates observed in financialm arkets and are most often quoted by financial new services loanable funds theory equilibrium interest rates in financial markets as a result of the supply of and demand for loanab anas supply of loanable funds anasprovided to the financialmancets by net suppliers of funds move was supplied as interest rates increases demand for loanable anas the total net demand for funds by tuna users more was demanded as interestrates decrease equilibrium interest rate interestratesthat equates the aggregate quantity of loanable funds supplied and loanable funds demanded for financial security Factors mat shift sad curve supply Factor impacts impact e interestr ate along curve direct I I Ii economicconditions shift inverse T.IE n iii in shift direct Eticiveresaines snift inverse economic conditions shift direct  III I innit c a II a base of goods services throughout the economy as a whole real riskfreerate riskfree rate adjusted for inflation generally lower than nominal riskfreerate at any particular time default risk risk that a security issuerwill miss an interest or principal payment or continue tomiss suchpayments liquidityrisk risk that a security cannot be soldat a price relatively close to its fairmarket with low transactioncosts on shortn otice special provisions provisions taxability convertibility canability thatimpact a security holder beneficially or adversely and as soon reflected in the interest rates on securities that contain such provisions time to maturity length of time until security is repaidused in debt securitiesas the date upon which security holders get their principal back Hationcontinualincrease in the pricelevel of a standardized basket of goods services higher inflation higherinterestrates annual initiation Celt t too at riskfree rate therate that a risk free securitywould pay if no inflation were expected over its holding period fisher effect relationship among real riskfreeratesRFR expected inflation expectedIP and nominal riskfree rates default risk risk that a will default on that security by being late on or missing an interest or security issuer principal paymenthigherdefault risk higherinterest ustreasury securities are generally considered to be free of default risk DRP in it quidityriskriskthat a security cannot be sold at a fair market price with low transaction costs on shortnoticeinterestrate on security reflects its relative liquidity highliquid assets low interestrates liquidityriskpremium are added to interestrate it security isilliquid ERAL EQuation i IP RFR DRPLRP scp me ip inflation premium mn LRP liquidity risk premium see special covenant premium me maturity premium EE YIELDCURVE THEORIES 1 unbiased expectations the ye reflects the market's current expectations of future shortterm rates 2 Liquidity premium investors hold long term maturities only if these securities are offered at a premium to compensate for future uncertainty in value  3 market segmentation investors s have specific maturity preterences and convincing them to hold securities w maturitieshigher thanwhat'sperterre requires a nigher interest rate CODING FIXED INCOME bond debt security when you purchase a bond you lend money tothe issuer of the bond in return the issuer age to payyou a specified rate of interest over the length of the bond and to repay the face value principal when reaches maturity interest ratecoupon payment of facevalue paid to the investor as compensation for lending theirmoney yield average return the investor will recieve from the date theytrade the bond until it matures aprice what the investor recieves when they sell and theask iswhatthey pay to purchase the bond has mature 100 par oremium bonds bonds trading above par iscount bonds bonds trading below par accruedinterest interest that accumulates from the date of the last coupon payment to the day the bond is bought or so callablebond bond that can be redeemed eany ullet bond bond that cannot be redeemed early of bond investor has the right to return put bond to issuer utilized it rates increase bond price fallen investor could put back at par and reinvest at higher rates call risk to investor put protection to investor NCIPAL v AVERAGE LIFE principal bondpays interest throughout lifeof bond and repays principal at maturity ex IBMbond typically treasury agency corporate andmunicipal average life bondlike mortgage backed securitiesMBS paysinterestthroughout lifeof the bond but the issue is also retired throughout the life of the bond as thepool of mortgages that secure the bond arealso prepaid typical miss asset backed securities characteristics issuer price couponcrate maturity nature crest rates YIELDcurve Bondrisk 1 when rates rise bond price calls 2 when rates fall bond price rises 3 All bondshave interest rate risk me Federal reserve is responsible for setting rates and monitoring the economy  rateset bythetea and is what bankscharge other banks to effective federal fundsrate LEFER borrow their excess reserves deposited at thered To maintain the EFFR thered abuys sells securities Fedbuys treasury securities bank reservet EFFR Fed sellstreasury securities bank reserve EFFET ELD CURVE most recently auctioned 2 3 5 7 10 30year notes and bonds graphed w yieldly and term x THREE main shapesshape measured quoted bythe difference between the 2 yr ustnote andthe coyearustnote 2110 upwardslopingnormal normal because shorter bondsyield lessthan longer bonds 2 Hat signifies uncertainty in the manat short term bonds yield similarly to longert erm bonds ex us yield 3 negative short term notes yieldless than longterm precursor to recession W TO ANALYZE BONDS fixed rate coupon most common type of coupon never changes throughout the lifeof thebondprincipal pays at maturity floating rate coupon variable rate coupon Hoats w a set spreadamount of basis point aboveindex at reset to an unde index zero couponissued at a deep discount to par does not pay a coupon at maturity the income isthe difference between the purchase price and par at maturity t bill common zero coupon treasury commercial paper most common corporate zero yield to maturity YTM average return of a bondmostcommonused yieldquote YM accounts thatbonds mature at par PARBOND couponrate current yield am PremiumBOND couponrate current yield um Discount Bond couponrate current yieldcyim yield to cancytes yield calculation used it a bond has an embedded callo ption PARBond coupon rate yte premiumBond couponratesYtc DiscountB OND couponratecytc ield to worst YTW the lower yield of atm andyte if the bond does not have an embedded calloptioncytes thenYMYTW PARBond youYIM YTC PremiumBOND ytwyte Discount BOND yin yim duration main determinant of fixed income pricerisk threemain types of duration calculations a maculayDuration least used duration calculation and measured in years 2 modified duration most often used duration measure expands on macaway duration by measuring price sensitivity bond for 100basis point shift in underlyingrates 3 effectiveduration optionadjustedduration oas duration calculation utilized when a bond has an embedded callable option requires complex program for calculation  Principles of Duration 1 Duration should be the risk measure of a bond to be analyzed 2 the higher the duration the higher the risk morepricesensitivity 3 the higher the coupon the lower the duration 4 as a bond gets closer to maturity duration decreases and is therefore less sensitive to interest rate movements 5 use modified duration over maculayDurationmod a measures responsiveness of price to changes in underlyinginterest not just the amount of time it takes a bond to recoup its cost likemaca 6 use effective duration over mod a when the bond has an embedded call option Effective duration consia the call option when pricing the bond 7 as interest rates increase duration decreases and thus the bond is less sensitive to corner rateincreases asury a corporate securities treasury bills t bills issued in maturities of aweek sweek 13week 26week and52week as well as cash management bills issued at a to par discount so does not pay a coupon as the snonest of us treasury securities issued highest quality bonds in the world Tbills are considered treasurywoese.me fixed rate principal coupon bullet securities notes 2 3.5.7 coyear Bonds 30year issuer us treasury ust Bid price for which the security is sold ask price by which the security is bought the tight bidask spread is emblematic of us's strong credit worthiness change difference win the current trading day's bid price and the bidprice of the preceding day yield am b c ust bonds notes are not callable treasuries act as a reference rate by which all other securities especially corporate bonds trade Treasury risk at a GLANCE creditdefault risk none no liquidity risk treasuries are backed by the full faith and credit of the us govt consid the safest in the world call risk none as they are not callable eventrisk treasuries are flight of quality instruments in highvolatility investors purchase treasuries to minimize losses no riskier assets inflationrisktreasury yields may not keep up w inflation opportunity risk they are issued w the lowest coupons when interest rates are increasing thelonger the term ofthe treas the more significant the decrease in price thus harder to take advantage of more attractive opponuni should they become available like eBay Google mcdonalds IBM apple netflix etc issuedby corporations typically issued by 1 2 3 5,7 10 and so year denominations  corporate bonds are divided intothree groups 2 shortterm notes maturities up to 5years 2mediumterm notes maturities of 5 12years 3 congterm notes maturities greaterthan 12years coupons can be fixed floating or zerocoupon fixed rate majority of new issue corporate bonds arefixedrate principal bonds Hoatingrate bonds typically issuedin the 2 year maturity denomination zerocoupon issued at a discount to par like tbills and as maturity nears the pricewill get closer to par b c of their high minimum denominations are typically onlyused by moneymarket funds corporate Bond risk at a ocance creditdefault risk varies by bond depending on profile of the company investment grade bonds are BBB and above high yield credits are BB and above due to enhanced risk the liquidity can vary in times of economic and market distressbe very illiquid call risk bonds can be issued w a call option if interest rates decrease after issue the risk in bond is called increases event risk significant mergers acquisitions badearnings breaches of covenantsetc rise and tall the price of secondary bonds will diverge from par inflation risk as interest rates opportunity risk the longer the term the higher the risk that bondprice will fall making it difficult to seize higheryielding bond opportunities w o taking a loss CODING stocks ny do companies issuestock pay off debt launch new products expand into new markets or regions enlarge facilities or building new ones ny do investors buy stock capital appreciation as stock prices rise dividend payments used for income ability to vote and intive a company outpace inflation ii ownership when you buy a share of stock you are buying ownership in that company the goal for buying stock is to make money dividends dividendsdistributed earnings by the company capital gain investor demand stocks demand are based on their future performance WHATmoves stocks 2 fiscal monetary policy 4 job s consumer confidence inflation 2 geopolitical events 9111 hurricanes 5 utility price energy 3 politics congress 6 corporate profits SINESS CYCLES goods services rises of goods services tails employment T unemployment employment unemployment new construction rises new construction falls inflation rises inflation falls peak of cycle last month before indicators employment output retail sales beginto fall trough of cycle last month before indicators begin to rise ES OF stock common stocks ownership equity votingrights you want capital appreciation facesmost risk mostreturn share price volatile dividends not guaranteed dividend amount may rise w increase company payments preferred stock no voting rights highercapital structurenot fixed income shareprice not volatile dividends guaranteed fixed amount bought for totali ncome smallappreciation dividend payments w stocksare DESCRIBED companysize companysize is known as market capitalization marketcap refers to donaramount of the company of outstanding shares currentmarket price no fixed cutoff points designated as m il small cap mv 250 2bn mid cap mr 2bit 10bn largecap mv 10bit 200bi microcap mv 250mi pennystock 5 snare type company type also known as their industryor sector most common sector industrial utility financial industry an example would be banics as an industry in the financial sector economic events often affect an entire industry ex nigngas prices nun transportation industry profits ex a new wie affects pharmaceutical industry some industries sectors may be more in favor because of an excitinginnovation makingthemmore popular over another industry sector industries and sectors tend to go through cycles successful stock portfolio is over part of a u nderweigning various industries and sectors when economic conditions are appropriate performance during market cycles known as defensive or cyclicalstocks difference is nowtheirprofits and therefore their stock prices react to changes in the economy defensive stocks that exhibit lowvolatility things youalways need ex nygenic products pharmaceuticals cyclical stocks that perform well during periods of economic prosperity underp erform duringrecessions potential for short longterm growth growth fasterthan average mancetearnings value price to earnings incomestocks stocks purchased fortheir dividend payments generate consistent income through theirdividendpayments exutilityc ompan contrarian stocks investing inout of fashion stocks thatothers are sellingcontrananinvestors investagainst the prevailing option buylow sellhigh considerable risk requires considerable experience buyingcompaniesthatcanbe requires considerable patience nignlylevered w a serious company recoverymaytakeyears risk of bankruptcy estions to ask WHEN Buxino stocks whatdoes the company do is the company profitable what areits earningspershareEps andpricetoearnings PIE who are its competitors How does it differentiate what are its plans for the future How does it reward investors arnings of company strength per IE angg'indication riceto earnings ratio much investors are paying for each dollar of earnings vac FUNDS Ple vs ETF L go I mutual funds an investment vehiclethatpoof money from investors and then investsthat capitalinto a diversifiedstock portfolio of securities likestocksor bonds ETFs an investment fund that holds a diversified portfolio of securities buttrades on anindex similar to individual stock similarities DIFFERENCES both consist of a diversified asset portfolio diversification reduces risk both can be actively or passively managed by processional management both are fairly liquid mutual funds areboth sold at their net assetvalue Nav ETF shares are bought soldon an index like stocks at marketprices both charge management sees mutual and feeshigher bc theymayinclude sales loads or redemptionfees ETFs have lower expense rations both.mu ficient ua b c of turnover ratio frequent capitalgains distribution ETFs more taxefficient due to inkind transactions thatreduce capitalg ains  ana wIn he prospectus lookat total return notNAV 2 sees 3 R sharpe ratio traynor senson'sApna R 1 Ip Initiition percentage of a tuna's pricemovements that canbe explained by movements in a benchmanindex return sharperatio of.PT sineiiiteerate measures volatilityto assess riskadjusted performance sensen'salpha measures how much a person returns vs overallmarket alpha asset outperforms themarket alpha security is underperforming the market Alpha asset performs consistently w or tracks the mancet 4turnover ratio thehigherratio less taxefficient 5 Betavolatility measures volatility in relation to overallmanat analyze me upon 1 3 5 10yeartotalreturn ANALYZING an ETF 2 Expense ratio now much it costs to trade an ETF 2 assetsunder management 3 pastperformance us benchman 4 Liquidity 5trackingerror a INDEXES on sonesindustrialaverageasia dates isan contains so largest firms standardpoor's500 see500 dates1957 contains 500 stocks that are value weighted and is considered the benchmark index for large stocks contains 80 of all us stocks most watchedby professional traders assagindex Inassae valueweighted greatly influenced by technology stocks that tradeonNassao exmicrosoft intell ussell2000 small stock index organstanley EAFE Europe Australasia and far east containsalmost all internationalstocks SJ QUIZZES Inings to watch as a morgan kicksoffBank Earnings in July many of the biggest cardissuing banks reported an uptick in delinquinces andsaidmore borrowers carried balances over frommonth to month Due to the red rate out banks will be able to pay less interest on deposits but the interest they colle on variable rate loans willlikely also decline  again with rates headed lower the carryingvalue of those securities previously underwater should continue to inch nigher erasing the paper losses III II ii.mil weaematoamaiswona continue to an interest rates from a twodecade high to maintain solid economic growth employers added 254000 jobs last month muchmore than 150000 economists expected it mancedthelargestmonthlyincre sincemarch During much of the inflationary postpandemic boom stocks often quaked temporarily at strongerthanexpected economic data bc traders took such shocks as a sign that the red would tighten monetary policy more aggressively nation comes handinhand with a sharp slowdown in the labor mancet us ii ijiii.is nmtiiiinn Higherincome consumers are driving mostof the growth while middleincome households are beingmore selective aboutspending and lower income consumers are feeling pressure consumers have shifted away from splurges like travel and entertainment lately toward necessities like food and gasoline mortgage rates have been on the rise recently butare still down meany one percentage point from eanier this stock this oained to.lt mrough thirdQuarter the average usstock and rose 6.6 in the third quarter up utility funds were 20.2 yearto date me key day oct 28 1929 also known as Black monday a moniker whichthen resurfaced to describe the crash of 1987 was the beginning of a crash in which the DSIA tell 1st and 12 on backtoback days the 1920s investors embraced buying shares w borrowed money often as much as aot of the stock'svalue my in savers BidFarewell to Higher yields the average yieldon the largest money market fundswas 4.69 on Fridaydown from 5.1 at the end of August CDs made up 17 of domestic bank deposits in the secondavaner of this year up from it in thefirst quarterof 2022 the wealth managerretirementplan provider empower tell to 4.2 from4.7 interestr ates to 4