Financial Assets, Markets, and Securities: Key Concepts

Posted on Feb 11, 2025 in Economy

Chapter 1

  1. Real & Financial Assets: In aggregate for the entire economy, the sum of financial assets equals ZERO, and the sum of real assets equals WEALTH OF THE ECONOMY.

  2. Debt Security: A security that pays a specified cash flow over a specified period.

  3. Derivative Security: A security that provides a payoff that depends on the values of other assets.

  4. Equity Security: A security that represents an ownership interest in a corporation.

  5. Types of Financial Assets (Less Risky to More Risky):

    1. Six-month certificate of deposit
    2. Long-term bonds
    3. Preferred stock
    4. Common stock

  6. Financial Markets and the Economy: The act that increases the number of independent directors on company boards, requires the CFO to personally verify the financial statements, created a new oversight board for the accounting/audit industry, and charged the board with maintaining a culture of high ethical standards is the SARBANES-OXLEY ACT.

  7. The Investment Process: An investor begins to build her investment portfolio by choosing individual securities. She is engaging in what is called BOTTOM UP or SECURITY SELECTION.

  8. Markets are Competitive: If an investor believes that markets are efficient, then which of the following investment strategies fit that belief? BUYING AND HOLDING A DIVERSIFIED PORTFOLIO.

  9. The Players: Businesses are net borrowers, households are net savers, governments can be both.

  10. The Players: A market where newly issued securities are offered to the public is called a PRIMARY MARKET.

Chapter 2

  1. Money Market Instrument: Which of the following is a Money Market Instrument? COMMERCIAL PAPER.

  2. Money Market Instruments: All else equal, which of the following will usually have the lowest yield? TREASURY BILL.

  3. Money Market Instruments: Which of the following is typically the most liquid? TREASURY BILL.

  4. Money Market Instruments: Which of the following are discount instruments? TREASURY BILL.

  5. The Bond Market: Which of the following is not an issuer of federal agency debt? MUNICIPALITIES.

  6. The Bond Market: The primary risk to an investor from holding a standard treasury bond is: INFLATION RISK.

  7. Money market securities are sometimes referred to as “cash equivalents” because they are safe and marketable.

  8. The most actively traded money market security is treasury bills.

  9. Cumulative voting of common stock gives minority shareholders the most representation on the board of directors.

  10. Owner of a put option entitles the owner to the RIGHT to Buy a specific stock, on or before a specific date, at a specific price.

Definitions

Underwriters: Purchase securities from issuing company and resell them to the public. Bears price risk associated with placement securities. IPO’S (Initial Public Offering) usually underpriced to the price they could be marketed; however, some IPOs are overpriced, and they cannot even fully be sold. STOP ORDER: Trade is not to be executed unless the stock hits a price limit. STOP-LOSS ORDER: Stock must be sold if the price falls below a limited price. STOP-BUY ORDER: Specifies that a stock should be bought when its price rises above a limit.

Chapter 3

  1. How Firms Issue Securities: Xerox, which has been a public company for a long time, hires Morgan Stanley to help Xerox market additional new stock for sale to the general public. Morgan Stanley purchases the shares from Xerox and resells the shares to the public. This is an example of an UNDERWRITTEN GENERAL CASH SEASONED OFFERING.

  2. Rule 415: SEC 415 allows which of the following? ALLOWS A SECURITY ISSUE TO BE PREREGISTERED AND OFFERED AT ANY TIME WITHIN TWO YEARS.

  3. Types of Markets: DIRECT SEARCH: Buyers and sellers locate one another on their own; BROKERED MARKET: A third party assists a participant in locating a buyer or seller; DEALER MARKET: A third party acts as an intermediate buyer/seller.

  4. Market Orders: LIMITED ORDER: An order to buy or sell at a specified price or better. LIMIT BUY: Only makes sense if it were lower than the current yield price. LIMIT SELL: Only makes sense if it were higher than the current yield price.

  5. Market Orders: An investor shorted stock that is currently trading at 56/share. She is now worried about taking losses from an unfavorable price move, although she is not yet ready to close out the position. It may make sense for the investor to enter a STOP BUY ORDER AT 57.50/SHARE.

Chapter 10

  1. US Credit Market Instruments in 2008: US government, government agency, and government-sponsored enterprise debt comprised 27% of total credit market debt.

  2. US Credit Market Instruments: Rank the following components of US credit market debts from largest to smallest using the third quarter 2008 provided in the PwP: MORTGAGES (28%); CORPORATE FOREIGN BONDS (22%); MUNICIPAL BONDS (5%) of total credit market debt in the third quarter of 2008.

  3. International Bonds: BULLDOG bonds are issued in GB by non-British borrowers and are denominated in British pounds.

  4. ASSET-BACKED BONDS: Income from specified assets used to service debts; INVERSE FLOATERS: Coupon rate falls when the interest rate rises; PAYMENT IN KIND BONDS: Bond that pays interest in additional bonds rather than in cash during the initial period; INDEXED BONDS: Are bonds where the principal is indexed to inflation or deflation on a daily basis; the payments are tied to a general index/price of a particular commodity.

  5. BB is speculative; AA and AAA are not necessary and would result in a lower promised yield than an A-rated bond.

  6. Default Protections: All but which one of the following will tend to reduce the required yield on a corporate bond? A CALL PROVISION WITH A FIVE-YEAR DEFERRED CALL.

  7. Exotic Contracts: A contract where the seller of the contract collects an annual premium (and sometimes an upfront fee) from the buyer, and in exchange, the seller of the contract pays the drop in value from par to the buyer if a security defaults is called a CREDIT DEFAULT SWAP (A Credit Default Swap provides the swap buyer with insurance that covers the par value of the security in the event the security defaults).

  8. The Term Structure: Which of the following result from the expectations theory of the yield curve? A) LONG-TERM RATES ARE A FUNCTION OF EXPECTED FUTURE SHORT-TERM RATES B) AN UPWARD SLOPE MEANS THAT THE MARKET IS EXPECTING HIGHER FUTURE SHORT-TERM RATES. (OTHER COME FROM THE LIQUIDITY PREFERENCE THEORY).

  9. The Term Structure: If the observed yield curve is flat, then the curve of expected future short-term rates is: DOWNWARD SLOPING.

Chapter 11

  1. Interest Rate Sensitivity: An increase in a bond’s YTM results in a smaller price decline than the gain associated with a decrease in yield. This result is due to… THE NON-LINEAR RELATIONSHIP BETWEEN BOND PRICES AND INTEREST RATES.

  2. Target Date Immunization: An attempt to earn the promised yield on the bond over the investment horizon.

  3. Problems with Immunization: 1) Immunizing requires incurring transaction costs over time. 2) Immunizing assumes the bond’s default risk does not change. 3) Does not work very well for large interest rate changes. 4) Does not work well for bonds with option features.

  4. Bond Convexity: Because of bond convexity, duration underestimates the INCREASE IN BOND PRICES WHEN YIELDS FALL and overestimates the DECLINE IN BOND PRICES WHEN YIELDS RISE.

  5. Bond Swaps: SUBSTITUTION SWAP: Exchanging one bond for another that is more attractively priced but has very similar characteristics; RATE ANTICIPATION SWAP: Choosing a duration different than your investment horizon to exploit an interest rate change.

  6. Exchanging one bond for another that is more attractively priced but has very similar characteristics is called a

  7. Exchanging one bond for another that is more attractively priced but has very similar characteristics is called a