exam 2

yield to worst

Given a bond with multiple potential maturity dates and prices due to embedded call options, the practice is to calculate a yield to maturity for each of the call dates and prices and select the lowest yield (the most conservative possible yield) as yield to worst.

coupon

Indicates the interest payment on a debt security. It is the coupon rate times the par value that indicates the interest payments on a debt security.

notes

Intermediate-term debt securities with maturities longer than 1 year but less than 10 years.

capital asset pricing model (CAPM)

It extends capital market theory in a way that allows investors to evaluate the risk-return trade-off for both diversified portfolios and individual securities.

basis point value

It is a measure of the bond's dollar price change for a one basis point change in yields (for example, from 8.00 percent to 7.99 percent).

accrued interest

It is a term used to define the interest payment received for that day for a bond. As a bond represents a loan, whoever owns the bond on a particular day is entitled to receive the interest.

flat price

It is the amount gained after subtracting the accrued interest from the total invoice price.

arbitrage pricing theory (APT)

It makes fewer assumptions than the CAPM and does not specifically require the designation of a market portfolio.

yield to call

It measures the promised rate of return the investor will receive from holding this bond until it is retired at the first available call date.

bottom up approach

It rolls all the individual earnings estimates up into a total that we can use for the index.

forward multiple

It uses the expected earnings for the next year. They usually make stocks sound cheaper (assuming next year's earnings are expected to increase) and the sell side would prefer to call clients and market cheap stocks.

characteristic line

Regression line that indicates the systematic risk (beta) of a risky asset.

asset-backed securities (ABS)

Securitized debt that can be backed by a range of assets beyond the traditional mortgage assets. The other assets include car loans, credit card debt, student loans, or home equity loans.

benchmark error

Situation where an inappropriate or incorrect benchmark is used to compare and assess portfolio returns and management.

undervalued

Some investments are so cheap that they offer a rate of return that is a greater reward than the risk that the investor has taken.

term to maturity

Specifies the date or the number of years before a bond matures or expires.

market risk premium

The amount of return above the risk-free rate that investors expect from the market in general as compensation for systematic risk.

core plus

The bond portfolio management that places a significant part of the available funds in a passively managed portfolio of highgrade securities that broadly reflects the overall bond market; this is the "core" of the strategy.

price risk

The component of interest rate risk due to the uncertainty of the market price of a bond caused by changes in market interest rates.

coupon reinvestment risk

The component of interest rate risk due to the uncertainty of the rate at which coupon payments will be reinvested.

present value of the growth opportunity

The concept that represents the portion of a stock's intrinsic value that is attributable to the company's growth.

internal rate of return

The discount rate at which cash outflows of an investment equal cash inflows.

sustainable growth rate equation

The equation states g equals return on equity multiplied by retention rate.

realized yield

The expected compounded yield on a bond that is sold before it matures assuming the reinvestment of all cash flows at an explicit rate. Also called horizon yield for the yield realized during an investment horizon period.

Credit card-backed securities

The fastest-growing segment of the ABS market and differ from mortgage-backed and car loan-backed securities in that the principal payments from credit card receivables are not paid to the investor but are retained by the trustee to reinvest in additional receivables.

horizon yield

The final measure of bond yield that measures the expected rate of return of a bond that you anticipate selling prior to its maturity.

money market

The market for short-term debt securities with maturities of less than one year.

principal:

The original value of the debt underlying a bond that is payable at maturity.

intrinsic value

The portion of a call option's total value equal to the greater of either zero or the difference between the current value of the underlying asset and the exercise price; for a put option, intrinsic value is the greater of either zero or the exercise price less the underlying asset price; for a stock, it is the value derived from fundamental analysis of the stock's expected returns or cash flows.

crossover price

The price at which the yield to maturity equals the yield to call. Above this price, yield to call is the appropriate yield measure; below this price, yield to maturity is the appropriate yield measure.

yields

The promised rates of return on bonds under certain assumptions.

estimated rates of return

The rate of return an investor anticipates earning from a specific investment over a particular future holding period.

term structure of interest rates

The relationship between term to maturity and yield to maturity for a sample of comparable bonds at a given time. Popularly known as the yield curve.

total invoice price

The resulting amount obtained after compounding the present value from a period of time using the semiannual-adjusted trade date yield of a particular percentage in the calculation.

valuation

The study of how investors determine whether a stock is fairly priced, overpriced, or underpriced.

overvalued

The term refers to a situation when a company has an excellent growth and whose stock is selling at an extremely high price/earnings ratio.

par yield

The term refers to yield to maturity statistics when investor's expected return over the life of the bond will involve all five of these coupons as well as any potential capital gain or loss from the difference in the initial price (P subscript c) and the face value (F)

Spot Yield

The yield on a zero-coupon bond when the expected return from the zero-coupon bond will only come from the appreciation between the current price (P subscript z) and F.

Certificates for automobile receivables (CARs)

They are securities collateralized by loans made to individuals to finance the purchase of cars.

multifactor models

They attempt to bridge the gap not identifying common risk factors by selecting a set of variables that are thought to capture the essence of the systematic risk exposures that exist in the capital market.

free cash flow to equity

This cash flow measure equals cash flow from operations minus capital expenditures and debt payments.

Static yield spreads

Yield spreads over the total term structure.

investment horizon

the time period used for planning and forecasting purposes or the future time at which the investor requires the invested funds.

equity multiples

they are simply trying to value the equity portion of the firm.

trailing multiples

they use an underlying fundamental metric from the year that just ended.

Secured (senior) bonds

A bond backed by a legal claim on specified assets of the issuer.

registered bonds

A bond for which ownership is registered with the issuer. The holder receives interest payments by check directly from the issuer.

serial obligation bond

A bond issue that has a series of maturity dates. Typical for municipal bonds.

immunization

A bond portfolio management technique of matching modified duration to the investment horizon of the portfolio to eliminate interest rate risk.

high-yield bonds

A bond rated below investment grade; also referred to as speculative-grade bonds or junk bonds.

premium

A bond selling at a price above par value due to capital market conditions.

discount

A bond selling at a price below par value due to capital market conditions.

term bond

A bond that has a single maturity date.

refunding bond

A bond that is issued to withdraw a bond that has been not been resolved or paid.

revenue bonds

A bond that is serviced by the income generated from specific revenue-producing projects of the municipality such as toll roads or athletic stadiums.

zero-coupon bonds

A bond that pays its par value at maturity but no periodic interest payments. Its yield is determined by the difference between its par value and its discounted purchase price. Also called original issue discount (OID) bonds.

pure cash-matched dedicated portfolio

A conservative dedicated portfolio management technique aimed at developing a bond portfolio that will provide cash payments that exactly match the specified liability schedules.

collateralized mortgage obligations (CMOs)

A debt security based on a pool of mortgage loans that provides a relatively predictable term by paying of tranches in specified order.

variable-rate (or floating-rate) notes

A debt security for which the interest rate changes to follow some specified short-term rate, for example, the T-bill rate; see Floating rate note.

dedication with reinvestment

A dedication strategy in which portfolio cash flows may precede their corresponding liabilities. Such cash flows can be reinvested to earn a return until the date the liability is due to be paid.

small-firm effect

A frequent empirical anomaly where risk-adjusted stock returns for companies with low market capitalization (i.e., share price multiplied by number of outstanding shares) are significantly larger than those generated by high market capitalization (large cap) firms.

January effect

A frequent empirical anomaly where risk-adjusted stock returns in the month of January are significantly larger than those occurring in any other month of the year.

Public bonds

A long-term, fixed-obligation debt security in a convenient, affordable denomination for sale to individuals and financial institutions.

asset liability management

A matched-funding approach to portfolio management where the characteristics (e.g., cash flow amount, duration) of the assets are coordinated with those of the liabilities that the investor faces.

modified duration

A measure of Macaulay duration divided by one plus the bond's periodic yield used to approximate the bond's price volatility.

convexity

A measure of the degree to which a bond's price-yield curve departs from a straight line. This characteristic affects estimates of a bond's price volatility for a given change in yields.

duration

A measure of the interest rate sensitivity of a bond's market price taking into consideration its coupon and term to maturity; the percent change in price for 100-basis point change in yield.

macaulay duration

A measure of the time flow of cash from a bond where cash flows are weighted by present values discounted by the yield to maturity.

discounted cash flow analysis

A method of calculating cash flows that are left over for all of the providers of capital.

General obligation bonds (GOs)

A municipal issue serviced from and guaranteed by the issuer's full taxing authority.

indexing

A passive bond portfolio management strategy that seeks to match the composition, and therefore the performance, of a selected market index.

buy and hold

A passive portfolio management strategy in which securities (bonds or stocks) are bought and held to maturity.

enhanced indexing

A portfolio management strategy that attempts to outperform a designated benchmark on a risk-adjusted basis by combining passive (i.e., indexed) and active management approaches.

dedication

A portfolio management technique in which the portfolio's cash flows are used to retire a set of liabilities over time.

relative valuation

A process that often involves comparing the industry multiple to the market multiple.

beta

A standardized measure of systematic risk based upon an asset's covariance with the market portfolio.

bond ladder

A strategy for managing a fixed-income portfolio where the investment funds are divided evenly among bonds that mature at regular intervals surrounding the desired time horizon.

dividend discount model

A technique for estimating the value of a stock issue as the present value of all future dividends.

free cash flow to the firm

A term that is used to describe the standard discounted cash flow Analysis when a firm value is comprised of the value of the debt, the value of any preferred stock, and the value of the equity.

option adjusted spreads

A type of yield spread that considers changes in the term structure and alternative estimates of the volatility of interest rates. It is spread after adjusting for embedded options.

fundamental multiples

A way of assessing what multiple a stock should be assigned.

call premium

Amount above par that an issuer must pay to a bondholder for retiring the bond before its stated maturity.

credit analysis

An active bond portfolio management strategy designed to identify bonds that are expected to experience changes in rating. This strategy is critical when investing in high-yield bonds.

interest rate anticipation

An active bond portfolio management strategy designed to preserve capital or take advantage of capital gains opportunities by predicting interest rates and their effects on bond prices.

bond swaps

An active bond portfolio management strategy that exchanges one position for another to take advantage of some difference between them.

constant growth model

An approach that treats cash flow as a growing perpetuity.

implied forward rate

An essential factor in understanding how short-term interest rate futures contracts are priced. They represented the sequence of future short-term rates that were built into the yield to maturity of a longer-term security.

bearer bond (par value)

An unregistered bond for which ownership is determined by possession. The holder receives interest payments by clipping coupons attached to the security and sending them to the issuer for payment.

sinking fund

Bond provision that requires the issuer to redeem some or all of the bond systematically over the term of the bond rather than in full at maturity.

Unsecured bonds (debentures)

Bonds that promise payments of interest and principal but pledge no specific assets. Holders have first claim on the issuer's income and unpledged assets. Also known as debentures.

collateralized debt obligations (CDOs)

Considered part of the asset-backed securities (ABSs) market because they are backed by the cash flows from a portfolio of securities. In contrast to the specific securities such as mortgages, credit card debt, and auto loans, CDOs are unique because they will generally include a variety of debt with a diversity of credit ratings. Finally, there are typically several tranches with different credit ratings from AAA to non-investment grade.

Subordinate (junior) debentures

Debentures that, in case of default, entitle holders to claims on the issuer's assets only after the claims of holders of senior debentures and mortgage bonds are satisfied.