Investment Management - Final Exam

Carry Return

-Dividend or Coupon Interest -Convenience Yield

Out-of-the-money option

An option that would not yield a positive payoff if the stock price remained unchanged until expiration

At-the-money option

Any option with a positive intrinsic value

Buyer of Puts option market

Bear

Seller of Call option market

Bear

Municipal Bonds

Bonds issued by state and local governments. most of the coupon payments grow tax free.

General Obligation Bonds

Bonds to be repaid from general taxes and other revenues; such bond issues usually must be approved by voters

Buyer of Call option market

Bull

Seller of Put Options Market

Bull

Futures Price < Fair Value

Buy Side of Futures Contract

Protective Put

an asset combined with a put option that guarantees minimum proceeds equal to the put's exercise price. THE SAME AS A WRITTEN CALL.

Every futures contract has ___________

an initial margin and maintenance margin.

Revenue Bonds

investments secured by the revenue generated by a state or municipal project

On the day of expiration, the future and spot price ____

must be equal

how do MBS work

pooled mortgages sold to individuals who packages the loans and sells them to investors. Take the difference in fixed rate and coupon to make the profit.

Private Label MBS

refer to MBS that are made up of mortgage loans that are not guaranteed by one of the GSEs. include subprime loans, such as those that contributed to the 2008 financial crisis. These securities tend to pay higher interest rates than their agency counterparts, but are subject to default risk in the event that the underlying mortgages stop getting paid.

Maintenance Margin

the minimum margin that must be present at all times in a margin account

Initial Margin

the minimum margin that must be supplied on a securities purchase

Call Option

the option to buy shares of stock at a specified time in the future

Put Option

the option to sell shares of stock at a specified time in the future

Spot Price

the price at which a commodity or financial asset can be sold at the current date

Settlement Price

the price used to settle futures contracts; usually the daily closing price

Securitization

the process of transforming loans or other financial assets into securities

Purpose of Derivatives

to transfer risk from one person or firm to another

Normal Yield Curve

upward-sloping; long-term yields are higher than short-term yields

Covered Call

writing a call on an asset together with buying the asset. THE SAME AS A WRITTEN PUT OPTION

Call In the money and put out of the money

Market price is above the exercise price

Call out of the money and Put in the money

Market price is below the exercise price intrinsic value is this, must be 0

Strike Price

The price at which the stock or commodity underlying a call option (such as a warrant) or a put option can be purchased (called) or sold (put) during a specified period

Kinked Yield Curve

When one maturity is extremely high or low and the others are more flat.

Backwardization

When the future price is below the spot price.

arbitrage profit

When the futures price and market value are not inline.

Can you buy stocks of Fannie Mae and Freddie Mac?

Yes. Really low. In hopes that government releases them back to private sector

Margin Call

a demand by a broker that an investor deposit further cash or securities to cover possible losses.

Mark to Market

a method of accounting for certain investments that requires that they be adjusted to their fair value at the end of each period

zero-sum game

a situation in which one person's gain is another's loss

Commercial Paper

a written promise from one company to another to pay a specific amount of money

Flat Yield Curve

a yield curve that indicates that interest rates do not vary much at different maturities

Economic benefits of securitization least likely include: a). reducing excessive lending by Banks b). reducing funding cost for firms that securitize assets c). increasing the liquidity of the underlying Financial assets

a). reducing excessive lending by Banks

In a securitization, the issuer of asset-backed Securities is best described as: a). the SPE b). the seller c). the servicer

a). the SPE

Inversion of Yield Curve Formula

10 Year - 1 Year

Fixed Rate Mortgage Calculation

10-Year Note + 160-180 Basis Points

Inverted Yield Curve

A downward-sloping yield curve indicates that short-term interest rates are generally higher than long-term interest rates.

Ginnie Mae

A government agency that plays an important role in the secondary mortgage market it guarantees mortgage backed securities using FHA insured and VA guaranteed loans as collateral. Backed by the Government, so there is less risk.

Fixed Rate Mortgage

A mortgage in which the interest rate does not change during the entire term of the loan.

Variable Rate Mortgage

A mortgage loan in which the interest rate varies depending on market conditions.

Derivative

A security that derives its value from the value or return of another asset or security

Money market Bonds

A short-term, one-year or less, bond.

Negotiable Certificates of Deposit

Certificates issued by large commercial banks and other depository institutions as a short-term source of funds

Government Sponsored Enterprises

Fannie Mae and Freddie Mac

Freddie Mac

Federal Home Loan Mortgage Corporation - A government supervised enterprise established to purchase primarily conventional mortgage loans in the secondary mortgage market.

Fannie Mae

Federal National Mortgage Association - The nation's largest, and privately owned, investor in residential mortgages.

Two Types of Muni Bonds

General Obligation and Revenue Bonds

In the Money Option (ITM)

If immediate exercise of the option would generate a positive payoff.

Option Premium

Intrinsic Value + Time Value. A contract has intrinsic value if in the money, time value is based on time left until expiration and market volatility.

Speculators

People who invest in a risky venture in the hope of making a large profit

Stock Goes Up

Put Premium Down, Call Premium Up

Stock Goes Down

Put premium up, call premium down

Futures Price > Fair Value

Sell Side of Futures Contract

Futures Price

Spot Price + Carry Costs - Carry Return

Futures Basis

Spot Price - Futures Price

Who should invest in Municipal Bonds?

Wealthy individuals because there are tax benefits to owning these type of bonds.

Contango

When a future price is above the spot price; Caused by companies wanting to lock in future rates to match future liabilities

Residential Mortgages that may be included in agency RMBS are least likely required to have: a). a minimum loan-to-value ratio b). Insurance on the mortgaged property c). a minimum percentage down payment

a). a minimum loan-to-value ratio

At expiration, the exercise value of a put option is: a). positive if the underlying asset price is less than the exercise price b). zero only if the underlying asset price is equal to the exercise price c). negative if the underlying asset price is greater than the exercise price

a). positive if the underlying asset price is less than the exercise price

The price of an out-of-the-money option is: a). less than its time value b). equal to its time value c). greater than its time value

b). equal to its time value

The risk that mortgage prepayments will occur more slowly than expected is best characterized as: a). default risk b). extension risk c). contraction risk

b). extension risk

Which of the following derivatives is a forward commitment? a). stock option b). interest rate swap c). credit-default swap

b). interest rate swap

A call option is: a). the right to sell at a specific price b). the right to buy at a specific price c). the obligation to buy at a specific price

b). the right to buy at a specific price

A customer agreement to purchase a specific t-bond next Thursday for $1,000 is: a). an option b). A Futures Contract c). a forward commitment

c). a forward commitment

A mortgage that has a balloon payment equal to the original loan principal is: a). a convertible mortgage b). a fully amortizing mortgage c). an interest only lifetime mortgage

c). an interest only lifetime mortgage

Which of the following statements about exchange-traded derivatives is least accurate? Exchange-traded derivatives: a). are liquid b). are standardized contracts c). carry significant default risk

c). carry significant default risk

Which of the following statements most accurately describes a derivative security? A derivative: a). always increases risk b). has no expiration date c). has a payoff based on an asset value or interest rate

c). has a payoff based on an asset value or interest rate

Derivatives are least likely to: a). improve liquidity b). provide price information c). prevent Arbitrage

c). prevent Arbitrage

Arbitrage prevents: a). market efficiency b). earning returns higher than the risk-free rate of return c). two assets with identical payoffs from selling at different prices

c). two assets with identical payoffs from selling at different prices

Credit Default Swaps

contracts that offer protection against the default of a particular security

Carrying Cost

cost of holding an item in inventory. -Financing Cost -Storage Cost

Tranches

different classes of securities that comprise a single bond issuance