The document discusses various types of risks associated with bonds, including default risk, credit spread risk, and downgrade risk. It then provides information on analyzing bonds and issuers, including sources of default risk information, the four Cs of credit analysis (character, covenants, collateral, capacity), factors for evaluating capacity and financial position, using ratios in credit analysis, and cash flow and leverage ratios used by ratings agencies. The document also discusses analyzing specific types of bonds and issuers.
The document discusses various types of risks associated with bonds, including default risk, credit spread risk, and downgrade risk. It then provides information on analyzing bonds and issuers, including sources of default risk information, the four Cs of credit analysis (character, covenants, collateral, capacity), factors for evaluating capacity and financial position, using ratios in credit analysis, and cash flow and leverage ratios used by ratings agencies. The document also discusses analyzing specific types of bonds and issuers.
L2 flash cards corporate finance - SS 8analystbuddy
The document discusses various concepts related to capital budgeting and corporate finance. It provides formulas for calculating the investment needed for expansion and replacement projects. It also discusses factors that affect a firm's capital structure, dividend policy, and methods of valuation. Key terms defined include economic profit, residual income, and real options. The document is a study guide that references various readings related to capital budgeting, capital structure, and corporate governance.
The document discusses various methods for valuing companies and estimating required returns. It covers sum-of-the-parts valuation, conglomerate discounts, characteristics of good valuation models, different return concepts such as holding period return and required returns, methods to estimate required returns including CAPM and multifactor models, and discount rates. It also discusses Porter's five forces framework and factors that influence industry competition and profitability.
L2 flash cards alternative investments - SS 13analystbuddy
The document discusses six main types of real estate investments: 1) Raw land, 2) Residential rentals (apartments), 3) Office buildings, 4) Warehouses, 5) Community shopping centers, and 6) Hotels and motels. For each type, it outlines the main value determinants, investment characteristics, principal risks, and most likely investors. It also provides guidance on testing real estate investments, focusing on understanding the logic rather than memorizing details. Real estate valuation approaches include income approach, cost approach, and sales comparison approach.
The document discusses several topics related to international finance including exchange rates, currency markets, balance of payments, and current and capital accounts. It defines key terms like spot rates, forward rates, currency strength, and covered interest arbitrage. It also summarizes the components of the balance of payments account including the current, capital, and official reserve accounts. Current account deficits are typically offset by financial account surpluses as foreign capital flows finance trade deficits.
The document provides an overview of fundamental analysis and technical analysis techniques used in security analysis. It discusses various fundamental analysis approaches like economy analysis, industry analysis, and company analysis. It also covers technical analysis indicators like Dow Theory, Elliott Wave Principle, chart types, chart patterns, and moving averages. Finally, it provides a brief introduction to the efficient market theory which states that security prices reflect all available information.
Capital Structure Theories, Valuation of Shares & Efficient Market HypothesisSwaminath Sam
The presentation contains details on Net Income, Net Operating, Traditional and Modigliani & Miller Approach; valuation of shares i.e., different models for valuation of shares in particular CAPM; Efficient Market Hypothesis (EMH) & forms of hypothesis
There are two main types of derivatives - exchange-traded and over-the-counter. Exchange-traded derivatives are traded on a centralized exchange, have standard terms, involve a clearing house and have low default risk. Over-the-counter derivatives are privately negotiated between two parties, have no central exchange and higher counterparty risk. Common derivatives include forwards, futures, options, and swaps. Forwards and futures are agreements to buy/sell an asset at a future date, while options provide the right but not obligation to do so. Swaps involve exchanging payments over time based on an underlying asset.
The document discusses various types of risks associated with bonds, including default risk, credit spread risk, and downgrade risk. It then provides information on analyzing bonds and issuers, including sources of default risk information, the four Cs of credit analysis (character, covenants, collateral, capacity), factors for evaluating capacity and financial position, using ratios in credit analysis, and cash flow and leverage ratios used by ratings agencies. The document also discusses analyzing specific types of bonds and issuers.
L2 flash cards corporate finance - SS 8analystbuddy
The document discusses various concepts related to capital budgeting and corporate finance. It provides formulas for calculating the investment needed for expansion and replacement projects. It also discusses factors that affect a firm's capital structure, dividend policy, and methods of valuation. Key terms defined include economic profit, residual income, and real options. The document is a study guide that references various readings related to capital budgeting, capital structure, and corporate governance.
The document discusses various methods for valuing companies and estimating required returns. It covers sum-of-the-parts valuation, conglomerate discounts, characteristics of good valuation models, different return concepts such as holding period return and required returns, methods to estimate required returns including CAPM and multifactor models, and discount rates. It also discusses Porter's five forces framework and factors that influence industry competition and profitability.
L2 flash cards alternative investments - SS 13analystbuddy
The document discusses six main types of real estate investments: 1) Raw land, 2) Residential rentals (apartments), 3) Office buildings, 4) Warehouses, 5) Community shopping centers, and 6) Hotels and motels. For each type, it outlines the main value determinants, investment characteristics, principal risks, and most likely investors. It also provides guidance on testing real estate investments, focusing on understanding the logic rather than memorizing details. Real estate valuation approaches include income approach, cost approach, and sales comparison approach.
The document discusses several topics related to international finance including exchange rates, currency markets, balance of payments, and current and capital accounts. It defines key terms like spot rates, forward rates, currency strength, and covered interest arbitrage. It also summarizes the components of the balance of payments account including the current, capital, and official reserve accounts. Current account deficits are typically offset by financial account surpluses as foreign capital flows finance trade deficits.
The document provides an overview of fundamental analysis and technical analysis techniques used in security analysis. It discusses various fundamental analysis approaches like economy analysis, industry analysis, and company analysis. It also covers technical analysis indicators like Dow Theory, Elliott Wave Principle, chart types, chart patterns, and moving averages. Finally, it provides a brief introduction to the efficient market theory which states that security prices reflect all available information.
Capital Structure Theories, Valuation of Shares & Efficient Market HypothesisSwaminath Sam
The presentation contains details on Net Income, Net Operating, Traditional and Modigliani & Miller Approach; valuation of shares i.e., different models for valuation of shares in particular CAPM; Efficient Market Hypothesis (EMH) & forms of hypothesis
There are two main types of derivatives - exchange-traded and over-the-counter. Exchange-traded derivatives are traded on a centralized exchange, have standard terms, involve a clearing house and have low default risk. Over-the-counter derivatives are privately negotiated between two parties, have no central exchange and higher counterparty risk. Common derivatives include forwards, futures, options, and swaps. Forwards and futures are agreements to buy/sell an asset at a future date, while options provide the right but not obligation to do so. Swaps involve exchanging payments over time based on an underlying asset.
This document discusses how accounting books can be engineered to the advantage of shareholders under accounting regulations like FASB and IFRS. It provides an example of how goodwill and intangible assets are treated differently under FASB 142 compared to previous rules. Financial engineering techniques can structure statements to maximize reported earnings through interpretations of accounting rules that are legal and aim to benefit the corporation. The document also discusses challenges in valuing intangible assets and provides a demonstration of the effect of FAS 142 on a company's balance sheet through an example.
The document summarizes key concepts from Chapter 11 of the textbook "Investment Analysis and Portfolio Management" regarding security valuation. It discusses the two major approaches to valuation - discounted cash flow and relative valuation. For discounted cash flow, it covers the dividend discount model (DDM) and its assumptions of constant growth. It also discusses how to value bonds, preferred stock, and common stock using these approaches. The key inputs of growth rates and discount rates are also addressed.
Financial engineering involves the design, development, and implementation of innovative financial instruments and processes to creatively address problems in finance. It refers specifically to bundling and unbundling securities to maximize profits using various asset combinations, applying theoretical finance and computer modeling. Financial engineering relies on tools from fields like computational intelligence, mathematical finance, and computer simulation for trading, hedging, investment decisions, and risk management. In contrast, financial analysis assesses the viability, stability, and profitability of a business by professionals through evaluation of financial statements and market conditions.
This chapter introduces derivative markets and securities such as forwards, futures, and options. It discusses how these contracts are distinguished from fundamental securities like stocks and bonds. Key characteristics of forwards, futures, and options are described, including how they can be interpreted as types of insurance policies. The chapter also covers how derivative markets are organized, common terminology, pricing of derivatives, and similarities/differences between contract types. It explains how derivatives can be combined to create synthetic securities and discusses various uses of derivatives in portfolio management like hedging and restructuring cash flows.
The document discusses portfolio management and modern portfolio theory. It defines key concepts like investment, speculation, asset allocation, risk, return, diversification, efficient frontier. Portfolio management aims to balance risk and return through diversification across different asset classes based on an investor's goals, risk tolerance and constraints. Modern portfolio theory provides a framework for optimizing risk-adjusted returns through careful selection of a combination of assets.
This document discusses different approaches to portfolio management, including passive and active management. It describes passive management as a buy-and-hold strategy that aims to match overall market returns by investing in a broad market index. Active management aims to outperform the market by selecting stocks believed to have the best prospects. The document also discusses formula plans, which provide rules for allocating funds between stocks and bonds based on market conditions, and for buying and selling securities based on price changes.
The document discusses portfolio management and Markowitz portfolio theory. It defines a portfolio as a combination of securities like stocks and bonds that are blended together to achieve optimal returns with minimum risk. Portfolio management aims to maximize returns and minimize risk through activities like monitoring performance, evaluating investments, and revising the portfolio. Markowitz portfolio theory introduced diversification to reduce unsystematic risk and developed algorithms to minimize portfolio risk by measuring the standard deviation of returns and considering the expected returns and covariances between securities. The theory assumes investors are risk-averse and can reduce risk by adding diversified investments to their portfolio.
Portfolio revision involves periodically reviewing and changing the asset allocation of a portfolio to align with an investor's objectives. The frequency of review depends on factors like portfolio size and securities held. The review should examine objectives, performance targets, actual results, and reasons for variations. It should be followed by timely action. Techniques for revision include buying low and selling high relative to normal price fluctuations. The timing of revisions is important to balance transaction costs and analysis against ensuring the portfolio still meets its goals.
Modern portfolio concepts ppt @ bec domsBabasab Patil
This document discusses modern portfolio concepts including portfolio objectives, return and risk measures, diversification through correlation, international diversification, components of risk, beta as a risk measure, the capital asset pricing model, and traditional versus modern approaches to portfolio construction. Key concepts covered include the efficient frontier, portfolio betas, and reconciling risk-return tradeoffs. Tables and figures are included to illustrate concepts such as correlation, efficient portfolios, security market lines, and portfolio risk-return relationships.
Harvard Management Company Investment Analysisbensigler
The document discusses Harvard Management Company's (HMC) consideration and adoption of inflation-linked bonds (TIPS) into its investment portfolio. It provides background on HMC and its goal of achieving a 6-7% average annual real return. It then explains what TIPS are and how they work, and analyzes their potential performance in different inflation scenarios. HMC ultimately recommended including a 7% allocation to TIPS in its portfolio to help hedge against inflation risk and improve risk-adjusted returns.
The activities of large, internationally active financial institutions have grown increasingly
Complex and diverse in recent years.This increasing complexity has necessarily been accompanied by a process of innovation in how these institutions measure and monitor their exposure to different kinds of risk. One set of risk management techniques that has attracted a great deal of attention over the past several years, both among practitioners and regulators, is "stress testing", which can be loosely defined as the examination of the potential effects on a firm’s financial condition of a set of specified changes in risk factors, corresponding to exceptional but plausible events. A concept of security analysis and portfolio management services has been very famous and old among various institutions. This report represents practices application of portfolio management techniques in the portfolio section. Portfolio management is an integrated and exhaustive of fundamental and technical methods which are used for calculation of annul return and earnings per share for the portfolio. Modern portfolio theory suggests that the traditional approach to portfolio analysis, selection and management may yield less than optimum results. Hence a more scientific approach is required, based on estimates of risk and return of the portfolio and the attitudes of the investor toward a risk-return trade-off stemming from the analysis of the individual Securities.
noorulhadi Lecturer at Govt College of Management Sciences, noorulhadi99@yahoo.com
i have prepared these slides and still using in mylectures, Reference: Portfolio management by S kevin and online sources
This document discusses dividend decision and policy. It defines dividends as profits distributed to shareholders from company earnings. There are several types of dividends including cash, stock, scrip, and bond dividends. Factors that influence a company's dividend policy include future growth needs, business cycles, the age and industry of the company, and shareholder preferences. Dividend theories also impact policy, such as Walter's model stating dividends influence firm value, and the MM irrelevance theory stating dividends do not impact value or shareholder wealth. Overall the document provides an overview of dividends, factors in determining policy, and influential theoretical frameworks.
Passive bond strategies involve less active management and rely on known inputs like risk tolerance at the time of investment. Two main types are buy-and-hold, which selects bonds to match the investor's horizon with minimal trading, and indexing, which constructs a portfolio matching a bond index. Active strategies try to maximize returns through interest rate forecasts, selecting undervalued bonds, credit analysis of issuers, or yield spread trades between bonds. Matched-funding techniques combine passive and active approaches for higher returns than buy-and-hold but less than fully active management.
The document discusses portfolio management and asset allocation strategies. It defines a portfolio as a collection of investments that can include stocks, mutual funds, bonds, and cash. It then describes different types of portfolios including a market portfolio and a zero investment portfolio. The main phases of portfolio management are outlined as security analysis, portfolio analysis, portfolio selection, portfolio revision, and portfolio evaluation. Asset allocation strategies focus on establishing an appropriate mix of asset classes in a portfolio to optimize risk and return based on an investor's goals.
Cfa l1 exam formula & concepts sheet 2013analystbuddy
AnalystBuddy is an online CFA exam preparation provider that offers comprehensive study materials including study notes, practice questions, flash cards, mock exams, and more for $69 per exam. Users can also try the materials for free by visiting their website at www.AnalystBuddy.com. The provider aims to help users save time and money in preparing for the CFA exam.
The document discusses key concepts for investment analysis and project selection, including:
1) Projects should yield a return greater than the minimum hurdle rate, which is higher for riskier projects. Returns should consider cash flows, timing, and side effects.
2) The optimal financing mix minimizes the hurdle rate and matches the assets financed.
3) If not enough high-returning investments exist, excess cash should be returned to stockholders.
Ratio analysis is used to evaluate a company's financial health and performance. Ratios are calculated using numbers from financial statements and compared over time and against industry benchmarks. The document discusses various types of ratios like liquidity, profitability, and solvency ratios and their formulas and interpretations. It also covers the uses and limitations of ratio analysis as well as break-even analysis which is used to evaluate sales volumes required to cover costs and make a profit.
This document provides information on ratio analysis including its definition, purpose, types of ratios, and how they are calculated and interpreted. Ratio analysis is a technique used to analyze financial statements and evaluate the performance, financial position, and viability of a business entity. It involves calculating various financial ratios using data from the income statement, balance sheet, and cash flow statement, and comparing them over time and against industry benchmarks to gain insight into the entity's profitability, liquidity, leverage, and operating efficiency. The document outlines various financial ratios that can be computed such as the current ratio, quick ratio, debt-to-equity ratio, and discusses how ratios are expressed and important considerations in their use and interpretation.
This document discusses how accounting books can be engineered to the advantage of shareholders under accounting regulations like FASB and IFRS. It provides an example of how goodwill and intangible assets are treated differently under FASB 142 compared to previous rules. Financial engineering techniques can structure statements to maximize reported earnings through interpretations of accounting rules that are legal and aim to benefit the corporation. The document also discusses challenges in valuing intangible assets and provides a demonstration of the effect of FAS 142 on a company's balance sheet through an example.
The document summarizes key concepts from Chapter 11 of the textbook "Investment Analysis and Portfolio Management" regarding security valuation. It discusses the two major approaches to valuation - discounted cash flow and relative valuation. For discounted cash flow, it covers the dividend discount model (DDM) and its assumptions of constant growth. It also discusses how to value bonds, preferred stock, and common stock using these approaches. The key inputs of growth rates and discount rates are also addressed.
Financial engineering involves the design, development, and implementation of innovative financial instruments and processes to creatively address problems in finance. It refers specifically to bundling and unbundling securities to maximize profits using various asset combinations, applying theoretical finance and computer modeling. Financial engineering relies on tools from fields like computational intelligence, mathematical finance, and computer simulation for trading, hedging, investment decisions, and risk management. In contrast, financial analysis assesses the viability, stability, and profitability of a business by professionals through evaluation of financial statements and market conditions.
This chapter introduces derivative markets and securities such as forwards, futures, and options. It discusses how these contracts are distinguished from fundamental securities like stocks and bonds. Key characteristics of forwards, futures, and options are described, including how they can be interpreted as types of insurance policies. The chapter also covers how derivative markets are organized, common terminology, pricing of derivatives, and similarities/differences between contract types. It explains how derivatives can be combined to create synthetic securities and discusses various uses of derivatives in portfolio management like hedging and restructuring cash flows.
The document discusses portfolio management and modern portfolio theory. It defines key concepts like investment, speculation, asset allocation, risk, return, diversification, efficient frontier. Portfolio management aims to balance risk and return through diversification across different asset classes based on an investor's goals, risk tolerance and constraints. Modern portfolio theory provides a framework for optimizing risk-adjusted returns through careful selection of a combination of assets.
This document discusses different approaches to portfolio management, including passive and active management. It describes passive management as a buy-and-hold strategy that aims to match overall market returns by investing in a broad market index. Active management aims to outperform the market by selecting stocks believed to have the best prospects. The document also discusses formula plans, which provide rules for allocating funds between stocks and bonds based on market conditions, and for buying and selling securities based on price changes.
The document discusses portfolio management and Markowitz portfolio theory. It defines a portfolio as a combination of securities like stocks and bonds that are blended together to achieve optimal returns with minimum risk. Portfolio management aims to maximize returns and minimize risk through activities like monitoring performance, evaluating investments, and revising the portfolio. Markowitz portfolio theory introduced diversification to reduce unsystematic risk and developed algorithms to minimize portfolio risk by measuring the standard deviation of returns and considering the expected returns and covariances between securities. The theory assumes investors are risk-averse and can reduce risk by adding diversified investments to their portfolio.
Portfolio revision involves periodically reviewing and changing the asset allocation of a portfolio to align with an investor's objectives. The frequency of review depends on factors like portfolio size and securities held. The review should examine objectives, performance targets, actual results, and reasons for variations. It should be followed by timely action. Techniques for revision include buying low and selling high relative to normal price fluctuations. The timing of revisions is important to balance transaction costs and analysis against ensuring the portfolio still meets its goals.
Modern portfolio concepts ppt @ bec domsBabasab Patil
This document discusses modern portfolio concepts including portfolio objectives, return and risk measures, diversification through correlation, international diversification, components of risk, beta as a risk measure, the capital asset pricing model, and traditional versus modern approaches to portfolio construction. Key concepts covered include the efficient frontier, portfolio betas, and reconciling risk-return tradeoffs. Tables and figures are included to illustrate concepts such as correlation, efficient portfolios, security market lines, and portfolio risk-return relationships.
Harvard Management Company Investment Analysisbensigler
The document discusses Harvard Management Company's (HMC) consideration and adoption of inflation-linked bonds (TIPS) into its investment portfolio. It provides background on HMC and its goal of achieving a 6-7% average annual real return. It then explains what TIPS are and how they work, and analyzes their potential performance in different inflation scenarios. HMC ultimately recommended including a 7% allocation to TIPS in its portfolio to help hedge against inflation risk and improve risk-adjusted returns.
The activities of large, internationally active financial institutions have grown increasingly
Complex and diverse in recent years.This increasing complexity has necessarily been accompanied by a process of innovation in how these institutions measure and monitor their exposure to different kinds of risk. One set of risk management techniques that has attracted a great deal of attention over the past several years, both among practitioners and regulators, is "stress testing", which can be loosely defined as the examination of the potential effects on a firm’s financial condition of a set of specified changes in risk factors, corresponding to exceptional but plausible events. A concept of security analysis and portfolio management services has been very famous and old among various institutions. This report represents practices application of portfolio management techniques in the portfolio section. Portfolio management is an integrated and exhaustive of fundamental and technical methods which are used for calculation of annul return and earnings per share for the portfolio. Modern portfolio theory suggests that the traditional approach to portfolio analysis, selection and management may yield less than optimum results. Hence a more scientific approach is required, based on estimates of risk and return of the portfolio and the attitudes of the investor toward a risk-return trade-off stemming from the analysis of the individual Securities.
noorulhadi Lecturer at Govt College of Management Sciences, noorulhadi99@yahoo.com
i have prepared these slides and still using in mylectures, Reference: Portfolio management by S kevin and online sources
This document discusses dividend decision and policy. It defines dividends as profits distributed to shareholders from company earnings. There are several types of dividends including cash, stock, scrip, and bond dividends. Factors that influence a company's dividend policy include future growth needs, business cycles, the age and industry of the company, and shareholder preferences. Dividend theories also impact policy, such as Walter's model stating dividends influence firm value, and the MM irrelevance theory stating dividends do not impact value or shareholder wealth. Overall the document provides an overview of dividends, factors in determining policy, and influential theoretical frameworks.
Passive bond strategies involve less active management and rely on known inputs like risk tolerance at the time of investment. Two main types are buy-and-hold, which selects bonds to match the investor's horizon with minimal trading, and indexing, which constructs a portfolio matching a bond index. Active strategies try to maximize returns through interest rate forecasts, selecting undervalued bonds, credit analysis of issuers, or yield spread trades between bonds. Matched-funding techniques combine passive and active approaches for higher returns than buy-and-hold but less than fully active management.
The document discusses portfolio management and asset allocation strategies. It defines a portfolio as a collection of investments that can include stocks, mutual funds, bonds, and cash. It then describes different types of portfolios including a market portfolio and a zero investment portfolio. The main phases of portfolio management are outlined as security analysis, portfolio analysis, portfolio selection, portfolio revision, and portfolio evaluation. Asset allocation strategies focus on establishing an appropriate mix of asset classes in a portfolio to optimize risk and return based on an investor's goals.
Cfa l1 exam formula & concepts sheet 2013analystbuddy
AnalystBuddy is an online CFA exam preparation provider that offers comprehensive study materials including study notes, practice questions, flash cards, mock exams, and more for $69 per exam. Users can also try the materials for free by visiting their website at www.AnalystBuddy.com. The provider aims to help users save time and money in preparing for the CFA exam.
The document discusses key concepts for investment analysis and project selection, including:
1) Projects should yield a return greater than the minimum hurdle rate, which is higher for riskier projects. Returns should consider cash flows, timing, and side effects.
2) The optimal financing mix minimizes the hurdle rate and matches the assets financed.
3) If not enough high-returning investments exist, excess cash should be returned to stockholders.
Ratio analysis is used to evaluate a company's financial health and performance. Ratios are calculated using numbers from financial statements and compared over time and against industry benchmarks. The document discusses various types of ratios like liquidity, profitability, and solvency ratios and their formulas and interpretations. It also covers the uses and limitations of ratio analysis as well as break-even analysis which is used to evaluate sales volumes required to cover costs and make a profit.
This document provides information on ratio analysis including its definition, purpose, types of ratios, and how they are calculated and interpreted. Ratio analysis is a technique used to analyze financial statements and evaluate the performance, financial position, and viability of a business entity. It involves calculating various financial ratios using data from the income statement, balance sheet, and cash flow statement, and comparing them over time and against industry benchmarks to gain insight into the entity's profitability, liquidity, leverage, and operating efficiency. The document outlines various financial ratios that can be computed such as the current ratio, quick ratio, debt-to-equity ratio, and discusses how ratios are expressed and important considerations in their use and interpretation.
This document provides an overview of credit monitoring and risk management in banks. It discusses the need for credit monitoring to ensure funds are used as intended and loan terms are followed. It describes methods to monitor borrowers' financial status. It also explains models to predict financial distress and the rehabilitation process. The document outlines different types of risks faced by banks including interest rate, liquidity, foreign exchange, credit, market, operational, and solvency risks. It discusses the risk measurement and mitigation process as well as non-performing assets and asset-liability management.
The document discusses capital markets and the bank loan syndication process. It describes two types of loan markets - the investment grade loan market and leveraged loan market. It then details the typical steps in the loan syndication process, including the roles of the issuer/company, arrangers, agents, and lenders. It provides an example of a large syndicated loan for Harrah's Entertainment.
This document provides an overview of a unit on managing financial resources and decisions. The unit is designed to give learners an understanding of finance management within businesses. It will cover sources of finance, implications of finance as a resource, making financial decisions based on information, and analyzing financial performance. Learners will explore finance sources, analyze impacts, make budgeting and pricing choices using tools like costing and investment appraisal, and interpret financial statements. Assessment may involve case studies and projects analyzing real or simulated company finances and decision-making.
This document discusses various types of financial ratios used to analyze the financial statements of a business unit. It defines ratio analysis as comparing two components of a balance sheet, profit and loss statement, or trading account to understand trends. The main types of ratios covered are:
1) Profitability ratios like gross profit margin and net profit margin, which indicate earnings levels.
2) Return ratios like return on assets and return on equity, which measure earnings power and returns to investors.
3) Liquidity ratios like current ratio and quick ratio, which analyze a company's ability to meet short-term obligations.
4) Turnover ratios which relate trading figures to balance sheet items to understand stock holding periods
This document discusses ratio analysis, which is a technique used to analyze and interpret financial statements. It provides ratios that can be used to evaluate a company's liquidity, solvency, activity/turnover, and profitability. Specifically, it outlines various ratios that fall under each of these categories, such as current ratio, debt-to-equity ratio, inventory turnover ratio, gross profit ratio, and return on equity. The objectives, advantages, and limitations of ratio analysis are also summarized.
The document discusses analyzing risks and profitability for credit analysis. It provides:
1) A list of 20 sources of risk that should be monitored, from international exchange rates to firm-specific management competence.
2) An overview of how loan officers analyze financial statements to understand how firms monitor risks and the financial consequences of risks. Key ratios are used to assess dimensions of risk.
3) A framework for financial statement analysis of risk, examining a firm's ability to generate cash from operations vs. its need for cash in operations, investing, and financing activities. Analysis of short-term liquidity and long-term solvency risk is discussed.
Financial ratios and their use in understanding Financial StatementsPranav Dedhia
An introduction and in-depth understanding on the importance of Financial ratios in understanding financial statements of business entities along with relevant examples
Here are the key ratios calculated from the financial information provided:
1. Tangible Net Worth for 2005-06: Capital (300) + Reserves (140) - Goodwill (50) = 390
2. Current Ratio for 2006-07: Current Assets (170 + 30 + 170 + 20 + 240 + 190) / Current Liabilities (580 + 70 + 80 + 70) = 820/800 = 1.02
3. Debt Equity Ratio for 2005-06: Total Debt (Bank Term Loan 320 + Unsec. Long Term Loan 150) / Tangible Net Worth (390) = 470/390 = 1.2
Deliverable 07 WorksheetScenarioYou are currently working at.docxcargillfilberto
The summary analyzes patient data from NCLEX Memorial Hospital's Infectious Diseases Unit. Over 65 patients ranging from 41-84 years old were admitted with an infectious disease. A PowerPoint presentation was created to examine the mean, median, mode, range, standard deviation, variance, 95% confidence interval, and conduct a hypothesis test on the average patient age. The analysis aimed to determine if patient age plays a critical role in treatment method. The presentation concluded that the average patient age was 63 years old and the hypothesis test found no evidence that the average age was less than 64 years old.
This document discusses investment fundamentals, securities analysis, and portfolio management. It covers topics such as understanding investment, risk and return, securities analysis concepts, fundamental analysis framework, intrinsic and relative valuation, portfolio theory, and portfolio performance measurement. The key points are:
- It defines investment, risk, sources of risk, and different types of securities. It discusses the risk-return tradeoff between different securities.
- It covers the concepts of securities analysis, fundamental analysis framework using top-down and bottom-up approaches, and intrinsic valuation using discounted dividend models.
- It provides an overview of portfolio theory including modern portfolio theory, capital market theory, portfolio construction, and performance measurement.
Corporate Bridge Group provides financial training programs and e-learning services. It has two verticals: 1) Edu Corporate Bridge which deals with instructor-led and online training programs in financial courses and exam preparatory courses. 2) Elearning Labz which develops custom e-learning content and solutions. The management team includes Dheeraj Vaidya as CEO, S. Premananda as MD, and Kayideni Kholi. Business valuation is complex and involves various financial and non-financial factors. Valuations are performed for different purposes such as transactions, disputes, compliance, and planning. Direct valuation methods like discounted cash flow models provide an explicit equity value by discounting estimated future cash flows.
This document provides class notes on Lecture 7 which covers interest rates, bond valuation, and stock valuation. The key topics discussed include:
- Types of bonds including treasury, corporate, and municipal bonds as well as their characteristics like par value, coupon rate, and maturity.
- How bond values change with interest rates, with bonds trading at a premium, discount, or par value depending on if rates are lower, higher, or equal to the coupon rate.
- Bond valuation which discounts future cash flows from coupons and principal.
- Common stock valuation using the dividend discount and constant growth models.
- Capital budgeting techniques like net present value for evaluating investment projects.
The document provides an overview of financial institutions group (FIG) investment banking, including typical roles, products and services in FIG, as well as learning objectives and sections for understanding FIG concepts like benchmarking analyses, capital roll forwards, and risk management. It defines FIG as the investment banking group that provides capital raising and advisory services for financial institutions like banks, insurance companies, and asset managers.
Partnership Risk Management Sample Slides from MasterclassAlexander Larsen
A sample of my slides from my Masterclass I held in Dubai a few years ago covering the topic of Partnership Risk Management. Slideshare doesn't allow animations so some slides may look odd.
This document provides an overview of asset/liability management for banks. It discusses key concepts like net interest margin, yield curves, types of interest rate risk including repricing risk and option risk. It describes how the asset/liability committee (ALCO) oversees pricing, profitability, cash flows, interest rate risk management and other risks. An effective ALM program identifies goals, assesses risks, uses tools to evaluate strategies before implementation, and works to maximize bank performance while managing different types of risks.
This document provides information on various financial analysis tools and ratios. It includes explanations of the 3Rs of credit analysis, the 5Cs of credit, the 7 principles of credit and repayment plans. It also discusses different types of financial statements (income statement, balance sheet, cash flow statement), ratio analysis, and examples of various financial ratios including liquidity, leverage, coverage and activity ratios. Specific calculations and comparisons to industry averages are provided for Basket World.
The document provides an overview of investment management including defining key terms, outlining the investment management process, and discussing portfolio evaluation methods. Specifically, it discusses creating an investment policy statement, selecting portfolio strategies such as passive and active, choosing asset types, and measuring performance using Sharpe's measure, Treynor's measure, and Jensen's measure which compare the portfolio return to benchmarks.
This document provides guidance on assessing a company's performance using financial statement analysis techniques. It discusses various types of ratios that can be used, including profitability, liquidity, management efficiency, solvency, and investment ratios. It also covers cash flow analysis. Key points include:
- Ratios and cash flows should be analyzed over time and compared to peers to evaluate a company's performance.
- Non-financial factors like the business environment must be considered when assessing performance.
- Multiple ratios across different categories should be examined together rather than in isolation to get a full picture of a company's financial health.
Similar to L2 flash cards fixed income - SS 14 (20)
The document discusses several topics related to economic growth including:
1. Factors that affect economic growth such as physical capital, human capital, and technological advancement.
2. Preconditions for growth including incentive systems, markets, property rights, and monetary exchange.
3. Sources of faster growth including saving and investment in new capital, investment in human capital, and new technologies.
4. Theories of economic growth such as classical, neoclassical, and new growth theories.
L2 flash cards portfolio management - SS 18analystbuddy
Mean-variance analysis is used to identify optimal portfolios based on expected returns, variances, and covariances of asset returns. The minimum-variance frontier shows the efficient combinations of expected return and risk. The efficient frontier begins with the global minimum-variance portfolio and provides the maximum expected return for a given level of variance. The capital market line describes combinations of the risk-free asset and market portfolio. The capital asset pricing model expresses expected returns as a linear function of systematic risk measured by beta.
The document discusses various financial derivatives including synthetic instruments, options, interest rate derivatives, currency and equity swaps, credit default swaps, and credit derivative trading strategies. It provides formulas for pricing these instruments and outlines how their values are affected by various risk factors.
The value of a forward contract at initiation is zero. Over time, the value depends on the relationship between the forward price and the expected future spot price. Futures prices also converge to the spot price at expiration. Like forwards, futures have value of zero at initiation but are marked to market daily. Factors like storage costs, convenience yields, and interest rates can cause the futures price to be in contango or backwardation relative to the expected future spot price.
L2 flash cards financial reporting - SS 7analystbuddy
The document discusses various definitions of earnings metrics like EBITDA, operating income, and net income. It also discusses the reliability of cash flow trends compared to earnings trends, noting that sustainable earnings growth requires growth in operating cash flows over the long run. Finally, it discusses accounting treatments for different types of hedges, as well as cash versus accrual basis accounting and how management can intervene in the external financial reporting process.
L2 flash cards financial reporting - SS 6analystbuddy
The document discusses various topics related to accounting for inter-corporate investments and post-employment benefits under IFRS. It covers classification of investments, effects of different accounting methods, components of pension obligations and expenses, assumptions used in valuations, and impact on financial statements. Translation of foreign subsidiary financial statements using current and temporal methods is also summarized, along with effects of translation on parent company ratios and treatment of hyperinflationary economies.
L2 flash cards financial reporting - SS 5analystbuddy
The document discusses various inventory costing methods and their effects on financial ratios. It also covers LIFO reserves, converting financial statements between LIFO and FIFO, implications of using net realizable value for inventory valuation, and differences in financial reporting between companies using LIFO versus FIFO. Additional topics covered include capitalization versus expensing costs, various depreciation methods, impairment and revaluation of assets, leasing versus purchasing assets, and classifications of finance versus operating leases.
The document provides information on various statistical and econometric concepts related to correlation, regression, and time series analysis. It defines key terms like scatter plots, correlation coefficients, covariance, standard deviation, outliers, hypothesis testing, dependent and independent variables, assumptions of linear regression, F-tests, R-squared, dummy variables, heteroskedasticity, serial correlation, and trend models. It also provides the formulas and explanations for calculating these various concepts.
The document discusses general fiduciary standards and the prudent man rule vs the prudent investor rule for trustees. It provides 3 key points:
1) Trustees have a duty of care, skill, caution, loyalty and impartiality. This includes seeking advice if lacking relevant investment knowledge.
2) The prudent man rule focuses on diversification to reduce risk, while the prudent investor rule emphasizes investing in the best interest of beneficiaries.
3) When investing and managing trust assets, trustees must consider economic conditions, inflation, tax impacts, risk/return of individual investments and the portfolio overall, and the needs of beneficiaries.
The document discusses the CFA Institute's Professional Conduct Program which establishes rules of conduct for CFA members and candidates through a Code of Ethics and Standards of Professional Conduct. The CFA Institute enforces these rules through a Professional Conduct Program that investigates potential violations and issues disciplinary sanctions if needed. The Code outlines six principles of ethical conduct while the Standards describe rules in more detail across seven areas including professionalism, duties to clients and employers, and conflicts of interest. Adherence to these rules is meant to maintain the integrity of the investment profession.
L1 flash cards alternative investments (ss18)analystbuddy
The document discusses various types of investment funds including open-end funds, closed-end funds, exchange traded funds (ETFs), real estate investment funds, private equity funds, hedge funds, and fund of funds. It provides details on key characteristics such as legal structure, fees, investment strategies, risks, and performance measurement challenges for each type of fund. The document also covers topics such as net asset value calculation, types of fees for mutual funds, real estate valuation approaches, stages of private equity investments, and challenges of investing in venture capital.
The document discusses portfolio management concepts including diversification, types of investors, the portfolio management process, developing an investment policy statement, mutual funds, and measures of investment returns. It provides definitions and formulas for key concepts such as holding period return, money weighted return, annualizing returns, portfolio return, variance, standard deviation, beta, the capital asset pricing model, and the Sharpe ratio.
The document discusses key aspects of the capital budgeting process, including:
1) The main steps such as brainstorming ideas, analyzing cash flows, integrating projects, and post-auditing.
2) Types of capital projects like replacement, expansion, new products, and regulatory projects.
3) Methods for evaluating projects like NPV, IRR, payback period, and profitability index.
4) Estimating cash flows, costs of capital including WACC, and dealing with conflicts between methods.
So in summary, it provides an overview of the capital budgeting process, types of projects, evaluation methods, and considerations for costs and cash flows.
Reasons companies may over-report earnings include:
- To meet analysts' earnings expectations or debt covenants.
- To obtain additional financing or higher pay and commissions tied to performance.
- To negotiate concessions from unions, creditors or vendors.
- To save on income taxes through aggressive accounting techniques.
The document discusses various topics related to accounting for inventory, property, plant and equipment, intangible assets, bonds payable, leases, and income taxes. It covers the different costs included in inventory, methods for valuing inventory, calculating depreciation and amortization expense, accounting for bonds payable including premiums and discounts, classification of leases, and temporary versus permanent differences between accounting and taxable income.
The document discusses key components of the income statement, balance sheet, and cash flow statement. It provides definitions and formulas for items such as net income, revenue, expenses, assets, liabilities, equity, operating activities, investing activities, financing activities, and common liquidity and profitability ratios. Calculation of items like net cash from operating activities using both the direct and indirect method is also covered.
The document discusses key aspects of financial statements and financial reporting standards. It provides information on the four basic financial statements, accounting equations, notes to financial statements, auditing standards, and frameworks for setting accounting standards. The purpose of financial reporting is to provide transparent and useful information to investors and other stakeholders, though there are ongoing challenges in achieving global convergence due to differences in business and regulatory environments.
The document discusses several topics related to international trade and foreign exchange markets:
- International trade can provide benefits like increased economies of scale and product variety, but may also result in costs like job losses and income inequality. Countries benefit most from trading goods they have a comparative advantage in.
- Foreign exchange markets allow currencies to be exchanged and determine exchange rates. The value of currencies is influenced by interest rates and supply and demand. Forward rates are calculated based on spot rates and interest rate differentials between countries.
- Institutions like the IMF and World Bank were formed to encourage international cooperation on monetary and trade issues and provide financing to support economic development.
The document discusses various methods for calculating GDP, including the expenditure, income, and production approaches. It also discusses nominal and real GDP, as well as the GDP deflator. Additionally, it covers related topics such as national income, personal income, the business cycle, unemployment, inflation, and factors that can affect price levels.
- Market interactions take place voluntarily between firms and households in the market. Demand and supply curves show the relationship between price and quantity demanded/supplied. The intersection of the curves indicates the market equilibrium price and quantity.
- Firms aim to maximize profits by producing at the quantity where marginal revenue equals marginal cost. They can earn economic profits in the short run but competition drives profits to zero in long run equilibrium under perfect competition. Monopolies can earn economic profits through product differentiation and control of supply.
- Governments sometimes interfere in markets through price floors, ceilings, and taxes which typically result in deadweight losses. Firms minimize costs and maximize profits subject to various market structures and conditions like economies/
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1. Default Risk, Credit Spread Risk,
and Downgrade Risk
default risk - the risk that the borrower will not repay the
obligation
credit spread risk - the risk that the credit spread will increase
and cause the value of the issue to decrease and/or cause the
bond to underperform its benchmark.
downgrade risk - the risk that the issue will be downgraded by
the credit rating agencies, which will also cause the bond price
to fall, and/or cause the bond to underperform its benchmark.
Study Session 14, Reading 42
2. Sources of information to asses
the default risk of a bond
1. Credit Rating
2. Rating Watch
3. Rating Outlook
Study Session 14, Reading 42
3. Four Cs of credit analysis
1. Character - management’s integrity and commitment to
meet obligations
2. Covenants - the terms and conditions, the borrowing and
lending parties have agreed to as part of the bond issue
Two types of Covenants
i.
Affirmative covenants
ii. Negative covenants
3. Collateral - the assets offered as security for the debt as well
as other assets controlled by the issuer
4. Capacity - to the corporate borrower’s ability to generate
cash flow or liquidate short-term assets to repay its debt
obligations.
Study Session 14, Reading 42
4. Factors to Evaluate the Capacity
to Pay
Industry trends
Regulatory environment
Operating and competitive position
Financial position and sources of liquidity
Company structure
Parent company support agreements
Special event risk
Study Session 14, Reading 42
5. Factors to Evaluate the financial
position and sources of liquidity
Working capital position of the firm
Dependable cash flow
Back up facilities
Securitized assets
Third party guarantees
Study Session 14, Reading 42
6. Credit Analysis with Ratios
Solvency Ratios
Current Ratio = Current Assets / Current Liabilities
Acid Test Ratio = (Current Assets – Inventories) / Current
Liabilities
Capitalization or Financial Leverage Ratios
Long term debt to capitalization ratios = Long term debt / (Long
term debt + Minority Interest + Shareholders common and
preferred equity )
Total debt to capitalization ratios = (Current Liabilities + Long term
debt) / (Current Liabilities + Long term debt + Minority Interest +
Shareholders common and preferred equity)
Study Session 14, Reading 42
7. Credit Analysis with Ratios (cont.)
Coverage Ratios
EBIT Coverage Ratio = EBIT / Annual Interest Expense
EBITDA Coverage Ratio = EBITDA / Annual Interest Expense
Du Pont Analysis
ROE = Net Income / Shareholders equity = ( Net Income / Sales) *
(Sales/Total Assets) * (Total assets / Shareholders equity)
Study Session 14, Reading 42
8. Cash Flow Measures Used by S&P
Funds from operations = Net Income + Depreciation +/- other
non cash items
Operating cash flow = Funds from operations + decrease
(increase) in non current assets – increase (decrease) in non
current liabilities
Free operating cash flows = Operating cash flow – capital
expenditures
Discretionary cash flows = Free operating cash flow – cash
dividends
Pre-financing cash flows = Discretionary cash flows –
acquisitions + asset disposals + other sources
Study Session 14, Reading 42
9. Ratios Used by S&P
Coverage Ratios (the higher the ratio, the stronger the
issuer’s capacity to pay):
Funds from operations / total debt
Funds from operations / capital spending requirement
(Free operating cash flow + Interest) / Interest
(Free operating cash flow + Interest) / ( Interest + Annual
Principal Repayment)
Leverage Ratio ( the lower the ratio, the stronger is the
issuer’s capacity to pay)
Debt Payback Period = Total debt / Discretionary cash flows
Study Session 14, Reading 42
10. Two Areas to Analyse High-Yield
Issuers
Debt Structure Analysis - includes the following types of
issues: bank debt, reset notes, and senior and subordinated
debt (which may be zero coupon bonds).
Corporate Structure Analysis - Debt is borrowed at the parent
level, and funds to pay the obligation in the future are
obtained from operating subsidiaries
Study Session 14, Reading 42
11. Credit Analysis of Asset Backed
Securities
Collateral Credit Quality - Rating agencies evaluate whether the
collateral is of sufficient quality to be able to provide cash
flows to pay principal and interest over the life of the issue
Seller/ Servicer Quality - Rating agency looks at the servicer’s
performance history, experience, underwriting standards
adopted for loan originations, servicing capabilities (including
databases, systems, and personnel), financial strength, and
growth relative to its competitive and business environment.
Study Session 14, Reading 42
12. Credit Analysis of Asset Backed
Securities (cont.)
Cash Flow Stress and Payment Structure - Rating agencies
analyses cash flow projections under different scenarios
related to losses, delinquencies, and economic conditions to
assess how these cash flows are distributed to the various
tranches (bonds) in the asset-backed security structure.
Legal Structure - A firm that securitizes assets, , in the event of
bankruptcy, the courts will not apply the cash flow from the
collateral toward satisfaction of general corporate liabilities
Study Session 14, Reading 42
13. Risk Considerations
for Tax Backed Debt
Issuer’s debt structure
Budgetary policy
Local tax and intergovernmental revenue availability
Issuer’s socioeconomic environment
Study Session 14, Reading 42
14. Risk Considerations
for Revenue Bonds
Limits of the basic security
Flow of funds structure
Rate, or user charge, covenant
Priority-of-revenue claims
Additional Bonds Test
Study Session 14, Reading 42
15. Economic risk factors in evaluation
of Sovereign Ratings
Economic and income structure
Prospects for economic growth
Degree of fiscal flexibility
Public debt burden
Monetary policy and price stability
Balance of payments flexibility
External debt and liquidity
Study Session 14, Reading 42
16. Political risk factors in evaluating
Sovereign Ratings
Form of government and degree of citizen participation in the
political process.
Political stability and orderliness of leadership or political
party succession.
Degree of national agreement on economic policy goals.
Integration of its economy in global trade and financial
systems.
Internal and external security risks.
Study Session 14, Reading 42
17. Local Currency Ratings
and Foreign Currency Debt Ratings
Factors used in analysis of local currency debt ratings:
political stability and the extent of participation by the populace in
the political process
income base and growth along with economic infrastructure
tax discipline and budgetary record
monetary policy and the rate of inflation
the government debt burden and debt service experience
Factors used in the analysis of foreign currency debt ratings:
country’s balance of payments
the composition of external balance sheet relative to its external
debt (foreign currency) obligations.
Study Session 14, Reading 42
18. Multiple Discriminate Analysis (MDA)
Multiple Discriminate Analysis (MDA) - a statistical technique
used to predict default.
Z Score Model - one type of MDA
Z =1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5
Where:
X1 = Working capital/Total assets (in decimal)
X2 = Retained earnings/Total assets (in decimal)
X3 = Earnings before interest and taxes/Total assets (in decimal)
X4 = Market value of equity/Total liabilities (in decimal)
X5 = Sales/Total assets (number of times)
Z = Z-score
Study Session 14, Reading 42
19. Credit Risk Models
Structural Models - based on option pricing theory((Brian
Scholes Option Pricing Model)
Reduced Form Models - do not look “inside the firm,” but
instead model directly the probability of default or downgrade
Popular Models:
Jarrow and Turnbull Model
Duffie and Singleton Model
Study Session 14, Reading 42
20. Three Types of Yield Curves
1. normal or positively sloped yield curve –the most common
relationship are yields in which the longer the maturity, the
higher the yield
2. flat yield curve - the yield for all maturities is approximately
equal.
3. inverted or a negatively sloped yield curve - the relationship
between maturities and yields was such that the longer the
maturity the lower the yield
steepness or slope of the yield curve - The difference between
long-term Treasury yields and short-term Treasury yields
Study Session 14, Reading 43
21. Parallel and Non Parallel Shifts
in the Yield Curve
shift in the yield curve - the relative change in the yield for each
Treasury maturity
parallel shift in the yield curve - a shift in which the change in
the yield for all maturities is the same
nonparallel shift in the yield curve - the yield for different
maturities does not change by the same number of basis
points
Study Session 14, Reading 43
22. Types of Non Parallel Shifts
1. A downward shift in the yield curve combined with a
steepening of the yield curve.
2. An upward shift in the yield curve combined with a flattening
of the yield curve.
twist in the slope of the yield curve - a flattening or steepening
of the yield curve
butterfly shifts - nonparallel shifts in the yield curve that change
its curvature
Study Session 14, Reading 43
23. Construction of Spot Rate Curve
shift in the yield curve - the relative change in the yield for each
Treasury maturity
Selection of Securities
Determine the methodology for constructing the curve
bootstrapping is used as a repetitive technique
Study Session 14, Reading 43
24. Selection of Securities
Yields should not be biased on the following:
1. Default
2. Embedded options
3. Liquidity
4. Pricing errors
Treasury issues that are candidates for inclusion
1. Treasury coupon strips
2. On the run Treasury issues
3. On the run Treasury issues and selected off the run issues
4. All Treasury coupon securities and bills
Study Session 14, Reading 43
25. Elements of Swaps and Swap Curve
Two parties “swapping” payments
One party is paying a floating rate and receiving a fixed rate, and
The other party is paying a fixed rate and receiving a floating rate.
Swap is described in terms of a “rate”.
The most common reference rate used in swaps is the 3-
month LIBOR. When LIBOR is the reference rate, the swap is
referred to as a “LIBOR- based swap”.
Study Session 14, Reading 43
26. Swap Spread
Swap spread reflects the risk of the counterparty to the swap
failing to satisfy its obligation.
Swap spread primarily reflects credit risk.
Value:
Swap spread = Swap rate - Government yield on a bond with the same
maturity as the swap
Study Session 14, Reading 43
27. Pure Expectations Theory
pure expectations theory - forward rates exclusively represent
expected future spot rates
The theory neglects the risks inherent in investing in bonds. Two
types of risks in bond investments:
1. interest rate risk
2. reinvestment risk
Study Session 14, Reading 43
28. Liquidity Preference Theory,
Preferred Habitat Theory
Liquidity Preference Theory - the investors will hold longer-term
maturities if they are offered a long-term rate higher than the
average of expected future rates by a risk premium that is
positively related to the term to maturity
Preferred Habitat Theory - rejects the assertion that the risk
premium must rise uniformly with maturity
Study Session 14, Reading 43
29. Measuring Yield Curve Risk
yield curve risk - the exposure of a portfolio or position to a
change in the term structure
Yield curve risk can be measured by changing the spot rate for
a particular key maturity and determining the sensitivity of a
security or portfolio to this change, holding the spot rate for
the other key maturities constant.
Study Session 14, Reading 43
30. Measuring Historical Yield Volatility
yield volatility – Parameter measured the exposure of a
portfolio to rate changes depends on how likely and how
much interest rates may change
Formula:
Xt = 100[Ln(yt/yt- 1)]
Study Session 14, Reading 43
31. Annualizing the Standard Deviation
Formula:
Daily standard deviation * sqrt (number of days in a year)
Some investors and traders use the number of days in the year,
365 days, to annualize the daily standard deviation. Some
investors and traders use only either 250 days or 260 days to
annualize.
Study Session 14, Reading 43
32. ARCH Model
autoregressive conditional heteroskedasticity (ARCH) model The statistical model used to estimate this time series
property of volatility
conditional - the value of the variance depends on or is
conditional on the value of the random variable
heteroskedasticity - the variance is not equal for all values
of the random variable
Study Session 14, Reading 43
33. Determination of benchmark
interest rates
The Treasury market
A sector of the bond market
The market for issuers securities
Study Session 14, Reading 44
34. Generation of Interest Rate Trees
The interest rates on the tree are used to generate the cash
flows taking into account the embedded option.
The interest rates on the tree are used to compute the
present value of the cash flows.
Study Session 14, Reading 44
35. Binomial Model, Trinomial Model,
Discrete Time Option Pricing Model
interest rate model - a probabilistic description of how interest
rates can change over the life of the bond
Interest Rate Tree Models:
binomial model - valuation model that assume that interest rates can
realize one of two possible rates in the next period
trinomial models - valuation model that assume that interest rates
can take on three possible rates in the next period
discrete time option pricing model – a more complex model that
assume in creating an interest rate tree that more than three
possible rates in the next period can be realized
Study Session 14, Reading 44
36. Benchmark interest rates
Benchmark interest rates can be one of the following:
The Treasury market
A specific bond sector with a given credit rating
A specific issuer
Benchmark interest rates can be based on either:
An estimated yield curve
An estimated spot rate curve
Thus there are six potential benchmark interest rates (2*3).
Study Session 14, Reading 44
37. Spread Measures
nominal spread – a spread measured relative to the Treasury
yield curve and reflects compensation for credit risk, liquidity
risk and option risk
zero volatility spread – a spread relative to the Treasury spot
rate curve and reflects compensation for credit risk, liquidity
risk and option risk
option adjusted spread - a spread relative to the Treasury spot
rate curve and reflects compensation for credit risk and
liquidity risk.
Study Session 14, Reading 44
38. OAS, Benchmark and Relative Value
When the benchmark is the Treasury spot rate curve:
the security is expensive if the security OAS is greater than required
OAS
the security is cheap if the security OAS is less than required OAS
if the security OAS is equal to the required OAS, the security is fairly
priced
When a sector of the bond market with the same credit rating is the
benchmark:
if the security OAS is greater than the required OAS, the security is
cheap
if the security OAS is less than the required OAS, the security is
expensive
if the security OAS is equal to the required OAS, the security is fairly
priced
Study Session 14, Reading 44
39. Backward Induction Methodology
It is a discounting process for valuing bonds with a binomial
interest rate tree.
It refers to the process of discounting distant values in a
binomial tree, one node at a time, backwards through time to
generate a current value.
Study Session 14, Reading 44
40. Valuation of Callable Bonds
and Putable Bonds using Binomial Model
Callable bonds can be valued by modifying the cash flows at
each node in the interest rate tree to reflect the cash flow
prescribed by the embedded call option according to the call
rule.
Putable bonds are valued using the same procedure as for a
callable bond, except that the relevant cash flows are dictated
by the rules governing the exercise of the embedded put
option.
Study Session 14, Reading 44
41. Valuation of Bond with Embedded
Options and Floating Rate Notes
using Binomial Model
bond with an embedded option or options - can be valued by
requiring that the value at each node of the tree be adjusted
based on whether or not the option will be exercised
floating-rate note - the binomial method must be adjusted to
account for the fact that a floater pays in arrears. That is, the
coupon payment is determined in a period but not paid until
the next period.
Study Session 14, Reading 44
42. Convertible Securities
The owner can exchange the bond for the common shares of
the issuer.
Gives the bondholder the right to buy the common stock of
the issuer.
Almost all convertible bonds are callable, and some
convertible issues are putable.
Study Session 14, Reading 44
43. Conversion Price, Conversion Ratio
and Straight Value
conversion ratio - number of common shares for which a convertible
bond can be exchanged.
conversion price - issue price divided by the conversion ratio.
conversion value - value of the stock into which the bond can be
converted.
conversion value = market price of stock × conversion ratio
straight value - value of the bond if it were not convertible
market conversion price - price that a convertible bondholder would
effectively pay if the bond were purchased and immediately
converted.
market conversion price = market price of convertible bond/conversion
ratio
Study Session 14, Reading 44
44. Fixed Income, Common Stock
and Hybrid Equivalents
fixed income equivalent (or a busted convertible) - the straight
value is considerably higher than the conversion value so that
the security will trade much like a straight security.
common stock equivalent - the conversion value is considerably
higher than the straight value so that the convertible security
trades as if it were an equity instrument.
hybrid equivalent - the convertible security trades with
characteristics of both a fixed income security and a common
stock instrument.
Study Session 14, Reading 44
45. Advantages and Disadvantages
of Convertibles
Advantages:
reduction in downside risk
the price appreciation resulting from an increase in the value
of the common stock
Disadvantages:
the upside potential given-up because a premium per share
must be paid
when the stock price rises, the bond will underperform
because of the conversion premium of the bond
Study Session 14, Reading 44
46. Mortgages
mortgage - a loan secured by the collateral of some specified
real estate property which obliges the borrower to make a
predetermined series of payments
the mortgage rate or contract rate - interest rate on the
mortgage loan
Study Session 14, Reading 45
47. Types of Mortgage Designs
mortgage design - a specification of the interest rate, term of
the mortgage, and the manner in which the borrowed funds
are repaid
Types of Mortgage Designs:
fixed-rate, level-payment fully amortized mortgages
adjustable-rate mortgages
balloon mortgages
growing equity mortgages
reverse mortgages
tiered payment mortgages
Study Session 14, Reading 45
48. Types of Mortgage Backed Securities
1. residential mortgage-backed securities - backed by
residential mortgage loans
Sectors:
agency mortgage backed securities - issued by federal agencies
non agency mortgage-backed securities - issued by private entities
Residential mortgage-backed securities include:
mortgage passthrough securities
collateralized mortgage obligations
stripped mortgage-backed securities.
2. commercial mortgage-backed securities - backed by
commercial loans
Study Session 14, Reading 45
49. Residential Mortgage Design
Most common mortgage design in the United States:
fixed-rate mortgage
level-payment mortgage
fully amortized mortgage.
Features:
the mortgage rate is fixed for the life of the mortgage loan
the dollar amount of each monthly payment is the same for
the life of the mortgage loan
when the last scheduled monthly mortgage payment is made,
the remaining mortgage balance is zero
Study Session 14, Reading 45
50. Residential Mortgage Servicing Fee
servicing fee - a portion of the mortgage rate
Servicing of a mortgage loan involves:
collecting monthly payments and forwarding proceeds to owners of
the loan
sending payment notices to mortgagors
reminding mortgagors when payments are overdue
maintaining records of principal balances
initiating foreclosure proceedings if necessary
furnishing tax information to borrowers (i.e. mortgagors) when
applicable.
Study Session 14, Reading 45
51. Residential Mortgage Prepayment
prepayment - a payment made in excess of the monthly
mortgage payment
curtailment - When a prepayment is not for the entire
outstanding balance
prepayment risk - the risk when amount and timing of the cash
flow from a mortgage loan are not known with certainty
lockout period or penalty period - a period of time over which if
the loan is prepaid in full or in excess of a certain amount of
the outstanding balance, there is a prepayment penalty
Study Session 14, Reading 45
52. Types of Mortgage Passthrough
Securities
mortgage passthrough security - created when one or more holders of
mortgages form a collection (pool) of mortgages and sell shares or
participation certificates in the pool.
Types:
1. agency mortgage pass through securities – backed by an agency
security
Underwriting Standards:
conforming mortgage
nonconforming mortgage
2. non agency mortgage pass through securities - are nonconforming
mortgages used as collateral for mortgage pass-through securities
and are privately issued
Study Session 14, Reading 45
53. Weighted Average Coupon
and Weighted Average Maturity
of Mortgage Passthrough Securities
weighted average coupon rate(WAC) - found by weighting the
mortgage rate of each mortgage loan in the pool by the
percentage of the mortgage outstanding relative to the
outstanding amount of all the mortgages in the pool.
weighted average maturity(WAM) - found by weighting the
remaining number of months to maturity for each mortgage
loan in the pool by the amount of the outstanding mortgage
balance.
Study Session 14, Reading 45
54. Measuring the Prepayment Rates
of Mortgage Passthrough Securities
single monthly mortality rate(SMM) - ratio of the prepayment
in a month and the amount available to prepay that month
Formula:
SMM = (Prepayment in month) / (Beginning mortgage balance for
month t – Scheduled Principal Payment in month t)
Formula: Given an assumed SMM for month t:
(Prepayment in month) = SMM * (Beginning mortgage balance for
month t – Scheduled Principal Payment in month t)
Study Session 14, Reading 45
55. Conditional Prepayment Rate (CPR)
of Mortgage Passthrough Securities
Formula: Given the SMM for a given month
CPR = 1 - (1 - SMM)12
Formula: Given a CPR
SMM = 1 – (CPR)1/12
Study Session 14, Reading 45
56. PSA Prepayment Benchmark
Expressed as a monthly series of CPRs.
It assumes that prepayment rates are low for newly originated
mortgages and then will speed up as the mortgages become
seasoned.
It assumes the following prepayment rates for 30-year mortgages
a CPR of 0.2% for the first month, increased by 0.2% per year per month
for the next 30 months until it reaches 6% per year, and
a 6% CPR for the remaining months.
Mathematically, 100 PSA can be expressed as follows:
if t < 30 then CPR = 6% (t/30)
if t > 30 then CPR = 6%
Study Session 14, Reading 45
57. Average Life of Mortgage
Passthrough Securities
weighted average life or average life - measure widely used by
market participants
Formula:
Average Life = ∑ (t * Projected Principal received at time t) /
(12 * Total Principal)
Study Session 14, Reading 45
58. Factors affecting Prepayment Behaviour
Prevailing mortgage rate
Housing turnover
Characteristics of the underlying residential mortgage loans
Study Session 14, Reading 45
59. Contraction and Extension Risk of
Mortgage Passthrough Securities
contraction risk - undesirable consequences of declining interest
rates:
MBS exhibit negative convexity
cash flows must be reinvested at a lower rate.
extension risk - the drop in bond prices and the slowing of
prepayments as interest rates increase
Study Session 14, Reading 45
60. Collateralized Mortgage Obligations
(CMOs)
Collateralized mortgage obligations are bond classes created by
redirecting the interest and principal from a pool of pass
throughs or whole loans.
CMOs are securities issued against a pool of mortgages for which
the cash flows have been allocated to different classes called
tranches.
Study Session 14, Reading 45
61. Design of CMOs
Sequential-pay tranches - a common arrangement for
separating mortgage cash flows into classes to create CMOs
where each class of bond is retired sequentially.
Planned Amortization Class (PAC) tranches - the most common
type of CMO, have a payment schedule that is established
within a range of prepayment speeds called the initial PAC
collar.
Study Session 14, Reading 45
62. Stripped Mortgage Backed Security
stripped mortgage-backed security - a derivative mortgagebacked security that is created by redistributing the interest
and principal payments to two different classes.
Classes:
principal-only mortgage strip (PO) - a class of securities that
receive only the principal payment portion of each mortgage
payment. The PO exhibits some negative convexity at low
rates.
interest-only mortgage strip (IO) – a classes that receive only
the interest component of each payment. The IO price is
positively related to mortgage rates at low current rates.
Study Session 14, Reading 45
63. Non Agency Residential Mortgage
Backed Security
non agency MBS (non agency securities) - issued by private
entities and are usually backed with nonconforming mortgage
loans
nonconforming mortgage - loans that fail to meet the agency’s
underwriting standards
Non agency security cash flows are affected by mortgage default
rates and thus require credit enhancement
Study Session 14, Reading 45
64. Commercial Mortgage Backed
Security
commercial mortgage-backed securities - backed by a pool of
commercial mortgage loans—loans on income-producing
property.
Features:
structured as nonrecourse loans
on two key ratios to assess the credit risk
Debt-to-service coverage ratio
Loan-to-value ratio.
Study Session 14, Reading 45
65. Call Protection for CMBS
Degree of call protection available investor:
At the loan level
From the actual CMBS structure.
Methods of call protection at the loan level includes:
Prepayment lock outs
Defeasance
Penalty fees
Yield maintenance charges
Study Session 14, Reading 45
66. Parties in a Securitization Process
Seller - originates the loans and sells them to the issuer/trust.
Issuer/trust - buys the loans from the seller and issues the ABS.
Servicer - who services the original loans.
Study Session 14, Reading 46
67. Home Equity Loans
Closed-end Home Equity Loans (HELs) - secondary mortgages
that are structured just like a standard fixed rate, fully
amortizing mortgage.
Distinctive Feature: credit traits of the borrowers
Structure:
non-accelerating senior tranches
planned amortization class (PAC) tranches.
Study Session 14, Reading 52
68. Manufactured Housing Backed
Securities
manufactured housing asset backed securities - backed by loans
for manufactured homes.
Distinctive feature: relatively stable prepayments
Study Session 14, Reading 52
69. Auto Loan Backed Securities
Auto loan-backed securities - backed by loans for automobiles
Distinctive Features: Prepayments are caused by sales and tradeins, the repossession/resale process, insurance payoffs due to
thefts and accidents, borrower payoffs, and refinancing.
Auto loans have 36- to 72-month maturities and are issued by
the financial subsidiaries of auto manufacturers, commercial
banks, credit unions, etc.
Study Session 14, Reading 52