Chapter 05 Flashcards

1
Q

Floating-rate notes (FRNs)

A

FRNs pay a regular coupon, plus promise of a return of face value at maturity.

Rate of interest resets periodically, based on “reference rate” (e.g. London Interbank Offered Rate (LIBOR) or Euro Interbank Offered Rate (Euribor).)

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2
Q

money market funds (MMFs)

called “unit trusts” in UK and Europe

A
  • commingled pools of money mkt securities (invests in various short-term instruments)
  • usually weighted avg. maturity of ~60 days
  • typically have a fixed unit currency value (i.e. net asset value (NAV)) in terms of the currency of the asets held by the fund
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3
Q

short-duration mutual funds

A
  • typically l_onger investment maturity_, higher risk of price volatility, and greater prospect for higher returns vs. MMFs
  • do not typically have a fixed unit currency value, i.e., a net asset value (NAV).
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4
Q

asset-backed commercial paper (ABCP)

A
  • Has most features of standard CP, plus it is secured w/ company assets
    • Single seller ABCP - backed by assets from a single firm
    • Multi-seller - backed by assets purchased from a number of issuers
  • Advantages:
    • Liquidity support (credit enhancements) facilitate timely repayment
    • Moderately higher rate of return than on standard CP
  • Disadvantages:
    • Harder to appraise overall risk (may require 3rd party credit monitoring)
    • Smaller market than standard CP (i.e. increased liquidity risk)
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5
Q

commercial paper (CP)

A

tradable promissory notes that represent an unsecured obligation/debt of the issuer (i.e., CP not backed/“secured” by any collateral of the issuer).

Maturity: usually less than 45 days, but…

  • Publicly traded CP: ranges from overnight to 270 days (i.e. CP issued in US under SEC 1933 Act, Sect. 3(a)(3))
  • Private placement CP: up to 397 days (i.e. CP issued under Sect. 4(a)(2),
  • Most CP matures in less than 45 days.
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6
Q

Price risk

A

refers to changes in interest rates having an adverse impact on the value of a security.

Securities with longer maturities have increased price risk as their market values are more responsive to changes in interest rates. As interest rates increase, the investor demand will be lower for previously issued securities with lower coupon rates. In general, price risk refers to the potential for an increase in interest rates. A chart showing a one-year bond and a ten-year bond would show that as interest rates rise, the value of the ten-year bond drops faster than for a one-year bond.

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7
Q

Commercial Book-Entry System (CBES)

aka Treasury/Reserve Automated Debt Entry System (TRADES)

A
  • a multi-tiered, automated system for purchasing, holding, and xferreing marketable treasury securities
  • delivery syst that allows simultaneous xfer of securities & funds settlement (i.e. securities owners (or brokers, on their behalf) receive interest and redemption payments wired directly to their linked accounts.)
  • one of the 2 primary systems to process/clearmoney mkt investments in the US
  • top tier = National Book-Entry System (NBES)– operated by the Fed
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8
Q

broker-dealer

A

an entity that trades securities for its own account (dealer) or on behalf of customers (broker)

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9
Q

primary vs. secondary market transactions

A
  • primary - newly issued debt/equity securities
  • secondary - involve previously issued securities
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10
Q

“ask price”

A

price/yield @ which dealer SELLS a security

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11
Q

“bid price”

A

price/yield @ which dealer PURCHASES a security

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12
Q

“spread”

A

the difference between ask and bid price

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13
Q

Central Securities Depositories (CSDs)

A

companies that hold securities to enable book-entry xfers

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14
Q

default/credit risk

A

likelihood of debts not repaid under original loan terms

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15
Q

liquidity risk

A

likelihood that a security cannot be sold quickly without incurring a substantial loss in value

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16
Q

reinvestment risk

A
  • one of 2 components of interest rate risk
  • refers to potential DECLINE in interest rates
  • likelihood that proceeds from maturing investments are reinvested @ lower interest rates (i.e. after market interest rates drop)
  • longer term investment = greater price risk (i.e. the further into the future an investment’s maturity date is, the greater the uncertainty as to what interest rates will be @ the time of maturity)
17
Q

price risk

A
  • one of 2 components of interest rate risk
  • refers to potential INCREASE in interest rates
  • as interest rates increase, demand declines (for previously issued securities w/ lower coupon rates)
18
Q

Bank obligations

A
  • includes time deposits, banker acceptances, repurchase agreements
  • sometimes collectively called “bank paper” or “bank obligations”
19
Q

4 basic types of market risk:

A
  • Equity price risk
  • Interest rate risk*
  • FX risk*
  • Commodity price risk*

*collectively, “financial risks” (general term for impact on an org. from unexpected changes in interest rates, FX rates or commodity prices)

20
Q

FX risk arises when investors purchase securities denominated in foreign currencies

when does FX risk results in a loss…?

A

adverse change in FX rates (i.e. lower ROR when investment proceeds are converted to the firm’s home currency.)

  • foreign ccy. depreciates vs. investor’s LCY = decline in investment’s value
  • Example: Chinese investor invests in US T-bills. During investment holding period, CNY appreciates relative to USD (CNY > USD)
    • Since CNY value went UP,
    • USD value (investment) DEPRECIATES