FIN 355 Exam 1 Cheat Sheet
FIN 355 Exam 1 Cheat Sheet FIN 355
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This 2 page Study Guide was uploaded by Gabby Greenberg on Monday September 26, 2016. The Study Guide belongs to FIN 355 at Colorado State University taught by Tianyang Wang in Fall 2016. Since its upload, it has received 13 views. For similar materials see Principles of Investments in Finance at Colorado State University.
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Date Created: 09/26/16
Treasury Notes & Bonds Price quotes are % of par Short Sales to profit from a decline in the price. Covered Call Writing buy a stock & write a call. ($1000). Numbers to right of colon in bid & ask prices Mechanics: Borrow stock from a broker, margin up Gives up upside to increase income. represent units of 1/32 of a point (1/32 = 0.0313 front b/c very risky. Sell it & deposit proceeds & Naked Call Writing speculator writes (sells) a call .03125). Ask price 102:23 = 102(23/32) = 102.719% * margin in an account. Closing out the positions: buy option on a security w/o owning. Unlimited risk. $1,000 = $1,027.19 $1,027.19 PLUS accrued the stock & return to the party from which was Straddle buy a call & a put. Value increases with interest. borrowed. Unlimited risk as price goes up, used with uncertainty. Objective: Profit from uncertain stock Corporate Bonds Price quotes are % of par "stop-buy". price movements. Ingredients: buy 1 call & buy 1 put, ($1,000), but quoted in decimals instead of the 32nds Buy to Cover buy order made on a stock or other same exercise price & maturity. Buying a call option of the Treasury Market. listed security that closes out an existing short & the same underlying stock at same price & Eurodollars Time-deposits denominated in USD at position. A short sale involves selling shares of a expiration date. This creates a V shape graph - banks outside the US, not under jurisdiction of the company that one does not own, as the shares are always wasting one side of the contract, but hopefully fed, less regulated. Euro- prefix can be used to borrowed & need to be repaid at some point. one profit will exceed the loss & net profit overall. You indicate any currency held in a country where it is not Contingent Order simultaneous execution of 2 or know something big is going to happen, you just don't the official currency. more transactions. An order’s execution depends know what so you double bet. Eurobonds denominated in a currency other than upon the execution &/or price of another security. Other Combinations Spreads: Multiple call/put that of the country in which it is issued. Ex: dollar Derivatives are a contract between two parties, options with different exercise prices or expiration denominated bond sold in Britain called a Eurodollar predetermined payoffs linked to another ('underlying') dates. Example: A collar is the use of a protective put bond. asset. & covered call to collar/bracket the value of your Foreign Bond issued in a domestic market by Call Option right to buy. Put Option the right to sell. portfolio within a narrow range. Collars: To bracket foreign entity, in the domestic market's currency. In the Money profitable. Call: market price (s) > the value of your portfolio within a narrow range. Municipal Bonds equivalent to a higher rate than an exercise price (x) Put: exercise price (x) > market Stop-Loss the stock will be sold if its price falls to the alternative investment. Key features: interest is tax- price (s) Out of the Money not profitable. stipulated level. free at federal & state level. Call: market price (s) < exercise price (x) Put: Stop-Buy the stock will be bought if its price rises Break-even tax rate: t = 1 - (muni rate/taxable rate). exercise price (x) < market price (s). At the Money above the stipulated level. Forwards contract today which specifies price & Taxable Rate = Muni Rate / (1-tax rate). exercise price & asset price are equal. Capital Market: Equity Indexes Standard Option right to buy/sell 100 underlying quantitates to be transacted in the future. No money Dow Jones Industrial Average (1896) about 1/5 of the shares. Mini Option 10 shares. Jumbo Option 1000 changes hands today, but sale prices & quantities total market cap. S&P 500 is 500 "larger" shares. are LOCKED IN. There is no limit to the variety of capitalization firms. S&P 100 (large), S&P 400 (mid), Option Payoff Graph, contingency table (in money possible forward contracts; can be anything parties S&P 500 (small), S&P 1500. NASDAQ Composite: or out of the money), or maximization formula. want. Difference between option & future is that the Tracks al 4000 stocks trading on NASDAQ. Heavy in Gross payoff does not consider the premium you future has an obligation, unlike options. software/hardware technology.International: Nikkei paid. Net payoff accounts for the premium paid Futures formalized forward contract, can be sold off. 225; DAX (Ger), FTSE (Fin Times). (subtract from payoff). Disadvantage is limited variety in terms (types, Stock Indices are usually value-weighted: S&P 500, Call Option W/O Premium =max(0, ST-K) prices, delivery dates). Advantages over forward NASDAQ. Interpretation: portfolio with market S = Market Price of Stock. K = Exercise/Strike Price. contracts is liquidity; trading action concentrated in a weights. Market Value = # shares outstanding * share T = Expiration Date. few contracts provides liquidity to market participants. price. Can be price-weighted: Dow Jones & Nikkei If ST < K then you will not exercise the option. They Futures Payoff Long future position commits to 225. Interpretation: portfolio with equal shares. payoff to you is simply 0. If ST > K then you will buying a maturity at F* Short future position commits Trading Hours are 9:30am-4pm EST. Pre-market: exercise the option b/c you can buy a stock which is to selling at maturity at F* 4am-9:30am EST. After-hours: 4pm-8pm EST. worth $ST at the strike price $K. Exercising the 3 Trading Mechanisms: Dealers: NASDAQ: option would give you a payoff of (ST-K)>0. National Association of Securities Dealers Automated Put Option W/O Premium Quotations, OTC: Over the Counter, consists a Payoff on expiration date =Max(0, K-ST) network of dealers. Dealer has the inventory & they If ST > K then you will not exercise the option. The sell the stock to you from their inventory. Each dealer payoff would be 0. If ST < K then you will exercise posts bid, ask, & the depth (# of shares dealer is the option. You can sell the stock which is worth $ST willing to buy or sell at quoted prices. at the strike price $K. Exercising the option gives you Specialists: Mostly act as Broker, but also act as a payoff of (K-ST)>0. Futures Profits Profit to long: spot price at maturity - Dealer when market needs liquidity & price continuity. Put-Call Parity 2 portfolios have same payoffs at Futures price. Bought for original future price, can sell Set the buy or sell prices (i.e. bid & ask) based on the expiration, their current price should be the same. at maturity for spot. Profit to short: futures price - spot observed order flow (sell & buy orders). Should pay the same price for the same return no price at maturity. Futures contract, like option ECNs: Electronic Communication Networks. Rely on matter what. Otherwise, arbitrage exists. Aligning the contracts, are zero sum. Gain to long is loss to short computer networks without brokers. Direct crossing payoff chart to the cash for the portfolio: Call Payoff + & vice-versa. of trades without using a broker-dealer system. No Cash in Portfolio at expiration. Call Premium + PV of Return on Invested Capital Commodities allow use need for market makers. Eliminate the bid-ask X = Put Premium + Current Stock Price of leverage for potentially high returns. Return on spread. Better price for buyers & sellers. Capital = (Selling price of commodity contract - Market Order: an order to buy or sell at a current Purchase price of contract) / amount of margin market price. deposit X=Exercise Price or K=Strike Price Limit Order: an order to buy or sell a pre-specified Option Strategies Future-Spot Parity 2 ways to obtain asset at some price. Use options for speculation (increase risk) & hedging future date: 1) Purchase the asset now & store it until Stop Order: Trade is not to be executed unless stock (reduce risk). the target date. 2) Take a long future position that hits a price limit (when the market is moving against Protective Put/Married Put buy insurance against calls for purchase on the target date. Each strategy you). downturns. Buy a stock or a put. Objective: Limit yields the same result in the future, & therefore you Buying on Margin using a portion of the proceeds would expect the cost of each strategy to be equal. If downside portfolio risk. Ingredients: Buy 1 stock, buy the cost of the 2 strategies were not equal, you would for an investment & borrow remaining component 1 put. from brokers. Fed requires 50% initial margin. Broker Covered Call Objective: Earn extra portfolio income. expect arbitrage. F0 = S0 (1+rf - dividend yield)^t sets maintenance margin & if margin account falls Ingredients: Buy 1 stock, write 1 call. below, you get a margin call. Exchanging uncertainty for certainty - covering our risk. Players in the Futures Markets Hedgers: Producers Holding Period Return (HPR) amount return earned & processors. Protecting their interests in underlying from holding an investment for a specified holding commodity or financial instrument. Provide the actual period (usually 1 year or less). All direct cash flows products being sold. Speculators: Investors. Trying to received over a specified period. Realized return, earn profit on expected swings in prices of futures includes the reinvestment rate of coupons. Includes contracts. Provide liquidity. both capital gains & income. Futures & Options Key Differences: Option holder is Calculated by: net cash flows / cost. not required to complete the transaction, futures Cash flows = income & sales of capital. Net cash buyer is. Futures positions are marked-to-market; flows = cash flows - cost. options positions are not. Holding period = (income during period + capital gain Mark to Market Daily settlement of margin (or loss) during period) / beginning investment value. obligations. Clearinghouse eliminates counterpart Capital gain (or loss) = ending investment value - default risk; allows anonymous trading since no credit beginning investment value. evaluation is needed. Without this feature you would If your reinvestment rate is the same as it was at not have liquid markets. purchase, the HPR is equal to your yield. If your rate Strategy Call Put Stock Settlements Delivery is settled at delivery & Cash is lower, the yield will be higher than the HPR & if the Agreements are settled as cash (cash is more rate is higher, the yield will be less than the HPR. Limit Portfolio Protective Put Buy Buy 1 common due to more speculators). Speculation & Term Structure The relationship between YTM & Downside Risk 1 hedging use of contracts requires that settlement maturity. Information on expected future short term Earn Extra Covered Call Sell Buy 1 price at expiration reflects underlying value of the rates can be implied from yield curve (graph displays Portfolio 1 commodity. relationship between yield & maturity). Income Contango market condition wherein the price of a Various Annual Rates of Return spot rates are forward or futures contract is trading above the known yields on Zeros. Future rates are not known Profit from Straddle Buy Buy expected spot price at maturity. May be due to today, forward (short) rates are known today (implied Uncertain 1 1 Price people's desire to pay a premium to have the rate for the future). Movement commodity in the future rather than paying the cost of Break-even definition storage & carrying cost of buying the commodity today. Backwardation (normal) price of contract is trading Example of Forward Rates below expected spot price at maturity. Opposite of contango. More like a "lease rate," the cost of 3 yr spot y3 = 7%. 2 yr spot y2 = 6%. Two equivalent 3-year strategies: borrowing a stock or commodity for a period of time. 1) Buy a 3-year zero Options have call & put from buyer perspective, 2) buy a 2 year zero & roll over into 1 year zero at mirror image from seller’s perspective. For futures & year 2 at forward short rate f3. forwards, there is only one perspective of the buyers (1+y3)^3 = (1+y2)^2*(1+f3). F3 = 9.03% (combination of buying a call & writing a put). The Expectations Hypothesis idea: the slope of the short is the opposite side of futures & forward & this is the perspective of the seller. yield curve is attributable to expectations of changes in short-term rates. Predicts that Ft = E (Rt) for all t. Zero Coupon Bonds bought at lower price than face Observed long-term rate is a function of today's value, with face value paid at time of maturity. Pay no short-term rate & expected future short-term rates. explicit interest & owner must pay taxes on "imputed" Long-term & short-term securities are perfect interest. Value of a Zero is the PV of the par substitutes. Forward rate that are calculated from the payment. Zeros are the most fundamental bonds. yield on long-term securities are market consensus Portfolio of zeros can replicate any no-default bond. Pricing & Valuing Bonds sum of all future coupon expected future short-term rates. Liquidity Hypothesis idea: risk-averse investors payments, discounted by the coupon payments, plus have preferred investment horizons (short or long- par value discounted by the maturity time. Bond price term) is the PV of future cash flows. Discount rate is market Predicts that Ft = E (Rt) + liquidity premium. int. rate. Long-term bonds are riskier. The yield curve has an upward bias built into the long-term rates b/c of the risk premium. Forward rates contain a liquidity premium & are not equal to expected future short- Rule of 72 a 6% return on investments, take 72/6 = term rates. 12, so it will take you about 12 years to double the Market Segmentation Theory market is not investment. $1000 balance on your credit card with a homogeneous or the same everywhere - different 24% APR, 72/24 = 3 so it will take three years to market segments. Investors have set preferences double your debt. Yield to Maturity the compound rate of return IF regarding the length of maturity that they will invest compounds are reinvested at YTM. Usually quoted in. The buyers & sellers are each of the different maturity lengths cannot be easily substituted for each as a bond-equivalent yield (simple rate). other. Different Yields Bond Equivalent Yield: Semiannual Investors prefer short-term investments: Upward Rate * 2. Real return, bank discount is tradition - we Curve. are assuming there are 360 days a year and that you Investors prefer long-term investment: Downward are dividing the profit by the par instead of principle. Effective Annual Yield: (1+Semiannual Rate)^2-1. Curve. Firm prefers short-term projects: Downward Curve. Current Yield: Annual coupon payment / current Firm prefers long-term projects: Upward. price.
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