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FI 301 Study Guide for Test 2

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by: Julie Knight

FI 301 Study Guide for Test 2 FI 301

Marketplace > University of Alabama - Tuscaloosa > Business > FI 301 > FI 301 Study Guide for Test 2
Julie Knight
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This study guide covers chapters 7, 8, 10, 12, and 23.
Financial Institutions
Sherwood Clements
Study Guide
FI, FI 301, finance
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This 11 page Study Guide was uploaded by Julie Knight on Monday April 4, 2016. The Study Guide belongs to FI 301 at University of Alabama - Tuscaloosa taught by Sherwood Clements in Spring 2016. Since its upload, it has received 163 views. For similar materials see Financial Institutions in Business at University of Alabama - Tuscaloosa.

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Date Created: 04/04/16
Sherwood Clements FI 301 Financial Institutions: Test 2 Study Guide *** I tried to highlight what Professor Clements specifically said would be on the test as well as what he wrote on the board. Chapter 6: Money Markets  Money market securities: o Maturity of one year or less o Used through investment brokers o Purpose: short term liquid investment o Very low end return (1-2%) o Relatively risk free o Helps to diversify  Main types: o Treasury bills  Federal government borrowing money  Issue: 4 week, 13 week, 26 week, and 52 week  Sold at a discount from par value  Buy for less than face value  Free from risk  Backed by government (print money)  1) Investors in Treasury Bills:  commercial banks, other nation’s governments, money market mutual funds, investment banks  invest in others to diversify  safer  2) Treasury Bill Auction  investors have the option of bidding competitively or noncompetitively  3) Estimating the Yield   4) Estimating the Treasury Bill Discount  o Commercial paper  Short term debt instrument issued by well known credit worthy firms and is typically unsecured  Between 1-270 days (no government paperwork)  “unsecured”- no collateral Sherwood Clements  minimum denomination of commercial paper is usually $100,000  1) Ratings:  S&P, MODYS, FITCH  2) Credit Risk During Credit Crisis  99% is good  2008 credit crisis  Lehman Brothers  3) Placement  firms place commercial paper directly with investors or rely on dealers to sell  unsecured  higher interest rate  4) Backing Commercial Paper  some backed by assets of the issuer  maintain backup lines  5) Estimating the Yield  commercial paper does not pay interest and is priced at a discount from par value  like a T-bill  commercial paper pays a higher yield  6) Commercial Paper Yield  o Negotiable certificates of deposit  Certificates used by large commercial banks and other depository institutions as a short term source of funds  o Repurchase agreements  Placement  Impact of the credit crisis  Estimating the yield  o Federal funds  The fed  Discount rate  borrowing from the Fed o Banker’s acceptance  A bank accepts responsibility for a future payment for a customer Sherwood Clements  Because acceptances are often discounted and sold by the exporting firm prior to maturity, an active secondary market exists   Risk: o Interest rate risk- risk of rapidly rising rates o Credit risk- default risk o Worry more about credit risk **  Impact of changes in credit risk o Credit risk follows Lehman’s Default  Move to T-bills o Risk premiums among MMS  Globalization of Money Markets o Measured by the effective yield  Chapter 7: Bond Markets  Bond- debt security o Control costs better than stocks o 2X bigger than stock market  Background on Bonds o Types:  Treasury bonds  Municipal bonds Sherwood Clements  Federal bonds  Savings bonds  Corporate bonds o Interest payments  coupon payments (semi annually) o Original bonds- bearer bonds  Bond Yields o 1) yield from the issuer’s perspective o 2) yield from the investor’s perspective  Treasury and federal agency bonds o Treasury bonds- federal government debt between 10-30 years o Paid differently  Bills  discount; notes/bonds  coupon rate o 1) treasury bond auctions  normally held in the middle of each quarter  competitive bids- bids to determine return  non competitive bids- take interest rate as given o 2) trading treasury bonds o 3) stripped treasury bonds  investment brokers buy to sell o 4) inflation indexed treasury bonds  commonly referred to as TIPS  bond that changes with inflation o 5) savings bonds  federal government bonds that people buy to pay for education  *** SAVINGS BONDS  EE- today  HH- old  I- inflation  Patriot – after 9/11 o 6) federal agency bonds  MBB- mortgage backed bonds  Municipal Bonds o Issued by state and local governments  1) general obligation bonds  2) revenue bonds o Call provision- if interest rates drop  pay off and issue new  Yields offered on municipal bonds o Municipal bonds have risk  More than federal; less than other  Tax advantages o Municipal bonds are FREE from taxes  Want people to invest  So the government does not have to pay  Corporate Bonds o Agency bonds- Fannie Mae and Freddy Mac  Collateral  mortgage backed bonds o Corporate bonds- debt issued by business Sherwood Clements  More default risk  Unsecured no collateral  NOT tax free to investors  BUT tax deduction on interest paid  Minimum denomination- $1000  Typical maturity- 10 to 30 years  Characteristics of Corporate Bonds: o Sinking fund provision  Must pay a percentage of debt off each year o Protective covenants  Assure that you will get your money back o Call provisions  Reissue bonds  Call premium o Bond collateral  Real estate of the company  Collateral everyone wants o Zero coupon bond  NO coupon payments  Buy at a discount o Variable rate bond  Rate changes over time o Convertible bond  Company has the option to issue stock to pay off bond holders  Secondary market for corporate bonds: o Bond mutual funds are typical investors o Or pension funds o Or insurance company  long term investment o Liquid  so much money is traded a day  3X more than stocks  1) corporate bond listings o sold on OTC market  investment brokers  2) types of orders o market order  pay at current market price o limit order  you set the price, if it hits it, then you buy it  3) trading online  Junk Bonds: o Bonds with much higher risk of default o Pays higher returns o Pays 4-7% more risk premium than treasury o Lower rated bonds o New companies o Higher risk premium  How corporate bonds finance restructuring: Sherwood Clements o 1) corporations use bonds to finance a leveraged bond  LBO- leverage buyout  Using debt to buyout a company  RJR Nabisco (most famous buyout)  KKR Kohlberg Kravis and Roberts  Late 80’s  Barbarians at the Gate (movie) o 2) corporations use bonds to revise capital structure  capital structure- the way a company borrows money for its investments, growth and operations  DEBT is cheaper (bonds)  Equity rises in value  Debt for equity swap  Give someone stock to replace their debt to keep your cash Chapter 10: Stock Offerings and Investor Monitoring  Private equity: o Buying into an investment that is not publically traded (buy businesses) o Some business owners hope to go public so that: trying to get cash  Reinvest into company  Make a profit o A public offering is feasible if you can provide a liquid market  Venture capital- put money into start up companies  technology o 4-7 years  Public Equity: (stocks) o Primary market- company gets money  IPO o Secondary market- traded between investors o Going public: 2 effects  Ownership structure  A few owners to hundreds of owners  Capital structure  More stock vs. debt  Ownership and Voting rights: o Common stockholders can vote  Once a year (mostly spring) o Common stock votes:  Board members (10-15)  External auditors (check financials)  Bylaws from common stockholders o Proxy- choose to vote with the company (check one box  done)  Preferred stock: o Much less  traded less o Paid dividends each quarter o Not every company pays common stock dividends o Cannon vote o Not as volatile  will not go up in value o Common stock is more desirable Sherwood Clements o Preferred ALWAYS get paid before common o Common stock is more risky o Bonds are more risky (trick questions) o Bonds are more desirable (cheaper)  Participation in stock markets: o Stock prices changes  1) anticipated cash flows  2) behavior o one investor can change the stock price o efficient? Yes long term; No  short term  Initial public offerings: (IPO) o Company first goes public o Prospectus- how they make their money and what their risks are  Filed with the SEC o Offer price is determined by lead underwriter o Investment bank allocates the IPO shares o Transaction costs- usually 7% of the funds raised o Lockup provision- cannot sell your shares for 6 months after the IPO  Preventing from price going down o Flipping shares- buying low- selling quick for a high return  Causes prices to go down  Abuses in the IPO market: o 1) spinning o 2) laddering o 3) excessive commission  Long term o Stock price goes down overtime  Newer companies come in  Example in class: GOOGLE o They do not always know what they are going to get or what they want o Stock split- own stock- split it in half  make it more liquid  Stock offerings and repurchases o 1) secondary stock offerings  issue shares a 2 ndtime  decreases stock prices o 2) stock repurchases  company buys own shares back  increase stock prices  investors view: depends…..  good  increase price  bad  short sighted: not looking in the long run  Stock exchanges o 1) organized exchanges  floor brokers  person representing buyer or seller  specialists  set bid/ask spread Sherwood Clements  buy and sell stock themselves  set closing price  execute limit orders o 2) over the counter  buy and sell from a broker  NASDAQ  not over the counter  2 ndbiggest stock exchange  lots of tech companies  ALL on computers  OTC bulletin board  Penny stocks  Too cheap for NASDAQ or NYSE  Prices very volatile o 3) Extended trading sessions:  NYSE and NASDAQ  open for trading normal hours  Spread is much larger at night  Market liquidity is much lower o 4) stock quotations provided by exchanges  52-week price range  high/low for past year  Symbol  Ford  F  Dividends  Average company pays quarterly  Dividend Yield  % return from dividend  Price earning ratio  Price/earnings per share  Ranges from 5-100  Compare to other P/E’s in sector  Volume  Amount of shares bought/sold a day  Closing price quotation  Set by the specialist  Not necessarily opening price o 5) Stock Index quotations  DJIA- DOW 30  30 elite companies in America  good indicator of how economy is doing o IN= Visa, Nike, Goldman Sachs, Apple o OUT= Alcoa, Bank of America, Hewlett Packard, AT&T  S&P 500  Wilshire 5000  Monitoring publicly traded companies o Role of analysts  Role is to tell whether to buy, hold or sell Sherwood Clements  Teach investors about stocks  Accounting irregularities o There are crooks  Sarbanes oxley act o Auditing  accountants evaluate financials  Shareholder activism o Buys 10-15% of company then tries to advise company how to run  Communicate with firm  letter  Proxy contest  get the most votes  Shareholder lawsuits  sues company Chapter 12: Market Microstructure  Stock market transactions: o Placing an order- to place an order to buy or sell a specific stock o Bid quote- executed by buyer o Ask quote- executed by seller o Market order- take price at given o Limit order- buyer sets the price o Stop loss order- protect against losses  Investor specifies a selling price that is lower than the current market price of the stock o Stop buy order  Investors specifies a purchase price that is higher than the current market price o Maintenance margin  margin call  Bring in more money  Impact on returns: o o (60-20-22+1) /20 = 95% return o (30-20-22+1)/20 = -55% return  MARGIN o (60-40+1)/40 = 52.5% return o (30-40+1)/40 = -22.5% return  CASH  Short selling (betting against the company) o Selling someone else’s stock to make money o Risk  stock increases (inflation) o Short selling  3 months or less o Naked shorting- illegal  short without trading hands o Uptick rule- cannot short unless it goes up 1 tick Sherwood Clements  *** DO NOT HAVE TO KNOW: how stock transactions are executed  program trading- the simultaneous buying and selling of 15 or more stocks at 1 time o mutual fund cash surplus o arbitrage- find imperfection in market  circuit breakers/ trading halts o trading is stopped if trading falls o keeps from going into a freefall Chapter 23: Mutual Fund Operations  mutual fund- investment company that invests for you in a large amount of investments o less risk  diversify o manage the investment o most people have 401ks o  open end- issue new shares every day  price shares of the mutual fund o net asset value (NAV)  Market Value= Total MV of Assets + I and D Received – Expenses and any D Paid  NAV = market value/ # of shares outstanding  Expenses incurred by mutual shareholders o Mutual funds pass their expenses to shareholders  Management, employees, etc.  Load funds  Front end loads  purchase  Back end loads  sell  12B fees  No load funds  Take out  lower market value  Mutual fund categories: o Stock (equity) mutual funds ** dominant o Bond mutual funds o Money market funds  Mutual fund categories: (STOCK) o 1) Growth  small cap: 2 billion; large cap: 10 billion Sherwood Clements o 2) Income  large cap bonds o 3) International and Global  foreign stocks o 4) Specialty  certain sectors o 5) Index  mimic indexes ( DOW) o 6) Multifund  other mutual funds o 7) Tax Free  municipal bonds o 8) High Yield (Junk) bonds  higher return  Private equity funds: o Buy businesses  take over to build back up  Trying to make high returns  ETF (Exchange traded funds) o Chance at higher return (not as risky as a stock) o Invest in 25 stocks o Incest in a sector o Trade like a stock  Not actively managed  REITS (Real Estate Investment Trusts) o Company that invests in real estate o 1) equity REITS – physical property o 2) mortgage REITS o 3) hybrid REITS- invests in both  Hedge funds o Very expensive funds with less liquidity o Trying to make big returns o Exotic investing o Uses financial leverage o Very risky  fails all the time


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