FI 301 Study Guide for Test 2
FI 301 Study Guide for Test 2 FI 301
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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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