Investment Principles - Chapters 1 and 2 Practice Flashcards

A set of 100 vocabulary flashcards based on lecture notes covering the investment environment, asset classes, financial markets, and financial instruments for FIN 312.

Real Assets

Used to produce goods and services, they determine the productive capacity and net income of the economy; examples include land, buildings, and machines.

Financial Assets

Claims on the income produced by real assets that finance real assets but do not contribute directly to the productive capacity of the economy.

Capital budgeting

The analysis of real assets used to produce goods and services.

Fixed-Income

Financial assets where the borrower promises a fixed stream of income, such as a corporate bond.

Equity

Represents an ownership share in a corporation, such as common stock.

Derivatives

Financial instruments that provide payoffs determined by the prices of other underlying assets such as stocks, exchange rates, or interest rates.

Informational Role

The function of financial assets where stock and bond prices reflect the collective judgment of market participants.

Consumption Timing

The use of financial assets to store or build wealth now and transfer consumption to the future.

Allocation of Risk

The role of financial assets in providing investors with choices that fit their specific risk preferences.

Agency problems

Issues that arise when managers pursue their own interests instead of maximizing the firm's value.

Stock options

A mechanism to mitigate agency problems by tying managers' income to the success of the firm.

Board of directors

A group elected by common shareholders to monitor management and mitigate agency problems.

Activist investors

Large investors who may pose a takeover threat for poor performers to replace management.

Portfolio

A collection of investment assets.

Asset allocation

The selection and proportion of investing among broad asset classes such as stocks, bonds, and real estate.

Security selection

The choice of specific securities within each asset class.

Security analysis

The valuation of securities to find those with better return and risk prospects.

Top-down approach

An investment process that starts with asset allocation followed by security selection.

Bottom-up approach

An investment process focused on finding attractively priced securities without primary regard for asset allocation.

Risk-return trade-off

The principle that risk and expected return are positively correlated.

Efficient Markets

The hypothesis that security prices fully reflect all available information and adjust quickly to new relevant data.

Passive Management

Holding a highly diversified portfolio with no attempt to find undervalued securities or time the market.

Active Management

The practice of finding mispriced securities and timing investments by buying low and selling high.

Financial Intermediaries

Institutions such as banks, insurance companies, and mutual funds that bring suppliers and demanders of capital together.

Investment bankers

Specialists who advise issuing corporations on prices and interest rates and specialize in the sale of new securities through underwriting.

Primary market

The market where new issues of securities are offered to the public.

Secondary market

The market where investors trade previously issued securities amongst themselves.

Venture capital (VC)

Money invested to finance a new, not yet publicly traded firm, where investors often take an active management role.

Private equity

Investments made in companies whose shares are not publicly traded on a stock market.

Fintech

The application of technology to financial markets that has changed the financial landscape.

Peer-to-peer lending

Technology used to link lenders and borrowers directly, leading to financial disintermediation.

Cryptocurrencies

Payment systems like bitcoin or ethereum that bypass traditional channels such as credit cards or cheques.

Blockchain

Technology offering greater speed, security, and anonymity for financial transactions.

Global Financial Crisis (GFC)

A crisis peaking in September 2008 characterized by housing price declines, mortgage delinquencies, and the failure of major investment banks.

Sub-prime mortgages

Risky mortgages that contributed to the sufferance of investment banks during the GFC.

Lehman Brothers

A major investment bank that went bankrupt during the peak of the 2008 financial crisis.

Dodd-Frank Wall Street Reform and Consumer Protection Act

A 2010 act that created mechanisms to mitigate systemic risk and increased transparency in derivatives markets.

Office of Credit Ratings

An office created within the SEC by the Dodd-Frank Act to oversee credit rating agencies.

Universal banks

Banks in Canada that benefit from stable funding provided by bank deposits, making the GFC less severe in Canada.

Oligopoly

The Canadian banking industry structure consisting of six major banks: RY, TD, BMO, BNS, CIBC, and NB.

Money markets

Subsector of the fixed-income market consisting of short-term, liquid, low-risk debt securities with maturities of 1 year or less.

Capital markets

Markets for longer-term and riskier securities, including bond, equity, and derivative markets.

Treasury Bills (T-bills)

Highly marketable debt sold at a discount by federal or provincial governments with maturities of 1, 3, 6, and 12 months.

Ask price

The price an investor would have to pay to buy a security from a dealer.

Bid price

The price an investor receives when selling a security to a dealer.

Bid-ask spread

The difference between the bid and ask prices, which serves as the dealer's source of profit.

Guaranteed Investment Certificate (GIC)

A time deposit with a chartered bank for smaller amounts, similar to a Certificate of Deposit.

Commercial Paper

Short-term unsecured debt notes issued by well-known companies.

Bankers’ Acceptances

An order to a bank by a customer to pay a sum on a future date, endorsed by the bank for a fee and used widely in foreign trades.

Policy interest rate

A target rate set by the Bank of Canada for overnight borrowing and lending among banks.

Federal funds rate

A target range for overnight borrowing set by the US Federal Reserve.

Eurodollars

U.S. Dollar-denominated time deposits in banks located outside the United States.

Repurchase agreements (repos)

Short-term, usually overnight, borrowing backed by government securities.

Bond-equivalent yield ($r_{BEY}$)

$r_{BEY} = \frac{1000 - P}{P} \times \frac{365}{n}$, where yield is computed using simple interest and a 365-day year.

Bank-discount method ($d$)

$d = \frac{1000 - P}{1000} \times \frac{360}{n}$, used for US T-bills assuming a 360-day year and par as the denominator.

Effective annual yield ($r_{eay}$)

$r_{eay} = \text{compounded yield calculated as } \binom{F}{P}^{\frac{365}{n}} - 1$.

Government of Canada bonds

Marketable federal securities with maturities from 3 to 40 years that pay semiannual coupons.

Canada Savings Bonds (CSBs)

Nonmarketable federal securities which have been discontinued.

Provincial Bonds

Fixed-income assets issued by provincial governments or provincial Crown corporations.

Municipal Bonds (Canada)

Debt issued by Canadian municipalities that is fully taxable by federal and provincial governments.

Municipal Bonds (U.S.)

Debt issued by U.S. states or municipalities that is exempt from federal income tax and often state/local taxes.

Eurodollar bond

A USD denominated bond issued outside of the United States.

Maple Bond

A CAD denominated bond issued by a foreign borrower within Canada.

Yankee Bond

A USD denominated bond issued in the United States by a foreign entity.

Debentures

Unsecured corporate bonds that are not backed by specific collateral.

Callable bonds

Bonds that give the issuer the right to repurchase them from holders at a stipulated price.

Retractable bonds

Bonds that give the holder the option to redeem them earlier than the stated maturity date.

Convertible bonds

Bonds that give holders the option to exchange them for a stipulated number of shares.

TIPS

U.S. Treasury Inflation-Protected Securities that provide protection against inflation.

Asset-backed securities

Securities created from a pool of assets, such as Mortgage-Backed Securities (MBS).

National Housing Act (NHA)

The act under which Canadian Mortgage-Backed Securities carry a federal government guarantee.

Common Stock

Equities representing residual claims on assets with voting rights and limited liability.

Limited liability

A feature of common stock where losses are limited to the original cost of the investment.

Preferred Equity

Equity with debt-like features, providing promised fixed income but typically no voting rights.

Dividend Tax Credit

A Canadian tax treatment benefit applied to dividends from preferred and common shares.

Cumulative Preferred

Preferred shares where unpaid dividends accumulate and must be paid before common dividends.

S&P/TSX Composite

A market-value-weighted index representing the Canadian equity market.

DJIA (Dow Jones Industrial Average)

A price-weighted index consisting of 30 large US stocks.

Market-value-weighted index

An index where a stock's weight is based on its market capitalization; returns are not affected by stock splits.

Price-weighted index

An index where the high-priced stocks have more weight; the divisor is adjusted for stock splits.

Equally-weighted index

An index where each security adds an equal proportion to the calculation regardless of price or market cap.

Divisor

A value used in price-weighted indices that is modified following stock splits or firm substitutions.

Equivalent taxable yield

$\frac{r_{muni}}{1 - \text{tax rate}}$, used to compare tax-free municipal bonds to taxable bonds.

Cutoff tax rate

$1 - \frac{y_{muni}}{y_{taxable}}$, representing the tax rate at which an investor is indifferent between taxable and tax-free bonds.

Futures contract

An obligation to purchase or sell an asset at an agreed-upon price on a specified future date.

Forward contract

A customized agreement between counterparties to trade an asset in the future, not traded on an exchange.

Call option

The right, but not the obligation, to purchase an asset at a specified exercise price on or before a future date.

Put option

The right, but not the obligation, to sell an asset at a specified exercise price on or before a future date.

Exercise price

The stipulated price at which an option holder can buy or sell the underlying asset; also called the strike price.

Premium

The price paid to purchase an option.

Open interest

The total number of outstanding derivative contracts that have not been settled.

Implied volatility

A measure of the expected volatility of a stock's price derived from the current price of its options.

Long position

In a futures contract, the commitment to buy the asset at the specified futures price.

Short position

In a futures contract, the commitment to sell the asset at the specified futures price.

Contango

A market condition where future prices of a commodity are higher than the current spot prices.

Backwardation

A market condition where future prices of a commodity are lower than the current spot prices.

Residual claim

The right of stockholders to assets or income only after all other senior claimants have been paid.

Capital gains

The profit realized from the sale of a financial asset at a higher price than its purchase price.

Price-earnings (P/E) ratio

The ratio of a stock's current price to its earnings per share.