The Capital Asset Pricing Model (CAPM) and the Security Market Line (SML)

The Capital Asset Pricing Model (CAPM) calculates the expected return on equity of an individual company. It is based on the expected rate of return on the market, the risk-free rate and the beta coefficient of an individual security or portfolio. Where,  Re: Return on Equity Rf: risk-free rate E(Rm): expected rate of return on market, and […]

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Yield Spreads & Credit Spreads

A yield spread is the difference in yield between two bonds or two types of bonds. It can be used to compare the maturity, credit rating, liquidity and risk of two bonds, or of one bond to a benchmark. This difference can be measured in the following ways: Absolute yield spread or nominal spread: (yield […]

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Financial Ratio Cheat Sheet

This is a summary of financial ratios commonly used in the evaluation of a company. Liquidity ratios 1)      Current Ratio = Current Asset / Current Liability 2)      Quick Ratio = (Cash + Marketable securities + account receivables) / Current Liability 3)      Cash Ratio = (Cash + Marketable securities)/current Liability 4)      Cash flow from operations ratio […]

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Yield Curves and Term Structures

A yield curve plots the yield to maturity (TYM) of similar debt securities, against the time to maturity (term). A normal yield curve is upward-sloping and shows higher yield for longer maturity due to the risks associated with the passage of time. However, the yield curve can be inverted and downward-sloping if the economy is […]

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Collateralized Bond Obligations

A collateralized bond obligation (CBO) is an investment-grade bond backed with by a pool of high-yield junk bonds, which are not considered to be of investment-grade on a standalone basis. The junk bonds in a CBO are from different classes and purposely chosen to be diversified. CBOs offer fixed-income investors the opportunity of enjoying the […]

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Treasury Securities

Treasury securities, or simply Treasuries, are issued by the U.S. Treasury. They are considered to be risk free as they are backed by the U.S. government. There are four  types of treasury securities: Treasury bills (T-Bills) have maturities of less than 1 year. Like a zero-coupon bond, they only pay par value at the maturity […]

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Credit risk /Default risk and bond rating

The credit risk or default risk is the risk of an issuer not making timely interest or principal payments as promised. Bonds issued by the US federal government have nearly zero default risk while corporations have risk of being unable to meet payments (and default on their debts). Since the standard investor is risk-averse, the […]

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Interest Rate Risk and Duration

Interest rate risk is the sensitivity of a bond’s value to variability of market interest rates/yields. In general, as interest rates increase, bond prices decrease (and vice versa). A bond’s duration is the number of years it takes for a bond to pay out its original cost by its internal cash flows and is the […]

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Yield to Maturity, Nominal Yields, and Current Yields

A Yield is a rate that shows the return you get on a bond. The basic yield formula is: yield = coupon amount / price. There are a few kinds of yield related to bonds; when investors or analysts refer to yield, they usually mean the yield to maturity (YTM). YTM measures the annual return earned […]

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Embedded Options in Bonds

An embedded option is a component of the bond contract and grants the holder or the issuer certain rights to dispose of or redeem a bond. It cannot be separated from the bond and therefore does not trade by itself. A bond with security holder options (which benefit the holders) has additional value and therefore […]

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