Firm’s financing – Debt + Equity

Debt securities are promises to repay borrowed funds, while giving fixed payment in the process.

Capital Markets refer to markets for longer-term debt securities and equity securities that have no specific maturity date.** Capital market** instruments used for **market** trade include stocks and bonds, treasury bills, foreign exchange, fixed deposits, debentures, etc. As they involve debts and equity securities, the instruments are also called securities, and the **market** is referred to as securities **market.**

NPV – Net Present Value – Present value of expected future cash flows, minus initial cost of investment. if > 0, take the project. the excess is what flows over to the shareholder.

IRR – Internal Rate of Return. Percentage that equates the PV of all cash inflows to PV of all cash outflows. IRR is the rate that makes NPV = 0.

If IRR of project > project’s expected rate of return, take the project. That would mean NPV is > 0 too. If there are 2 project with IRR > expected rate of return, and they are mutually exclusive (if undertake one then the other must be foregone), then take the one that gives the biggest NPV.

Money weighted return = IRR of the portfolio

Time weighted return = geometric mean of subperiod returns.

Yield to Maturity (YTM) = IRR on a bond. For the most common kind, YTM is 2 * semi annual IRR, since bonds commonly pays semi annual coupons.

Bond Equivalent Yield = Holding period yield (365/days)

Risk Management:

- Financial Risks
- Credit risk is the uncertainty about whether the counterparty to a transaction will fulfill its contractual obligations.
- Liquidity risk is the risk of loss when selling an asset at a time when market conditions make the sales price less than the underlying fair value of the asset
- Market risk is the uncertainty about market prices of assets and interest rates.

- Non-Financial Risks – Operational / Solvency / Regulatroy / Accounting risks/

Tail risk – uncertainty about probability of extreme negative outcomes. Commonly used measure include Value at Risk (VaR) – minimum loss over a period that will occur with a specific probability.

For VaR, there are 2 methods of risk assessment –

- Stress Testing – effects of a specific (usually extreme) change in a key variable; or
- Scenario analysis – what-if analysis of expected loss but incorporates specific changes in multiple inputs.

Total risk = Systematic (cannot be diversified away) (“beta”) + Unsystematic risk (Can be diversified away).

Strategic asset allocation – specifies the percentage allocations to the included asset classes. In choosing asset classes for an account, the correlations of returns *within* an asset class should be relatively high, and the correlations of returns *between* asset classes should be relatively low in comparison.