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Rate-capped swaps A rate-capped swap involves the exchange of fixed-rate payments for floating-rate payments that are capped The floating-rate payer pays an up-front fee for this feature The fixed-rate payer may allow the cap if it believes interest rates will not exceed the cap and receives the up-front fee Equity swaps An equity swap involve...

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Economic conditions and market conditions can cause abrupt changes in the stock rice or in the anticipated volatility of the stock price This would have a major impact on the stock option premium Indicators monitored by participants in the option market Option market participants closely monitor the indicators that are monitored for stocks: Eco...

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Using interest rate futures to create a short hedge (cont’d) Tradeoff from using a short hedge Interest rate futures can hedge against both adverse and favorable events The probability distribution of returns is narrower with hedging than without hedging Institutions that frequently use interest rate futures may be able to reduce the variabilit...

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Specialists and market-makers (cont’d) Front running involves the specialist setting a price below the price offered by other investors May prevent other investors from having their orders executed if the price reverses as a result The “trade-through rule” on the NYSE requires that an order for stocks must be executed on the exchange that offers...

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Market-related factors Investor sentiment In some periods, stock market performance is not highly correlated with existing economic conditions Stocks can exhibit excessive volatility because their prices are partially driven by fads and fashions A study by Roll found that only one-third of the variation in stocks returns can be explained by sys...

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An IPO is a first-time offering of shares by a specific firm to the public Usually, a growing firm first obtains private equity funding from VC firms An IPO is used to obtain new funding and to offer VC firms a way to cash in their investment Many VC firms sell their shares in the secondary market between 6 and 24 months after the IPO

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The mortgage contract should specify: Whether the mortgage is federally insured The amount of the loan Whether the interest rate is fixed or adjustable The interest rate to be charged The maturity Other special provisions

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Duration (cont’d) Estimation errors from using modified duration If investors rely only on modified duration to estimate percentage price changes in bonds, they will tend to overestimate price declines and underestimate price increases To accurately estimate the percentage change in price, bond convexity must also be considered

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Treasury bond quotations Published in financial newspapers The Wall Street Journal Barron’s Investor’s Business Daily Bond quotations are organized according to their maturity, with the shortest maturity listed first Bid and ask prices are quoted per hundreds of dollars of par value Online quotations at

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Federal funds (cont’d) Two depository institutions communicate directly through a communications network or through a federal funds broker The lending institution instructs its Fed district bank to debit its reserve account and to credit the borrowing institution’s reserve account by the amount of the loan Commercial banks are the most active pa...

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