IMC Financial Analysis & Derivatives 4

Question 1

What does 'yield to maturity' (YTM) represent for a bond?

Accepted Answer

The total return anticipated on a bond if held until maturity, assuming all coupons are reinvested at the same rate

Answer

YTM is the internal rate of return of a bond — the discount rate that equates the present value of all future coupon payments and principal repayment to the bond's current market price. It reflects the total expected return if the bond is held to maturity and coupons are reinvested at the YTM.

Question 2

What is the 'credit spread' on a corporate bond?

Accepted Answer

The additional yield a corporate bond pays over a comparable maturity government bond, compensating for credit risk

Answer

The credit spread is the yield difference between a corporate bond and a comparable government bond (e.g., gilt). It compensates investors for the additional credit risk (default risk) of the corporate issuer compared to the government, which is assumed to be risk-free.

Question 3

What is the 'dividend discount model' (DDM) used for?

Accepted Answer

Valuing a company's shares based on the present value of expected future dividend payments

Answer

The DDM values a share as the present value of all future expected dividends, discounted at the required rate of return. The Gordon Growth Model simplifies this: Price = D1 / (r - g), where D1 is next year's dividend, r is required return, and g is the sustainable dividend growth rate.

Question 4

What is 'price-to-book' (P/B) ratio and when is it most commonly used?

Accepted Answer

The ratio of market capitalisation to net asset value (book value), commonly used for financial sector companies and asset-heavy industries

Answer

P/B ratio = Market Cap / Net Book Value (shareholders' equity). It measures the premium or discount investors pay relative to the accounting value of assets. It is widely used for banks (where assets are largely financial and book value is meaningful) and capital-intensive industries.

Question 5

What is the 'enterprise value' (EV) of a company?

Accepted Answer

The total value of a company including equity market cap plus net debt (debt minus cash), representing the total cost to an acquirer

Answer

Enterprise Value = Market Cap + Net Debt (total debt minus cash). EV represents the total value of a business to all capital providers (equity and debt holders) and is the theoretical acquisition price. EV-based ratios (EV/EBITDA) enable comparison across companies with different capital structures.

IMC Practice Test

IMC Practice Test

IMC Financial Analysis & Derivatives 4