Accruals and Valuation Adjustments
When preparing its complete financial statements, a company will review its operations in order to determine whether any accruals or adjustments are needed. This allows for allocation of revenue and expense items into the proper accounting period. The Need for…
Relationships Among Statements
Financial statements use the financial data that is reported in the accounting system to present data in a more meaningful manner. The primary financial statements are: balance sheet, income statement, statement of cash flows, statement of owners’ equity, and statement…
Flow of Information in an Accounting System
It is important for accountants to understand each step involved in an accounting system. This is because they are the ones who will be preparing the financial records which are subsequently presented in financial statements. Analysts, on the other hand,…
The Accounting Process in Security Analysis
Financial statements are products of the accounting process. They provide useful and meaningful information on the financial performance of a company. These pieces of information are particularly useful to managers, investors, creditors, and analysts who rely on them to make…
Benefits of Securitization
The Securitization Process Securitization involves transferring ownership of assets from original owners (usually individual borrowers) to a special legal entity. This entity, in return, issues asset-backed securities backed by these transferred assets. The pool of securitized assets from which cash…
Describe Securitization
A hypothetical financial institution, BCG Bank, decides to raise a $100 million loan by securitizing loans rather than issuing corporate bonds. The company sets up a legal entity, Loan Trust, to which it sells the loans. Such a legal entity…
Understanding Fixed-income Risk and Return
There are 3 sources of return in a fixed-income security: receipt of the promised coupon and principal payments; reinvestment of coupon payments; and/or capital gains or losses on the sale of the bond prior to maturity. A discount bond offers…
Macaulay, Modified, and Effective Durations
The duration of a bond measures the sensitivity of the bond’s full price (including accrued interest) to changes in the bond’s yield-to-maturity or, more generally, changes in benchmark interest rates. Bond duration estimates changes in bond price assuming that variables…
Effective Duration-Measure of Interest Rate Risk
Another approach to assessing interest rate risk of a bond is to estimate the percentage change in price against a change in the benchmark yield curve, such as the government par curve. The effective duration is defined as the sensitivity…
Interest Rate Risk Given a Bond’s Maturity, Coupon, and Yield
Duration – whether it’s Macaulay duration, effective duration, or any other kind of duration – is a measure of interest rate risk. Some factors affect duration and consequently affect interest rate risk. Time to Maturity Longer maturity bond prices are…
