Investment planning Flashcards

Question

Dividend Dates

Answer 1

Dividends are declared by the BOD and typically paid quarterly Ex-Dividend Date Date of Record

Answer 2

Date the stock trades without a dividend If you sell the stock on the ex-dividend date, you will receive the dividend If you buy the stock on or after the ex-dividend date, you will NOT receive the dividend Ex-dividend is ONE BUSINESS DAY before the date of record Remember: EX-Date trades without dividend

Answer 3

Date on which you must be a registered shareholder in order to receive the dividend = ONE BUSINESS DAY after the ex-dividend date Investor must purchase the stock 2 business days prior to the date of record in order to receive the dividend Purchases made on ex-dividend date will not receive the dividend; to receive the dividend, an investor must purchase the stock prior to the ex-dividend date or 2 business days before the date of record

Answer 4

Cash dividends: Qualified dividends receive capital gains tax treatment A cash dividend is taxed upon receipt Stock dividends: not taxable to shareholder until stock is sold

Answer 5

Increase shares and reduce stock price: 2-for-1 split for 100 shares at $50 per share results in 200 shares at $25 per share 3-for-2 split for 100 shares at $60 per share results in 150 shares at $40 per share

Answer 6

Regulates issuance of new securities (Primary Market) - IPOs | Requires that new issues are accompanied with prospectus before being purchased

Answer 7

Regulates secondary market and trading of securities | Created SEC to enforce compliance with security regulations and laws

Answer 8

Authorized SEC to regulate investment companies | 3 types of investment companies: Open, Closed, UITs

Answer 9

Required investment advisors to register with the SEC or state

Answer 10

Established SPIC to protect investors from losses resulting from brokerage firm failures Does not protect investors from incompetence or bad investment decisions

Answer 11

Defines and insider as anyone with information that is not available to the public Insiders cannot trade on that information

Answer 12

Treasury bills Commercial paper Bankers Acceptance Eurodollars

Answer 13

Issued in varying maturities up to 52 weeks Denominations in $100 increments through Treasury Direct up to $5 million per auction. Larger amounts available through a competitive bid

Answer 14

``` Short-term loans between corporations Maturities of 270 days or less Does not have to register with the SEC Denominations of $100,000 Sold at discount ```

Answer 15

Facilitates exports/imports Maturities of 9 months or less Can be held until maturity or traded

Answer 16

Deposits in foreign banks that are denominated in US dollars

Answer 17

Establishes (a) client's objectives: required return, risk tolerance (b) limitations on investment manager (time horizon, liquidity needs, taxes, laws and regulations, circumstances unique to the client) Used to measure investment manager's performance Does NOT include investment selection Remember: IPS establishes RR TT LL U - risk, return, taxes, timeline, liquidity, legal, unique circumstances

Answer 18

Dow Jones Industrial Average: Simple Price-Weighted Average Does not incorporate market capitalization S&P 500: Value-Weighted index Incorporates market capitalization Russell 2000: Value-Weighted index of the smallest capitalization stocks in the Russell 3000 Wilshire 5000: Broadest Value-Weighted index measuring performance of over 3000 stocks EAFE: Value-Weighted index tracking stocks in Europe, Australia, Asia, Far East

Answer 19

Measures risk and variability of returns The higher the SD, the higher the riskiness of the investment Measures TOTAL RISK of an UNDIVERSIFIED portfolio Probability of returns: 68% = 1 x SD; 95% = 2 x SD; 99% = 3 x SD (add or subtract to mean return)

Answer 20

Dan has 2 stocks in his portfolio with the following returns over the past 5 years: A: 10%, 13%, 8%, -2%, 14% B: 6%, -3%, 4%, -5%, 7% Calculate the SD for both stocks: 10 Σ+ 13 Σ+ 8 Σ+ 2+/-Σ + 14 Σ, Orange Shift Sx, Sy 6 Σ+ 3+/- Σ+ 4 Σ+ 5+/-Σ + 7 Σ, Orange Shift Sx, Sy A= 6.3875% B= 5.4498% A is more risky because SD is higher

Answer 21

Answer: 13.80% | 10% x 30%) + (15% x 60%) + (18% x 10%

Answer 22

CV= Standard Deviation / Average Return Useful in determining which investment has more relative risk when investments have different average returns Tells us probability of actually experiencing a return close to the average return The higher the coefficient of variation the more risky an investment per unit of return. If 2 investments have the same return, go with the higher Standard Deviation to determine the higher risk investment.

Answer 23

- used in probability analysis of expected returns around an average return - average (expected) outcome in the middle X - symmetrical curve - 50% probability of a return > X - 50% probability of a return < X Standard deviation σ measures variance around that expected return - probability of a return falling within +/- 1 σ of the average is 68% - probability of a return falling within +/- 2 σ of the average is 95% - probability of a return falling within +/- 3 σ of the average is 99%

Answer 24

appropriate when investor is considering a dollar amount or portfolio value at a point in time

Answer 25

Refers to the extent to which a distribution is not symmetrical. Positively skewed distributions may have outliers in the upper, or right tail ("skewed to the right") Stock markets tend to be positively skewed. Negatively skewed distributions have many outliers in the lower, or left tail ("skewed left"). Commodity returns tend to be skewed.

Answer 26

Describes when a distribution is more or less peaked than a normal distribution. Refers to the variation of returns: Normal distribution: mesokurtic Little variation of returns: distribution has high peak = positive kurtosis (Leptokurtosis) - slender (e.g., Treasuries) Widely dispersed returns: low peak = negative kurtosis (Platykurtosis) - broad

Answer 27

Process of adding risky securities to the portfolio but keeping the expected return the same, finding the balance of combining asset classes that provide the lowest variance as measured by standard deviation.

Answer 28

Spreadsheet simulation that gives probabilistic distribution of events occurring, e.g., what is the probability of running out of money in retirement with a client who has a withdrawal rate of 3%, 4%, 5%. Monte Carlo simulation adjusts assumptions and returns the probability of an event occurring depending upon the assumption.

Answer 29

measure of 2 securities combined in their interactive risk, i.e., how price movements between the 2 are related to each other measures relative risk If correlation coefficient is known, or a given, covariance is calculated as the deviation of investment A times the deviation of investment B times the correlation of investment A to investment B: COV AB = (σA) (σB) (ρAB) ρ= correlation coefficient σ = Standard deviation

Answer 30

Correlation and Covariance measure movement of one security relative to that of another, both are RELATIVE measures. ρAB = Cov AB /(σA) (σB) Correlation ranges from +1 to -1 and provides insight into strength and direction 2 assets move relative to each other: Correlation of +1 denotes perfectly positive correlation to each other Correlation of -1 denotes perfectly negative correlation Correlation of 0 denotes that assets are completely unrelated Diversification benefits (risk reduced) begin anytime correlation is LESS than 1

Answer 31

Risk = experiencing an outcome different than the expected outcome Total risk = Systematic + Unsystematic Risk, measured by STANDARD VARIATION Systematic Risk cannot be eliminated through diversifying the portfolio, measured by BETA Unsystematic Risk can be eliminated through diversifying the portfolio (aka "firm-specific risk")

Answer 32

PRIME: ``` Purchasing Power Risk Reinvestment Risk Interest Rate Risk Market Risk Exchange Rate Risk ```

Answer 33

ABCDEFG: ``` Accounting Risk Business Risk Country / Sovereignty Risk Default or Credit Risk Executive Risk Financial Risk Government / Regulation Risk ```

Answer 34

The higher the standard variation, the greater the variance around the expected return. Investments with greater standard deviation (higher risk!) require greater expected return. (e.g.: common and preferred stock, junk bonds, options, futures, forwards, small cap and growth-oriented funds) Investments with lower standard deviation will typically provide lower returns, but provide limited downside risk. (e.g., cash, MMKT securities, Treasury securities, investment grade bonds)

Answer 35

Time horizoin Liquidity needs Total investable assets

Answer 36

Potential return and Risk in order from LOW to HIGH: ``` Treasury Bills (cash alternatives) CDs (cash alternatives) Government Bonds Corporate Bonds Preferred Stocks Common Stocks Options & Futures ```

Answer 37

= measure of systematic (market) risk measures individual security's volatility relative to that of the market best used to measure volatility of a diversified portfolio (one that has a high r2 Beta of the market = 1 Stock with Beta of 1 is expected to mirror the market in terms of direction, return, and fluctuation Stock with a Beta >1 means it fluctuates more than the market, and greater risk is associated with that security Stock with a Beta <1 indicates it fluctuates less relative to market movements. → The greater the Beta Coefficient of a security, the greater the systematic risk associated with that security. NOTE: The BETA of an INDEX Fund is always 1 because it tracks the market!

Answer 38

βi = COVim / σ²m = (ρim) (σ) / σm ``` COVim = (σi) (σm) (ρim) σ²m = Variance of the market σm = SD of the market σi = SD of the individual security ρim = correlation coefficient between individual security and market ``` Beta can also be calculated in the following way: Security risk premium / Market Risk premium Example: If a fund has a return of 20% and the market has a return of 10%, the beta would be 20 / 10 = 2. If a fund has a return of 5% and the market has a return of 10%, the beta would be 5 / 10 = 0.5.

Answer 39

measures what percentage of a security's return is due to the market Calculate Coefficient of Determination by squaring correlation coefficient : Example: If mutual fund XYZ has a correlation coefficient of 0.80, its coefficient of determination is 0.64, which means 64% of the fund's return is due to the market. R-squared also provides insight into how well-diversified a portfolio is: the higher R-squared, the higher percentage of return from the market (systematic risk) and less from unsystematic risk. R-squared tells the investor if Beta is an appropriate measure of risk: if R-squared ≥ 0.70, Beta is an appropriate measure of total risk. If R-squared ≤ 0.70, use Standard Deviation instead to measure total risk.

Answer 40

Mutual Fund XYZ has a 5-year return of 12%, with a standard deviation of 15%. Fund XYZ has a Beta of 1.4 with a correlation of 0.90 to the S&P 500. What percent of the return from Fund XYZ is due to the S&P 500? a) 90% b) 81% c) 19% d) 10% 81% - answer B: 0.90 = r, thus R-squared = 0.81 or 81%. 81% is due to the market, and 19% is due to unsystematic risk. A mutual fund has a correlation coefficient of 0.80. What percent of return is due to unsystematic risk? R Squared = 0.64 or 64% is due to systematic risk, thus 36% is due to unsystematic risk!

Answer 41

Can be measured through determination of the interactivity of the standard deviation and covariance of securities in the portfolio. "Portfolio Deviation Formula" or "Standard Deviation of a Two Asset Portfolio" utilizes the weight of both securities involved, the deviations of the respective securities, and the correlation coefficient of the two securities (see Formula sheet) Alternative possibility: Take simple weighted average of the standard deviation of a portfolio, then choose the answer that is the next lower one than the average (e.g., SD 10.5% and 23.8%, equal weight of 50% → (10.5x 50) + (23.8x50) = 17.5% Answer choices: 10.8%, 13.7%, 18.45, 20.5% → choose 13.7%

Answer 42

Acceptance by an investor of a given level of risk while maximizing expected return objectives. When designing a portfolio the most important variables are risk, return and covariance (how asset classes relate to each other). Negatively correlated assets are not necessary to reduce risk, simply assets with a correlation < 1 are necessary. Diversifying across asset types is more effective by combining stocks and bonds. The efficient frontier is very sensitive to the risk and return input variables.

Answer 43

Curve illustrates optimal amount of return for a unit of risk taken. Uses standard deviation for risk measure. All points on the efficient frontier are deemed equally efficient. Where you plot on the curve is determined by risk tolerance. Portfolios below the efficient frontier are inefficient because there is a portfolio that provides more return for that level of risk. Area above the efficient frontier is considered unattainable.

Answer 44

Occurs when an investor's indifference curve is tangent to the efficient frontier.

Answer 45

Constructed using selections made based on highest level of return given an acceptable level of risk. Risk averse investor will have steep indifference curve. This investor requires significantly more return to take on just a little more risk. A risk tolerant investor will have a flat indifference curve. This investor will not require a significant amount of return to take on more risk.

Answer 46

The one selected from all efficient portfolios: the point at which an investor's indifference curve is tangent to the efficient frontier represents the investor's optimal portfolio. Investors seek the highest return attainable at any level of risk. Investors want the lowest level of risk at any level of return. Investors are assumed to be risk-averse.

Answer 47

Macro aspect of the Capital Asset Pricing Model (CAPM) Specifies the relationship between risk and return in all possible portfolios. CML becomes the new efficient frontier, mixing in the risk-free asset with a diversified portfolio. A portfolio's returns should be on the CML. Inefficient portfolios are below the CML. CML is NOT used to evaluate performance of a single security. CML uses STANDARD DEVIATION to measure risk. Rp =rf + σp (rm - rf) / σm where: Rp = portfolio return rf = risk free rate σp = standard deviation of portfolio returns rm = market return σm = standard deviation of market returns

Answer 48

Calculates the relationship of risk and return of an individual security using Beta as its measure for risk. Often referred to as the Security Market Line (SML) equation because its inputs and results are used to construct the SML. The difference between (rm - rf) is considered the market risk premium, i.e., how much an investor should be compensated to take on a market portfolio vs. a risk-free asset. - quantifies expected return - quantifies required ROR - plots the SML ri = rf + (rm - rf) βi ``` ri = required or expected ROR rf = risk free ROR βi = Beta, systematic risk of the portfolio rm = return of the market rm - rf = market risk premium ``` Exam tip: sometimes the market risk premium will be given rather than the return of the market. stock premium = (rm - rf) βi

Answer 49

The relationship between risk and return as defined by the CAPM and graphically plotted results in the SML. Both the CAPM and the SML assume an investor should at least earn a ROR equal to the risk-free rate of return. The SML intersects the y-axis at the risk-free rate of return. SML uses BETA to measure risk, CML uses SD to measure risk. If a portfolio provides a return ABOVE the SML, it would be considered undervalued and should be purchased. If a portfolio provides a return BELOW the SML, it would be considered overvalued and should not be purchased. SML may be used with individual securities.

Answer 50

Relative risk-adjusted performance measure Measures EXCESS RETURN and the CONSISTENCY provided by a fund manager, relative to a benchmark. The higher the excess return (Information Ratio) the better Excess return can be positive or negative depending on the fund's performance relative to its benchmark. IR = (Rp - Rb) / σA Rp = portfolio's actual return Rb = benchmark return Rp - Rb = excess return σA = tracking error of active return (standard deviation of the difference between portfolio returns and index returns)

Answer 51

Tp = (rp - rf) / βp ``` rp = realized return of the portfolio rf = risk free return βp = beta of the portfolio ``` Measures risk-adjusted performance of a portfolio manager Relative risk-adjusted performance indicator, i.e., one Treynor ratio needs to be compared to another to provide meaning ONLY appropriate when R² > 0.70 Measures how much return was achieved for each unit of risk; higher Treynor ratio means more return was provided for each unit of risk. Measures reward achieved relative to the level of systematic risk (as defined by Beta) - accomplished by standardizing portfolio returns for volatility. Treynor justifies use of the model on the assumption that in a well-diversified portfolio, unsystematic risk is always close to zero. Treynor Index does not indicate whether a portfolio manager has outperformed or underperformed the market. EXAM TIP: Use for well-diversified portfolios because Treynor uses Beta!

Answer 52

Risk adjusted performance measure that measures reward to total variability or total risk (standard deviation): Sp = (rp - rf) / σp ``` rp = realized portfolio return rf = risk free return σp = standard deviation of the portfolio ``` Relative risk adjusted performance indicator, thus needs to be compared to another Sharpe ratio to provide meaning ONLY appropriate when R² < 0.70 When R² is low, you need to consider all risks and would use standard deviation as the risk statistic. Measure of how much return was achieved for each unit of risk; the higher the Sharpe Ratio the better (more return was achieved for each unit of risk). Measures risk premiums of the portfolio relative to the total amount of risk in the portfolio. Does NOT measure a portfolio manager's performance against that of the market. EXAM TIP: Use for non-diversified portfolios because Sharpe uses Standard Deviation.

Answer 53

Differs from Treynor and Sharpe in that it can distinguish a manager's performance relative to that of the market and determine differences between realized (actual) returns and required returns as specified by CAPM. While Treynor and Sharpe provide measure for relative performance, Jensen's Model measures absolute performance on a risk-adjusted basis. Positive Alpha → fund manager provided more return than expected for risk taken Negative Alpha → fund manager provided less return than expected for risk undertaken Alpha = 0 → fund manager provided return equal to expected return for risk taken - quantifies risk-adjusted return αp = rp - [rf + (rm - rf) βp] ``` rp = realized portfolio return rf = risk-free return rm = expected return on the market βp = beta of portfolio αp = measure of portfolio manager's contribution to the return ``` The higher the alpha, the better the performance. Negative alphas indicate managers who have underperformed the market on a risk-adjusted basis. Only when BETA = 1, ALPHA = amount a fund beat the market!

Answer 54

Both TREYNOR and ALPHA use Beta as measure of risk, thus, Treynor and Alpha are appropriate risk-adjusted performance indicators for a DIVERSIFIED portfolio, i.e., when R squared ≥ 0.70. When R squared ≤ 0.70, the portfolio is not well diversified, thus Standard Deviation is an appropriate risk-adjusted measurement, thus using SHARPE is appropriate. EXAM TIP: if exam doesn't give you R Squared, select Sharpe!

Answer 55

Calculates effective annual interest rate earned on an investment when compounding occurs more often than once a year EAR= (1 + i/n)^n -1 ``` i = stated annual interest rate n = number of compounding periods ``` Example: Effective annual rate of 10% compounded quarterly: (1+ 0.10/4)^4-1 = 10.38%

Answer 56

AM = (a1 + a2 + a3 + an) / n OR on calculator: a1 Σ+ a2 Σ+ a3 Σ+ an Σ+, Orange shift x̄, ȳ ignores compounding effect over time

Answer 57

Time weighted compounded rate of return: GM = n√(1 + r1) * (1 + r2) * (1 + r3) − 1 (May not be appropriate for a time series of asset returns due to possibility of a zero or negative return and due to compounding)

Answer 58

of a share price: (Σ (# of shares x price per share)) / total # of shares of portfolio return or weighted Beta (same calculation): Σ((%weight A x %return A) + (%weight B x %return B) +(%weight N x %return N))

Answer 59

Used to evaluate capital projects and capital expenditures that will result in differing cash flows over the useful life or investment period. The method discounts future cash flows at an appropriate discount rate and allows the present value of the inflows to be compounded to the present value of the outflows. Discount rate = investor's required ROR. NPV = deterministic: if NPV = positive, investor would make the investment (actual return > required return), if negative, investor would not make the investment (actual return < required ROR); if NPV = 0, return meets required return, investor should make investment. NPV = PV of Cash Flows - Initial Cost +/- Initial cost = CF0 If sold in last year, add sales price to last year cash flow. Solve for NPV

Answer 60

IRR allows financial planner to compare computed rate to required ROR The method discounts future cash flows at an appropriate method used to determine the exact discount rate to equalize cash inflows and cash outflows of a specific investment or project. IRR = discount rate that sets the NPV formula equal to zero IRR calculation assumes reinvestment rate = IRR Accept project where IRR > required ROR YTM and YTC are examples of IRR calculation. Can be thought of as a compounded rate of return. IRR should be calculated when you have uneven cash flows and you are asked to calculate a compounded rate of return. If NPV is positive, IRR > Discount Rate If NPV is negative, IRR < Discount Rate If NPV = 0, IRR = Discount Rate NPV is considered superior model to IRR when comparing investment projects of unequal lives. Investing at the required ROR is more reasonable than at the IRR. With changes of more than 2 inflows or outflows in an investment project there will be only one NPV, however, multiple IRRs. If NPV and IRR suggest two different investment projects, select the project with the higher positive NPV!

Answer 61

Calculates IRR using investor's cash flows: ``` Bob purchases 1 share of DIS for $50. One year later the stock pays a $4 dividend, and Bob purchases an additional share for $65. Bob sold the stock one year later for $75/share. What was Bob's dollar weighted return? Period Cash Flow 0 +/- 50 1 +/- 61 2 150 IRR = 22.63% ```

Answer 62

Bob bought 100 shares of CISCO at $20/share; initial margin was 60%, he was charged 10% margin interest annually. After 1 year he sold the shares at $30/share. What is his HPR? (3000 - (2000 x 0.6) - (2000 x 0.4 x 0.1) - (2000 x 0.4)) / (2000 x 0.6) Where: 2000 x 0.6 = initial equity 2000 x 0.4 x 0.1 = margin interest paid 2000 x 0.4 = to be paid back

Answer 63

Bob bought 100 shares of CISCO at $20/share; initial margin was 60%, he was charged 10% margin interest annually. After 1 year he sold the shares at $30/share. Bob is in the 35% tax bracket and his LT capital gains tax rate is 15%. What is his after tax HPR? (3000 - (2000 x 0.4) - ((2000 x 0.6) x (1 - 0.15)) - ((2000 x 0.4) x (1 - 0.35)) - ) / (2000 x 0.6) ``` Where: 2000 x 0.6 = initial equity 2000 x 0.4 = to be paid back (2000 x 0.6) x (1 - 0.15) = LTCG tax (2000 x 0.4) x (1 - 0.35) = interest income tax ```

Answer 64

- pricing imbalances cannot exist for a significant period of time, otherwise, investors will exploit the price imbalance until market prices are back to the equilibrium - attempts to take advantage of pricing imbalances - multi-factor model that attempts to explain return based on factors - anytime a factor has a value of zero, that factor has no impact on the return - inputs are factors, such as inflation, risk premiums, expected returns, and their sensitivity to those factors - Standard deviation and Beta are NOT input variables to the APT

Answer 65

Mutual funds report on a time-weighted basis.

Answer 66

1. Convert US Dollars to foreign currency to determine the cost 2. Compute the return, typically using HPR 3. Convert foreign currency back to US Dollars Example: 100 shares in Intl. Easy Co. @ £12.75 when currency rate is $1.50/£ with transaction costs of £25. Cost in £ = £12.75 x 100 + £25 = £1,300 Cost in $ = £1,300 x $1.50 =$1,950 If stock price increases to £17.50 a share, transaction cost to sell are £25 and currency rate is now$1.55/£, what is the gain in US dollars? 37.12% (HPR) or $723.75

Answer 67

The Constant Growth Dividend Discount Model values a company's stock by discounting the future stream of cash flows. V = D1 / (r-g) ``` r = required ROR g = dividend growth rate D1 = next expected dividend ``` Calculated using current dividend and dividend growth rate as follows: D1 = D0 (1+g)

Answer 68

``` r = (D1 / P) + g P = market price or value ``` If the required ROR decreases, the stock price increases. If the dividend is expected to increase, the stock price will increase. If the required ROR increases, the stock price will decrease. If the dividend is expected to decrease, the stock price will decrease. Sample calculation: current annual dividend = $2/share 5 years ago the dividend was $1.36/share Dividend is expected to grow at the same compound annual rate as the past 5 years. Required ROR = 12% Expected return on the market portfolio = 14% What is the value of a share of common stock using the constant dividend growth model? N = 5 PV = +/-1.36 FV = 2 Solve for I/YR: 8.02% V = D1 / (r-g) 2 (1.0802) / (0.12 - 0.0802) = $54.28

Answer 69

Normal / Upward sloping yield curve: short term rates are lower than long term rates Flat: short and long term rates are similar Inverted / Negative sloping: short term rates are higher than long term rates (An inversion of the yield curve is indicative of a looming recession. Long-term investors will settle for lower yields.)

Answer 70

business cycle - longer end of the curve is a market rate and predicts anticipated economic conditions Fed policy - short end of the curve is very sensitive to Fed policy (e.g., if fed aggressively increases the discount rate and predictions are keeping the longer end of the curve down, an inverted curve will likely be the result)

Answer 71

bond's coupon payments (PMT) (assume semi-annual compounding: payment per period is half of the coupon) market rate of interest for comparable bonds (I/YR) amount of time remaining to maturity (N) maturity / par value (assuming $1,000) (FV) (Solve for PV to get the bond's intrinsic value)

Answer 72

Provide for exchange of capital and credit in the economy Money Markets - short term debt instruments Capital Markets - long term debt and equity instruments; consist of Primary and Secondary Markets

Answer 73

New securities issued and sold to the public for the first time - registered with the SEC and sold to clients through IPO process - issuing firm = recipient of proceeds - Primary Markets and issues = regulated by Securities Act of 1933

Answer 74

previously issued securities trade among investors - issuing company not directly involved - Secondary Markets and issues = regulated by the Securities Act of 1934 - 2 forms of Secondary Markets: 1. Organized Exchange (NYSE) 2. OTC (NASDAQ)

Answer 75

Stock market = efficient, all stocks reflect relevant information and are priced in equilibrium. Investors who accept EMT would be passive investors and buy only index funds Strong Form Semi Strong Form Weak Form

Answer 76

Investor has no access to Technical Analysis Fundamental Analysis Insider Information

Answer 77

Investor has Access to Inside Information No Access to Fundamental or Technical Analysis

Answer 78

Investor has Access to Insider Information and Fundamental Analysis No Access to Technical Analysis

Answer 79

Cannot be explained away by EMT - Low P/E effect - Small Firm effect - Neglected Firm effect - January effect - Value Line Phenomenon

Answer 80

global standard for fund performance based solely on appreciation or depreciation of a portfolio from period to period

Answer 81

coupon yield

Answer 82

annual coupon / current market price

Answer 83

YTM and YTC are calculated in similar ways. When asked which yield is appropriate to make an investment decision, choose the lower one (= YTW)

Answer 84

Intrinsic value of the existing bond goes up

Answer 85

time to recoup your money on a bond investment (= effective maturity) used to estimate changes in bond prices based on hypothetical changes in prevailing rates (a 1% change in rates would lead to roughly a % change in bond's price equal to duration expressed as a percent)

Answer 86

Weighted average of the Present Values of the future cash flows of a bond / bond portfolio always stated in years for income producing bonds, duration will always be shorter than maturity for Zero Coupon bonds, duration = maturity Duration increases with maturity higher coupon → lower duration Duration = linear estimate, tends to overestimate risks from rising interest rates and underestimate benefits from lowering interest rates

Answer 87

It immunizes those assets, thus, significantly reduces purchasing power and reinvestment rate risks for the assets

Answer 88

Rate Decrease leads to Price Increase Rate Increase leads to Price Decrease A 1% change in rates roughly equals a % change in bond's price that is equal to the duration expressed as a percent. Short end of the curve will not move too much with rate changes. Long end of the curve will move significantly with rate changes. The LONGER the duration and the LOWER the coupon, the MORE SENSITIVE to rate changes. The SHORTER the duration and the HIGHER the coupon, the LESS SENSITIVE to rate changes. (If asked to calculate price change in portfolio, multiply percentage change in price by $$ in portfolio.)

Answer 89

The day of acquisition is excluded | the day of disposal is included

Answer 90

returns: 20%, 15%, -9%, 34%, -16% What percentage of the time would you expect a return between-12% and -32.8%? ``` 20 Σ+ 15 Σ+ 9, +/- Σ+ 34 Σ+ 16, +/- Σ+ Shift, 7 (x,y) - mean Shift, 8 (sx, sy) - SD ```

Answer 91

Sharpe Treynor Jensen's Alpha What? risk adjusted return risk adjusted return excess return When? R² < 0.70 R² > 0.70 R² > 0.70 Value relative relative absolute Relevant Standard Beta Beta Risk Statistic Deviation

Answer 92

- investors cannot deduct losses from sales or trades of stock or securities in a wash sale unless the loss was incurred in the ordinary course of their business as a dealer in stock or securities Wash sale: occurs when taxpayer realizes a loss on the sale of a security and acquires a substantially identical security within a 61-day period (30 days prior to the trade date to 30 days after the trade date) Substantially identical: - bonds: unless exact same bond or bond fund is purchased, it is difficult to violate the wash sale rule with fixed income - stocks that trigger "substantially identical": convertible bond (can convert to same stock that was sold for a loss); purchase a call option that can be exercised into the same stock that was sold for a loss Wash sale ramifications: - loss on sold security will be disallowed - disallowed loss will be added to basis of new securities purchased - when new (replacement) securities are sold (via higher cost basis), loss will be allowed eventually

Answer 93

Example: Patrick bought 1000 shares of BIF Current dividend $4.00 Dividends are expected to grow 5% annually for the next 3 years After 3 years, BIF dividends are projected to grow at 4% Patrick's required ROR = 8% What is the valuation of BIF stock? Step 1: D1 = D0 x (1+g) = 4.20 D2 = D1 x (1+g) = 4.41 D3 = D2 x (1+g) = 4.63 Step 2: (4.63 x 1.04) / (0.08 - 0.04) = 120.38 + 4.63 = 125.01 ``` Step 3: Solve for NPV 8 I/YR 0 CF0 4.2 CF1 4.41 CF2 125.01 CF3 Shift, NPV = 106.91 ```

Answer 94

``` Buyer = holder, long Seller = writer, short ``` Buyer of the contract has the right (or option) to do the following: - call contract: right to purchase shares - put contract: right to sell shares Seller of the contract has the obligation to do the following: - call contract: obligation to sell shares - put contract: obligation to buy shares ``` The buyer of the contract pays the seller a premium to enter the contract. Premium is $ per share. Premium presents: - maximum possible loss for buyer - maximum possible gain for seller ``` All contracts will stipulate: - exercise price - expiration date All contracts cover 100 of the underlying stock. Value comes from favorable difference between market price of the stock and the exercise price of the contract, - know as "in the money": - for a call favorable difference is when MP > EP - for a put favorable difference is when MP < EP If there is no favorable difference, option is "out of the money". If MP = EP, option is "at the money". Options Clearing Corporation (OCC) guarantees the performance of both parties. - eliminates counterparty risk Both the buyer and the seller of an option can be bullish or bearish on the underlying stock. Options Strategies Long Straddle↓ Short Straddle ↓ Buy (hold) Sell (write) Call Bull ↑ Bear ↓ Spreads Put Bear ↓ Bull ↑ Spreads To arrive at the profit net the premium paid from the current gain!

Answer 95

The premium is the price the option buyer pays to the option seller to establish the option contract. - premium is paid on a per-share basis - 2 basic variables and 5 expanded variables that determine an option's price: - intrinsic value: market price of underlying stock exercise price of option contract - Time premium: risk-free rate of return time to expiration variability of underlying stock (as measured by standard deviation) The greater any or all of the 3 expanded variables, the greater the time premium Time premium is greatest at the creation of the contract and approaches $0 at the expiration of the contract. Intrinsic value can never be less than $0. Options Premiums Option Type Total Premium EP MP Intrinsic Value Time Premium Call $5 $30 $32 $2 $3 Call $4 $60 $58 $0 $4 Call $8 $20 $25 $5 $3 Put $7 $45 $44 $1 $6 Put $2 $75 $85 $0 $2 Put $6 $90 $92 $0 $6 Intrinsic Value calculations: Intrinsic Value for Call options: COME: Call Option = Market Value - Exercise Price Intrinsic Value for Put option: POEM: Put Option = Exercise Price - Market Value

Answer 96

Used to hedge existing stock position or to speculate on stock without owning it - Covered call writing: Long the underlying stock - short the call - Only considered covered if you own enough shares to cover all contracts sold - Used to generate income for portfolio - Naked call writing: does not own underlying stock - short the call - unlimited risk for writer - Protective put: Long the stock - long the put - portfolio insurance - Protective call: Short the stock - long the call - used to protect a short position in the stock - Covered put: Short the stock - short a put - writer uses the stock put to cover their short stock position - Collar (Zero cost collar): Long the stock - long the put - short the call - put is used to protect against a stock price decrease, call premium used to offset cost of the put - Straddle: Long a put and a call on the same underlying stock with the same expiration date and strike price - used to capitalize in volatility regardless of the direction - Spread: involves purchasing and selling same type of contract - benefit from stability (i.e., minimum moves in underlying stock's price)

Answer 97

Agreement to buy or sell a specific amount of commodity, a currency, or a financial instrument at a particular price on a stipulated future date. Spot price = current market value of the item in today's market (e.g., melt value of gold) Futures contract allows speculation and hedging on the spot price at some point in the future (almost all contracts are settled through an offsetting contract, not through physical delivery) Futures contracts are standardized Clearinghouse acts as intermediary that guarantees performance of both parties involved in the contract and eliminates counterparty risk. Using futures for hedging strategies: - long position: if you own something you are long (e.g., corn farmer is long corn) - short position: if you have to buy something, you are short (e.g., construction company that needs to build is short lumber) - Short hedge: anyone who is long needs a short hedge (selling a futures contract establishes a short hedge) - Long hedge: anyone who is short needs a long hedge (buying a futures contract establishes a long hedge) Forward contracts are different in that they are not standardized (can take any form the parties agree to) and are not executed through a clearinghouse, thus cary counterparty risk

Answer 98

If Sri’s T-Bill were sold today, he would receive $990.83, calculated as follows: Face Value × [1 - ((Days to Maturity ÷ 360) X Yield)] = Current Price $1,000 × [1 – ((120 ÷ 360) × 0.0275)] = $990.83

Answer 99

Since the conversion price is $1,000/75, or, $13.34 per share, the investor can convert and sell the shares for $12.75. This would create a $0.59 loss per share or a total loss of $44.25 ($0.59 x 75 shares). Because the conversion would result in a loss, the bondholder should not convert.

Answer 100

When interest rates decrease below the stated interest of the debt (the coupon rate), the security will be worth more since new debt pays less interest. Therefore, the market price for the debt would be above par value, otherwise known as a premium bond.

Answer 101

Payout Ratio and Expected Earnings Dt = (Pt)(Et); dividends are replaced by the payout ratio multiplied by expected earnings. When solving for the normal price/earnings ratio, the expected earnings is divided into the intrinsic value.

Answer 102

Divide standard deviation by return to determine Coefficient of Variation. This tells us the unit of risk per unit of return. The lowest one is the most efficient portfolio!

Answer 103

Short-term yield is lower than long-term yield A ladder structure will be the most beneficial in a normal upward sloping yield curve indicating higher yield at longer maturities, with a stable interest rate environment. (Barbells work better in a flat yield curve while bullet works better for a steep yield curve.)

Answer 104

A collar is beneficial when the rate goes above the cap.

Answer 105

Integrated asset allocation considers the investor's goals and policies and capital market conditions, and then uses these data as inputs to some kind of optimizer. The optimizer's solution becomes the new inputs that are reconsidered along with the investor's latest goals and policies and most recent market conditions when revising the asset allocation.

Investment planning Flashcards

(131 cards)