Investment Planning

Question 1

Monte Carlo Simulation

Answer 1

If there is a question, it will most likely be to adjust the assumptions and return the probability of an event

Question 2

What are systematic risk?

Answer 2

Remember PRIME

P- Purchasing Power Risk

R- Reinvestment Rate Risk

I- Interest Rate Risk

M- Market Risk

E- Exchange Rate Risk

Question 3

**Purchasing Power Risk

Answer 3

• Purchasing power risk is the risk that 1) inflation will erode the amount of goods and services that can be purchased, 2) a dollar today cannot purchase the same amount of goods and services tomorrow or the day after.
• Purchasing power risk impacts both equities and bonds

Question 4

**Reinvestment Rate Risk

Answer 4

• Reinvestment rate risk is the risk that an investor will not be able to reinvest at the same rate of return that is currently being received.
• Reinvestment rate risk mostly impacts bonds

Question 5

**Interest Rate Risk

Answer 5

• Interest rate risk is the risk that changes in interest rates will impact the price of both equities and bonds.
• There is an inverse relationship between interest rates and both equities and bonds

Question 6

Market Risk

Answer 6

-Market risk impacts all securities in the short term because the short term ups and downs of the market tend to take all securities in the same direction.

Question 7

Exchange Rate Risk

Answer 7

Exchange rate risk is the risk that a change in exchange rates will impact the price of international securities

Question 8

What are unsystematic risk?

Answer 8

Remember ABCDEFG

A- Accounting Risk

B- Business Risk

C- Country Risk

D- Default Risk

E- Executive Risk

F- Financial Risk

G- Government/ Regulation Risk

Question 9

Accounting Risk

Answer 9

Accounting risk is the risk associated with an audit firm being too closely tied to the management of a company, for example: Arthur Anderson and Enron

Question 10

**Business Risk

Answer 10

Business risk is the inherent risk a company faces by operating in a particular industry. For example, Halliburton faces much different risk in the oil industry than Microsoft does, which is primarily selling intellectual property and protecting copyrights.

Question 11

**Country Risk

Answer 11

Country risk is the risk a company faces by doing business in a particular country. For example, Halliburton faces unique risks doing business in Iraq.

Question 12

**Default Risk

Answer 12

Default risk is the risk of a company defaulting in their debt payments. Default risk can be thought of as the likelihood of a firm being able to satisfy its debt obligations on time.

Question 13

Executive Risk

Answer 13

Executive risk is the risk associated with the moral and ethical character of the management running the company.

Question 14

**Financial Risk

Answer 14

Financial risk is the amount of financial leverage deployed by the firm. Financial leverage is the ratio of debt versus equity the firm has deployed, or the financial structure. The higher the percentage of debt deployed by the firm, the more risky.

Question 15

**Government/ Regulation Risk

Answer 15

Government or regulation risk is the risk that tariffs or restrictions may be placed on an industry or firm that may impact the firm’s ability to effectively compete in an industry

Question 16

Standard Deviation

Answer 16

A measure of total risk for a non diversified portfolio. Higher standard deviation, higher the risk

Question 17

Coefficient of variation

Answer 17

Useful in determining which investment has more relative risk when investments have different average returns. Higher coefficient of variation the more risky

Question 18

Coefficient of Variation Formula

Answer 18

CV= Standard Deviation/ Average Return

Question 19

Beta

Answer 19

Appropriate measure of risk for a diversified portfolio

Question 20

R squared

Answer 20

A measure of how much return is due to the market. You get it by squaring correlation coefficient
( it can be shorten to correlation)

Question 21

At what level of r squared can one use beta?

Answer 21

.7 or greater

Question 22

At what level of r squared should one use standard deviation to measure total risk?

Answer 22

Less than .7

Question 23

Arbitrage Pricing Theory (APT)

Answer 23

Multi factor model
sensitivity to factors: inflation, risk premium, expected returns
Standard Deviation and Beta are not inputs

Question 24

Finding Div0

Answer 24

Div0= EPS* (1- retention rate)

Question 25

Dividend Payout Ratio

Answer 25

Dividend Payout Ratio= Common Stock Dividend/ EPS

Question 26

Return on Equity (ROE)

Answer 26

Earnings per Share (EPS)/ Stockholder’s Equity per Share

Question 27

Dividend Yield

Answer 27

Dividend Yield= Dividend/ Stock Price

Question 28

P/E Multiplier

Answer 28

Used to determine value in a growth stock that pays no dividends

Question 29

Securities Act of 1933

Answer 29

Regulates the issuance of new securities (Primary Market)

Question 30

Securities act of 1934

Answer 30

Regulated the secondary market and trading of securities. Created SEC

Question 31

Investment Company Act of 1940

Answer 31

Authorized SEC to regulate investment company

3 types: open, closed, unit investment trusts

Question 32

Investment Policy Statement covers (not as important)

Answer 32

RR TTLLUU

Risk, return, time, taxes, liquidity, legal, and unique circumstances

Question 33

Doe Joe’s Industrial Averages

Answer 33

Simple price weighted average
Doesn’t incorporate market capitalization
Adding up the stocks simply
There are 30 stocks

Question 34

S&P 500

Answer 34

Value weighted index- incorporates market capitalization of individual stocks into the average

Question 35

SP 400

Answer 35

Mid cap stocks

Question 36

Russell 2000

Answer 36

Small caps

Question 37

Standard Deviation

Answer 37

To calculate only undiversified investments

Question 38

Beta

Answer 38

Use to only calculate diversified investments

Question 39

Standard Deviation

Memorize area under curve

Answer 39

68% of the time +/- 1 standard deviation

95% of the time +/- 2 standard deviation

99% of the time +/- 3 standard deviation

Question 40

MEMORIZE

Coefficient of Variation

Answer 40

Useful when comparing two assets with different average returns

The higher the coefficients of variation, the more risky an investment and less likely an investor is to achieve the average return

CV= standard deviation/ mean expected (average) return

Asset with lower CV has the higher risk adjusted return