202 Flashcards
Stocks are
Securitized ownership
Bonds are
securitized loans
Ownership vs loan
Ownership could get 100% or nothing back where as loan you could get intertest and prinicipal
Measurement of equity
Price of a stock
What is the point in buying a stock and never selling?
to collect dividends
What does the Gordon Growth Model assume
constant g growth rate
What is the GGM?
P=D/r-g
Why is the GGM helpful/what can it be used for?
To calculate the r, as you may not be sure what the equity investors r is, you can then use that for NPV calculation
Money in business
Book Equity per share
Profit %
ROE %
Profit
EPS
Give away %
DR
Give away $
Dividend
If paid out entirely to shareholders DR=
100%
Another note if DR=100%
g=0 as g=ROEx(1-DR)
Shares mean you have
small portion of ownership of the company
Is more EPS/r or more PVGO
value stock, growth stock
PVGO
PV of growth opportunities
What is PVGO?
how much in a share you are paying for the fact that the price/div will grow
log return and log of return
NOT the same thing
weights rule
add up to equal 1
The return of a portfolio only depends on 2 things
stock weights and returns
Why can’t you just P1+P2/N to measure the performance of the whole stock market? (2)
1) companies sometimes have much bigger
2) stock splits
Weight is also known as
market capitilisation
Why is the market index helpful?
It means you can find the change over longer periods of time rather than from one day to the nxt
Std of a stock is the
risk
Correlation rule
-1 <= p <= 1
Risk of a stock is the
std
Higher std means
more risky, more spread of returns
diversification ___ apart from __
lowers std/risk
p=1
p=-1 you could obtain
std=0
when does it mean there is a higher chance of a loss?
std=4mean
S v S given r* and std*
one r* point
one, two, none std* point
weights rule
w1+w2=1
Short Selling
borrow shares to sell, hoping price will fall, so that they can buy them back cheaper
Short-selling does though…
extends possibilities on a risk return graph
S v Bank
model bank as stock with std=0 as 0 risk you are guaranteed to get the money back
S v Bank with one negative weight?
you can’t short sell a bank but you could borrow money, leveraging
S v Bank risk return graph is ..
linear
Leveraging does what to the possibilities between S v B
extends
B v B is
Arbitrage
both have std=0
Arbitrage is only legal..
only legal in the US
If you are treating portfolios like stocks you use what maths technique…
vectors
S v S, S v B, B v B summaries
S v S
- without selling can only get pts on curve (stocks lie on curve)
- given r* 1 pt
-given sigma* 1, 2 or none
- short seling extends curve
- curved line
S v B
- banks risk/sigma=0 it has guaranteed return
- bank is like a risk free asset
- straight line
- short selling (borrowing) extends line
- S/sell is borrowing to invest in stock (leverage)
B v B
- impossible
-maths is all good, not financially feasible
With 3 or N socks what is the curve called on returns/sigma graph?
minimum variance set
What is the upper half of MVS?
efficient frontier
What is possible on or in MVS?
everything inside
Do stocks lie on MVS?
not necessarily like the 2 stocks do
given an r* on a N stocks graph
infinite possibilities for portfolios
MVS gives portfolio with lowest
risk
N stock optimization uses what maths?
Lagrangian
The two fund theorem means that P1, P2 are any Ps that lie on ___ and if they are optimal that means
MVS
every other optimal P comes from distributing money between P1, P2
How to find if P(x,y,z) lie on MVS?
3 equations for a
if all of the a’s are equal
How to find if stock 1 on MVS?
sub P(1,0,0) into P
If you have N stocks and 1 bank the efficient frontier is called
capital market line
Risk free portfolio
P(1,0,0)
Tangent portfolio
Pt(0,w1,w2)
what is CAPM?
is a financial model that calculates the expected rate of return for an asset or investment
2 assumptions of CAPM
every investor has same values for r*, std , p for all stocks
everybody does mean variance optimizationC
CAPM means that what are equal
Pm=Pt
Why can’t you just do rt/stda for sharpe ratio?
as banks std is 0 so would go to inf
CAPM tell us that
you can’t beat the sharpe ratio for Pm as it has the highest sr
for CAPM everything on off frontier has same SR
as PM
Find P on eff frontier with return x%
sub in return risk free then calculate return t then solve for a
if financed by the bank the discount rate comes from
banks IR
if financed by shareholders comes from
CAPM (re)
risk and return key message
for correlation (-) increased risk does not mean increased return
2 takeaways of finance
p too high diversification does not help
p(-) increased risk does not mean increase return
IRR is r* that bank offers to be
exactly the same as business
For continuous compounding what is the formula for PV?
FV/e^rt
A bond contract always has the following 4
face value
maturity
coupon rate
coupon schedule
Coupon payments end when the bond
matures
on the maturity date for a bond, what is the payment you receive?
C+fV
bond price is not a part of the contract but defined
by the market
how could you compare if putting money in a bank is better or worse than purchasing a bond?
compare int payments and coupon payments
When using y as int rate gives you an NPV of ____ or a ____ of
0
bond price
yield price relationship
yield increases, price decreases
yield decreases, price increases
YTM is essentially the ___ of a bond
IRR
What is the price of a bond if yield=0?
Price= (Cxt) + fV
If CR=y then
P=fV
An example of bond default risk
if you buy a gov bond and they go bust
Prob of annual default risk
P=y-y
y being the yield of the ‘shady’ company
y is the yield of a ‘safe’ company
where does the compensation for bond default risk come from?
yield
if you were to default in year 1 what is the prob of default year 2
0
2 steps for prob of default
P(survive each year)=1-apd
P(survive N years) Psey^N
P(default within N years= 1-PsNy
compare bond and bank
consider IRR, bank should at least offer that if not more
priced at par
Cr= yeild, P=fV
ZCb duration, Cr
duration=maturity
CR=0
what is appropriate discount rate in bond replication?
yield of ZCM of that maturity
OCR
official cash rate
rate at which govt lends to banks (minimum lending rate, cheapest money bank can get)
govt changes
changes in OCR has changes on other interest rates
Duration is like
centre of gravity
higher coupons means what for duration
lower
duration should never
be higher than maturity
sensitivity analysis formula means __ and only works for
if y changes by a small amount price changes by that amount but only works for small changes in y
