410 Final Flashcards
financial asset - what 3 things determine value of fin. asset and how fin. markets enable us to offload risk
written obligation to FCFs
–timing, amt., risk
offload risk by insurance for ex.
what are 2 ways fin. mkts. help allocate resources to their most beneficial use
- -liquid asset
- -broker’s role in trading securities
making prices transparent and informative - make prices transparent and help aggregate vast amts. of info. into a single # in the market place
- -can be easily bought or sold at fair value
- -act as a middle man - arranges transactions btwn buyer and seller (REAL ESTATE is ex. of brokered mkt.)
buy 1 hsare of target for $26 at beg. of year - over year value of stock grows 16% - what is payoff at end of year?
26*(1.16) = $30.16
know diff. btwn profit, gross return (what sell for / what you paid for it), net return (just subtract 1 from gross)
buy share for $54 - in 1 year sell for 65 - after rec. dividend pmt. of $8
- -profit?
- -gross return?
- -net return?
- -div. yield?
- -cap. gains?
profit = 19
gross return = 1.35
net return = .35
div. yield? = (8/54) = 14.8%
cap. gains = (65/54 - 1) = 20.4%
(75bps = .75%, = .0075)
effective 2 yr. return on investment is 10% - what is EAR?
Eff. quarterly return = 5%, what is effective 3 year return?
EAR on investment is 13% - what is monthly return?
effective monthly retun is 2% - what is EAR
eff. 2 year return is 23% - what is effective quarterly return?
(1 + X)^2 = 1.10 ….. X = 4.88%
(1.05)^12 = x …. x = 1.795 —> (1 + x)^1 = 1.795, x = 79.5%
(1 + x)^12 = 1.13…. 1.13^1/12 -1 = 1.02%
(1.02)^12 - 1 = x …. x = 26.8%
(1 + x)^8 = 1.23….. 1.23^1/8 - 1 = 2.62%
APR is 14% with ann. compounding - what is effective quarterly rate?
what is effective annual rate?
what is eff. 2 month rate?
14/4 = 3.5% eff. quarterly rate
EAR = 1.035^4 - 1 = 14.8&
2 mo. rate = 1.148^1/6 - 1 = 2.32%
ch. 2 conceptual
1. firms often acquire STD by issuing ____ to public
- Treasury notes have maturities ____ and Treasury bonds have maturities ____
- what is a Eurobond
- the bid price of a treasury bond is
- commercial paper
- up to 10 years (T notes), from 10-30 years (T bills)
- euro-denominated bond issued in Moscow
- -Russian denominated bond issued in London - the price at which a dealer in treasury bills is willing to buy the bill
- fed. funds rate is
- real estate generally trades in a
- a limit buy order is an order to
- the third market is
- the NASDAQ stock market is
- which mkt. consists of indiv. or firms that stand prepared to sell from or buy to add to an inventory of securities?
- rate banks charge each other for over night loans to meet reserve requirements
- brokered market
- buy a stock when price falls below certain level
- loose networkof brokers and dealers
- a hybrid exchange and dealer market
- dealer mkt.
diff. btwn primary and secondary market - who are buyers and sellers in each market?
PRIMARY
—market for new security issues - in this mt. the sellers of securities are firms or gov. who want to raise capital and the buyers are investors
SECONDARY
- -mkt. for already existing securities
- -both buyers and sellers are investors
Look at characteristics of hedge funds
- funds are heavily regulated by SEC
hedge funds diff. than mutual funds
- -hedge funds have less regulation bc part of private partnerships and free from SEC refulation
- -permit investors to take on many risks unavailable to mutual funds
- -however, hedge funds req. higher fees, lock-up periods, and provide less transparency to investors
what are advantages and disadvantages for buying ETF vs. index
- ETFs can be bought and sold anytime like regular stocks at real-time prices
- ETFs can be sold short
for INDEX
1. when trading index funds you avoid the explicit and many of the implicit costs of trading on the secondary market - you simply buy at the 4pm NAV
NAV - mutual fund manages protfolio of securities worth $120M
- -fund owes $4M to its investment advisors and another $1M for rent, wages, other exp.
- -Fund has 5M shares
net asset value
- -value of each share
- -assets minus liability expressed as per share basis
NAV = (mkt. value of assets - liabilities) / shares outstanding
NAV = (120 - 5) / 5
= $23 per share
most mutual funds are OPEN END funds - investment comps. raise capital by issuing shares to public - use capital raised to buy portfolio of fin. securities - each share is partial ownership in the firm
- -rather than exchange traded securities…investors buy and sell shares of open-ended fuds directly from investment company itself (Charles Schwab)
- –price you pay for share of a mutual fund? - all new orders during a given day pay the 4pm NAV!!! - When buying…they show the $ amt. not # of shares - at end of day…calc. 4pm NAV and all orders are executed at 4pm NAV (using 2nd mkt. info)
- -if buy orders exceed sell orders…the fund issues an appropriate # of new shares - or if sell orders exceed buy,,,fund buys back shares
NAV EX.
1. at 4pm Mon. A = $36B, L = $1B, 900M shares outstanding
- at 4pm Tues. fund assets inc. 1% that day - in addition, fund rec. 900,000 sell orders and buy orders of $1.4M that day
- -at what price will orders be executed (NAV) - how many new shares does fund issue or buy back Tues?
- what are total asset and shares outstanding at end of day on Tues after acc. for new order flow?
- what return did long-term shareholders earn from 4pm on M to 4pm on T
- NAV = $35 / .9 = $38.89
- $36*(1.01) - $1B / .9B shares - $39.29
- -buy and sell at $39.29 per share - $1.4M - $900,000 in sell orders = 500k net new order flow
500,000 / 39.29 = 12,726 additional new shares fund will ISSUE
- total shares outstanding = 900M + 12,726 = 900,012,726
total new assets = $36.36B + $500,000 = $36,3605B
- return = 39.29 / 38.89 - 1 = 1.029% (higher return than funds assets growth of 1% bc of leverage)
front/back end load
Charles Schwab acts as a broker for Vanguard - so when invest in Vanguard through middleman, charges a fee called front end load
ex. put in $1000 of Vanguard in small-cap fund and CS charges 4% fee
1000*.04) = $40 in fees –> so only $960 actually invested in Vanguard
return on Vanguard to break even = 1000/960 - 1 = 4.2%
same with back end but on the back of equation - each have the SAME IMPACT on returns
- -when we pay front end fees we give up fraction of our principal that is invited and ability to generate returns on that portion that is lost
- -on back end load - we earn returns on FULL principal inveted, but then pay fee that is a fraction of the original principal and returns earned on that principal (so front could be better or worse…depends how mkt. behaves)
annual fees
–what are 12b-1 fees
investors always pay ann. fees when investing in mutual fund - are operating expenses - admin., advisory
–called ann. fees or ann. expense ratio
12b-1 fees - are ann. fees charged by a mutual fund to pay for their authorized brokers, marketing, and distribution costs
why does introduction of front end load cause req. return to depend on holding period (time amt.) – front end load reps a fixed cost that is spread out over more years - shorter you hold it, higher fund return has to be to make up the cost
an open-end fund has NAV of 10.7 per share - sold with front end load of 6^ and ann. expense ratio of 2%
- what is offering price per share?
- assume invest $10,000 in fund and hold shares 5 years - what is total 5 year return if NAV inc. by 7% each year
- without any fees what would be your total 5 yr return if NAV inc. 7% every year
- net of fees, what is effective ann. return on fund per year if NAV inc. 7% each year
- P = 10.7 + .06*P
P = 10.7 / (1 - .06) = $11.38
B. .94 *(1 + .07 - .02)^5 = 19.97%
C. return = (1 + .07)^5 = 40.26%
D (1.1997)^1/5 -1 = 3.7%
choosing portfolio weights
as prices change portfolio weights also change - to maintan a portoflio with given weights investors will often have to REBALANCE their portfolios by buying/selling securities to keep portfolio weights from moving off target
indices - index is a hypothetical portfolio of securities uniquely defined by set of portfolio weights and initial investment amt
- –companies report value and return of index each day - investors use info. to understand how broad macroeconomic events influene prices for a large # of securities
- -imp. is S&P 500 and Dow-Jones industrial average
akways define portfolio weights using info. known at the BEGINNING of the investment period
value weighted portfolio
- value weighted portfolios
–create portfolio where target portfolio weights don’t change!!
w(t) = mcap (stock t) / sum of all stock’s mcap’s in my portfolio
–stocks issued by larger companies will carry a higher weight in my portfolio
ex. have $500k to invest and want to create value weighted portfolio - need to see how much to invest in stocks A, B, C
OH so we will be given a chart with each firm’s (A, B ,C) price per share and total # shares which we use to find market cap of each and then sum!!
- -we take market cap of A and divide by market cap of sum to get weight of A
- -same for B and C - should add to 1 bc just dividing each firm’s mkt. cap by total of the stocks we want to invest in
then multiply each weight by the amount of money we have to invest (Ex. A = .357) - do (.357 * $500k = $178.571 K to invest in A
- -price per share of A is 8, so buy 178.571 / 8 = 22.321K shares of A
- -do same for B and C
- -require no rebalancing!! - once created…will always be a value weighted portfolio
- -also called “BUY AND HOLD portfolios”
VALUE WEIGHTED INDEX can be thought of as hypothetical value-weighted portfolio
—S&P 500 is value weighted!! - selects among the 500 largest companies (using qualities such as liquidity, fin. stability, company) - make it broad representative of the economy
price weighted index
Dow Jones!!!
- -based on daily average price not return
- -buy an EQUAL # of SHARES of every security
- -so buy x shares of 3 diff. stocks - so total equity invested in portfolio is x*P1 + xP2 + xP3
weight in each security depends on its Price!!
- -stock SPLITS influence PRICE weighted portfolios
- -price cuts in half and # of shares held doubles
find average stock price
= (10 +11 + 19) / 3 = 13.33
need divisor (d) to find the average price = solve as if split didn’t happen
as long as there are no splits…rebalance does not need to happen
—splist do not however affect value weighted portfolio’s bc value is the same (split price and double shares = same mcap) – only changes if they mkt. cap changes
equaly weighted portfolio
the amount of MONEY invested in each security is the same!!
–so weights are exact same!!!
if invest 1/3 equity (1000) in A,B,C each has a weight of $3333.3 which you multiply by the return to find portfolio return!
find value to be (1/3)(.06)+(1/3)(-.1)+(1/3)(.1) = .019 –> weights are same as 1/3 but find return by looking at price changes from periods
then ask if level of eq. w portfolio is 1055.4 at time 0…what is its level at time 1?
= 1055.3 * (1.019) = 1074.54
find va eq. portfolio - NOTICE THERE WAS A SPLIT…went from 10 to 8 - solve without split
return A - 8/10 - 1 = -20%
then do all returns divided by 3 (divisor) = -2.57%
tilting
if tilt always maintain 100% weight in the original portfolio
–tilt by financing with borrowing or lending
if tilt towards a certain stock in portfolio - buy rf bonds in order to do so (or short another) - gives you a negative weight
–ex. tilt 5% towards FB,so borrow 5% of equity at rf rate and use money to invest in FB - so have negative weight in rf so weights sum to 1
or if tilt away - we sell 5% shares of FB and use money to invest in rf bonds
–how to increase exposure to a SINGLE security
say “you have a weight of 1 in the original portfolio, and additional weight of .1 in Stock A an an additional rf weight of -.1
if tilt towards - you get a negative rf rate from borrowing at the rf rate
–if tilt away - you get a negative (or dec.) holdings in stock you tilt from but use money to buy/invest in rf bonds
Short selling
enables investors to profit from neg. info. about a security, even if they don’t own it
- -ex. hear stock is selling for $60 and going to drop to $50
- -could borrow from someone who owns it and sell it in the market for $50
- -it becomes $60 in your pocket but a liability to return the security to the owner at some point
- -so if stock drops $50 - you buy it on the market and give back to owner… you profited $10 from the short selling
remember when annualizing
do 12 for monthly and 250 for annual
- -bc 250 trading days in a year
- -do * sq.12 for st. dev.
law of diminishing utility
humans are risk averse
- -this law says that the marginal utility (Extra utility) you get from an additional dollar of wealth dimishes or shrinks as you get wealthier
- -as you get wealthier, each additional dollar of wealth inc. well being, bu to a smaller extent than previous dollars
- -shows that the pain we feel from loss is greater than the satisfaction we feel from a gain of equal magnitude
- -implies we don’t like utility
