AF4 Calculations

Question 1

Standard Deviation - Calculation?

What does it tell you?

Answer 1

Return - mean (of returns)

= Result squared

Mean of result squared

Find the square root

Standard deviation helps determine market volatility or the spread of asset prices from their average price. When prices move wildly, standard deviation is high, meaning an investment will be risky. Low standard deviation means prices are calm, so investments come with low risk.

Question 2

CAPM Calculation?

What does it tell you?

Answer 2

= Rf + B (Rm - Rf)

Describes the relationship between systematic risk and the expected return for assets.

Rests on two assumptions: (1) securities markets are efficient (that is, relevant information about the companies is quickly and universally distributed and absorbed); (2) these markets are dominated by rational, risk-averse investors, who seek to maximize satisfaction from returns on their investments.

Question 3

Holding Period Return Calculation?

What does it tell you?

Answer 3

D + V1 - V0
/
V0

Total return earned on an investment during the time that it has been held.

Question 4

MWR Calculation?

What does it tell you?

Answer 4

D + V1 - V0 +/- C
/
V0 +/- C * n/12

Calculates the performance of an investment that accounts for the size and timing of deposits or withdrawals

Question 5

TWR Calculation?

What does it tell you?

Answer 5

1+R = (1+R)(1+R2) = R is holding period return -

D + V1 - V0
/
V0

The TWR is a measure of the compound rate of growth in a portfolio. The TWRR measure is often used to compare the returns of investment managers because it eliminates the distorting effects on growth rates created by inflows and outflows of money.

Question 6

Interest Yield Calculation?

What does it tell you?

Answer 6

Coupon
/
Clean price

The annual return that an investor receives from the bond investment

Question 7

(GRY) Redemption Yield Calculation?

What does it tell you?

Answer 7

Interest Yield +/- gain or loss / yrs to maturity
/
Clean Price

• 100

The yield is the annual income and anticipated capital gain (or loss) from holding a bond until maturity. The yield represents the expected annual returns.

If less than Interest Yield then there will be a capital loss, and vice versa.

Question 8

Sharpe Ratio Calculation?

What does it tell you?

Answer 8

Rp - Rf
/
Standard Deviation

The Sharpe ratio adjusts a portfolio’s past performance—or expected future performance—for the excess risk that was taken by the investor.

Assumes that returns are normally distributed.

Can be manipulated by portfolio managers seeking to boost their apparent risk-adjusted returns. This can be done by lengthening the measurement interval.

Question 9

Alpha Calculation?

What does it tell you?

Answer 9

Rp - CAPM

Alpha is the excess return on an investment after adjusting for market-related volatility and random fluctuations.

Tells investors whether an asset has consistently performed better or worse than its beta predicts.

Question 10

Information Ratio Calculation?

What does it tell you?

Answer 10

Rp - Rb
/
Tracking Error

A measurement of portfolio returns beyond the returns of a benchmark, compared to the volatility of those returns.

Attempts to identify the consistency of the performance.

A low tracking error means the portfolio is beating the index consistently over time. A high tracking error means that the portfolio returns are more volatile over time and not as consistent in exceeding the benchmark.

Question 11

EPS Calculation?

What does it tell you?

Answer 11

Net income
/
Shares in issue

How much money a company makes for each share of its stock.

Question 12

P/E Calculation?

What does it tell you?

Answer 12

Price per share
/
EPS

The price-to-earnings (P/E) ratio relates a company’s share price to its earnings per share.

A high P/E ratio could mean that a company’s stock is overvalued, or else that investors are expecting high growth rates in the future.

Question 13

Dividend Yield Calculation?

What does it tell you?

Answer 13

Dividend
/
Share Price
* 100

The percentage of a company’s share price that it pays out in dividends each year.

Question 14

Dividend Cover Calculation?

What does it tell you?

Answer 14

EPS
/
DPS

Measures the number of times that a company can pay dividends to its shareholders.

Question 15

P/B Calculation?

What does it tell you?

Answer 15

Share Price
/
NAV

Measures the market’s valuation of a company relative to its book value.

Question 16

NAV Calculation?

What does it tell you?

Answer 16

Assets - Liabilities
/
Shares in issues

Net worth of a company per share

Question 17

Behavioural Finance

What does it tell you?

Answer 17

Emotional & Psychological factors which affect investment decisions.

Loss aversion - People do not behave rationally; they are more distressed about a prospective loss than being happy about gains.

Regret - Less willing to sell investments at a loss.

Overconfidence - Tendency to overestimate own skills, more optimistic in rising markets, pessimistic in falling markets.

Question 18

EMH

What does it tell you?

Answer 18

A hypothesis that states that share prices reflect all information and consistent alpha generation is impossible. It should be impossible to outperform the overall market through expert stock selection or market timing, and the only way an investor can obtain higher returns is by purchasing riskier investments.

Weak form - This type of EMH claims that all past prices of a stock are reflected in today’s stock price. Therefore, technical analysis cannot be used to predict and beat the market

Semi-Strong - This form of EMH implies all public (but not non-public) information is calculated into a stock’s current share price. Neither fundamental nor technical analysis can be used to achieve superior gains.

Strong form - All information in a market, whether public or private, is accounted for in a stock’s price.

Question 19

MPT

What does it tell you?

Answer 19

A diversified portfolio of un correlated assets.

Investors are risk adverse and seek a maximum return for a given risk.

Efficient Frontier - plots the risk/reward of various portfolios and shows the expected return for a given risk.

Uses Standard Deviation and the correlation to optimise the portfolio.

A rational investor will only hold a portfolio on the efficient frontier.

Systematic risk cannot be removed, non systematic risk can be diversified out.

Sensitivity is then measured by Beta.

CAPM

Limitations:
Assumes SD is the correct measure of risk.
Uses historical data which may not be stable.
No charges or tax included.
Assumes portfolios are index funds/ETFs.
Doesn’t take C4L into account - Only looks at risk.

Question 20

R.E.I.T

What does it tell you?

Answer 20

A company that owns, operates, or finances income-producing properties.

REITs generate a steady income stream for investors but offer little in the way of capital appreciation.

UK Listed REITs are CLOSED ENDED publicly traded like stocks, which makes them highly liquid (unlike physical real estate investments).

REITs invest in most real estate property types, including apartment buildings, cell towers, data centres, hotels, medical facilities, offices, retail centres, and warehouses.

Derive at least 75% of profits and assets relate to rental income.

Borrowing of 125%

Pay a minimum of 90% of profits in 1 year.

PIDs are paid after deducting withholding tax at 20%. A basic rate taxpayer should have no further tax to pay. Higher rate taxpayers (40%) and additional rate taxpayers (45%) will have an additional tax liability of 20% and 25%. Nil rate taxpayers can reclaim the tax back.

Question 21

M0 & M4

What does it tell you?

Answer 21

M0 Narrow Money: M0: Notes and coin in circulation plus banks’ reserve balance with Bank of England.

M4 Broad money: is defined as a measure of notes and coins in circulation (M0) + bank accounts. It is a broader definition because it includes bank accounts and not just notes and coins in circulation

Question 22

Capital vs Current account

What does it tell you?

Answer 22

Capital Account: Part of the balance of payments which records all movement of money in and out of the country for investment.

Current account: Consists of transactions in goods (oil, raw materials) and services (tourism, financial), import and export. A deficit means that more goods and services have been imported.

Question 23

Sequencing Risk

What does it tell you?

Answer 23

Sequence risk is the danger that the timing of withdrawals from a retirement account will damage the investor’s overall return.

Account withdrawals during a bear market are more costly than the same withdrawals in a bull market.

A diversified portfolio can protect your savings against sequence risk.

Reduce income/stop it, change frequency, invest in more stable income producing assets.

Question 24

ESG

What does it tell you?

Answer 24

Negative screening: aiming to avoid investing in the ‘bad stuff’.

Positive screening: is a process that identifies companies that are actively making contributions to social or environmental change

ESG: focuses on companies that demonstrate great behaviours in terms of their environmental impact, their social responsibility and the quality of their internal governance practices.

(SRI): aims to generate positive social outcomes through investment. SRI is a blend of Ethical and ESG investing.

Impact Investing: focusses on the outcome (or impact) of an organisation’s work on the planet and its people.

Sustainable Investing: is a broad approach to ethical investing that encompasses an element of all of the above forms of ethical investing, including negative screening, positive screening, and a focus on the output and impact of companies’ operations on the environment.

Question 25

UCITS

What does it tell you?

Answer 25

UCITS stands for Undertakings for the Collective Investment in Transferable Securities.

This refers to a regulatory framework that allows for the sale of cross-Europe mutual funds.

UCITS funds are perceived as safe and well-regulated investments and are popular among many investors looking to invest across Europe.

Question 26

Macaulay duration vs modified duration

What does it tell you?

Answer 26

The modified duration of a bond is an adjusted version of the Macaulay duration and is used to calculate the changes in a bond’s duration and price for a change in interest rates. Volatility & Risk measurement.

The Macaulay duration assesses how sensitive one bond is compared to another. Macaulay duration is frequently used by portfolio managers who use an immunization strategy.

The most volatile bonds have long maturities and low coupons and the least volatile are short dated high coupon bonds.

The longer the period to redemption the more volatile the bond and the lower the coupon the more volatile the bond.

Question 27

R.O.E Calculation?

What does it tell you?

Answer 27

net profit after tax + preference shares
/
Shareholder equity

Return on equity (ROE) is a measure of a company’s financial performance, calculated by dividing net income by shareholders’ equity.

ROE is considered a gauge of a corporation’s profitability and how efficient it is in generating profits.

Whether an ROE is considered satisfactory will depend on what is normal for the industry or company peers.

Question 28

R.O.C.E Calculation?

What does it tell you?

Answer 28

Profit before tax and interest
/
total assets - total liabilities

Return on capital employed (ROCE) is a financial ratio that measures a company’s profitability in terms of all of its capital.

Question 29

ETF’s

What does it tell you?

Answer 29

A synthetic exchange-traded fund (ETF) is a pooled investment that invests money in derivatives and swaps rather than in physical stock shares.

A conventional ETF invests in stocks with the stated goal of replicating the performance of a specific index,

Question 30

P.A.I.F

What does it tell you?

Answer 30

At least 60% of income from exempt property business. Value of property assets must be at least 60% of total assets. Shares widely held. No corporate investor, not allowed to hold 10% of NAV.

Question 31

Fettered and unfettered funds

What does it tell you?

Answer 31

FOFs usually invest in other mutual funds or hedge funds. They are typically classified as “fettered,” or only able to invest in funds managed by the FOF’s managing company, or “unfettered,” or able to invest in funds across the market.

Question 32

VCTs

What does it tell you?

Answer 32

When you invest in new VCT shares, you are entitled to claim a number of tax incentives on investments up to £200,000 each year. These include:

Income tax relief – You can claim up to 30% upfront income tax relief on the amount you invest, provided you keep your VCT shares for at least five years. So if you invest £10,000 in a VCT, £3,000 can be taken off your income tax bill, although the amount of income tax you claim cannot exceed the amount of income tax due.

Tax-free capital gains – If you decide to sell your VCT shares and you make a profit, the proceeds won’t be liable for capital gains tax.

Tax-free dividends – If your VCT pays dividends, there is no tax to pay, and you won’t need to declare them on your tax return.

Question 33

EIS

What does it tell you?

Answer 33

Up to 30% tax relief – You can claim up to 30% upfront income tax relief on the amount you invest, provided you keep your EIS for at least 3 years. (up to 1M per year or 2M if knowledge based companies)

Tax-free growth

Capital gains tax deferral

Loss relief

IHT free EIS shares qualify for Business Property Relief (BPR).

Carry back contributions

Question 34

SEIS

What does it tell you?

Answer 34

Up to 50% tax relief – Invest up to £100,000 per tax year.

Tax-free growth

Halve your capital gains bill

Loss relief

Carry back contributions

IHT free