Chapter 5 Portfolio Evaluation

Question 1

Intrinsic value

Answer 1

the present value of its expected cash flows
if intrinsic value is > than market price then the security is undervalued
If intrinsic value is < market price the security is overvalued

operating cash flow/(required return on equity - dividend growth rate)
divide that by the number of outstanding shares

Question 2

Relative valuation

Answer 2

A company can be valued by comparing it to its competition - easier to understand and calculate vs intrinsic value and reflects current market conditions

Question 3

Price to earnings ratio

Answer 3

stock price divided by earnings per share
(capacity to earn revenue)

Question 4

Price to book ratio

Answer 4

stock price divided by book value (net worth) per share
(structure of assets vs debt)

Question 5

Price to sales ratio

Answer 5

stock price divided by total dollar amount of sales per share
(capacity to earn revenue)

Question 6

Price to cash flow (PCF)

Answer 6

stock price divided by the total dollar amount of net cash flow per share
(capacity to earn revenue)

Question 7

Enterprise to earnings (EE)

Answer 7

combines a company’s book value with its market value and divides by its earnings
(structure of assets vs debts)

Question 8

Technical analysis

Answer 8

use of historical pricing and volume data to make asset selection decisions
market is not completely efficient due to - trading restrictions, government regulations, behavioral investors, evidence does not support the use of technical analysis

Question 9

Risk adjusted measures of performance

Answer 9

Sharpe ratio
Treynor ratio
Jensen’s alpha

Question 10

Sharpe Ratio

Answer 10

uses standard deviation (total risk) to estimate risk-adjusted return
is a relative measure of performance and must be compared to another portfolio or benchmark
(return - risk free rate)/standard deviation

Question 11

Treynor Ratio

Answer 11

uses systemic risk (beta) to adjust the return for risk
is a relative measure of performance and must be compared to another portfolio or benchmark
(return - risk free rate)/beta

Question 12

Jensen’s Alpha

Answer 12

shows the difference between actual and expected portfolio performance
absolute measure of performance
measure of excess return and portfolio manager skill
return - (risk free rate + beta(market return -risk free rate))

Question 13

Indexing

Answer 13

assumes assets are priced fairly in an efficient market
primary value is in capturing asset classes and not security selection
expense ratios lower

Question 14

Core and satellite approach

Answer 14

Bucketing
mix of active and passive investing

Question 15

Constant weighting allocation

Answer 15

periodically sell off certain assets in the portfolio to ensure that their relative weight stays constant over time