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1
Q

What are 2 investment objectives

A

Return
Risk

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2
Q

Investment constraints

A

Time Horizon
Taxes
Liquidity
Legal
Unique circumstances

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3
Q

Investment Policy statement has 2 categories

A

-Investment Ojectives
-Investment Constraints

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4
Q

Absolute return example

A

Client wants to hit 5% return every year

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5
Q

Relative Return

A

benchmarking against something
ex + or - 1% of the S&P 500

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6
Q

Goals based return

A

ex retiree shouldn’t focus on the S&P 500 - focus on the rate of return that makes you successful for the things you want to achieve

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7
Q

2 Factors regarding risk

A

Ability - based on financial situation
Willingness - how comfortable are you
THESE MAY CONFLICT

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8
Q

If a retiree has sufficient pension/SS - how does that affect their risk regarding other assets

A

they should be more willing to take on risk with their other investments

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9
Q

σ or Sd

A

standard deviation

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10
Q

k or r

A

required return

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11
Q

N or T

A

time periody

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12
Q

y or i

A

market rate of interest

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13
Q

α or a

A

Alpha

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14
Q

β or B

A

Beta

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15
Q

b or r

A

retention ratio

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16
Q

Rf or rf

A

risk free rate

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17
Q

ρ or r

A

correlation coefficient

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18
Q

2 things a company can do with its earnings

A

-pay to shareholder as dividend
-retain and reinvest back into company

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19
Q

Payout ratio

A

total dividend / total earnings
or
DPS/EPS

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20
Q

Retention ratio

A

retained earnings/total earnings
OR
1- payout ratio

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21
Q

Retention ratio and payout ratio have to add up to what

A

1

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22
Q

Company’s policy is to retain 75% of earnings. Earnings per share were $10 what is Dzero?

A

$2.50

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23
Q

g = ROE x b
Dividend growth rate where:

A

g = dividend growth rate
ROE = return on equity
b = earnings retention rate

1-b = dividend payout ratio

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24
Q

Return on equity is a company doing what

A

reinvesting the money they make back into the company

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25
Q

Who might have a higher return on equity, google or target?

A

Google more likely because they’re a growth company whereas target is more established and stable - target would pay a dividend

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26
Q

A firm pays a dividend of $1.20, has return on equity ROE of 15%, reports total earnings per share of $6. What is the firm’s sustainable growth rate? g?

A

Calculate the payout ratio
1.20/6 = .2
Calculate the retention ratio
1-.2 = .8
Calculate g = ROE x b
.15 x .8 = .12 or 12%

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27
Q

Dzero is what vs Done

A

Dzero is current dividend, Done is next year’s dividend

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28
Q

Intrinsic value formula uses what year’s dividend?

A

next years

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29
Q

Next year’s dividend (D one) formula

A

D zero (1 + g) where D zero is this years dividend and g is the growth rate

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30
Q

If you have Dzero and the growth rate, how would you find Dthree if the growth rate is 10%. Dzero is 1.50

A

Dzero ( 1+ g)
1.50(1.10) = D one
D one (1.10) = D two
D two (1.10) = D three

Tip: DO A TIMELINE

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31
Q

A firm currently pays a dividend of $3.30 and expects that to grow at a constant 7%. The stock’s required return is 11% What is the intrinsic value of the stock?

A

Remember they gave you D zero you need D one
V = D one / r - g
V = (3.30 * 1.07) / .11 -.07
V = 3.5310 / .04
V = $88.275 = $88.28
88.28 is the value we think the stock is worth based on our required return

If the stock is trading at 92 - should you buy it?
No

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32
Q

Stock Yield Formula

A

D one / P

D one = next year’s dividend
P = current price

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33
Q

Stock has an expected return of 8% and your client’s required rate of return is 7% do you buy the stock?

A

Yes

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34
Q

Current Dividend has been paid or not?

A

Yes, current dividend has already been paid. Sometimes referred to as last year’s dividend

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35
Q

What is the risk free rate based on?

A

yield on 90 day T Bill

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36
Q

Market RIsk Premium

A

Rm - Rf
If you’re given Market Risk Premium you don’t need to then subtract the risk free rate, it’s already been subtracted

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37
Q

Rm - Rf is also called

A

Market Risk Premium

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38
Q

XYZ Co
Current Dividend = 2.20
Current EPS = $11
ROE = 10%
Beta = 1.25
Firm expects constant dividend and earnings growth rate of 8%
If the market risk premium is 8% and and the 90 Day T Bill rate is 4% what is the co’s intrinsic value?

A

V = D one / r - g
V = ($2.20 * 1.08) / r - .08
You need R - they gave you Rm-Rf when they gave Market Risk Premium
R = Rf + (Rm - Rf) B = .04 + (.08)1.25 = .14 or 14% SO
V = (2.20 * 1.08) / .14 - .08
V = 2.376 / .06 = $39.60

If they hadn’t given g you could do
g = ROE x b where b is the retention ratio
payout ratio is DPS/EPS = 2.20/11 = .2
Retention ratio = 1 - b = .8
.1 * .8 = .8 or 8%

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39
Q

Jensen’s Alpha
A = Rp - [Rf - (Rm - Rf) Bp

A

A = Rp - [Rf - (Rm - Rf) Bp
A = Jensen’s Alpha
Rp = realized return on portfolio (this will be given)
Rf = risk free
Rm = return of the market
Bp = beta
NOTE everything inside the brackets is just required return or CAPM

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40
Q

Another way of saying Jensen’s Alpha

A

portfolio return minus CAPM

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41
Q

When there’s a line above a letter in an equation what does that mean?

A

Realized - we’re looking at backwards looking actual numbers - not future projections

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42
Q

If realized return is higher than the required return the Alpha is?

A

Positive

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43
Q

If the realized return is lower than the required return the Alpha is?

A

negative

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44
Q

Rsquared > 70 you would use what

A

Beta, alpha, traynor

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45
Q

Rsquared is < 70 you would use what

A

Standard deviation based like Sharpe ratio

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46
Q

Standard Deviation measures what

A

how much, on average, an investment’s return varies or deviates from the mean return

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47
Q

Variance measures what

A

the average distance between each of a set of investment returns and their mean value

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48
Q

What is standard deviation squared?

A

Variance

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49
Q

ABC stock has returns over the last 4 years of: 12%, 18%, -2%, and 6%. Calculate the standard deviation.

A

12 E+ (weird e plus key)
18 E+
2 CHS E+
6 E+
G x (zero key) gives mean 8.5
G s (decimal key) gives standard deviation 8.544

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50
Q

What percent probability will the actual return fall within 1 standard deviation?

A

68%

51
Q

What percent probability will the actual return fall within 2 standard deviations?

A

95%

52
Q

What percent probability will the actual return fall within 3 standard deviations?

A

99%

53
Q

If you have a mutual fund with average return of 8% and standard deviation of 6 - where would you expect returns to fall in 95% of the time?

A

returns fall within 2 standard deviations 95% of the time so it would be

-4% and 20%

54
Q

If you have a mutual fund with average performance of 8% and a standard deviation of 6%, what percent of the time would you expect a return of 2% or higher?

A

2% is one standard deviation below.

You know on the bell curve that 68% at the top divides in half, so 1 standard deviation represents 34%. Add that to the other 50% on the other side. 84%

54
Q

Tail Risk is greater than how many standard deviations?

A

3 - the .5% on either side of the end of the curve

55
Q

What market has typically been negatively skewed?

A

US Stocks

56
Q

What market typically has been positively skewed?

A

VC market

57
Q

Mode is

A

the most common number to appear in your set of data

58
Q

Mean is the same as

A

average

59
Q

Kurtosis

A

degree to which bell curves are peaked or flat at the top. High kurtosis data is peaked at the mean, low kurtosis data is rounded at the mean. The kurtosis for normal data is 3.

60
Q

Leptokurtic

A

high kurtosis. peaks at the mean, lots of data in the middle. Downside is tail risk is higher

61
Q

Platykurtic

A

low kurtosis. rounded at the mean - less rail risk

62
Q

Kurtosis for normal data is

A

3

63
Q

Unsystematic diversifiable risks

A

Business Risk
Financial Risk
Default Risk
Regulatory Risk

64
Q

Systematic undiversifiable risk

A

Market Risk
Interest Rate Risk
Reinvestment rate risk
Purchasing power risk
Exchange rate risk

65
Q

Does the market reward you for taking on unsystematic risk?

A

No

66
Q

How many stocks typically would you need in a portfolio to have it be diversified?

A

30 - research supports this

67
Q

Total investment risk is measured how

A

standard deviation, a statistical measure of variability

68
Q

Market risk example

A

everything sells off at once - not much you can do - like 2008 - doesn’t matter how good of a company/investment, everyone was selling bc they needed liquidity

69
Q

Interest rate risk

A

broadly the risk of interest rates going up. if you don’t buy bonds do you not have interest rate risk? - no because companies have higher borrowing costs

70
Q

Reinvestment rate risk

A

You own investments in a declining rate environment. Say you own a bond from the 80s - was paying 10% - when it matured rates were 4% or 5%. Reinvesting bonds in a bond ladder in a declining rate environment

71
Q

Inflation risk

A

the loss of buying power. prices are going up. medical costs, education. need to account for increasing costs in investments and in planning

72
Q

Exchange rate risk

A

Dollar strengthens and you had international investments, you could have a loss even though the investment made money.

73
Q

Unsystematic risks effect

A

both individual companies and sectors/industries

74
Q

Business Risk

A

unsystematic risk - the business model - Blockbuster or Kodak model went bust, they were replaced.

75
Q

Financial risk

A

unsystematic risk - how the company is structured. Do you have too much debt, credit quality, enough earnings to pay dividends, do you need to cut dividends?
Tesla using convertible bonds that could be exchanged for equity, diluting shareholder value or bankruptcy

76
Q

Default risk

A

can you pay your creditors - do you have enough cash flow. issue as rates go higher. do you bring in enough revenue to cover the cost of debt. Toys R Us took on too much debt/complicated financing

77
Q

Regulatory Risk

A

law/government changes - ESG - adapt to new regulations - environmental changes. Uber - are drivers employees or no re: benefits

78
Q

High credit quality bonds pay higher or lower interest?

A

Lower interest bc default risk (unsystematic) is lower

79
Q

Security A has a return of 8% and a standard deviation of 10%, what is the coefficient of variation?

A

CV = SD/Return

.10/.08 = 1.25

For every unit of return, which there were 8, I have 1.25 units of risk

80
Q

COVij = Pij Oi Oj

A

COV = covariance between assets i and j
Pij = correlation coefficient between i and j
Oi = standard deviation of i
Oj = standard deviation of j

81
Q

Correlation

A

statistical technique that measures the relationship of one asset to another

82
Q

Assets that move together have what correlation

A

positive

83
Q

Assets that don’t move together have what correlation

A

negative

84
Q

Correlation coefficient expressed in what range

A

-1 to +1
+1 is perfectly positive
-1 is perfectly negative

85
Q

Does preferred have voting rights?

A

Not typically - but dividends have a higher % and typically guaranteed to be paid

86
Q

Dividends guaranteed on common?

A

No - dividend can be cancelled. Preferred would be paid first

87
Q

American Depository Receipts

A

Foreign stocks which trade on a US exchange - Bank buys shares on foreign exchange and then issues ADR version of the shares which are backed by the shares held by the bank

88
Q

Who owns the stock in an ADR?

A

The bank that issues the ADR

89
Q

Prospect Theory

A

investors fear losses more than they value gains

90
Q

Date of record

A

date it is determined who owns stock in the company and is entitled to receive a dividend

91
Q

Date of declaration

A

Date the board approves and decides to pay a dividend

92
Q

Ex dividend date

A

date the market price adjusts for the dividend

93
Q

If portfolio A has a correlation of +1 to Portfolio B and portfolio A returned 10% what would we expect portfolio B to return?

A

10%

94
Q

If portfolio A has a correlation of -1 to Portfolio B and portfolio A returned 10% what would we expect portfolio B to return?

A

-10%

95
Q

Portfolio A returns 7% and portfolio B has a correlation of .75 what would we expect B to return?

A

.07 * .75 = 5.25%

96
Q

If you are given correlation in a standard deviation of 2 asset portfolio - what will you need to calculate?

A

Covariance

97
Q

Beta formula is

A

correlation * standard deviation
_____________________________
standard deviation of the market

98
Q

Most common Beta question example will ask about

A

A stocks performance to the market most likely S&P 500

99
Q

Market by definition has a Beta of what

A

1

100
Q

Betas > 1 have what volatility compared to the market

A

more volatile than the market

101
Q

Beta < 1 have what volatility compared to the market

A

less volatile than the market

102
Q

What is a defensive beta?

A

Less than1

103
Q

Stock A has a beta of 1.25 and the market return is 10% what is the return of stock A?

A

12.5%

104
Q

Can you use beta to compare other things than stock to index?

A

Yes

105
Q

High R squared means the portfolio is what?

A

Diversified

106
Q

If you have a decreasing market do you want beta to be high or low?

A

low

107
Q

If you have an increasing market do you want beta to be high or low?

A

High

108
Q

How can you change your beta?

A

You can adjust your portfolio weightings to different sectors of the market or different securities

109
Q

Using coefficient of determination how can you represent unsystematic risk?

A

1 - R squared

110
Q

Rsquared or coefficient of determination represents

A

Systematic risk meaning we can use beta

111
Q

Portfolio A returned 20 with a standard deviation of 12 and Portfolio B returned 18 with a standard deviation of 8. Risk free rate is 3. What has the better sharpe ratio?

A

.20 - .03 / .12 = 1.42
.18 - .03 / .08 = 1.875

Always take the higher sharpe ratio

112
Q

Numerator of sharpe is also called excess returns why?

A

It’s the return minus the risk free rate, returns outside of risk free

113
Q

How to remember the sharpe ratio higher the better?

A

Think of a high point - you want the sharp point high in the air

114
Q

A 100% bond portfolio has the exact same risk level as what other allocation

A

30 stock 70 bond

115
Q

Treynor is the exact same calculation as Sharpe only instead of using standard deviation you’re using what

A

Beta

116
Q

Another name for Information ratio

A

appraisal ratio

117
Q

Information Ratio

A

numerator is known as alpha, denominator is standard deviation of alpha not the standard deviation of the portfolio

118
Q

Do you want a higher or lower information ratio?

A

Higher - just like sharpe

119
Q

On a joint account, what is the FDIC coverage?

A

250k per depositor

120
Q

30 day t bill also known as what

A

cash

121
Q

If a husband and wife each have an individual account and a joint account together, what is the full FDIC coverage?

A

1 mil

122
Q

What are some examples of alternative investments?

A

Hedge funds, private equity, etfs, crypto, digital assets

Investments CFP (14 decks)

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