Exam 2 Flashcards
Risk Return trade off
The greater the risk, the greater the potential return
assumption about investors
they are averse to risk (dont like)
Formula for interest
Principle * interest * fraction of a year
Formula for return in $
amount received - amount invested
Formula for return in %
Return in $ / amount invested
Alt names for return in %
rate of return / expected return
Required rate of return
the minimum acceptable potential return given the risks
Decision rule
expected return must be greater than required return for people to invest
Formula for expected return in dollars
take each scenario and multiply return by weight, add the products to get the total
Formula for expected rate of return
Return in $ / Amount Invested
Efficient Portfolio
provides either greatest expected return or least risk relative to amount invested
Calculate expected portfolio return
% holding * return expected for all holdings then added together
objective of portfolio construction
to invest in assets whose prices are non or negatively correlated
company specific risk
derived from events specific only to a company
alternate names for company specific risks
diversifiable risk
nonsystematic risk
market risk
derived from events that affect all/most investments in the marketplace
alternate names for market risk
nondiversifiable risk
systematic risk
which risk does diversification mitigate
only company specific
MPT
Modern Portfolio Theory - investors want to max return and manage risk
Discount Rate
rate charged to financing operations for businesses
Present Value
the amount if invested today will grow to a specified amount by a specified date
To compound or discount more or less frequently than annually you
Divide interest by number of terms and multiply periods by number of terms
When is each annuity paid
Ordinary - at the end of each period
Annuity Due - at the beginning of each period
Amortizing Loan
borrower pays principal and interest, loan balance is zero at maturity, highest payment
Non-amortizing loan
interest only loan
borrow pays interest only, loan balance is the principal at maturity, medium payment
Negative Amortizing loan
borrow pays less than interest, loan balance is greater than principal at maturity, lowest payment
Formula to determine amortization payment
FV = PV(1+i)^n
FV is always 0
Uneven cashflows
find the present value of each of the sums and then add together (divide PV by (1+i)^n)
Formula to determine interest portion of amortization payments
principal * interest * fraction of a year. for subsequent years use the principal - payments for principal
relative valuation
determined by comparing it to a similar assets value
absolute value
the fundamental value is based on its own characteristics
asset - based valuation
absolute fundamental value is determined by the asset the company owns
discounted cashflow analysis
absolute fundamental value is based on present value of the future cashflows based on require return (i)
equilibrium
when market price = fundamental value, investors will hold the asset and have a neutral outlook
discounted cashflow analysis steps
place future cashflows on a timeline
find present value of the cashflows (v) PV formula
compare v to market value
buy, sell, or hold
undervalued
asset is worth more than what the market thinks its worth, you should buy it
overvalued
asset is worth less than what the market thinks it is, you should sell it
bullish
prices undervalued, will return more than expected, going up
bearish
prices overvalued, will return less than expected, going down
goal of financial services company
maximize the wealth of the owners
goal of financial management
maximize the wealth of stakeholders
5 subsectors of financial services
lending institutions insurance companies investment banks securities brokers funds
lending institutions
products are loans and cash accounts
revenue is interest and fees
insurance companies/underwriter
product is policies
revenue is premiums and returns from investing premium money
investment banks
product is securities underwriting, consulting and mergers and acquisitions
revenue is flotation costs passed from the issuer
securities/stock brokers
product is executing trades
revenue is commission paid by investors
funds
product is shares in the fund and pro money management
revenue is management fees of the funds
Market
a place where buyers and seller meet to exchanges goods and services
bull market
prices are rising
bear market
prices are falling
flat , sideways market
prices are steady over time
public market
NYSE / NASDAQ
open to anyone with money not on a terror list, highly regulated
private market
only open to those invited, where an owner is willing to sell, less regulated
what is the SEC/ do they do
government organization that regulates public businesses and protects investors
IPO
initial public offering - when a private company goes public and offers people to buy shares
3 functions of securities underwriter
locates investors
aids regulatory compliance
aids pricing of IPO shares
seasoned offering
releasing more shares after you are already public, technically new offering
primary market
consists of transactions involving the issuance of new securities
buyers and sellers of primary markets
sellers are issuers
buyers are investors
secondary market
transactions between investors
buyers and sellers of secondary market
sellers and buyers are both investors
which market do seasoned offerings occur
secondary
are issuers involved in secondary market transactions
no
2 examples of secondary markets
NYSE / NASDAQ
does the secondary market affect the primary market, why
yes, seasoned offerings can only be released at current prices
when is the most ideal time to release IPO
bull market
efficient market
one in which all participating has access to all info
first implication of efficient market
1 - if all info is accessible immediately, it is factored into the price of the security
second implication of efficient market
2 - markets react only if the info is different than what was expected
third implication of efficient market
3 - it is impossible to consistently beat an efficient market
fourth implication of efficient market
4 - more participants, more efficiency, fewer participants offer more opportunity to outperform
real assets
physical, tangible assets - gold/land
financial assets
valuable based on legal rights they bestow (profits and dividends) - stock/bond
