final review

Question 1

total dollar return formula

Answer 1

total dollar return = (end price - beg price) + total dividends in the period

Question 2

percent return formula, capital gain formula, dividend yield formula

Answer 2

percent return = [(end price - beg price)/beg price] + (dividends/beg price) OR capital % + dividend %

capital return % = (end price - beg price) / beg price

dividend yield = dividends / beg price

Question 3

steps when finding CAGR

Answer 3

step 1) find the % return (monthly)
step 2) do compounded return by 1+return (monthly)
step 3) use product function -1 for comp. return
step 4) convert into annual frequency (ex. months -> year)
step 5) use product function return and new year figure to find cagr –> (1+comp. return)^(1/year)-1

Question 4

how do you find the annual dividend yield

Answer 4

(1+Dividend Yield)^(1/years)-1

Question 5

For each stock how do you calculate the expected return, level of risk, and the annualized Sharpe ratio

Answer 5

Step 1] monthly mean return: average monthly return
Step 2] Std dev monthly = STDEV.S function
Step 3] monthly sharpe = mean - risk free rate / std. dev
Step 4] annualized sharpe = monthly share * sqrt(12)
Step 5] z,score = x - mean / std dev
Step 6] P(-0.05) = NORMDIST function

Question 6

If you are given probabilities and weights - how do you calculate the expected return and standard deviation for the investment

Answer 6

step 1] turn return and probability into decimals
step 2] to find expected return do sumproduct function on the decimal forms of both variables
step 3] compute (x-mean)^2
step 4] compute dec.prob x (x-mean)^2
step 5] use sum function on probx(x-mean)2 to find the variance
step 6] to find standard deviation do variance^0.5
step 6] sharpe ratio = expected - risk free rate / std dev

Question 7

what does a negative sharpe ratio mean?

Answer 7

a negative sharpe ratio indicates that the investment is below the risk free rate and therefore no investor would do that because they have no return

Question 8

what do we use to measure risk

Answer 8

standard deviation

Question 9

what impacts asset returns

Answer 9

1) new information
2 ) liquidity

standard deviation quantifies how often and how much investors recieve unexpected information

Question 10

when do we use p(x) and 1-p(x) for probability returns

Answer 10

p(x) = return less or equal to
1-p(x) = return greater than

Question 11

sharpe ratio

Answer 11

sharpe ratio = (expected - risk free)/std dev

Question 12

Comparing the riskiness of different stocks: “what do we look at”

which security demonstrated greatest risk – largest standard deviation

which stock produced the best risk adjusted return – highest sharpe ratio

which stock has the greatest probability of a substantial negative monthly retirn - highest prob from x< -5%

which stock has the greatest porbability of a substantial positive monthly return – highest prob from x> 5%

Answer 12

which security demonstrated greatest risk – largest standard deviation

which stock produced the best risk adjusted return – highest sharpe ratio

which stock has the greatest probability of a substantial negative monthly retirn - highest prob from x< -5%

which stock has the greatest porbability of a substantial positive monthly return – highest prob from x> 5%

Question 13

systematic risk vs idiosyncratic risk

Answer 13

systematic = market wide
idiosyncratic = firm specific and is diversifiable

Question 14

how does adding unrelated assets to your portfolio decrease idiosyncratic risk

Answer 14

Allows us to control volatility as when there is fluctuations in the portfolio it is not majorly impacted as then some assets go down, some will go up essentially offsetting the volatility

Question 15

what risk are investors rewarded for

Answer 15

investors are only rewarded for systematic risk that they bear since idiosyncratic risk is diversifiable

Question 16

how do you know if a portfolio is underperforming or overperforming

Answer 16

step 1) find the beta of the portfolio: (correlation * portfolio B std deviation) / market port std dev

2) find the fair value and outperforming return
fair value = beta * (market portfolio return - asset c return) + asset c return

Outperform = portfolio B expected return - fair return

Question 17

how do you find the beta of a portfolio

Answer 17

average all the individual asset betas

Question 18

How is relatedness measured

Answer 18

Relatedness is measured using correlation, we use a correlation matrix to determine stock relatedness

Question 19

how do you calculate the standard deviation of a portfolio

Answer 19

standard deviation = weight on market portfolio x standard deviation of market portfolio

Question 20

what is a derivative

Answer 20

a derivative is a contract between two or more parties whose value is based on an agreed upon underlying financial asset

Question 21

whats the difference between being in a long and short position

Answer 21

long = agreed buy in the future
short = agreed to sell in the future

Question 22

what is the strike price

Answer 22

strike price is the price at which the contract both parties have agreed to transact

strike price = market price -> no value to either party
strike price < market price –> value for long (buyer) party
strike price > market price –> value for short (seller) party

Question 23

what are some advantages of derivative contracts

Answer 23

1) enable hedging which stabilizes cash flows
2) allow investors to more easily realize short positions
3) Mitigate recall risk
4) Lower transaction costs compared to short sale contracts
5) highly leveraged
6) less visible - attractive if want to hide trades

Question 24

what are futures/forwards

Answer 24

binding contract (obligation) to buy/sell an asset in the future at a price set today – settled monetarily not physically

calculation = strike price x (1+r)^time
r = opportunity cost

Question 25

describe the difference between forwards and futures

Answer 25

forwards:
- fully customizable / non-standard
- counterparty risk
- unregulated

futures:
- no counterparty risk
- standardized
- regulated

long and short transact with a clearing house

Question 26

what are options

Answer 26

options - one party has the right but not the obligation to transact in the future “option” to transact or not to transact at their own discretion

types of options:
european - only exercised at time of maturity
american - any time prior or at maturity

Question 27

call option vs put option

Answer 27

call option - right but not obligation to buy an asset
put option - right but not obligation to sell an asset

Question 28

over the counter derivatives vs exchange traded derivatives

Answer 28

“OTC derivatives, such as forward contracts, have the advantage of specificity, the contract can be tailored to the exact specifications desired to the firm in regard to quantity, quality and timing of delivery. OTC contracts can also be specified for physical delivery so that the contract can be utilized to meet the demands of the supply chain. Major downside is the firm must accept counterparty risk.

Exchange traded derivatives have the major benefit of being counterparty risk free as they are settled by a clearinghouse. The contracts are standardize so the firm must deal with pre-determined contract size, timing and quality. Most exchange traded derivatives are monetarily settled so they can’t be used to acquire inputs or sell outputs which adds to the complexity of setting up the hedge.”

Question 29

what are the key factors that influence the proportion of forwards, futures, and options in a companys portfolio

Answer 29

If counterparties are available within the supply chain or as customers with low default risk then forward contracts are an option. Futures avoid the risk of counterparty risk and are good if the hedge needs of the company are common and align with the standardize timing and quantity on the exchange. Options are useful if there is uncertainty regarding the quantity that needs to be hedged as there is flexibility to not exercise the contract if the hedge is not needed. Options have the added benefit of providing protection from downside risk while allowing the firm to realize the upside related to changes in prices. However, this flexibility and upside potential comes at the costs of having to pay the option premium to enter the contract.

Question 30

why would a company select a hedging program

Answer 30

Hedge programs have several benefits including stabilizing cash flows which reduces financial distress likelihood. Jointly lower default risk and consistency in profits contribute to reduced borrowing costs and reduce the likelihood of need to raise costly emergency financing. Hedging removes the influence of financial risk on the profitability of the firm, making it easier to assess the efficacy of management. Drawbacks include the deadweight cost of implementing the hedge program from the perspective of human resources costs, buying and selling costs and option premiums. Derivatives complicate the financial statements of the firm making it more difficult for investors to value the firm and creating tax and accounting complications. Finally, hedge programs uncouple the firms performance from the financial risk in their industry which may be the very exposure investors are seeking, potentially reducing investor demand.