Final Test

Question 1

What is called “the difference in value between money today and money in the future”?

Answer 1

TIME VALUE OF MONEY

Question 2

How we call the rate at which we can exchange money today for money in the future?

Answer 2

INTEREST RATE

Question 3

What’s the formula for Future Value?

Answer 3

Vo x (1 + r)^n = Vn

Question 4

What’s the formula for Present Value

Answer 4

Vn = Vo x 1/(1+r)^n

Question 5

What’s the formula for Market Value?

Answer 5

MV = SUM [ f / (1+r)^t ]

Question 6

How can an annuity be classified?

Answer 6

Annuities can be classified by the frequency of payments, because an annuity is a series of payments made at equal intervals

Question 7

Formula for Future Value of an annuity

Answer 7

Vn = f x 1/r x [(1+r)^n - 1]

Question 8

Formula for Present Value of an annuity

Answer 8

Vo = f x 1/r x [1 - (1/(1+r)^n]

Question 9

What is a growing annuity?

Answer 9

It’s a finite stream of equal cash flows (f) that occur after equal interval of time grow at a constant rate (g)

Question 10

Formula for Present Value of Growing annuity

Answer 10

Vo = f x (1/r-g) x [1-(1+g/1+r)^n]

Question 11

Formula for future value of a growing annuity

Answer 11

Vn = f x [(1+g)^n - (1+r)^n/g-r]

Question 12

Formula for PERPETUAL annuity

Answer 12

Vo = f / r-g

Question 13

How does the profitability of a project work?

Answer 13

Computing a return of a project imples to take into account an inicial investment; then, if the current or PRESENT VALUE of a project is HIGHER than the INICIAL INVESTMENT, the project is profitable.

Question 14

What do uwe use to calculate the profitability?

Answer 14

the Net Present Value (NPV)

Question 15

What does the NPV tells us?

Answer 15

A positive NPV will increase the wealth of the firms and its investors. NPV is expressed in terms of CASH TODAY

Question 16

When making decisions about what’s the best project to invest based on NPV, how do we choose the best option?

Answer 16

You have to take the alternative with the HIGHEST NPV

Question 17

Formula for NPV

Answer 17

NPV = Inicial Investment + SUM [ (future inflows/(1+r)^t) + (Residual Value/(1+r)^maturity time)

Question 18

“When an interest rate drives the NPV to be equal to zero, we call this interest rate the…”

Answer 18

INTERNAL RATE OF RETURN (IRR)

Question 19

How to interpret the IRR?

Answer 19

“the average return earned by taking on the investment opportunity”. If the average return on the investment opportunity (IRR) is greater than the return on the other alternatives in the market with equivalent risk and maturity you should undertake the investment opportunity.

Question 20

What do we do if we have multiple IRR’s in one investment?

Answer 20

Nothing, we cannot apply the IRR rule

Question 21

What do we do if we have a nonexistent IRR in a investment?

Answer 21

Nothing, the IRR rule provides no guidance whatsoever

Question 22

What is the Law of One Price?

Answer 22

The LAW OF ONE PRICE implies that, to value any security, we must determine the expected cash flows an investor will receive from owning it

Question 23

Formula for the investor willing to buy the stock

Answer 23

Po <= (p1+d1)/(1+E(r))

E(r) is the equity cost of capital, which is the expected return of other investments in the market with equivalent risk to the firms share

Question 24

Formula for the investor willing to sell the stock

Answer 24

Po >= (p1+d1)/(1+E(r))

Question 25

Formula for the Total Return of the stock

Answer 25

E(r) = (p1-p0/p0) + (d1/p0)

Question 26

What does the Total Return of the stock states?

Answer 26

That the stock's total returns should equal the equity cost of capital. In other words, the expected total return of the stock should equal the expected return of other investmens available in the market with equivalent risk

Question 27

What is the GORDON-SHAPIRO model?

Answer 27

they suppose that for each period that the distributed dividend (d) is a constant portion of the Net Income

Question 28

Whats the formula for the GORDON-SHAPIRO model

Answer 28

Po = d/r-g

Question 29

Formula for return on portfolio

Answer 29

Rp = SUM (Wn x Rn)

Question 30

Formula for Return on Stock

Answer 30

Rs = (final stock value/inicial stock value) - 1

Question 31

Formula for covariance

Answer 31

Cov = SUM [(ReturnABC - Average ABC) x (ReturnXYZ - AverageXYZ) / Sample Size - 1] Keep doing the sum for the other years as well. This formula shows only one year.

Question 32

Formula for Correlation

Answer 32

Corr = Cov / (Standard Dev of ABC x Standard Dev of XYZ)

Question 33

Is it true that the correlation between two stocks has the same sign as their covariance?

Answer 33

Yes, that's why they have a similar interpretation

Question 34

Formula for Variance of a two-stock portfolio

Answer 34

OLHAR NO CADERNO FODA-SE

Question 35

When do we say a portfolio is inefficient?

Answer 35

Whenever it is possible to find another portfolio that is better in both expected return and volatility

Question 36

Can we rank efficient portfolios?

Answer 36

No, investors will choose based on their preferences of return or volatility (risk)

Question 37

What is a short sale?

Answer 37

Is a transaction in which you sell a stock today that you DO NOT OWN, with the obligation to buy it back in the future

Question 38

What is important to remember about short selling?

Answer 38

1. Short selling is profitable if you expect a stock price to decline 2. But even if the stock price rises, it can still be profitable if you had invested in a stock with a even higher expected return

Question 39

What is margin investing?

Answer 39

It's when we borrow money at the Risk Free interest rate to invest on stocks. This process can also be called using leverage or buying stocks on margin. It is a RISKY INVESTMENT Strategy

Question 40

What can you tell me about the tangent portfolio

Answer 40

The steeper the line, the better. "If the line is steeper, then for any level of volatility, we will earn a higher expected return".

Question 41

What is the sharp ratio of a portfolio?

Answer 41

It's the slope of the line through a giver portfolio p

Question 42

What can you tell me about the Sharp Ratio?

Answer 42

the OPTIMAL portfolio to combine with the risk-free asset will be the one with the HIGHEST Sharp Ratio, where the line with the risk free investment just touches (it tangent) to the efficient frontier of risky investments.

Question 43

Is it true that the tangent portfolio has the highest Sharp Raio of any portfolio in the economy?

Answer 43

Yes, that's why the tangent portfolio provides the biggest reward per unit of volatility (RISK AND RETURN TRADE-OFF)

Question 44

Why do we say that, on the tangent portfolio, optimal no longer depends on how conservative or aggresive the investor is?

Answer 44

Because once we include the risk-free investment, all efficient portfolios are combinations of Rf and the tangent portfolio. That means that every investor should invest in the tangent portfolio with the risk-free.

Question 45

What does Beta do?

Answer 45

Beta measures the sensitivity of the investment i to the fluctuations of the portfolio p. That is, for each 1% increase in the portfolio's return, investment i's return is expected to change by Beta% due to risks that i has in common with p

Question 46

About portfolio improvements and the beta, what an increase of the amount invested in "i" would do?

Answer 46

Increasing the amount invested in i will increase the Sharp Ratio of the portfolio p if its expected return exceed its required return (expected return that is necessary to compensate for the risk investiment "i" will contribute to the portfolio) given portfolio p So, if "i" expected return exceeds this required return, then adding more of it will improve the perfomance of the portfolio

Question 47

What is the Required Return in portfolio improvements?

Answer 47

It's the expected return that is necessary to compensate for the risk investment in "i" will contribute to the portfolio. The formula is Required return = Rf interest rate + risk premium of current portfolio

Question 48

What are the three CAPM assumptions?

Answer 48

1. Investors can buy and sell all securities at competitive market prices (without incuring taxes or transactions costs) and can borrow and lend at the risk-free interest rate 2. All investors choose a portfolio of traded securities that offers the highest possible expected return given the level of volatility they are willing to accept (homogeneous expectations) 3. Investor have homogeneous expectations regarding volatilities, correlations, and recpected returns of securities.

Question 49

What can you tell me about the Capital Market Line (CML)

Answer 49

When CAPM assumptions hold, the market portfolio is efficient, so the tangent portfolio is actually the market portfolio The tangent line graphs the highest possible expected return we can achieve for any level of volatility. When the tangent line goes through the market portfolio, it is called the capital market line. According to CAPM, all investor should choose a portfolio on the CML.