Investment Key Notes

Question 1

Bond

Current yield formula

Answer 1

Annual interest in dollars / Bond’s market price

Question 2

Bond’s market price (formula)

Answer 2

Annual interest in dollars / current yield

Question 3

intrinsic value of a bond

Answer 3

Solve for PV

Question 4

Computing the conversion value of a convertible bond

Answer 4

(Par/conversion price) x current market price

Question 5

Black-Scholes option valuation model

Answer 5

Considers 5 variables:

• exercise price
• time remaining to expiration
• interest rate
• volatility of underlying stock
• price of underlying stock

All variables have a direct up relationship for calls except exercise price

Question 6

Must know formulas

ROE (Return on equity)

Dividend payout ratio

Answer 6

ROE =

EPS / common equity per share (net worth or book value)

—————————————-———————————

Dividend payout ratio =

Common dividends per share paid / EPS

Question 7

Market risk and stock risk premium

Based on CAPM

Answer 7

Market risk premium

(Erm -rf )

Stock risk premium

(Erm -rf )B

Question 8

Performance measures

Jensen (alpha) / Treynor / Sharpe

Answer 8

Risk measured in terms of Beta:

Jensen (alpha) / Treynor

Volatility
Systematic risk only

1st key
Look for high R2 (60+) or diversified portfolio

2nd key
Look for highest positive alpha. If no alpha given then look for highest Treynor number

Risk measured in terms of Standard Deviation:

Sharpe

Variability
Systematic and unsystematic risk

1st key
Low R2 less than 60 or non-diversified portfolio

2nd key
Look for highest Sharpe number