Investment Plannin

Question 1

Monte Carlo theory

Answer 1

Returns are NOT linear, they vary from year to year

Question 2

Risk adjusted return, using Beta

Answer 2

Mean return/ Beta

Question 3

Hierarchy for testing investment performance

Answer 3

BATS
B, make sure Beta if reliable
A, if Beta reliable, use Alpha
T, if Alpha not available use Treynor
S, if these are not available OR Beta not reliable, use Shape

Question 4

Valuation of real estate

Answer 4

Net operating income ( NOI)/ capitalization rate (cap rate)

Question 5

Calculation of an investment’s dividend growth rate

Answer 5

Dividend discount model

g=ROE x rr (retention rate)

Question 6

Unsystematic risk, diversifiable risk ( unique risk)

Answer 6

1) business risk
2) financial risk ( use of debt, leverage)
3) country risk
4) default risk

Question 7

GDP

Answer 7

C + I + G + (NE)

Consumption, investment, government, less net exports

C, consumption is 70% of the economy

Question 8

Coefficient of variation, CV

Definition and calculation

Answer 8

Std (sigma) / mean

Security with the lowest CV generally should be chosen

Question 9

Primary bond risks

Answer 9

(DRIP)
Default risk
Reinvestment risk
Interest rate risk
Purchasing power risk

Question 10

Duration relationships

Answer 10

• Interest rates inversely related
  Lower coupon=higher duration
  Higher coupon= lower duration
• maturity, directly related to duration
  Short maturity=lower duration
  Long maturity=higher duration

Question 11

Dividend growth model

Answer 11

Dividend (1 + g)
______________ = value
r - g

Question 12

3 Bond yields

Answer 12

YMC

Current yield, yield to maturity, yield to call

Question 13

Standard deviation (normal distribution)

Answer 13

One standard deviation=68%
Two standard deviations= 95%
Three standard deviations= 99%

Want lower standard deviation

Question 14

Bond duration characteristics

Answer 14

• weighted average it takes to get your money back on a bond

ex. duration on a 10 yr zero coupon bond is 10

Question 15

Dividend discount model, 3 types

Answer 15

1) zero growth: V=Do / r (required return)
2) constant growth rate: V= Do (1 x g)/r-g
3) non- constant growth rate:
a) grow dividend by high growth initial years
b) calculate value of stock at end of initial growth period
c) do cash flow calculation

Question 16

Systematic risk

Answer 16

Undiversifiable
BS= beta measures systematic risk
PRIME
Purchasing power
Reinvestment
Interest rate
Market
Exchange rate

Question 17

Contrary opinion rules

Answer 17

1) Mutual fund cash positions: higher cash position=bullish
2) odd-lot theory: trades of less than 100 shares, smaller investors who are wrong= do the opposite
3) investment advisory opinions: more ia issue bearish opinions=more bullish the contrarian investor
4) put/call ratio: ratio of puts to call, higher ratio=more bullish the contrarian

Question 18

Follow the smart money rules

Answer 18

1) Barron’s confidence index: measures high quality bond yields to lower quality bond yields: lower spread=bull market
2) short sales by specialist: specialists are considers knowledgable, so more short sales=bearish

Question 19

Investment performance measurement: arithmetic

Answer 19

Considers each individual year during a holding period as a discrete holding period
Add up all various returns and then divide by total number of returns
Pro: simply and easy to use
Con: it’s Wrong

Question 20

Coefficient of determination, R squared

Answer 20

Amount of unsystematic risk

- measures the % change of a security that can be attributed to the market index against which the Rsquared is measured

Question 21

Investment performance measurement: Geometric

Answer 21

Considers return over entire holding period
Reflects economic reality
True compound return
Pro: accurate and easy
Con: dollar inflow and outflow not considered

Question 22

Investment performance measurement: time weighted return

Answer 22

Same a Geometric rate of return, but concerns itself with only $1 over entire time horizon

Question 23

IRR, dollar weighted return

Answer 23

Discount rate at which the present value of future cash flows in an investment equals the cost of the investment

CFo=$100,000
CF1=$1,000,000
CF2=$1,176,000
IRR is 6.3%

Question 24

Rsquared # that determines if Beta is reliable

Answer 24

70 or greater

Question 25

Dividend growth rate ( g) calculation

Answer 25

g= roe x rr

Question 26

Margin maintenance

Answer 26

1- margin%
_____________ x purchase price = margin call price
1- maintanence%

Question 27

Liquidity preference theory yield curve assumption

Answer 27

Under the liquidity theory the yield curve should continue to slope upward

Question 28

Tax equivalent yield formula

Answer 28

After tax yield
_____________
1- marginal tax rate

Question 29

Portfolio return using Sharpe ratio

Answer 29

Return p = risk free return + (Sharpe x std deviation)

Question 30

CML capital market line plots?

Answer 30

Standard deviation and expected return

Question 31

SML security market line plots?

Answer 31

Beta and expected return

Question 32

Dividend growth model expected return

Answer 32

Dividend (1 + g)
_______________ = expected return
Price

Question 33

Convertible bond, conversion value equation

Answer 33

Bond par value
______________ x market price = conversion share value
Conversion price

Conversion share value x shares = conversion value