Investment Plannin Flashcards
Monte Carlo theory
Returns are NOT linear, they vary from year to year
Risk adjusted return, using Beta
Mean return/ Beta
Hierarchy for testing investment performance
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
Valuation of real estate
Net operating income ( NOI)/ capitalization rate (cap rate)
Calculation of an investment’s dividend growth rate
Dividend discount model
g=ROE x rr (retention rate)
Unsystematic risk, diversifiable risk ( unique risk)
1) business risk
2) financial risk ( use of debt, leverage)
3) country risk
4) default risk
GDP
C + I + G + (NE)
Consumption, investment, government, less net exports
C, consumption is 70% of the economy
Coefficient of variation, CV
Definition and calculation
Std (sigma) / mean
Security with the lowest CV generally should be chosen
Primary bond risks
(DRIP) Default risk Reinvestment risk Interest rate risk Purchasing power risk
Duration relationships
- 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
Dividend growth model
Dividend (1 + g)
______________ = value
r - g
3 Bond yields
YMC
Current yield, yield to maturity, yield to call
Standard deviation (normal distribution)
One standard deviation=68%
Two standard deviations= 95%
Three standard deviations= 99%
Want lower standard deviation
Bond duration characteristics
- weighted average it takes to get your money back on a bond
ex. duration on a 10 yr zero coupon bond is 10
Dividend discount model, 3 types
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
Systematic risk
Undiversifiable BS= beta measures systematic risk PRIME Purchasing power Reinvestment Interest rate Market Exchange rate
Contrary opinion rules
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
Follow the smart money rules
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
Investment performance measurement: arithmetic
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
Coefficient of determination, R squared
Amount of unsystematic risk
- measures the % change of a security that can be attributed to the market index against which the Rsquared is measured
Investment performance measurement: Geometric
Considers return over entire holding period
Reflects economic reality
True compound return
Pro: accurate and easy
Con: dollar inflow and outflow not considered
Investment performance measurement: time weighted return
Same a Geometric rate of return, but concerns itself with only $1 over entire time horizon
IRR, dollar weighted return
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%
Rsquared # that determines if Beta is reliable
70 or greater
Dividend growth rate ( g) calculation
g= roe x rr
Margin maintenance
1- margin%
_____________ x purchase price = margin call price
1- maintanence%
Liquidity preference theory yield curve assumption
Under the liquidity theory the yield curve should continue to slope upward
Tax equivalent yield formula
After tax yield
_____________
1- marginal tax rate
Portfolio return using Sharpe ratio
Return p = risk free return + (Sharpe x std deviation)
CML capital market line plots?
Standard deviation and expected return
SML security market line plots?
Beta and expected return
Dividend growth model expected return
Dividend (1 + g)
_______________ = expected return
Price
Convertible bond, conversion value equation
Bond par value
______________ x market price = conversion share value
Conversion price
Conversion share value x shares = conversion value
