INVESTMENT PLANNING Flashcards
TIME VALUE
FV = PV (1 + r)^n
PV = Present value of inv. today r = req'd rate of return FV = Future value n = # of periods
***After Tax Return = Rate (1 - tax rate)
Bond: Face Value - FV; compute PV
RATES OF RETURNS (9 TYPES)
1) HPR
HOLDING PERIOD RETURN (HPR) = sale proceeds - purchase price + cash flow / purchase price
REAL RATE OF RETURN
r = Nominal pre-tax return - inflation
————————————————
1 + inflation rate (expressed as decimal)
REAL AFTER -TAX RATE OF RETURN =
After tax return - inflation / 1 + inflation (expressed as decimal)
Total return=
(Sales proceeds - purchase price + all net cash flows + reimbursement income) / purchase price
ARITHMETIC MEAN RETURN
GEOMETRIC MEAN RETURN
TIME WEIGHTED RATE OF RETURN
ARITHMETIC MEAN RETURN = Sum of observations / Number of observations
GEOMETRIC MEAN RETURN =
1+r = (1+r)(1+r)(1+r) ^ 1/n
r = {(1+r)(1+r)(1+r) ^ 1/n} - 1
alternatively: PV = -1 FV = (1+r)(1+r) PMT = 0 N = number of years reporting Solve for I/Y ***FUND MANAGERS MUST REPORT GEOMETRIC RETURNS
TIME-WEIGHTED RATE OF RETURN PV = +-1 FV = 1 x (1+r)(1xr)(1xr) N= number of periods PMT = 0 I/Y = ?
IRR - INTERNAL RATE OF RETURN
CF 2nd CLR WORK CF 100000 +- ENTER down arrow 0 ENTER down arrow (2) 0 ENTER down arrow (2) 0 ENTER down arrow (2) balance ENTER IRR CPT = %
EFFECTIVE ANNUAL RATE OF RETURN
e= (1+r)^m -1
Step 1: Convert annual rate to period rate (quarterly = /4)
Step 2: $1.00 invested for the period (months) would grow
RETURN ON A FOREIGN INVESTMENT IN CDN DOLLARS
{Sale proceeds(FC) x Exchange Rate} - Purchase cost (FC) x Exchange Rate)
% Return = {Profit (Loss) Cdn $ / Purchase Cost Cdn $}x 100
GOVERNMENT REGULATORS OF FIs
- OFSI: sets capital requirements, conduct audits, montiors activities of FIs.
- SECURITIES ACT: protects the investors
- CIPF (Canadian Investor Protection Fund): LIKE CDI FOR credit unions: coverage $1MM: protects clients again bankruptcy of FI; 180 calendar days to make a claim
- ASSURIS: in event of insolvency of a member insurance company;
a) covers greater of $200K or 85% of promised benefit;
b) greater of $60K for cash value portion of 85%;
c) up to $100K fro non-reg accumulation plans, RSP, RRIF, pension policies
d) greater of $2000/month or 85% for annuities, disability income, LTC
e) seg funds and CI: greater of $60K or 85% of promised benefit
ECONOMICS
GDP: focueses on what’s been produced “in Canada”.
GNP: focuses on what’s been produced “by Canadians”.
2 Methods of obtaining GDP:
i) Expenditure Approach: consumption (personal), investmnet (businesses), government, net exports
ii) Income Approach: profits, employee compensation, rent/mtg pmts, taxes, interest
REAL GDP
REAL GDP = Nominal GDP / 1+ inflation rate
CPI
Inflation
Deflation
Disinflation: prices are rising at a declining rate year over year
Stagflation: High unemployment, high inflation
Business Cycle
- Trough (low)
- Expansion
- Peak
- Contraction
Economic conditions
1) Employment
2) Inflation
3) Interest rates
4) Consumer and Business confidence
5) Inventory levels
6) Capacity Utilization
EMPLOYMENT
3 TYPES OF UNEMPLOYMENT
1) Frictional unemployment: found (haven’t found anything yet)
2) Structural unemployment: skills (outdated)
3) Cyclical unemployment: eConomic factors
4) Natural unemployment = frictional and structural combined
Economics OBJECTIVES of the Gov’t
- low unemployment
- stable economic growth
- low inflation
- preserving currency value
ECONOMIC POLICIES
Fiscal: Taxation and Spending
Monetary: money suply and credit conditions of BoC
interest rates; inverse relationship with bonds and money supply
Economic Indicators
"Leading": S stock prices H housing M money supply M manufactuere's new orders A avg hrs worked per week C commodity (goods) prices
"Coincient": At the same time G GDP R retail sales I industrial productions P personal income
Lagging: turned after U unemployment rate I inventory levels I interest rates I inflation L labour costs P private sector spending
ASSET ALLOCATION
1) STRATEGIC: long-term AA (regular asset mix)
- 2 approaches:
i) efficient/frontier approach: risk tolerance/objectives
ii) age approach (5% cash; 100-age Equity)
*** 5% got most investors and 10% cash for very conservative investors.
2) DYNAMIC: rebalancing on a regular basis to get back to strategic mix; prevents market drift by portfolio monitoring.
3) TACTICAL: tilt from regular asset mix to take adv. of short-term opportunities
FIXED INCOME and EQUITIES
F/I:
- ** Term Deposits
- preferred shares, bonds, mortgage backed securities, debentures,
EQUITIES:
- income trusts, derivatives (warrants, rights, calls, puts)
DETERMINING A YIELD FOR T-BILL
Annualized Yield: {(Face Value - Price)/ price x (365 days/no of days to maturity)} x 100
*** Calculating purchase price:
Face Value of bond x Price/100
*** Annualized Yield:
($100 - Purchase Price / Purchase price) x (365/days until maturity) x 100
*** Interest income:
Face Value - Purchase price
CURRENT YIELD BOND
Current Yield of Bond = Annual Interest Income in $ / Purchase price x 100
YIELD TO MATURITY
** Always assume that bond pays semi-annual interest
FV = FUTURE VALUE / FACE VALUE PV = Purchase price / market price PMT = % of bond (annual)/2 b/c semi-annual N = # of years x 2 b/c semi-annual periods I/Y = ? x 2 b/c semi-annual
*** WHEN STRIP BOND; PMT = 0
INTEREST RATE RISK
Macaulay duration = interest rate risk on a bond.
- measures how lont it takes to get cash back on investment
- Macaulay duration increaes with the term to maturity
Highest risk bond: 3 Ls
longest term
lowest coupon rate
lowest yield to maturity
MODIFIED DURATION PREDICTS A % PRICE CHANGE IN BOND
Modified Duration - Macaulay duration / 1 + semi annual YTM (in decimals)
if yields change 1%, the modified duration will change %of price. e.g. of modified duration is 12, then 12% per 1% yield change
S&P RATINGS
Money Market = R2 or higher
Bonds = BBB or higher (Bonds below are junk bonds)
Preferred Shares = P3 or higher
CONVERTIBLE BONDS
SEG FUNDS
- insurance contracts that provide 2 guarantees
1) Maturity guarantee - guarantee 75%-100% of original investmeent
- guarantee cannot come into effect for at lest 10 yrs of purchase date
2) Death benefit guarantee)
- guarantees beneficiary 75-100% ; no time limit with guarantee
INCOME TRUSTS (2 TYPES)
- Trusts that distribute a min. 90-95% of their free cash flow to unitholders. Free cash flow is cash flow after deducting mandatory expenses to keep business going.
1) REITS
2) Business Trust
LABOUR SPONSORED VENTURE CAPITAL COPORATIONS
- designed to attract to invest in small growing companies with aim to stimulate local empoyment and regional growth
- no annual contribution limit
max. federal tax credit is $5000 for provinically sponsored - minimum holding period is 8 years
PREFERRED SHARE CALCULATIONS
Market price of P/S - Annual Dividend income / yield (expressed as decimal)
*** Annual dividend = $ PAR price x % of share (decimal)
Yield = Annual Dividend income / Purchase price of P/S x 100
DERIVATIVE SECURITIES
- security where its price is related to another security
1) WARRANTS: as part of offering to buy more securities/issues; sweetner
2) RIGHTS: offered to existing common shareholders to buy additional C/S
3) CALL OPTIONS: private deal b/n two parties: right to “buy” stock/ obligated to “sell”
4) PUT OPTIONS: private deal b/n two parties: right to “sell” sotck/obligate to “buy”
5) Forward contracts: private deals b/n two parties (no premiums)
6) Future contracts: Entered into and traded on exchanges (no premiums)
Warrants
- as part of offering to buy new securities/issues
1) intrinsic value = market price of “stock” - exercise price of warrant
2) Time value of warrant = markt price of :warrant” - intrinsic value
3) Break even price - exercise price of warrant + “cost” of warrant
CALL/ PUTS
Motives for Buying Call Options
i) leverage: invest hoping to make a return
ii) to fix a future price on the stock
iii) hedge againast a short sale
Motives for Writing Covered Call Options
i) premium
ii) partial protection agains the stock dropping
PORTFOLIO MANAGEMENT - MARKOWITZ PORTFOLIO THEORY
- Expected Return: average weighted expected return based on realized historical results
- Total Risk: standard deviation (total risk); can be systematic or unsystematic
a) Systematic Risk: market risk
- Beta: volatility of stock, asset, portfolio
b) Unsystematic risk: unique risk specific to the company
- Alpha: unique to company eg. manufacturing
- Efficient Frontier: line that connects the portfolios w/ the highest expected returns for the amount of risk taken
CALCULATING STANDARD DEVIATION (TOTAL RISK)
STEP 1: Calcalate Realized/Arithmetic Return (i.e. total returns / number of years
STEP 2: Calculate the Variance (i.e. sum of (Return minus realized return) / number of years: Take the SD of variance
COVARIANCE and CORRELATION
- If stocks move together on avg, the covariance is positive; if reverse then it’s negative.
- Correlation measure strenght of the relationshp b/n two stocks
- ** There is no risk reduction when correlation is +1.0
- ** There is BEST risk reduction is when correlation is -1.0
SHARPE RATIO: highest sharpe, most diversified( better.)
SHARPE RATIO = Rp - Rf / SD
RP = Return or expected return of portfolio RF = Risk free rate (T-Bill rate)
CAPM
Alpha; the higher, the better stock selection
- William Sharpe
- AA model b/n a risk free investment (T-bill) and a risky portfolio (market portfolio.)
- uses concept of Beta which is systematic risk
CAPM
STEP 1:
Expected Return = RF + B (RM - RF)
STEP 2: ALPHA = Actual Return - Expected Return
Investment risk
Principal Inflation Liquidity Interest Systemic (market) Unsystematic (company) Foreign currency Political
