Investment Planning (17%) Flashcards
Money Markets
Short-Term Debt Instruments
Primary Market
New Securities issued to the public
Securities Act of 1933
Secondary Market
Previously issued securities are traded among investors (issuing company is not directly involved).
Securities Act of 1934 (also created SEC)
Exchange (NYSE) vs. OTC (Nasdaq)
IPO
Initial Public Offering
Holding Period Return (formula)
(Ending Value - Initial Value) + Income Generated / Initial Value
aka: Profit / Cost
Assumes Dividends are NOT reinvested
Time-Weighted Return (TWRR) (forumula)
Appreciation or Depreciation of a portfolio from period-to-period.
(((1+R1)(1+R2)(1+R3))1/Rn) - 1
e.g.: [(1+.2)(1-.05)(1+.1)]1/3)-1
Or
N=3, PV=-1; FV=(1+.2)(1-.05)(1+.1)
Solve for I/YR.
Dollar-Weighted Return (DWRR) (formula)
aka. Geometric Mean & Money-Weighted Return
e.g.: returns of 20%, -10%, 5%
Timing of a specific client’s cash flows.
Use Cfj function
Total Risk
Systematic Risk + Unsystematic Risk
Measured by Standard Deviation
Systematic Risk (PRIME)
Can NOT be eliminated through diversification.
Measured by Beta.
PRIME:
Purchasing Power Risk
Reinvestment Risk
Interest Rate Risk
Market Risk
Exchange Rate Risk
Unsystematic Risk
aka. Firm-Specific Risk
(BFDRS)
Can be eliminated through diversification
Business Risk
Financial Risk
Default or Credit Risk
Regulation Risk
Sovereignty Risk
Rank Investments by level of risk
Most Risky:
Options & Futures
Common Stock
Preferred Stock
Corporate Bonds
Government Bonds
CDs
T-Bills
Bond Ratings
Investment grade Moody’s Standard & Poor’s Fitch
Strongest
Aaa AAA AAA
Aa1 AA+ AA+
Aa2 AA AA
Aa3 AA- AA-
A1 A+ A+
A2 A A
A3 A- A-
Baa1 BBB+ BBB+
Baa2 BBB BBB
Baa3 BBB- BBB-
Non-investment-grade Moody’s Standard & Poor’s Fitch
Ba1 BB+ BB+
Ba2 BB BB
Ba3 BB- BB-
B1 B+ B+
B2 B B
B3 B- B-
Caa1 CCC+ CCC+
Skewness
Positively skewed means right tail (bulb to the left)
Negatively skewed means left tail (bulb to the right)
Kurtosis
A distribution is more or less peaked than normal.
Normal is Mesokurtic
Slender is Leptokurtic
Broad is Platykurtic
Efficient Market Theory (EMT)
Efficient Market Hypothesis (EMH)
Strong; Semi-Strong; Weak
Inside Information - Semi-Strong and Weak
Fundamental Analysis - Weak
Technical Analysis - None
‘Random Walk” utterly unpredictable movement of stocks, lacking any pattern that can be exploited by an investor.
Efficient Frontier
A curve identifying the optimal return given risk taken.
Uses Standard Deviation
All points on curve are equally efficient.
Below the curve is inefficient
Above the curve is impossible
Sharpe Ratio
Risk-adjusted performance of a portfolio in terms of standard deviation.
Formula: Sp = Rp - Rf / σ
Use only when R2 < 0.70
Comparative to other Sharpe Ratio calculations
Higher the Sharpe Ratio the Higher the Risk-adjusted rate of return
Treynor Ratio
Risk-adjusted performance of a portfolio manager.
Formula: Rp - Rf / β
Use when R2 > 0.70
a Relative calculation
Higher the Treynor, the higher the risk-adjusted rate of return
Jensen’s Alpha
Evaluates the benefit of a portfolio manager
R2 > 0.70
Formula: Rp - [Rf+(Rm - Rf) * β]
An absolute calculation
Alpha = 0 matches the SML
Capital Asset Pricing Model (CAPM)
Foundation for all Modern Portfolio Theory (MPT).
Formula: Rf + (Rm - Rf) * β
(Rm - Rf) = Market Risk Premium and Equity Risk Premium.
(Rm - Rf) * β = Stock Risk Premium
Calculates expected return given: I. market return and ii. Beta
Calculates Security Market Line (SML)
Quantifies investor’s required rate of return.
With CAPM (which is the expected return) you subtract from Actual Return to get Alpha.
Upward Sloping Yield Curve
Normal / Positive
Short-term rates are lower than long-term rates
Flat Yield Curve
Rates of short-term paper and long-term paper are similar
Downward Sloping Yield Curve
Inverted / Negative
Rates on short-term paper are HIGHER than the rates of longer-term paper
Intrinsic Value of Bonds
N = 2 * Years to Maturity
i = 1/2 * rate
PMT = 1/2 (due to 2x year pmts)
FV = Maturity Value
Solve for PV
Bonds
Duration
