Investments Flashcards
systematic risk
what is it and what types are there
- influences that cannot be diversified away (i.e., impacts all companies at the same time; not necessarily to the same degree)
- measured by beta
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Types: PRIME
- purchasing power
- reinvestment risk
- interest rate
- market risk
- exchange rate
unsystematic risk
what is it and what types are there
- may affect all businesses but not at the same time
-
Types: ABCDEFG
- accounting risk (e.g., fraudulent activity in accounting)
- business risk
- country risk (e.g., firm has invested heavily in China)
- default risk
- executive (decisions)
- financial risk (how they’re financed)
- government regulations
what does standard deviation measure?
- total risk
- absolute measure
- measures variation around an average
Formula:
- r(t) = the return
- r(absolute) = absolute value of the average
what the standard deviation probabilities?
- 68% of the time, the return will fall within 1 standard deviation (+ or -)
- 95% of the time, the return will fall within 2 standard deviations (+ or -)
- 99% of the time, the return will fall within 3 standard deviations (+ or -)
what is the ideal beta and what does it mean if beat is more or less than that
- Ideal = 1
- E.g., If you have a beta of 1.5, that means your portfolio is 50% more volatile, so it will go up by 50% less and down by 50% more
- market goes down 10%, portfolio goes down 15%
- market goes up 10%, portfolio goes up 5%
what does beta measure?
- systematic risk
- how our asset returns relate to the market return
- beta = the slope of the line if you were to plot market returns vs the portfolio return
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call option & what is long/short position
- Holder has the right (but not the obligation) to buy
- long position = buyer (the right to buy)
- short position = seller (agrees to sell to the person with the long position and gets the premium either way)
put option & what is long/short position
- Holder has the right (but not the obligation) to sell
- long position = seller (right to sell)
- short position = buyer (agrees to buy from the long position and gets the premium either way)
in the money / out of the money / at the money
how does premium factor in?
- in the money - holder will make money if they exercise the option
- out of the money - holder will not make money if they exercise the option
- at the money - holder would break even if they exercised the option
disregards the premium because not everyone would have paid the same premium
how to value stock options
premium = fundamental (intrinsic value) + time value
fundamental (intrinsic value)
- How much the option is in the money
- for call = stock price - strike price
- for put = strike price - stock price
- Cannot be < 0 because if it wasn’t in the money, you wouldn’t exercise it
futures contracts
- long position = buyer
- short position = seller
- legally binding obligation to make (seller) and take (buyer) delivery on specified date
- highly leveraged (bought on margin)
futures hedgers vs speculators
- hedgers = producers/processors; protecting their interests by locking in a price
- speculators = investors trying to profit on expected price swings
Regulation T
initial margin requirement set by the federal reserve; must be at least 50%
formula to determine at what price an investor would receive a margin call
1 - (loan / maintenance margin)
what are the main rating agencies for mutual funds and stocks?
- Value Line: ranks stocks only; 1-5 and 1 is the best
- Morningstar: ranks mutual funds and stocks 1-5 and 5 is the best
Ex-dividend date
what is it and what happens if you buy on that date
business day prior to date of record; if you buy on or after you don’t get the dividend so the price typically falls this day
what is a qualified dividend and how is it treated for tax?
- Cash
- paid by US company or qualifying foreign company
- held >60 days during 121 period beginning before ex-dividend date
- Taxed as capital gains
- Stock
- not taxable to shareholder
Securities Act of 1933 vs 1934 vs Investment Company Act 1940 vs Securities Investors Protection Act of 1970
- 1933 - regulates primary market
- 1934 - regulates secondary market; created SEC
- 1940 - authorized SEC to regulate investment companies
- 1970 - protect from brokerage firm failures (up to $500K)
types of money market securities
- CDs
- T-Bills < 1 yr ($100 denominations)
- commercial paper (maturity <270 days; denominations $100K)
- Bankers acceptance (maturity < 9 mos; facilitates imports/exports)
- eurodollars (deposits in foreign bank denominated in USD)
investment policy statement
- establishes:
- objectives: return, risk tolerance
- constraints: time horizon, liquidity, taxes, laws (e.g., if in trust), unique circumstances (e.g., special needs child)
- limits on investment manager
market indices (Dow vs S&P)
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Dow - simple price weighted average of 30 stocks
- doesn’t incorporate market cap
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S&P - value weighted index
- incorporates market cap of individual stocks
- Russell 2000 - value weighted for small cap
- Wilshire 5000 - value weighted on all stocks
coefficient of variation
symbol, formula, what it measures, when to use, what # you want
- Symbol: CV
- Formula: CV = standard deviation / mean expected average return
- What it measures: risk relative to return
- When to use: when comparing two assets with different average returns
- Do you want lower or higher #?: lower = less risky
correlation coefficient
symbol, formula, ranges, what # you want
- symbol: r
- formula: r = COV / (standard deviation of stock 1 x standard deviation stock 2 etc)
- ranges: from -1 to 1
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what # you want: diversification benefits come whenever correlation is <1
- Note: negative is better but NOT necessary