Investments Flashcards
Current Yield MEMORIZE
- annual interest in dollars / bonds market price
Intrinsic Value of a Call MEMORIZE
- market price - exercise price
- remember COME
Intrinsic Value of a Put MEMORIZE
- exercise price - market price
- remember POEM
Tax Exempt Yield MEMORIZE
- taxable yield * (1 - marginal tax rate)
- remember to think about whether a bond would decrease in interest due to taxes
Return on Equity (ROE) MEMORIZE
- EPS / common equity
- common equity is either net worth or book value
Divided Payout Ratio
- common dividends paid / EPS
Margin Call MEMORIZE
- (1 - initial margin % / 1 - maintenance margin % ) * purchase price of the stock
P/E Ratio MEMORIZE
- current market price / earnings
Types of Funds: Aggressive Growth
- invests in securities offering maximum capital appreciation
Types of Funds: Balanced
- invests in both stocks and bonds for both appreciation and income not necessarily at a 50/50 allocation
Types of Funds: Growth
- invests in securities offering potentially rising share prices
- dividends are less important
Types of Funds: Global Equity
- invests in securities traded worldwide
- includes U.S. securities
Types of Funds: International
- invests in securities only outside of the U.S.
Types of Funds: Corporate Bond
- invests in U.S. based companies bonds
Types of Funds: GNMA
- invests in mortgage-backed securities
Types of Funds: High Yield
- invests in non-investment grade corporate bonds (BB and below) for greater potential interest income
Types of Funds: Municipal Bonds
- invests in bonds issued by state and others municipalities
Types of Funds: Specialty
- invests in securities in a particular sector such as technology
Net Operating Income (NOI) computation
- gross rental receipts + non-rental receipts = potential gross income (PGI)
- PGI - vacancy and collection losses = effective gross income
- effective gross income - operating expenses = net operating income (property cash flows)
Exercise Price
- price of option upon exercising (strike price)
Premium
- market price of option
Time Premium
- market price - intrinsic value
Market Price is Less than Exercise Price
- put = in the money
- call = out of the money
Market Price is Greater than Exercise Price
- put = out of the money
- call = in the money
Call Option Taxation (Writer)
- lapses - premium received is STCG
- covered - premium is added to sale price (LT if held underlying security for 12+ months, otherwise ST)
Call Option Taxation (Holder)
- if not exercised, option is considered sold and produces STCL
Inflation Risk
- purchasing power risk
Interest Risks
- reinvestment rate risk = lower interest interest rates at time of reinvesting
- interest rate risk = changes in interest rates (bonds)
Correlation of Investments (Short Cut)
- if zero choose number closest to zero
- if less than one, take average of standard deviation and pick the next lowest number
Risk Adjusted Return
- divide an individual funds realized return by its beta coefficient
- higher is better
Calculating Geometric Mean
- add 1 to the return’s expressed as decimals
- multiply the results of step 1
- plug into calculator as FV
- input PV as -1
- input number of years as N
- solve for i
Dollar Weighted Return
- is an IRR calculation
- assumes reinvestment rate is constant
Holding Period Return w/ Margin
- if margin calculate into actual dollars
- total value MINUS (Margin amount + margin Interest) MINUS actual investment / actual investment
- actual investment and margin are expected to be 50/50 but not always the case
Holding Period Return if Value is Lost
- [(Initial investment MINUS loss) - (margin + margin interest)] - actual investment / actual investment
After-Tax Holding Period Return
- sales proceeds + dividends - costs = taxable gain
- taxable gain * (1 - capital gains rate) = after tax return
Dividend Growth Models
- zero-growth model (preferred stock)
- constant growth model
- both are valuation techniques
Zero Growth Model
- good for preferred stock
- price = dividend / required rate of return
Constant Growth Model
- price = dividend (1 + growth rate) / required rate of return (r) - growth rate of dividends (g)
Dividend Discount (Shortcut)
- calculate based on 2nd number
- choose number higher or lower based on first number in comparison to the 2nd
Dividend Distribution Model Characteristics
- if market lowers required rate of return, common stock’s value will rise
- if market increases required rate of return, common stock’s value will fall
Valuation Techniques
- dividend growth model
- price/earnings
- free cash flow
- return of equity
- dividend payout ratio
Free Cash Flow (Valuation)
- similar to DDM, but instead of dividend use free cash flow (FCF)
Capital Market Line (CML)
- macro
- relationship between risk and return of portfolio
- point b is optimal risky portfolio (meets efficient frontier
- point a is risk free (t-bills)
Efficient Frontier (Risk Adverse)
- steep curve, a lot of return needed to take risk
- a risk tolerant investors curve would be more flat
Security Market Line (SML)
- micro
- used to value a single asset
- ri = rf + (rm - rf) beta
- use formula to calculate required rate of return
EMH - Strong Form
- nothing matters
- random walk
EMH - Semi-Strong Form
- reflects all publicly known information
- only insider information can produce superior results
EMH - Weak Form
- only fundamental analysis can produce superior results
- fundamental analysis looks at economic indicators
Fundamental Analysis
- examines financial statements to predict future
- top down method (looks for trends, invests in those trends)
- bottom up method (looks at companies)
- ratio analysis (compared with similar firms)
- liquidity ratio (current ratio)
- activity ratio (how quickly a firm can convert to cash)
- profitability ratio (compare two or more variables to measure firm’s income performance.
NOTE: it is best to use multiple ratios to compare stocks in the same industry
Benchmarks
- dow jones = price-weighted average
- s&p 500 = float weighted
- russell 2000 = popular capitalization weighted
- value line = equally weighted
- NASDAQ = broadest, OTC and capitalization weighted
- wilshire 5000 - broadest overall, value weighted
- EAFE - international equity market
Short Sale Formula
- sold short value - bought stock value - covered dividends = profit
Risk Tolerant Characteristics
- high debt ratio
- small amounts of insurance
- changes jobs/locations
- makes quick decisions
- high level of wealth for age
- optimistic
- handles stress well
- experienced
Risk Adverse Characteristics
- no debt
- high amounts of insurance
- stable employment
- deliberate
- low level of wealth for age
- pessimistic
- handles stress poorly
- inexperienced
When to Rebalance Asset Allocation
- change in wealth
- change in liquidity
- change in legal/regulatory consideration
- change in time horizon
- change in tax circumstances
- change in needs or circumstances
Passive Asset Allocation Strategies
- buy and hold (EMH)
- immunization
- laddered bonds
- indexed portfolios
- barbell strategy
- dollar-cost averaging
Strategies with Concentrated Portfolio’s
- selling position creates a capital gain but at favorable capital gains rates
- setting up some sort of hedge with the current position (long puts and collars)
Arbitrage Price Theory (APT)
- securities in different market’s cannot differ for significant periods of time
- unexpected inflation
- unexpected changes in industrial production
- unanticipated shift in risk premiums
- unanticipated changes in structures of yields
Black-Scholes Option Valuation
- uses options to value stock
- increase in exercise price decreases call value
Conversion Value Calculation
- (par (typically $1,000) / conversion price) x current market price of underlying stock
Property Cash Flow Calculation
- net operating cash flow - debt/mortgage services
Covariance Shortcut
- add the 2 risks
- divide by 2 to find average
- choose a number less than average if covariance is less than 1
Coefficient of Variation (CV) Shortcut
- to determine the riskiest divide standard deviation by the mean
- higher the number, higher the risk
Risk Adjusted Return Calculation
- annual return / beta
- highest number is best
Tax Equivalence Shortcut
- double coupon = 50%
- add up all taxes
- gage where in respect to the 50%
Duration Shortcut
- look at maturity
- if coupon paying, duration must be less
- choose a number less than maturity but make sure its not too close
Capital Market Line (CML)
- intersection of CML = risk free (100% t-bills)
- point B = optimal risky portfolio (tangency)
- moving from tangency to risk free, investor sells risky assets
Anomalies (Active)
- p/e effect
- small firm effect
- January effect
- neglected firm effect
- value line
Active Strategies
- anomalies
- ratio analysis
- fundamental analysis
- technical analysis
Alpha/Treynor/Sharpe Shortcut
- eliminate answers
- solve for risk adjusted return
- realized / beta
- if mixed r2, choose sharpe
Stock Split Calculation
- 5:2 stock split
- 5/2 x 100 - shares already owned
- 2/5 x prior price to find new par value
At Margin Formula
- (1 - initial margin % / 1 - maintenance % ) x purchase price of stock
Maintenance Call Formula
- find equity required by multiplying NEW value by maintenance %
- find actual equity by taking NEW value and subtracting out 50% of the original value
- take equity required and subtract out actual equity
= maintenance call
