Investments - Lect. 4-6

Question 1

What 4 functions are performed by investment companies?

Answer 1

1) Record keeping and administration, (2) Diversification and divisibility, (3) Professional management, and (4) Lower transaction costs

Question 2

NAV stands for:

Answer 2

Net Asset Value

Question 3

Formula to calculate NAV:

Answer 3

(Market Value of Assets - Liabilities) / Shares Outstanding

Question 4

Open End funds vs. Close End funds - Buy back

Answer 4

Open-end funds buy back shares at NAV. Close-end funds have set # of shares outstanding, if investors want to sell they have to sell to another customer/investor

Question 5

Open End funds vs. Close End funds - Sell Price

Answer 5

Open-end funds sell at NAV or above IF it has a load/sales commission. Close-edn funds sell at premium at issuance then a discount as it ages.

Question 6

Key points of a Hedge Fund:

Answer 6

1) Structures as private partnership = not subject to many SEC regulations (2) May require investors to agree to “lock-ups” - Periods where funds can’t be withdrawn (3) Pursues strategies mutual funds can’t - derivatives and short sales.

Question 7

Cost of investing in Mutual Funds: Commission or sales charge when you first purchase
shares (not exceed 8.5%, normally lower than 6%)

Answer 7

Front-End Load

Question 8

Cost of investing in Mutual Funds: Exit fee when you sell your shares (typically 5%-6%, decrease by 1% each year)

Answer 8

Back-End Load

Question 9

Cost of investing in Mutual Funds: Funds allow use of fund assets to pay for distribution costs. Similar to operating expenses, deducted from assets, but capped at 1% average net assets per year

Answer 9

12b-1 Charges

Question 10

Rate of return on mutual fund formula:

Answer 10

(EndNAV - BegNAV + Div + CapGain) / BegNAV

Question 11

Taxation of mutual funds:

Answer 11

1) “Pass-through status,” funds not taxed, investors taxed on income from fund (2) Can’t decide when to realize cap gains and losses for tax benefits (3) MFs with high turnover are tax inefficient

Question 12

Exchange-Traded Funds vs. Mutual Funds - Pricing/Trading

Answer 12

ETFs trade shares continuously, MFs priced once per day

Question 13

Exchange Traded Funds Advantages over Mutual Funds:

Answer 13

1) Can be traded continuously during the day (2) Tax advantage over mutual funds (3) Funds cannot depart from NAV for long periods (4) Cheaper than mutual funds

Question 14

Disadvantages to Mutual Funds:

Answer 14

1) Must purchase from broker for a fee and includes bid-ask spread (2) can depart from NAV for short periods in ways that overwhelm cost advantages to ETFs

Question 15

Type of risk that can be eliminated through diversification:

Answer 15

Idiosyncratic, Nonsystematic, or Diversifiable

Question 16

Type of risk that can’t be eliminated through diversification:

Answer 16

Systematic, Market or Nondiversifiable

Question 17

Correlation between bond and stock funds

Answer 17

Negatively correlated

Question 18

Formula: Portfolio Variance

Answer 18

= (Wb x SDb)^2 + (Ws x SDs)^2 + 2(Wb x SDb) x (Ws x SDs) x Correlation Coefficient(bs)

Question 19

Portfolio A will dominate Portfolio B as long as:

Answer 19

ExpRetA >= ExpRetB AND

SDa <= SDb

Question 20

Formula: Sharpe Ratio

Answer 20

(E(Rp) - RF) / SDp

Question 21

How to determine which portfolio will be optimal?

Answer 21

Highest Sharpe Ratio

Question 22

Positive Alpha indicates:

Answer 22

Security is undervalued

Question 23

Formula: Variance of Excess return

Answer 23

(Beta^2 x SDmrkt^2) + SD(ei-FirmSpec)^2

Question 24

Formula: Alpha

Answer 24

Rs - (Beta(s) x Rmkt)

Question 25

Formula: Ws0

Answer 25

(AlphaS / SD(S)^2) / (Rmkt / SDmkt^2)

Question 26

Formula: Weight using beta

Answer 26

Ws0 / (1 + Ws0 x (1 - BetaS))

Question 27

Formula: Sharpe Ratio of Portfolio

Answer 27

(AlphaA / SdA)^2

Question 28

Strategy: Invest everything in risky portfolio each year

Answer 28

“Two-In” Strategy

Question 29

Strategy: Invest in risk-free asset in year 1, risky portfolio in year 2

Answer 29

“One-In” Strategy

Question 30

Strategy: Invest half in risky portfolio and half in risk free each year

Answer 30

“Half-in-Two” Strategy

Question 31

Formula: HPR = Holding Period Return

Answer 31

(EndP - BegP + Div) / BegP

Question 32

Problem with arithmetic average of returns:

Answer 32

Ignores compounding

Question 33

Formula: Geometric Average

Answer 33

HPR %’s: if positive +1, if negative 1 - % - Example: 10, 25, -20, 20 = (1.10 x 1.25 x .80 x 1.20) ^(1/4) -1

Question 34

Dollar weighted average return =

Answer 34

internal rate of return (IRR)

Question 35

APR vs. EAR

Answer 35

Annual Percentage Rate ignores compounding interest while Effective Annual Rate includes compounding interest

Question 36

If returns are normally distributed then:

Answer 36

1) Portfolio with returns normally distributed will have returns that are too (2) Completely described by mean and SD (3) SD is the measure of risk foe a portfolio of assets w/normally distributed returns

Question 37

Formula: VaR Value at Risk

Answer 37

VaR = E(r) + (-1.64485)SD

Question 38

Difference between speculation and gambling:

Answer 38

Risk Premia

Question 39

Formula: Degree of Risk Aversion

Answer 39

( E(Rq) - Rf ) / Sdq^2

Question 40

Formula: Real Interest Rate

Answer 40

Nominal Interest Rate - Inflation

Question 41

Determining the fraction of a portfolio to be invested in broad asset classes such as stocks, bonds, or Treasury bills:

Answer 41

Asset Allocation

Question 42

Focusing on choosing the percentage of risky versus risk-free assets in the portfolio:

Answer 42

Capital Allocation

Question 43

Money market instruments are effectively risk-free due to:

Answer 43

Immunity to interest rate risk

Question 44

Formula: Where on capital allocation line, given degree of risk aversion:

Answer 44

[ E(Rp) - Rf ] / [A x SDp^2)