Review Flashcards
IIA Open End MF are traded at
Closed End MF are traded at
Open: NAV
Closed: sold at the prevailing market price; must sell shares thru broker
IIA
* publicly traded limited partnership
* limited partners provide capital, general partners
manage activities
* approximately 90% of cash flow must come from
investments in real estate, commodities, or natural
resources
MLP master limited partnership
IIA Investors’ Choice Fund had NAV per share of $37.25 on January 1, 2009. On December 31 of the same year the fund’s rate of return for the year was 17.3%. Income distributions were $1.14, and the fund had capital gain distributions of $1.35. Without considering taxes and transactions costs, what ending NAV would you calculate for Investors’ Choice?
.173 = (P - $37.25 + 1.14 + 1.35)/$37.25; P = $41.20
IIA
- are traded on a major exchange
* unsecured debt securities
* can be sold short or purchased on margin
* no coupon payments
* have a maturity date
ETNs
IIA
* may be public (trades on exchange) or private
* considered a form of UIT
* invests in real estate directly
* must distribute 90%+ of income to shareholders
* receives special tax treatment
* offers diversification, professional management, higher yields, tax
advantages, liquidity
REIT
IIB Size (Capitalization)
Value of a company
= share price X # of outstanding common shares
Style
Value: Market price is LOWER than fundamental valuation
Growth: higher
Book value
Defined
A valuation based on a company’s assets minus its
liabilities.
Formulae
Book Value = assets minus liabilities
Book Value Per Share
= (assets-liabilities) / shares outstanding
= shareholder equity / shares outstanding
Intrinsic Value vsMarket Price
- The intrinsic value (IV) is the “true” value,
according to a model. - The market value (MV) is the consensus value
of all market participants.
Volatility
Defensive: less susceptible to economic cycles/conditions (ie pharma, food, power, water, gas)
Dynamic: more susceptible
Current Ratio
current assets/current liabilities
Quick Ratio
[cash + cash equiv. + short-term investments + receivables] /
current liabilities
Cap Weighted Index
“Market value weighted index”
ex. S&P 500, Russell 2000, MSCI EAFE
this index weights individual
companies or stocks based on their market
capitalization thus larger stocks receive more
proportional representation in the index; the
value of a cap-weighted index may be
computed by summing the value of all market
capitalizations and dividing by the number of
stocks in the index
PEG Ratio
Price-Earnings-Growth Rate (PEG Ratio)
PEGR = (P/E) / EGR
This ratio employs the P/E ratio and relates it to a firm’s expected growth rate per year
(EGR). It reflects the firm’s potential value of a share of stock.
Suppose that a firm with a P/E of 8.72 expects an annual growth rate of 8%. Its PEGR
would be
=8.72/8 = 1.09
It is theorized that PEGRs represent the following:
If PEGR = 1 to 2: The firm’s stock is in the normal range of value.
If PEGR < 1: The firm’s stock is undervalued.
If PEGR > 2: The firm’s stock is overvalued.
Return on Assets
Defined
* ROA is a ratio that measures how well company management
is utilizing its assets to generate operating income. It is calculated by dividing earnings before interest and tax payments by total assets.
Example
* ROA = EBIT/assets or
= EBIT/(liabilities + owner equity + retained earnings)
Note: sometimes ROA may be defined as Net earnings
(i.e., after taxes and interest payments)/assets.
Return on Equity
Defined
ROE is a ratio that measures how well company management is
performing for shareholders (i.e., profitability). It is calculated
by dividing after-tax earnings by shareholder’s equity (i.e.,
book value). It can also be calculated by dividing earnings per share by book value per share.
ROE = net earnings/shareholder’s equity
= net earnings/book value
= earnings per share (aka EPS)/(book value per share)
Formula for P/B, P/E and ROE:
P/B = P/E * ROE
Retention Ratio
Example: Company has return on equity of 17%, earnings of $1.75 per share, and pays a dividend of $0.25 per share. The retention rate (i.e., amount used to keep
growing the company – and is not paid out to shareholders) is calculated as follows:
One method for calculating a company’s growth rate is to use something called a
retention rate (or ratio). You multiply the ROE x the retention rate. Retention rate is basically 1 minus the dividend rate paid out.
Example: Company has return on equity of 17%, earnings of $1.75 per share, and pays a dividend of $0.25 per share. The retention rate (i.e., amount used to keep
growing the company – and is not paid out to shareholders) is calculated as follows:
1 – (dividend/earnings)
1 – (0.25/1.75)
1 – .1429
Retention Rate = 85.71%
Growth = ROE x retention rate
= 17% x 85.71%
=14.57% (answer)
A firm has a P/E ratio of 12 and a ROE of 13%. What is the price-to-book value?
1.56
P/B = P/E * ROE
= 12 * 0.13
= 1.56
Note that the above formula is derived from the definitional formulas for the ratios: P/B (Price to Book), P/E (Price to Earnings) and ROE (Return on Equity).
Recall, the denominator in ROE is Equity, which is based on book value and NOT a stock’s market price. See CIMA textbook pages 426-433 for more detail about these ratios.
For the specific derivation of the formula:
P/E * ROE = [(Price/share) / (Earnings/share)] * [(Earnings/share) / (Book Value/share)]
= [(Price/share) / (Earnings/share)] * [(Earnings/share) / (Book Value/share)]
= [(Price/share)] * [ 1 / (Book Value/share)]
= (Price/share) / (Book Value/share)
= P/B
Reminder: the denominator of Equity in ROE is
= [(Price/share) / (Earnings/share)] * [(Earnings/share) / (Equity/share)]
= [(Price/share) / 1 ] * [ 1 / (Equity/share)]
= [(Price/share) / (Equity/share)]
= P/Eq
= P/B
A firm has an ROA of 14%, a debt/equity ratio of 0.8, a tax rate of 35%, and the interest rate on the debt is 10%. The firm’s ROE is ______________.
11.18%
ROE = (1-tax rate) X (ROA+ (ROA - interest)D/E Ratio)
ROE = (1 - 0.35)[14% + (14% - 10%)0.8] = 11.18%.
Bulldog Stock enjoyed earnings last year of $21,000,000 while holding $100,000,000 in assets and $10,000,000 in liabilities. Bulldog’s book value and return on equity last year were:
$90,000,000 and 23.3%
Book Value = assets minus liabilities = $100m - $10m = $90m
ROE = earnings / shareholder equity = $21m / $90m = 23.3%
Calculate the current and quick ratios, respectively, for IVY League stock.
Cash $10,000,000
Receivables $42,000,000
Inventories $35,000,000
Capital long-term investments $75,000,000
Property and equipment $225,000,000
Short-term accounts payable $27,000,000
Long-term debt $150,000,000
3.22, 1.93
Current Ratio = current assets divided by current liabilities.
Current Assets for this company = cash, receivables, inventories = $87m
Current Liabilities = short-term accounts payable = $27m
$87m / $27m = 3.22
Quick Ratio = (cash and equivalents + ST investments + receivables) / current liabilities
Quick Ratio assets for this company = cash, receivables = $52m
Current Liabilities = short-term accounts payable = $27m
$52m / $27m = 1.93
What is the CAPE ratio of the following stock?
Stock price $45.10/share
Forward looking PE ratio = 22.2
Current PE ratio = 31.6
Current earnings per share = $2.08
Inflation adjusted 10-year historical earnings per share = $1.12
40.27
Shiller PE Ratio
also known as the “cyclically adjusted (CAPE) PE”
smoothes out fluctuations in earnings due to the business cycle
uses earnings per share figures adjusted for inflation and averaged over 10 years as the denominator
CAPE Ratio formula:
share price / 10-year earnings average adjusted for inflation
$45.10 / $1.12 = 40.27
What is the PEG ratio of the following stock and determine whether it is over or undervalued?
Stock price = $60.00/share
Current PE ratio = 32
Current earnings per share: $1.87
Projected earnings per share: $1.96
6.65, overvalued
PEGR = P/E divided by expected growth rate
Solve for growth rate: ($1.96 - $1.87) / $1.87 = 4.81%
32 / 4.81 = 6.65
This ratio employs the P/E ratio and relates it to a firm’s expected growth rate per year (EGR). It reflects the firm’s potential value of a share of stock.
It is theorized that PEGRs represent the following:
If PEGR = 1 to 2: The firm’s stock is in the normal range of value.
If PEGR < 1: The firm’s stock is undervalued.
If PEGR > 2: The firm’s stock is overvalued.
Use the retention rate to determine growth rate for the following company.
ROA = 2.12
ROE = 3.57
EPS = $0.87
PE Ratio = 17.25
Dividends = $0.12
3.08%
Solve for retention rate: 1 – (dividend/earnings)
1 – (0.12 / 0.87) = 86.21%
Growth = ROE x retention rate
= 3.57 x 86.21% = 3.08%
Using Retention Ratio to solve for growth rate
One method for calculating a company’s growth rate is to use something called a retention rate (or ratio). You multiply the ROE x the retention rate. Retention rate is basically 1 minus the dividend rate paid out.
Another example: Company has return on equity of 17%, earnings of $1.75 per share, and pays a dividend of $0.25 per share. The retention rate (i.e., amount used to keep growing the company – and is not paid out to shareholders) is calculated as follows:
1 – (dividend/earnings)
1 – (0.25/1.75)
1 – .1429
Retention Rate = 85.71%
Growth = ROE x retention rate
= 17% x 85.71%
=14.57% (answer)
Which of the following statements concerning convexity are accurate or true?
I. A common use for convexity is to estimate the percentage price changes in bonds for assumed changes in time.
II. Convexity measures the curvature of the price/yield relationship.
III. Given its limitations, modified convexity is not ideal for analyzing securities with embedded options.
IV. Convexity is often described as the first-order approximation of price changes while duration represents a second derivative of price change.
II and III only
A common use for convexity is to estimate the percentage price changes in bonds for assumed changes in yield.
Convexity measures the curvature of the price/yield relationship.
Given its limitations, modified convexity is not ideal for analyzing securities with embedded options.
Duration is often described as the first-order approximation of price changes while convexity represents a second derivative of price change.
The duration of a perpetuity with a yield of 8% is:
1.08/0.08 = 13.50 years
You purchased an annual interest coupon bond one year ago with 6 years remaining to maturity at the time of purchase. The coupon interest rate is 10% and par value is $1,000. At the time you purchased the bond, the yield to maturity was 8%. If you sold the bond after receiving the first interest payment and the bond’s yield to maturity had changed to 7%, your annual total rate of return on holding the bond for that year would have been _________.
FV = 1000, PMT = 100, n = 6, i = 8, PV = 1092.46;
FV = 1000, PMT = 100, n = 5, i = 7, PV = 1123.01;
HPR = (1123.01 - 1092.46 + 100)/1092.46 =
11.95%.
A bond will sell at a discount when the coupon rate is ______than the current yield and the current yield is _____ than yield to maturity.
the coupon rate is less than the current yield and the current yield is less than yield to maturity.
In order for the investor to earn more than the current yield, the bond must be selling for a discount. Yield to maturity will be greater than current yield as investor will have purchased the bond at discount and will be receiving the coupon payments over the life of the bond.
What amount of loss should not be exceeded in a thirty-day period of time?
Assume the portfolio is valued at $6,000,000 and has a standard deviation of 18%. Use
a 99% confidence level.
a. $90,000
b. $614,790
c. $868,158
d. $1,080,000
Answer: c. $868,158
Solution: CIMA Section IV.B. Risk Measurements
VaR = [(portfolio value) x (SDEV) x ((square root of (value / days)) x confidence level]
VaR = [($6m) x (18%) x (square root of 30/252) x (2.33)]
VaR = [($6m) x (18%) x (.3450) x (2.33)]
VaR = $868,158
Remember the confidence levels: 95% = -1.65, 99% = -2.33
Remember there are 252 trading days in the year.
How much of a $1,000,000 portfolio is at risk this year, with 99% confidence
when the portfolio’s expected return is 11% and has a standard deviation of 13%.
a. $130,000
b. $192,900
c. $65,000
d. $90,909
Answer: b. $192,900
Solution: CIMA Section IV.B. Risk Measurements
VaR = - [(expected return) + (z-score x SDEV)] x portfolio value
VaR = - [(.11) + (-2.33 x .13)] x $1,000,000
VaR = .1929 x $1,000,000
VaR = $192,900
Remember the confidence levels: 95% = -1.65, 99% = -2.33
