TC-Investment Flashcards
Dark Pools
Trading of large blocks of stock generally without moving the price of the stock. Execute at the midpoint between the bid and ask price.
Net present value & Internal rate of return
Measure present value and the portfolio’s existing return.
Inflation adjusted return
Compares the return on a security to the current rate of inflation.
What is Discounted Cash Flow (DCF)
Calculations on bonds include the discount rate, coupon payments, and the principal payment at maturity.
Time-Weighted Return
Eliminates the effect of cash flows to give an idea of performance. It is an effective way to measure the performance of portfolio managers to one another as well as to a benchmark.
Time-weighted return attempts to eliminate distortions in performance that can be caused by incoming and outgoing capital, thus giving a better idea of the performance of the investment. When calculating time-weighted return, longer reporting periods are broken down into smaller reporting periods and the mean (mid-point) of performance results would be the time-weighted return percentage.
Dollar-Weighted Return
Includes cash flows so that investors can get an idea of the returns and growth of their portfolio in relation to their financial goals. It is not an effective way to compare managers.
Internal Rate of Return
Modern Portfolio Theory
max risk max return
“With this investment approach and depending on client, we either look at the client’s desired level of risk and attempt to maximize returns, or we look at the client’s desired returns and attempt to minimize risk.”
One of your clients purchased 100 shares of XYZ common stock at $30 per share. The client sells the shares one year later at $35 per share. Throughout the year, your client received quarterly cash dividends of $0.25 for a total of $1 in dividends. The client’s total return on the stock was
Total Return equals
Capital gains + Divided/ Original cost
all cash distributions during the period that the investment is held. It is the best measure of an investment’s performance. In this situation, the cash dividend of $1 per share is added to the capital gains of $5 per share for a total return of $6 per share. To get the rate of return, the $6 is divided by the original cost of the security which was $30 per share. $6 return / $30 investment = 0.20 or 20%
Opening a Margin Account
investor opened a new margin account. If it were not a new margin account, the investor would have deposited $1,750 (50% x $3,500). However, the rule requires a minimum deposit of $2,000 for the initial purchase in the margin account.
CAPM (the capital asset pricing model)
CAPM = Expected return compared to required return to determine whether or not an investment should be made.
Is used to measure the relationship between risk and expected return. The result is an expected return that can be compared to the required return to determine whether or not an investment should be made.
The Dividend Discount Model
Value of a common stock using the dividends paid.
A benchmark index drops 5%. What would be the expected return on a portfolio of stocks whose R-value (correlation coefficient) with respect to that index is -1 ?
The portfolio would be expected to rise when the index falls and fall when the index rises by the same amount as the benchmark index.
The question states that the correlation coefficient for the portfolio, the R-value, is -1 with respect to its benchmark index. This means that the portfolio has a perfectly negative correlation with the index. So the portfolio would be expected to rise when the index falls and fall when the index rises by the same amount as the benchmark index. The benchmark index falls 5%, so the portfolio would be expected to rise 5%. A perfectly positive correlation of +1 would mean that the portfolio would rise and fall in the same direction and amount as its benchmark index.
Quick ratio, also known as the “acid test” ratio,
Current assets - Inventory / Current liabilities
Is the most stringent measure of corporate liquidity.
The efficient frontier in Modern Portfolio Theory
Highest return is on the efficient frontier.
Represents a set of or group of portfolios that will provide the highest return at each level of risk incurred, often measured by standard deviation. The question states that all five portfolios have the same standard deviation so the one that has the highest return is on the efficient frontier.
Modern Portfolio Theory
In Modern Portfolio Theory, portfolio returns that measure below the efficient frontier are considered sub-ideal, because the rate of return does not justify the risk. Profiles that measure above the frontier are ideal, and the returns are well balanced to the risk.
Modern Portfolio Theory attempts to optimize returns for a given level of risk, or optimize risk for a given level of returns.
Standard deviation measures
The variance or dispersion of a set of values of a portfolio from an expected return (e.g., +/- 3%).
Capital Asset Pricing Model (CAPM)
Expected Return =
Risk-Free Rate of Return + [Beta x (Market Return - Risk-Free Rate of Return)].
In other words, CAPM evaluates the expected return of an asset or investment by setting it equal to the risk-free rate of return plus a risk premium adjusted with beta (via the beta)–assuming investors demand higher returns for greater risks.
Sharpe Ratio
Return - Risk Free Return / Standard Deviation.
13% - 1% / 12%
Sharpe Ratio is a measure of the risk-adjusted return relative to a portfolio’s volatility.
Discounted Cash Flow Methodology (DCF)
Discounted Cash Flow Methodology involves discounting returns to assign value in today’s dollars, either via a number (Net Present Value) or a percentage (Internal Rate of Return).
DCF and IRR are concepts used in the time value of money.
Dispersion
Dispersion illustrates a statistical range of potential returns for an investment or a portfolio’s returns. It is a tool to help measure the risk of an investment. Types of dispersion include range, variance, standard deviation, and mean.
Historical price
Historical price volatility is the plotting of past prices of the security.
Wayne is looking at buying a block of stock for his portfolio. He is evaluating one stock in particular, which has a beta of 1.15. Wayne is using the S&P 500 as his benchmark, and it has a beta of 1.0. If the S&P 500 returned 5% in the previous year and the stock that Wayne is evaluating returned 7.5%, what is the alpha of the stock that Wayne is evaluating?
Alpha =
Realized Return - (Market Return x Beta)
Alpha = 0.075 - (0.05 x 1.15) Alpha = 0.075 - 0.0575 Alpha = 0.0175 or 1.75%
Alpha =
Realized Return - (Market Return x Beta)
Alpha = 0.075 - (0.05 x 1.15) Alpha = 0.075 - 0.0575 Alpha = 0.0175 or 1.75%
The cost-to-equity ratio
Total cost / Account average balance
Measures how expensive the trading in the customer account has been. To calculate the cost-to-equity ratio, divide the total annual costs by the account’s average balance.
Buying Call option
Contracts allows the buyer to buy the stock at the specific strike price. So when the stock market price goes up, the investor can buy the stock at the lower strike price. Since the investor is interested in being able to do this long-term they would buy LEAPS Call options.