unit 13 Flashcards
strategic asset allocation
- proportion of various types of investments composing a long term investment portfolio
- passive strategy
- portfolios get rebalanced to bring the asset mix back to target allocations
- unsuitable for fee based acct
tactical asset allocation
- short term portfolio adjustments that adjusts the portfolio mix between asset classes in consideration of current market conditions
- active strategy
- candidate for fee based account
modern portfolio theory
- min risk by combining volatile and price stable investments in a single portfolio
- relationship among assets in the portfolio - looks to diversify
- diversification only reduces risks when assets move inversely or at different times, in relation to one another when combined
- wants negative correlation
capital asset pricing model (CAPM)
- used to calculate the return that an investment should achieve based on the risk taken
- calculated based on beta coefficient (risk multiplier)
beta/beta coefficient
- a stock or portfolio’s measure of its volatility in relation to the overall market (systematic risk)
- overall market is typically S&P500
- beta of 1 moves in line with market
- beta of more than 1 is volatile than the overall market
- beta of less than 1 is less volatile than the overall market (investment will move in opposite direction of the overall market)
- beta of 0 does not move in relation to market
alpha
- extent to which an asset or portfolio’s return exceeds or falls short of its expected return
- positive alpha indicates a buy reconnedatiwon
fundamental analysis
- study of business prospects of an individual company within the context of its industry and overall economy
- examine financial statements and company management
financial statements
- info needed to assess that corporation’s profitability, liquidity, financial strength (ability of cash flows to meet debt payments), operating efficiency
- issued quarterly and annual to the SEC
balance sheet
- snapshot of company’s financial position at a point in time
- IDs assets and liabilities
- difference between assets and liabilities is the corporation’s owners’ equity (net worth)
assets - liabilities = owners’ equity or
assets = liabilities + owners’ equity
assets on balance sheet
- appear in order of liquidity
- three types of assets: current assets, fixed assets, other assets
current assets on balance sheet
- cash and assets easily converted into cash within next 12 months
- includes: cash and equivalents, accounts receivables, inventory, prepaid expenses
fixed assets on a balance sheet
- physical assets - property, plant, equipment
- cost depreciates over time and deducted from taxable income
other assets on balance sheet
- intangible assets that are only of value to the corporation that owns them
- includes: formulas, brand names, contract rights, trademarks, goodwill
liabilities
- represent all financial claims by creditors against the corporation’s assets
- 2 types: current and long term
current liabilities on balance sheet
- corporate debt obligations that are due for payment in the next 12 months
- includes: accounts payable, accrued wages payable, current long term debt (portion due within 12 months), notes payable, accrued taxes
long term liabilities on balance sheet
- financial obligations that are due for payment after 12 months, like bonds and mortgages
income statement
- P&L statement
- summarizes a company’s revenues (sales) and expenses for a fiscal period (qtly, yr to date, full yr)
- compares revenue against costs and expenses during the period
- used to judge efficiency and profitability
- 3 primary components: revenue (sales), COGS, pretax income
revenue
- firm’s total sales during the period (money that came in)
cost of goods sold (COGS)
- cost of labor, materials and production (including depreciation of assets) used to create finished goods
operating profit = revenues - COGS
- first in first out (FIFO) or last in first out (LIFO) accounting methods
pretax margin
net operating profit (pretax margin/ EBIT) = revenues - COGS - other operating costs (rent, utilities)
pretax income
amount of taxable income
pretax income = operating income - interest payment expenses
shareholder equity
- net worth or owner’s equity
- the stockholder claims on a company’s assets after all its creditors have been paid
shareholder equity = total assets - total liabilities
- three types: capital stock at par, capital in excess of par, retained earnings
capital stock at par
- includes preferred and common stock, listed at par value
- par value is the total dollar assigned to stock certificates when a corp owners first contribute capital
- par value of common stock is arbitrary
capital in excess of par
- additional paid in capital or paid in surplus
- amount of money over par value that a company received for issuing the stock in a primary offering
- par value is arbitrary amount selected when company is formed
retained earnings
- earned surplus or accumulated earnings
- profits that have not been paid out in dividends
- rep total earnings since corp was formed minus dividends
- operating losses reduce retained earnings
capitalization
- combined sum of a company’s long term debt and equity securities
capital structure
- relative amounts of debt and equity that compose a company’s capitalization
- 4 elements
- long term debt (bond, debentures)
- capital stock (common and preferred)
- capital in excess of par (paid in or capital surplus
- retained earnings (earned surplus)
- how the firm has financed the assets
working capital
- amount of capital or cash a company has available
- measure of firm’s liquidity (liquidity measures a company’s ability to pay the expenses associated with running the business)
working capital = current assets - current liabilities
- factors that affect it:
- increase to working cap from profits, sales of securities (long term debt or equity) and sale of non-current assets
- decrease to working cap from dividends, paying off long term debt, net loss
current ratio
current ratio = current assets / current liabilities
The current ratio is a measure of liquidity. It is the current assets divided by the current liabilities. The higher the ratio, the more liquid the company.
quick asset ratio (acid test ratio)
- quick assets a current assets minus inventory
quick ratio = quick assets / current liabilities
financial leverage
- a company’s ability to use long term debt to increase its return on equity
- industrial company’s with debt to equity ratios of 50% + are highly levered
- utilities with stable earnings and cash does can be more highly levered without undue risk
- if a company is highly levered it is affected more by changes to interest rates
debt to equity ratio
- debt to total capitalization ratio
- way to measure the amount of financial leverage being employed by a company
book value per share
- similar to NAV
- liquidation value of the enterprise
- subtract intangible assets from total assets to only include tangible assets
book value per share = (tangible assets - liabilities - par value of preferred) / shares of common stock outstanding
depreciating assets
- fixed assets wear out over time
- tax bills are reduced each year the company depreciates fixed assets
- accumulated depreciation reduces the value of fixed assets on the balance sheet
- annual depreciation reduction reduces taxable income on the income statement
- straight line depreciation - depreciate fixed assets by equal amounts of the asset’s life
-accelerated depreciation - depreciate fixed assets during early years and diminishes over time
footnotes
- found in FS
- identify significant financial and management issues that may affect the company’s overall performance