Unit 20: Analytical Methods

Question 1

Future Value

Answer 1

= PV * (1+r)^n
-r rate of return
-n number of years

Question 2

Present Value

Answer 2

= FV * (1+r)^n
-r rate of return
-n number of years

Question 3

the discount factor

Answer 3

(1+r)^n portion of PV/FV formula

Question 4

Rule of 72

Answer 4

shortcut for figuring out how long an investment will take to double with compound earnings
72/rate=number of years to double
commonly used for a known expense like college, home purchase, or retirement to figure out how many years/return is needed.

Question 5

Net Present Value

Answer 5

difference between current cost and present value. expressed in dollar value, not rate of return.
typically more useful than IRR

Question 6

IRR

Answer 6

the discount rate that makes the future value equal to its present value
-bond’s YTM=IRR
-not used for stock, since there is no end date

Question 7

“How much should be invested today for [event] in [number of years]?”

Answer 7

looking for present value
-not net present value (that would determine if security is priced correctly), or IRR (used to analyze past performance)

Question 8

Bond duration

Answer 8

two components: interest rate and maturity date
-price sensitivity to change in interest rates

Question 9

When should you lengthen the average duration of a bond portfolio?

Answer 9

if interest rates are expected to decline (and bond prices will rise)

Question 10

duration and coupon payments

Answer 10

always shorter than maturity of bond
-if zero coupon, then duration = maturity

Question 11

The most useful component in determining the price volatility of a bond to change in interest rate

Answer 11

convexity
-the higher the convexity, the more interest rate risk protection.

Question 12

interest rate and discount rate

Answer 12

the higher interest rates are, the higher discount rates are

Question 13

use a discounted cash flow method to find

Answer 13

the FAIR VALUE of a security, not CMV or rate of return.

Question 14

The yield to maturity is

Answer 14

the discount rate which equates:
-the present value of the bond’s future cash flows until maturity to its price.

Question 15

geometric vs arithmetic mean

Answer 15

arithmetic mean will be higher until there is no variance in returns.

Question 16

skewed distribution

Answer 16

the median and mean are not equal
-whichever direction the mean is from the median (higher or lower) determines which kind of outliers there were.

Question 17

Beta

Answer 17

measures a stocks correlation with S&P500
-1 means exact correlation
-1.5 would mean 1.5x returns as the S&P
-negative beta would be a positive return when the market is down

Question 18

Alpha

Answer 18

positive alpha means the portfolio is outperforming the market

Question 19

calculating alpha

Answer 19

(portfolio return - risk-free) - (portfolio beta * (market return - risk free))
-the portion of return that is not explained by beta

Question 20

Standard deviation

Answer 20

used to measure the volatility of an investment’s projected returns. the higher the SD, the more you can expect returns to deviate from average.
-quoted percentage is 1 SD, ie, 8% SD is range expected 68% of the time, and then 16% 95%
-if returns are equal, one would prefer the one with lower SD

Question 21

SD and beta

Answer 21

beta- measures only market risk (systematic)
SD- measures both systematic and unsystematic risk

Question 22

Correlation

Answer 22

1=perfectly correlated
0=completely uncorrelated
-1=perfect negative correlation
the lower the correlation, the more diversified

Question 23

working capital

Answer 23

current assets - current liabilities

Question 24

Factors that increase working capital

Answer 24

-sale of securities (long-term debt or equity);
-profits from operations;
-sale of noncurrent assets, such as equipment no longer in use.

Question 25

Factors that decrease working capital

Answer 25

-declaring cash dividends;
-paying off long-term debt whether at maturity or, if called, earlier;
-net operating losses.

Question 26

Current Ratio

Answer 26

(Current Assets)/(Current Liabilities)
-the higher the ratio, the more liquid the company

Question 27

Quick Ratio (acid test)

Answer 27

(Current assets - inventory)/(current liabilities)

Question 28

debt to equity (AKA debt to total capitalization

Answer 28

(long term debt)/(long term debt + equity)

Question 29

Book Value per Share

Answer 29

(Tangible assets - liabilities - par value preferred)
/
(shares of common stock outstanding)

this reflects the theoretical value of liquidating the company

Question 30

Earnings Per Share

Answer 30

earnings available to common shares
/
number of shares outstanding

Question 31

Current yield (Balance Sheet)

Answer 31

annual dividends per common share
/
price per share

Question 32

Dividend payout ratio

Answer 32

annual dividend/EPS
measures proportion of earnings paid to stockholders

Question 33

Price to earnings ratio

Answer 33

helps compare stock prices as a multiple of earnings
share price/EPS
-sometimes sales to earnings will be used to deal with different accounting methods
-growth companies have higher PE than cyclical or defensive

Question 34

price to book ratio

Answer 34

share price/book value
-useful for companies with inconsistent or negative earnings

Question 35

gross profit

Answer 35

total revenue - COGS

Question 36

bond sensitivity to interest rates

Answer 36

the longer the duration of a bond, the more sensitive to small interest rate changes

Question 37

the lower the coupon, then longer the

Answer 37

duration
-if all maturities are the same, you move to coupon to figure out which has the longest duration

Question 38

Zero coupon and treasury strips have no

Answer 38

reinvestment risk, but they do have interest rate risk

Question 39

If NPV=0, bond’s IRR is

Answer 39

equal to current yield