Investment Planning

Which of the following best describes the fees charged based on the average daily fund assets and used principally to meet marketing expenses?

12b-1 fees.

In the mutual fund industry, 12b-1 fees are charged as part of

12b1 fees are used for marketing and distribution costs. All other costs, such as legal, accounting and analysis are paid through management fees. Commissions are paid using either a front load or a back load.

Treasury notes maturity

2 to 10 years

What risk can be eliminated using buy and hold with fixed income

interest rate risk

R-squared (R2)

is a statistical measure that represents the percentage of a fund or security's movements that can be explained by movements in a benchmark index. For fixed-income securities, the benchmark is the T-bill. For equities, the benchmark is the S&P 500. A high R2 value (between 85 and 100) indicates the fund's performance patterns have been in line with the index. The higher the R2 value, the less non-systematic risk present. calculated by squaring the correlation coefficient If R-squared is greater than or equal to 0.70 then beta is an appropriate measure of total risk

Belief perseverance

is evident when people are unlikely to change their views given new information.

The neglected firm effect

is one of the market anomalies. This anomaly is said to exist because the security in question is allowed greater potential for movement as a result of the lack of scrutiny by analysts.

Efficient Frontier

is the best possible returns that could be expected from all possible portfolios.

Systematic risk

is the lowest level of risk one could expect in a fully diversified portfolio. It is inherent in the "system" as a result of the unknown element existing in securities that have no guarantees. - Nondiversifiable risk - Market risk - Economy based rick

The indifference curve

is the risk return trade-off which investors are willing to make

Unsystematic risk

is the risk that exists in a specific firm or investment that can be eliminated through diversification. Through ownership of a number of different securities or investments, the investor can eliminate this risk and insulate their investments. - Diversifiable risk - Unique risk - Company specific risk

The longer the maturity the more or less volatile?

more volatile

The lower coupon makes bond more or less volatile?

more volatile

Overconfidence leads to

over trading

Banker's Acceptance

paper traded between banks such as letters of credit to facilitate international trade.

Bearer bonds

pay interest to the holder of the bond

What risk is there to being invested in an energy sector fund?

political risk

Stock option straddle

purchasing a put and a call on the same security, at the same exercise price, for the same period of time

Risks with mortgage backed securities

purchasing power risk interest rate risk prepayment risk actual maturity is not known with certainty actual cash flows are not known with certainty

How to calculate beta of whole portfolio?

take amount of fund and divide by total portfolio value and then multiply by beta add up all betas

How to calculate weighted average expected return of portfolio?

take position MV and divide by total portfolio amount and then multiply by performance of that fund add up all figures

Fundamental Analysis

the study of a company's accounting statements and future prospects to determine its value

True or False: Beta is a measure of systematic, non diversifiable risk

true

True or false: rational investors will form portfolios and eliminate unsystematic risk

true

True or false: systematic risk is the relevant risk for a well diversified portfolio

true

Treasury bills maturity

up to 52 weeks maturity maximum

Primary market

where investment bankers and corporations meet to arrange offerings to the public

Secondary market

where previously issued securities are sold (exchanges)

When is a portfolio considered diversified when using r-squared?

you take the correlation coefficient and multiply by same number. If the r-squared is greater than or equal to .70 then the portfolio is well diversified

Weak form of EMH

• Historical information will not help investors achieve above-average market returns. • The weak form rejects technical analysis and asserts that fundamental analysis will help an investor achieve above-average returns. • Holds that security prices reflect all price and volume data. • Is in direct contradiction with technical analysis, which attempts to predict future pricing based on the study of past pricing and volume patterns.

Efficient market hypothesis

• Investors cannot consistently achieve above-average market returns. • Prices reflect all information that is available and change very quickly to new information. • Stock prices will follow a "random walk." • Investors who believe in the efficient market hypothesis believe a passive investment strategy is appropriate, such as buy and hold an index.

What is the minimum margin?

50%

Standard deviation ranges

68%, 95%, 99%

Moody bond ratings

Aaa - C Aaa - Baa are investment quality bonds Ba and below are junk bonds

Unsystematic risk (ABCDEFG)

Accounting risk Business risk Country risk Default risk Executive risk Financial risk Government/regulation risk

Price Indicator

Advances and declines deal with price

What does alpha tell you?

Alpha is the fund's actual return minus the risk adjusted expected return, as measured by CAPM

Anchoring

Anchoring results in buying securities that have fallen in value because it "must" get back up to that recent high.

What is the capital asset pricing model?

R = Rf + b(Rm - Rf) on formula sheet Finds the required rate of return if given the risk free rate, market rate, and beta. Can be plugged into dividend discount formula

How to determine if stock is over or undervalued

Use intrinsic value formula. If formula gives you number above stock price then the stock is undervalued and you should buy

Market Indicator

Market indicators deal with directions of the market and related averages

Regret avoidance

(also known as the disposition effect) leads investors to take action or to refuse to act in hopes of minimizing any regret over their actions or inactions. In investments, it leads people to sell winners too soon and to hold on to losers too long.

tax-exempt Original Issue Discount (OID)

- The bond basis increases at a set rate each year. - The difference between maturity value and the original issue discount price is known as the OID. - The bond's earnings are treated as exempt interest income. - The bond was issued at a discount to its par value.

how many weeks in a year?

52

True or False: rational investors will form portfolios and eliminate systematic risk

false

True or false: beta captures all the risk inherent in an individual security

false

A red herring is:

A preliminary prospectus issued by the managing house of an offering.

Standard and Poor's ratings

AAA - D AAA - BBB are investment quality bonds BB and below are junk bonds

Michael has an investment with the following annual returns for four years: Year 1: 12% Year 2: -5% Year 3: 8% Year 4: 18% What is the Arithmetic Mean (AM) and what is the Geometric Mean (GM)?

AM = (.12 -.05 + .08 + .18) / 4 = .0825 = 8.25% GM = 4√ (1.12) × (.95) × (1.08) × (1.18) - 1 × 100 GM = (1.356)1/4 - 1 × 100 GM = 7.91%

Unit Investment Trust (UIT)

An investment company that sells redeemable shares in a professionally selected portfolio of securities. It is organized under a trust indenture, not a corporate charter. Passive management of the portfolios. Self-liquidating investments usually holding bonds.

Bonds matuirty

greater than 10 years typically 30 years

Holly Golightly has decided to try to save for a vacation to the Caribbean in 18 months. She will be putting the money into a short-term investment account returning at 3%. How much will Holly have to put away at the beginning of each month if the package cost for the trip is $2,000?

BEGIN MODE N = 18 I = 3 / 12 = 0.25 PV = 0 PMT = $108.50 FV = $2,000

Travis Bickle saved enough tip money from driving his cab to place $137,500 in an investment generating 8.15% compounded monthly. He wants to collect a monthly income of $1,500, at the beginning of each month, for as long as the money lasts. How long will Travis have this income coming to him?

BEGIN MODE N = ? 142.32 months or 11.86 years I = 8.15 / 12 = 0.6792 PV = <$137,500> PMT = $1,500 FV = 0 This problem is known as the Present Value of an Annuity Due (PVAD) and is always calculated in the BEGIN mode (as it is assumed that payments are wanted on the 1st of the period), but in this case we are given the PV and asked to solve for N instead.

Jack Clouseau just won the lottery and has been told that he can either accept annual payments at the beginning of each year of $162,785 per year for the next 20 years, or he can receive a lump-sum settlement. Jack figures he could invest the money at 5.62% (the same rate as the annuity). What would the amount of the lump-sum settlement be?

BEGIN MODE (PVAD) N = 20 I = 5.62 PV = ? = $2,034,369.29 PMT = $162,785 FV = 0

Jim is the winner of the $10 million Power Ball lottery. He has the choice of collecting $2.5 million after tax today or receiving $300,000 before tax at the beginning of each year over the next 20 years. If Jim is in the 35% tax bracket for federal purposes and the 6% bracket for state purposes, what does his after-tax rate of return need to be to break even between these two options?

BEGIN Mode N = 20 PV = -2,500,000 PMT = 300,000 x (1 - .35 - .06) = 177,000 FV = 0 I = ? = 4%

Which of the following reveals the relationship of a given security's movement relative to that of the market?

Beta

Barbell Strategy

Bonds for the portfolio are purchased with both long and short periods of time to maturity, with little in between.

Walter owns a well diversified portfolio of common stock. He is concerned about a downturn in the market in the short term and prefers not to sell his portfolio of common stock. Which of the following strategies would you recommend?

Buy a put option on the S&P 500.

NPV calculation: Costs 1,000,000, will be worth 2,000,000 at end of 3rd year, required/discount rate 10% compounded annually

CF0 -1,000,000 CF1 0 CF2 0 CF3 2,000,000 I 10 NPV 502,629

NPV calculation: Costs 10,000,000 offers cash 13,000,000 at the end of two years, discount/required rate 10% compounded annually

CF0 -10,000,000 CF1 0 CF2 13,000,000 I 10 NPV ? 743,901

Anne Darrow has asked her accountant, Jack Driscoll, to determine whether her company, Kong Industries, a leader in chain manufacturing, should purchase a new machine for $100,000 that can be sold at the end of 3 years for $35,000 and during that time will generate income as follows: Year 1) +3,000; Year 2) +6,000 and Year 3) +$12,000. She told Jack to determine her NPV with her cost of capital at 12%. With her NPV calculated, what will Mr. Driscoll tell her?

CF0 = <$100,000> CF1 = $3,000 CF2 = $6,000 CF3 = $12,000 + $35,000 = $47,000 I = 12% NPV = ? = <$59,084.59>

An investor buys a share of stock for $50. At the end of the first year, he purchases a second share for $55. At the end of the second year, the stock is worth $62 per share and the investor sells both shares. (The investor received a cash dividend of $2 per share each year.) What is the time-weighted return on this investment?

CFo = <50>, CFj = 2, CFj = 64 (62 + 2) then solve for IRR. Remember, time-weighted return is only concerned about the security's cash flow, not the investors. The question is asking about time weighted return. TWR is looking at the performance from start to end, not the investors performance. In this case it is looking at one share from start to end. Two years of dividends are accounted for. The second purchase is the investors return, which would be dollar weighted return.

How to calculate conversion value of convertible bond

CV = (PAR ÷ Cp) x Ps PAR = par value of bond so usually 1000 Cp = conversion price Ps = price of stock

change in price formula

Change in bond price = -Duration [Change in y / 1 + y]

Charting Indicator

Charts are used as indicators and in some instances, do not use price but rather movements.

A mutual fund investor who is looking for the opportunity to buy investments at a discount, so as to capture a greater portion of any capital gains, would probably decide to invest in a(n):

Closed-end funds generally sell at either a premium or a discount to par value. When purchased at a discount, they afford investors an opportunity to realize up-side capital appreciation.

Mutual fund XYZ has a beta of 1.5, standard deviation of 12% and a correlation to the S&P 500 of .80. How much return of fund XYZ is due to the S&P 500?

Correlation is .80, therefore r-squared is .64 (R-squared = correlation coefficient squared). Therefore 64% of mutual fund's return is due to the S&P 500. Remember, r-squared measures the percentage of return due to the market.

Which of these bonds initially immunizes a bond portfolio if the investors time horizon is 8 years? Coupon paying bond maturing in 8 years Coupon paying bond maturing in 10 years

Coupon paying bond maturing in 10 years

To immunize a bond portfolio over a specific investment horizon, an investor would do which of the following?

Match the average weighted duration of the bond portfolio to the investment horizon.

Alpha of zero

indicates that the fund manager provided a return equal to the return that was expected for the risk that was undertaken.

If the market risk premium were to increase, the value of common stock (everything else being equal) would:

Decrease in order to compensate the investor for increased risk.

How to value a firm?

Divide the capitalization rate factor into the net earnings to arrive at the correct response. $120,000 ÷ .10 = $1,200,000

Accurate measure of a bond's sensitivity to interest rate risk

Duration

How to find standard deviation when given returns?

Enter each return in decimal form (5% = .05) than hit sum key that looks like E+ and then hit Sx, Sy key

Expected rate of return

Er = (D1 / P) + g D1 = next year dividend P = price g = growth of fund

The entity that establishes the initial margin requirement is the

Federal Reserve

The type of risk which measures the extent to which a firm uses debt securities and other forms of debt in its capital structure to finance is known as:

Financial risk

Camping the US, Inc. is currently trading at $25 a share and will pay dividends of $1, $0, $2 respectively, at the end of this year and the following 2 years. They expect dividends to level out at a 3% growth rate after that. Your client is interested in purchasing some shares and would like to know the current value of the shares. Your client has a 7% required rate of return. What is the value per share of Camping the US, Inc. if you use the dividend growth model?

For uneven dividend cash flow, you will need two steps. First use the dividend growth model for the 3% consistent growth. D1/r-g D1 is next year's dividend, which we don't have so we substitute with D0(1+g)2 (1+.03) / .07-.03 = 51.50 Then do the cash flows to account for the uneven growthCFj 0CFj 1CFj 0CFj 2 + 51.50I = 7NPV = ?NPV = 44.6065

loss aversion

Loss aversion notes that people more strongly prefer to avoid losses than to seek gains. Loss aversion was identified by Amos Tversky and Daniel Kahneman. Kahneman received the Nobel Prize in Economics in 2002 for his work on prospect theory and loss aversion.

Negative alpha

indicates that the fund manager provided less return than was expected for the risk that was undertaken.

The Chesapeake Bay apartment complex contains 60 one-bedroom apartments renting for $650 per month. In addition, the complex generates $625 per month from laundry, parking, and vending machines. Vacancy and collection losses have averaged 8% of Potential Gross Income (PGI) and are expected to continue at about the same rate in the future. Annual expenses totaling $117,000 include: Property taxes = $22,000 Property management = $15,000 Maintenance and utilities = $36,000 Swimming pool = $13,000 Professional fees = $8,000 Other expenses = $23,000 What is the property's net operating income?

Gross rental receipts ($650 × 60 × 12) = $468,000 plus non-rental income ($625 × 12) = $7,500 equals potential gross income (PGI) ($468,000 + $7,500) = $475,500. PGI minus vacancy and collection losses ($475,500 - (.08 × $475,500) ) = $437,460 equals Effective Gross Income (EGI). EGI minus expenses equals net income ($437,460 - $117,000) = $320,460. Net Income + Interest + Depreciation = Net Operating Income 320,460 + 0 + 0 = 320,460 Since there is no information regarding interest or depreciation expense, Net income = NOI in this question.

The Chesapeake Bay apartment complex contains 60 one-bedroom apartments renting for $650 per month. In addition, the complex generates $625 per month from laundry, parking, and vending machines. Vacancy and collection losses have averaged 8% of Potential Gross Income (PGI) and are expected to continue at about the same rate in the future. Annual expenses totaling $117,000 include: Property taxes = $2,000 Property management = $7,000 Interest expense = $72,000 Swimming pool = $5,000 Professional fees = $8,000 Other expenses = $23,000 There is a monthly mortgage payment of $10,000 per month. Out of the $10,000 mortgage, $6,000 is interest expense and $4,000 is repayment of principal. Assuming a capitalization rate of 9%, what is the market value of the Chesapeake Bay complex?

Gross rental receipts ($650 × 60 × 12) = $468,000 plus non-rental income ($625 × 12) = $7,500 equals potential gross income (PGI) ($468,000 + $7,500) = $475,500. PGI minus vacancy and collection losses [$475,500 - (.08 × $475,500)] = $437,460 equals Effective Gross Income (EGI). EGI minus expenses equals net income $437,460 - $117,000 = $320,460. Next, determine net operating income by adding interest and depreciation expense back to net income. NOI = $320,460 + $72,000 interest + $0 depreciation = $392,460. Market value = $392,460 ÷ .09 = $4,360,667

Robin purchased a mutual fund at NAV of $20.00 and sold it 8 months later at $21.00. During the time he owned the fund, he received a LTCG of $1.00/share and a qualified dividend distribution of $.75/share from the mutual fund. He has a marginal tax rate of 32%. The tax on LTCG is 15%. What is his after-tax holding period return?

HPR = (SP - PP +/- CF) × (1-TR) / PP [($21.00 - $20.00) × (1 - .32)] + [($1.00 + $.75) × (1 - .15)] / $20.00 Answer: 10.84%

Holly bought a stock at the minimum margin, when the stock was trading at $10. The stock paid quarterly dividends of $.25. Holly held the stock for one year and sold the stock when it was trading at $11. What was Holly's holding period return?

HPR = (SP - PP +/- CF) ÷ PP HPR = ($11 - $10 + ($.25 × 4) ÷ ($10 × .5) HPR = 40%

When to use the treynor ratio?

If the fund is diversified Treynor = [(rp - rf) / (Bp)] on formula sheet rp = average return rf = risk free rate of return Bp = beta

Bob Conrad's investment portfolio consists of several types of stocks, bonds, and money market instruments. The portfolio has an overall standard deviation of 12%, a beta of 1.06, and a total return for the year of 11%. Bob is considering adding one of two alternative investments to his portfolio. Stock A has a standard deviation of 13%, a beta of .87, and a correlation coefficient with the portfolio of .6. Stock B has a standard deviation of 11%, a beta of .97, and a correlation coefficient of .95. Which stock should Bob consider adding to his portfolio, and why?

In the process of adding new investments to a portfolio, the lowest correlation coefficient makes the best addition. Closest to negative one (-1) is always best.

Purchasing power risk is also known as

Inflation risk

A fixed income security whose price has fallen as a result of an increase in interest rates in the market place is said to be subject to:

Interest rate risk

Reset bonds

Interest rates can be reset

In order to determine whether a stock is overvalued or undervalued, a planner would use which of the following formulas?

Intrinsic value formula

Whenever there is a cash dividend issued on an underlying stock, the price (or premium) for a call option available on that stock tend to be

Lower

What groups insures muni bonds?

Muni bond insurance association and American municipal bond assurance corporation

Roosevelt Construction needs to have a lump-sum deposit of $150,000 for the purchase of a surety bond in 6 months. They wish to immediately deposit a sum of cash into a short-term account paying 3% per year, com-pounded on a monthly basis. How much will they need to deposit into this account to have enough to purchase the bond?

N = 0.5 x 12 = 6 I = 3 / 12 = 0.25 PV = ? = $147,769.56 PMT = 0 FV = $150,000

Charles Foster Kane purchased a zero-coupon bond 121⁄2 years ago. He paid $387.55 for the bond. The bond matures today with a face value of $1,000. Given this information, what is the expected rate of return for Mr. Kane on this bond?

N = 12.5 x 2 = 25 I = ? = 3.86% x 2 = 7.72% PV = <$387.55> PMT = 0 FV = $1,000

Yield to call calculation par value 1000 callable in 7 years at 1200 matures in 20 years 11.5% coupon payable semi annually purchased at discount of 900

N = 14 I = ? PV = -900 PMT = .115 x 1000 x .50 = 57.50 FV = 1200 I = 7.7866 x 2 = 15.57%

John Q. Adams has just received a check for $26,333. This is a return from an investment that he made 16 years ago. He was told that the return was the equivalent of 12.5% per year. How much was his original investment?

N = 16 I = 12.5 PV = ? = $4,000.00 PMT = 0 FV = $26,333

Ramona Grant's grandfather, Ulysses, set up a trust fund for his grand-daughter with a $10,000 gift when she was first born. Ramona is 21 years old today, but will not be able to collect from the account that is accumulating interest annually at the rate of 8% per year, until she reaches 25 years of age. To date, how much has accumulated in Ramona's trust fund?

N = 21 I = 8 PV = <$10,000> PMT = 0 FV = ? = $50,338.34

Martha Custis invested $15,000 to help her friend George start his own extermination business five years ago. The business proved to be successful far beyond George's wildest dreams. Today he is returning a check to Martha and has told her that as best as he could figure, she was receiving the equivalent of about 43% per year for her initial investment. What is the amount of the check George has for Martha today?

N = 5 I = 43 PV = <$15,000> PMT = 0 FV = $89,695.66

How to find dividend growth rate when given what dividend was 5 years ago and what it is today 5 years ago $1.36 today $2

N = 5 I = ? PV = (1.36) make sure this is negative or error PMT = 0 FV = 2

Five years ago Luke Skywalker purchased an investment property for $157,500. He sold it today for $217,250. Based on this information, what was his annualized rate of return?

N = 5 I = ? = 6.6439% PV = <$157,500> PMT = 0 FV = $217,250

YTM calculation par value of $1,000 matures in 7 years $55 of interest income semi-annually bond's current price is $920 what is the yield to maturity of the bond?

N = 7 x 2 I = ? PV = -920 PMT = 55 FV = 1000 I - 12.76% - need to multiply by 2 sine its semi annual compounding

Barbara Reed owns an LMN, Inc. bond with a par value of $1,000. LMN is a AA-rated bond that matures in 7 years. Barbara receives $55 of interest income from LMN semiannually. Comparable debt, i.e., is AA-rated, 7-year maturity, yields 12%. The bond's duration is 5 years. What is the intrinsic value of the bond?

N = 7 × 2 i = 12 ÷ 2 PV = ? PMT = 55 ($110 ÷ 2) FV = 1,000

How to find dividend growth rate when given dividend years ago and current dividend

N = how many years ago first dividend given was I = what to solve for PV = first dividend given but put it in as a negative number PMT = o FV = current dividend

Assuming the current market yield for similar risk bonds is 8%, determine the discounted present value of a $1,000 bond with a 7.5% coupon rate which pays interest semi-annually and matures in 17.5 years.

N=17.5 × 2=35 i=8/2 = 4 PV=? PMT=(.075 × 1,000) / 2 = 37.50 FV= 1,000

Duration formula

On the formula sheet Dur = [(1 + y) / y] - [([1 +y] + t[c - y]) / [c([1 + y]supt - 1) + y] y = Yield-to-maturity per period c = Coupon rate per period t = Number of periods until maturity

If one of your clients has a profitable long position in an oranges futures contract and does nothing as the contract expires, what should she expect to occur?

Positions in futures contracts are closed by taking an equal and opposite position. One who is long on a contract at the expiration should expect delivery of the commodities at the stated contract price. It is the buyers responsibility, but in this case, we could say the broker was remiss in his or her duties!

If the risk/return performance of a stock lies above the Security Market Line, the stock is said to have a:

Positive alpha.

What would you invest in to hedge against possible, expected future inflation

Previous metals

Calculating what stock price will trigger a margin call? Required 50% initial margin 35% maintenance margin stock valued at $23 per share when purchased 1000 shares

Price = Loan ÷ (1 - MM) (23 x .50) / (1 - .35) = 17.69

Systematic risks (PRIME)

Purchasing power risk Reinvestment risk Interest rate risk Market risk Exchange rate risk

Holding Period Return (HPR)

Rate of return over a given investment period. Found by calculating-- (Ending Price - Beginning price + Cash dividend) / Beginning Price. HPR = (SP - PP +/- CF) × (1-TR) / PP SP = Sell price PP = Purchase price CF = dividend or distribution received TR = Tax rate

Calculating what margin call will be Margin requirement 50% 25% maintenance margin purchased 200 shares at $100 Price falls to $50 per share

Required equity: $50 × .25 = 12.50 per share Actual equity: $50 - $50 = 0 (current price- loan amount) To meet required equity: $12.50 per share × 200 shares = $2,500

Tightening the money supply causes interest rates to

Rise

SPREAD OPTION

SPREAD position involving the purchase of an OPTION at one EXERCISE PRICE and the simultaneous sale of another option on the same underlying security at a different exercise price and/or expiration date.

The Biomedics Corporation will have its initial public offering of securities this year. Which one of the following laws governs an IPO?

Securities Act of 1933.

The legislation that concerns itself with securities in the secondary market is:

Security Exchange Act of 1934.

What options can you use to increase portfolio income and protect against any price drops in the underlying investments?

Sell calls and buy puts

During the peak of the economic cycle, which of the following should one undertake? Sell debt instruments Begin allocations to cash positions Buy debt instruments Sell gold and real assets

Sell debt instruments Begin allocations to cash positions

Commercial Paper

Short-term debt securities issued by corporations in the open market usually less than 270 days maturity to avoid the necessity of SEC registration

Sharpe Index formula

Sp = (Rp - Rf) / σp on formula sheet Rp = realized return Rf = Risk-free return σp = Standard Deviation of Portfolio Sharpe ratio above 1 is considered good

As a measure for risk, the Capital Market Line (CML) uses the:

Standard deviation of the market.

XYZ company anticipates paying the following dividends, starting next year: Year 1: 2.25 Year 2: 2.75 Year 3: 3.01 After the third year, they anticipate dividends growing at 6%. If Diego's required rate of return is 12%, how much would he be willing to pay for this stock?

Step #1: Apply the constant growth dividend formula to value the stock as of year 3. V = 3.01(1.06) ÷ (.12 - .06) V = 53.18 Step #2: Use uneven cash flows to determine the NPV of the stock at time period zero (today). CF0 = 0 CF1 = 2.25 CF2 = 2.75 CF3 = 3.01 + 53.18 = 56.19 I = 12 NPV = ? Answer: $44.20

XYZ company paid a dividend of $3.00 this year and anticipates the dividend to grow each year by: Year 1: 5% Year 2: 7% Year 3: 8% After the third year, they anticipate dividends growing at 6%. If Sydney's required rate of return is 10%, how much would she be willing to pay for this stock?

Step #1: Determine the dividend to be paid each year. Year 1: 3.00 × (1.05) = 3.15 Year 2: 3.15 × (1.07) = 3.37 Year 3: 3.37 × (1.08) = 3.64 Step #2: Apply the constant growth dividend formula to value the stock as of year 3. V = 3.64 (1.06) ÷ (.10 - .06) V = 96.46 Step #3: Use uneven cash flows to determine the NPV of the stock at time period zero (today). CF0 = 0 CF1 = 3.15 CF2 = 3.37 CF3 = 3.64 + 96.46 = 100.10 I = 10 NPV = ? Answer: $80.86

Intrinsic value of call option

Stock price - Strike price Intrinsic value cannot be negative

Unsystematic (business) risk can be reduced by buying

Stocks in numerous companies in unrelated industries.

Intrinsic value of put option

Strike Price - Stock Price Intrinsic value cannot be negative

The type of risk which CANNOT be eliminated through diversification is

Systematic Risk

Non-diversifiable risk is also known as

Systematic risk

Positive alpha

indicates that the fund manager provided more return than was expected for the risk undertaken

Jan Grimlaw is interested in purchasing a municipal bond that pays $35 interest on a semi-annual basis. The bond is selling at par of $1,000 and Jan is in the 28% marginal tax bracket. She would like to know what pre-tax yield she would need to receive to have a comparable corporate bond investment.

TEY = (Tax Exempt Rate) ÷ (1 minus investor's marginal tax rate) = .07 ÷ (1 - .28) = .0972 or 9.72% Calculate the municipal bond's coupon rate: $35 × 2 = $70 70 ÷ 1,000 = .07

Your client's federal marginal tax rate is 36%, and the state marginal rate is 7%. The client does not itemize deductions on his federal return and is considering investing in a municipal bond which yields 5% issued in his state of residence. What is the taxable equivalent yield?

TEY= (Tax Exempt Security) ÷ (1 - the investor's marginal tax rate). = .05 ÷ (1 - .36 - .07) = .0877

Taxable Equivalent Yield (TEY)

Tax-Exempt Yield / (1 - Marginal Tax Rate)

Bristol-Buyers Company has a market price of $36.00 per share with earnings of $3.00 per share, a beta of 1.1 and a dividend of $1.20, which means a dividend payout ratio of 40%. Earnings for next year are projected to increase by 25%, and the retention ratio is projected to remain at 60%. Using the price/earnings multiplier, to what level might your client expect to see market prices move in a year?

The $36.00 per share price is divided by the $3.00 earnings per share resulting in a price/earnings multiplier of 12. The increase of earnings by 25% results in a projected earnings of $3.75 next year. This new earnings times the P/E multiplier of 12 (assuming the P/E ratio remains constant) results in a price of $45.00. The dividend information provided is unnecessary in answering the question.

Which securities act covers and regulates activities in the primary markets concerning itself with issuance, disclosure and registration of initial public offerings?

The Securities Act of 1933.

How to calculate how many shares of stock a convertible bond may get you

The conversion ratio is used here (PAR/Conversion Price) to determine how many shares are available upon conversion.

Stock dividend dates

The ex-dividend date is one day prior to the date of record. An investor must purchase the stock the day before the ex-dividend date to receive the dividend. Therefore, an investor would have to purchase the stock two days prior to the date of record to receive the dividend.

Fund A total return = 18% Fund A Standard deviation = 23% Fund A Percentage of portfolio = 35% Fund B total return = 11% Fund B Standard deviation = 16% Fund B Percentage of portfolio = 65% The Correlation Coefficient ("R") between the two funds equals .25. What is the standard deviation of the portfolio?

The information in [ ] is the COV formula. compute that prior to multiplying 2(.35)(.65)COVij On formula sheet s p = √(.35)2(.23)2 + (.65)2(.16)2 + 2(.35)(.65)[(.23)(.16)(.25)] s p = √.0065 + .0108 + .0042 s p = √.0215 s p = .1466

What positions best describe a long hedge?

The investor is short the underlying commodity and long the futures contract

On the Markowitz Model, at the point of tangency, we have attained:

The optimal portfolio.

what are factors to consider when investing in mutual fund?

The size of the fund. The amount of time until a distribution is made. The amount of time the current portfolio manager has managed the fund.

What is the geometric rate of return for a stock that has experienced the following prices over a four-year period? Year 1 = $20 Year 2 = $32 Year 3 = $24 Year 4 = $28

There are many ways to solve this, but here is the quickest: N=3 i=? PV=<20> PMT=0 FV=28

A client has bought a stock for $40 per share. At the end of the first year, she purchases another share at $43 per share. At the end of the second year with the share price of $48, she sells her shares. Along the way, at the end of each year, she received a $2 per share dividend. What is the time-weighted return on her investment?

This is simply an uneven cash flow problem. CF0 = <$40> CF1 = $2 CF2 = $50 IRR = 14.33% Note: Since this is a time weighted return, we are only concerned about the security's cash flow. Therefore, we ignore the second purchase at $43 per share. While you use the same IRR keys on the calculator for both time weighted and dollar weighted return, it is the inputs that distinguish if the result will represent a time vs. dollar weighted return. To achieve the dollar weighted return, the second purchase would have been taken into account.

Random walk theory

This theory states that: • The behavior of stock prices closely resembles a random walk. • Prices of stocks are unpredictable but not arbitrary. • It's impossible to consistently achieve above-average market returns. • At any given moment, prices that exist on securities are the best incorporation of all available information and a true reflection of the value of that security. • Prices are in equilibrium. • Changes in price and volume of trading are generated by changing needs of investors.

What is difference between muni bond mutual fund & muni bond unit trust

UITs have no money manager, just a trustee, which makes the fees lower.

municipal bond unit investment trust

Unit investments do not make additions to investments once the trust has been structured. Shares are not bought or sold after structuring and the portfolio is self-liquidating.

When comparing two stocks and you are given risk free rate, expected return of the market, standard deviation, & beta. What do you do?

Use this risk free rate, expected return of the market and beta to find the required rate of return Then plug that number in to the intrinsic value formula and compare if stock is over or under valued

What is the return that your client should expect from a security that last year returned 11.7% with a standard deviation of .146, a beta of 1.2, when the overall market return has been 10.93%, and U.S. Treasury issues are currently delivering around 3.56%?

Using the CAPM one can calculate this answer. Standard deviation and last years return are merely distractors. ER = Rf + B (Rm - Rf) ER = .0356 + 1.2 (.1093 - .0356) ER = .0356 + .0884 ER = .1240 = 12.4%

Intrinsic value formula

V = (D1) / (r - g) D1 = next yer dividend r = required rate of return g = growth of fund

Intrinsic Value Formula

V = (D1) ÷ (r - g) on formula sheet D1 is next years dividend, r is required rate of return, r is growth

Volume Indicator

Volume indicates the number of shares traded

Three forms of the efficient market hypothesis

Weak form Semi strong form Strong form

When do you use standard deviation as a measure of a portfolios risk level?

When a portfolio is not well diversified

Do series EE bonds have a phase out for interest income tax exclusion benefit?

Yes

In analyzing the position and performance of a portfolio in terms of risk/return on the Capital Market Line (CML), superior performance and undervaluation exists if the fund's position is _______________ the CML. Inferior performance exists if the fund's position is ______________ the CML, and equilibrium position exists if it is _________________.

above; below; on

Debenture

an unsecured debt, usually with a maturity of 10 years or more

Jensen Alpha

ap = rp - [rf + (rm - rf)Bp] rp = realized portfolio return rf = risk free rate of return ap = alpha, an intercept that measures the manager's contribution to the portfolio return. Bp = beta of the portfolio. rm = expected return on the market. allows the comparison of a portfolio manager's performance to that of the over-all market using just one calculation

Forward contracts

are agreements to transact in the future

Serial bonds

are issued in series and mature in series

Bottom up analysts

are looking for the next big, but as yet, undiscovered stock that will break onto the scene. Bottom up analysts start with the company, then the industry and finally the economic climate. Top-down starts with the economic climate, moves to the industry and then the company.

Repurchase agreements

are money market securities sold at a discount with an agreement to purchase them back at a higher price later on.

Registered bonds

are paid interest based on to whom the bonds are registered

Limited general obligation bond

bond issued by an entity that has some ability to levy taxes to support itself (for example, a school district). However, this ability is limited when compared to that of the general taxing power of the state.

Equipment Trust Certificates

bonds secured with factory and equipment as collateral

Fourth market

corporation and institutional investors deal directly with one another

Unsystematic risk is also known as

diversifiable risk

Calculate average cost per share

divide each dollar amount by share price Add up divide total dollar amount spent by added up per share price

Semi strong form of EMH

• The semi-strong theory asserts that both historical and public information will not help investors achieve above-average market returns. • The semi-strong theory rejects both technical and fundamental analysis but inside information will lead to above-average market returns.

Strong form of EMH

• The strong theory asserts that historical, public and private information will not help investors achieve above-average market returns. • The strong theory suggests that stock prices reflect all available information and react immediately to any new information. • The strong theory holds that even with inside information the market cannot be out preformed on a consistent basis.