Investment Strategies Exam

It is really smart to invest in the stock of a company you work with, because you are so familiar with that company? T,F,U

•FALSE •While it may seem favorable to invest in the company you work for due to increased familiarity of the firm and favorable pricing (from stock options for example) •It is actually a risky investment because you are essentially doubling down on that company •Bull markets: benefits in both your stock position and in the company (through raises, promotions, etc.) •Bear market: at risk for both a loss in stock returns and in company benefits (salary drop, job loss, etc.) •You're not diversifying your risk as much as you could and therefore not building your optimal portfolio •Swedroe advises "Do you confuse the familiar with the safe?" oFamiliarity breeds overconfidence (or an illusion of safety)

Index mutual funds are a better deal than actively managed mutual funds. T,FU

•TRUE •Most actively managed funds have underperformed benchmark indexes over time when costs are taken into account o Added fee of actively managed funds make them more costly than most index funds when final returns are realized •Difficult to identify a skilled active manager due to factors like luck, market cycles, and survivorship bias •Other reasons... o More tax efficient, lower expense ratios than actively managed funds because they generally trade less frequently o Actively managed funds can be dangerous because they attempt to "beat the market" o These funds often miss their goals and thus there are losses for the funds and the investors •An index fund is generally going to be a better deal than one that is actively managed over time •Historically outperforms most active managers •Jack Bogle says that if a managed fund has low expense ratios, low turnover, and a bunch of different managers so one crazy guy doesn't sink the ship, there is not much difference between the two

Lesson for investors of great financial crisis of 2008 (Siegel)

-"be fearful when others are greedy and greedy when others are fearful" -be careful about bubbles and over-leverage -recognize a time of irrational exuberance -ex: the increase in the housing market was a great example of a bubble, a time when many were greedy, so investors would have been well-served to be fearful

Explain how the French caused the Great Depression

-A large body of research has linked the gold standard to the severity of the Great Depression. -while economic historians have focused on the role of tightened US monetary policy, not enough attention has been given to the role of France, whose share of world gold reserves soared from 7% in 1926 to 27% in 1932. -suggests that France's policies directly account for about half of the 30% deflation experienced in 1930 and 1931.

Define the following: the continuously compounded geometric average rate of return over a 5-year period, say over 2000, 2001, 2002, 2003, and 2004

-CCGA: Vf = Viert r = [ln(Vf/Vi)]/t

What are exchange traded funds?

-ETFs are a very innovative and successful financial instrument -a claim to a basket of stocks -An ETF is a type of fund that owns underlying assets and divides ownership of those assets into shares. -collection of assets (stocks and/or bonds) -shares issued by an investment company that represent an underlying portfolio -a basket of securities such as stocks that tracks an underlying index -can be bought or sold at any time during the day -can be sold short (hoping to make a profit of buying them back at a lower price) -extremely tax efficient -generate almost no capital gains because swaps between the ETFs and underlying shares are considered exchanges in kind and are not taxable events

What is better, exchange traded funds or open end mutual funds?

-ETFs are more transparent and more liquid than open end mutual funds -advantages of ETFs on open end mutual funds: -can be bought or sold at any time during the day -can be short sold -extremely tax efficient (generate almost no capital gains either from sales of other investors or from portfolio changes to the index) -swaps between the ETFs and underlying shares are considered exchanges in kind and are not taxable events

The proportion income tax is a good tax. T,F,U

-FALSE -"Yay for consumption taxes. Boo for the corporation income tax." -this is because any system is unstable that allows lots of borrowing -there is an incentive for firms to use debt finance rather than equity finance because firms can deduct interest payments from their corporate profits and pay corporate income taxes only on the difference, but they cannot deduct dividend payments -if all bonds and stocks are held in tax sheltered accounts, then the government taxes equity finance but not bond finance -to fix this, we need to eliminate the corporate income tax and replace it by a consumption tax or a tax on carbon emissions

Stock are riskier than bonds no matter what the holding period. True, False, or uncertain and explain why

-FALSE -as the holding period increases, the probability that stocks will outperform fixed-income assets increases dramatically -in the SR... sometimes bonds can outperform stocks -BUT, in the LR... -stocks: safest LT investment is a diversified portfolio of equities, stocks have never given investors a negative real return over a 20-year horizon -Bonds: inflation is ruinous

It never makes sense to hold both stocks and bonds. True, False, or uncertain and explain why

-FALSE -it makes sense to hold both stock and bonds -bonds serve to diversify a portfolio and decrease overall risk -this is particularly true if stock and bond returns are negatively correlated -depending on the holding period, it can be advantageous to have a mix in a portfolio -efficient frontiers demonstrate that with more diversification of assets (stocks and bonds), an investor can increase expected return and decrease the standard deviation of those returns -1 year horizon: portfolio with 13% equity minimizes standard deviation -30 year horizon: portfolio with 68% equity minimized standard deviation

The value of a stock is given by the present discounted value of expected earnings. T,F.U

-FALSE -the value of a stock is given by the present discounted value of expected future dividends since those are for certain going to be paid to the shareholders -by using expected earnings, one overstates the value of a company

An unanticipated jump in the price level will hurt stock holders more than bond holders. True, False, Uncertain

-FALSE -will hurt bond holders more than stock holders -bonds have a lower expected return than stocks, so an increase in inflation eats into their returns more -stocks have a greater cushion than do bonds -inflation has a very negative impact on bonds -increase in inflation causes yields to increase, as investors will demand a higher yield to justify their money in bonds, so the price of bonds will fall -relationship is more indirect with stocks, as inflation will cause their actual net income to be lower than their reported net income, so they will be taxed too heavily

If you have wealth in your tax deferred account and in your regular account, you should put stocks into the tax deferred account and bonds into your taxable account. T,F,U

-FALSE -you should put STOCKS in the regular, taxable account and BONDS in the tax-differed account -this is because you are better off deferring taxes on securities, such as bonds, that generate a lot of taxable income

Explain why from 1802 the real return on stocks has exceeded the real return on bonds, which has exceeded the real return on bills, which has exceeded the real return on gold, and the real return on the dollar bill has been negative

-Jeremy Siegel shows in his book a chart tracing how real wealth has accumulated for a hypothetical investor for past 200 years -shows reasons to prompt: -stocks outperform bonds because of the risk premium (in the SR stocks are very volatile); investors need to be compensated for this volatility with a greater return -bonds outperform bills for the same reason -bills outperform gold and the dollar due to inflation, as there were dramatic changes in inflation that can be explained by the change in the monetary standard (world shifting to paper money after WWII and Great Depression) -Stocks have been better able to price inflation in and account for it

64. What is your favorite take away from Swedroe & Grogan: "Your Complete Guide to a Successful and Secure Retirement"

-Larry Swedroe loves factor-based investments and doesn't seem to trust the US stock market but also does argue you should be diversifying somewhat across value and growth o US stock portfolio weighted somewhat toward value - factor investing: strategy that chooses securities on attributes that are associated with higher returns. There are two main types of factors that have driven returns of stocks, bonds, and other factors: macroeconomic factors and style factors. -macroeconomic factors (credit, inflation, and liquidity whereas style factors embrace style, value, and momentum) capture broad risks across asset classes while -style factors aim to explain returns and risks within asset classes.

The risk minimizing mix of stocks and bonds depends on the holding period, and the longer the holding period the more bonds you should hold. T,F,U

-TRUE- the risk minimizing mix of stocks and bonds depends on the holding period -FALSE- the longer the holding period, the more STOCKS you would hold -it is advantageous to have a mix in portoflio -efficient frontiers demonstrate that with more diversification of assets (stocks and bonds), an investor can increase expected returns and decrease the standard deviation of those returns -1 yr horizon: portfolio with 13% equity presents minimized standard deviation -30 year horizon: portfolio with 68% equity minimizes standard deviation -as holding period increases, percentage of equity increases

63. What is your favorite take away from Swedroe & Balaban: "Investment Mistakes Even Smart People make."

-Mistake 55: Do You Prepare Your Heirs? -It is important to make sure attention is paid by the family to preparing the heirs for the assets they will inherit. -There is a disconnect between the issues that parents worry about with respect to wealth and its effect on their children: too much emphasis on material things, naivete about money, spending beyond means, initiative being ruined by affluence, etc. -Questions to ask yourself: do your children and their spouses know your estate plan? Have they read your will? Do they know the family's net worth? Are they in communication with your team of advisors? -Families treat money and the issues surrounding wealth as a taboo subject. Those who fail to plan, plan to fail. -Heirs should have some influence in how the estate is structured. -Does the estate plan match the skill and interest of the heirs -Solution: FAMILY WEALTH MISSION STATEMENT (FWMS). -Just as most battles are won in the preparatory stage, the success of a family wealth transition plan depends on the effort and emphasis placed on transitioning not only the family's wealth, but the family's values as well.

Do you think it would be wise for the world to return to the gold standard?

-NO -disadvantages significantly outweigh the advantages -gold standard does not provide the US enough flexibility because restricts monetary / fiscal policy -economic development would halt because there would not be sufficient gold reserve to fund businesses, as nations have developed to such a level that a limited commodity would be insufficient -price of gold may vary phenomenally, so tying this to the dollar introduces more volatility -the US could not go back to the gold standard without the rest of the world because the rest of the world could demand that the US convert their dollars to gold and the US would experience a total depletion of American reserves

Would you bet on small stocks doing better in the future than large stocks will do? Why?

-NO -historically, from 1926 to 2012, small stocks out-returned large stocks -this was due to the nine year period from 1975 to 1983, when pension fund managers discovered they wanted to put small stocks into their portfolio -even through the end of 1974 small stocks had only out-returned by .5% per year -the existence of the small stock premium does not mean that small stocks will outperform large stocks every year, or even every decade

Compare the following measure of whether the stock market is overvalued:the CAPE

-Robert Shiller: cyclically adjusted price to earnings ratio -similar to P/E ratio, but adjusts by dividing the price by the average earnings over the past 10 years, making it a cyclical ratio -this is especially useful because it adjusts for business cycles and potential outlier years, helping us to adjust to account for short-lived outlier earnings

Tax Sheltered retirement accounts are a good things even for the worker who does no saving. T,F,U

-TRUE -A tax-sheltered annuity allows an employee to make pretax contributions from his income into a retirement plan. Because the contributions are pretax, IRS does not tax the contributions and related benefits until the employee withdraws them from the plan. -when workers savings increase, their is more overall saving in the economy and thus the capital stock will increase -this increase occurs while the labor supply stays constant -this increases the Marginal Product of Labor (aka real wage rate) -this is a good thing even for the worker who does no saving

Once folks find a strategy to make money in the stock market and lots of folks take advantage of it, the opportunity will disappear. T,F,U

-TRUE -as more people find out about a trend, eventually the market becomes efficient and everybody knows about the "new" strategy -it becomes part of (and changes) the current model -the money-making opportunity is gone -trends are the result of the totally random movement of stock prices, but traders will not invest against a trend that they believe they have identified -momentum investing relies purely on past returns, regardless of earnings, dividends, or other valuation criteria -buy stocks that have recently risen in price and sell stocks that have recently fallen, expecting the price to move in the same direction for some time -work only in the short term and should not be part of a long-term strategy -over long periods, the advantage of buying "winning" stocks is completely eliminated

High inflation causes real earnings of companies to be taxed more heavily. T,F,U

-TRUE -companies are taxed based on nominal earnings -even when inflation outweighs earnings growth, companies will still get taxed and thus lose out of real returns

Flexible exchange rates are great. T,F,U

-TRUE -flexible exchange rates allow fiscal and monetary policy to focus on unemployment and the overall economy rather than focus on the exchange rate -in time of recessions and depressions, flexible exchange rates allow governments to inject a stimulus package which wouldn't be possible with fixed exchange rates -freely determined in an open market, varying from day to day based on supply and demand -"Essential for... the achievement and maintenance of a free and prosperous world community engaging in unrestricted multilateral trade" -to the extent exchange rates are unstable, it it because of underlying economic instability (not because the flexibility caused the instability)

The real rate of return is equal to the nominal rate of return minus the inflation rate. T,FU

-TRUE -simple way to calculate the real rate of return is to subtract the inflation rate from the nominal rate

Compare the following measures of whether the stock market is overvalued: the price/earnings ratio

-the P/E ratio of the market is the ratio of the current share price to the total aggregate earnings of the firms in the market -tells us aggregate value invests are willing to pay for a $1 return on the market, making it a simple yet useful tool to gauge how overvalued the market is

Explain how FDR caused he Chinese to become communist

-The silver purchase program, initiated by President Franklin Roosevelt in late 1933 in response to the economically small but politically potent silver bloc, gave a large short-run subsidy to silver producers at the cost of destroying any long-run monetary role for silver. -More important, it imposed severe deflation on China, the only major country still on a silver standard, and forced it off the silver standard and on to a fiat standard, which brought forward in time and increased in severity the subsequent wartime inflation and postwar hyperinflation. -The silver purchase program thereby contributed, though perhaps only modestly, to the ultimate triumph of the Communists.

Fundamental indexation is a good strategy. T,F,U

-UNCERTAIN -in typical, MCAP weighted index funds, stocks that are overvalued die to market noise (or other non-fundamental reasons such as taxes or liquidity) will be over-represented -fundamental indexation is a good strategy because it more accurately represents the market, and therefore produces better returns -tend to outperform the S&P 500 -Tower found that half of the funds outperformed regular indexed mutual funds with the same style, and half the funds underperformed -as Bill Bernstein says, the devil is in the details and you can get the same value exposure through regular index funds

When the interest rate rises folks will save more. T,F,U

-UNCERTAIN -interest rates determine the amount of interest payments savers will receive on their deposits -an increase in rates will make saving more attractive and should encourage saving -a cut in rates will reduce the rewards on savings and will tend to discourage saving -however, things are more complicated in the real world -ex: in 2009 the HH saving ratio increased from 5% to 8% even though there was a cut in interest rates from 5% to .5% -this was because the impact of the recession encouraged saving -the fear of unemployment and recession was greater than the effect of lower interest rates -while a rise in interest rates should make folks save more, there are many other factors

Buying stocks on margin is a good idea. T,F,U

-UNCERTAIN -buying stocks on the margin is borrowing money to purchase stock -advantages: an investor has more available capital as well as more liquidity, potential to realize more returns as well as an increased range of portfolio strategies -disadvantages: you can actually lose more money than you started out with in your initial investment because you are borrowing (repay the loan from the broker on top of what you lost); if you do not meet minimum requirements, may have to add more cash or liquidate some stock (increasing risk or decreasing return potential) -depends on a number of factors: investor risk preference, liquidity, and macroeconomic conditions

Define the following: the annualized geometric average rate of return

-Vf = Vi(1+r)t r = (Vf/Vi)(1/t) - 1 = erCCGA - 1

Would you bet on stocks with high dividend yield doing better in the future than stocks with low dividend yield?

-YES -historical analysis of the S&P 500 Index supports the case for using dividend yields to achieve higher stock returns -portfolios with higher dividend yield offered investors higher total returns than the portfolio of stocks with lower dividend yields -well known one: Dogs of the Dow or the Dow 10 strategy - strategy calls for investors at year-end to buy the 10 highest-yiledng stocks in the Dow Jones Industrial Average and to hold them for the subsequent year and then repeat the process -these high-yielding stocks are often those that fallen in price and are out of favor with investors - which is the reason is often called the Dogs of the Dow -has performed well consistently from 1957-2012

Is it a good policy to hold onto your winning stocks and sell your losing stocks? Explain.

-YES -holding onto your winners and selling your losers allows you to not realize capital gains taxes with the winners while simultaneously offsetting your capital gains taxes by selling your losers -selling the losers whenever prospects are dim is a good strategy -most investors do the exact opposite, to their detriment -cutting the losers before they get worse will seem like losses, but in the long run it will pan out if you hold on the winners

Does it make sense to have a lower tax on capital's return than on labor's earnings?

-YES -taxes on labor income and on consumption are much better 0encourages long-term savings and long-term investment -this leads to higher return in investment

Can inflation cause depression? What policies do you need in order to be sure that inflation does not cause depression?

-YES -inflation can cause depression -if the exchange rate is not changed in accordance with inflation, then instability is introduced into the economy -hyperinflation will lead to a decrease in purchasing power and a weaker dollar, and therefore a substantial drop in the ability for US firms to invest abroad -high inflation means the cost of borrowing increases because interest rates increase to account for the new price level -companies have to adjust their business models to account for the new price level, thus creating short-term inefficiencies in the market -to ensure inflation does not cause depression, the growth in the money supply must be regulated -if leading indicators (i.e. employment rate) start to rise, then the rental rate of money, the Fed rate, should rise to make it more expensive to borrow, reducing money support -there are also other policies that you can look up, such as increasing the reserve ratio, repurchasing bonds, that will tend to reduce the money supple and check inflation

What is a call option? Why might I want to buy a call option? Why might I want to sell a call option?

-a call option is the right to buy -a financial instrument that allows you to buy your stock at a predetermined price at any time before the option expires -if I am afraid the stock market will go up and I do not have additional money to invest, or I am not sure, and I do not want to underperform the stock market by too much -the sellers, or writers, of call options believe that the market will not rise sufficiently to make profit for option buyers -usually make money when they sell options since the vast majority of options expire worthless -but should the market move sharply against the options sellers, their losses could be enormous

Should Thailand adopt a capital gains tax?

-the current system in Thailand taxes the gross proceeds of any stock when it is sold regardless of the price it was purchased at -this means that only LT investment in the stock market is reasonable for an investor -Thailand has had some big inflation in the past -I think that capital gains tax should not be too high, as that discourages investment, and it should be indexed to the price level -my feeling is that a progressive consumption tax combined with a value added tax is a wise solution -a capital gains tax that is not too high is a reasonable part of the total tax system

what are open end mutual funds?

-a diversified portfolio of pooled investor money that can issue an unlimited number of shares. The fund sponsor sells shares directly to investors and redeems them as well. These shares are priced daily, based on their current net asset value (NAV) -buy and sell to equate the size of the fund to the demand for it -if the demand for the fund is volatile, then there will be lots of buying and selling of assets, which drags down the performance of the fund due to transaction costs -every time the fund sells an assets that has appreciated in value the owner of the mutual fund pays a capital gains tax -price of the mutual fund always equals the price of the underlying assets -majority of mutual fund provide investors with a useful and convenient investing vehicle -when a fund's investment managers determined that a fund's total assets have become too large to effectively execute its stated objective, the fund will be closed to new investors

What is a put option? Why might I want to buy a put option? Why might I want to sell a put option?

-a put option is the right to sell -a financial instrument that allows you to sell your stock at a predetermined price at any time before the option expires -buying a put option is buying insurance against a fall in the stock market -if you are worried about only a big fall, you can buy a put at a very low price -sellers of put options are primarily those who are willing to buy the stock. but only if the price declines -they collect a premium, but receives the stock only if it falls sufficiently to go below the strike price -put sellers are not as common as call sellers, so premiums on puts that are out-of-the-money are frequently quite high

Difference between anticipated and unanticipated inflation

-anticipated: an expected, predicted, steady long-term increase in general price levels -unanticipated: an unstable variable inflation in the general price level that was not predicted or expected

Why has the ratio of dividends to earnings shrunk in recent years?

-before WWII, firms paid out 2/3 of earnings as dividends -since WWII, firms have paid less than half of earnings as dividends -this is because... -companies have increased buybacks because of the tax benefit --> alternative to dividends as a way to return capital to shareholders -tax rates have increased over time -companies have used earnings to pay down debt

How would an investor use stock options who is afraid that the stocks he owns may fail?

-buying an option is buying insurance against a fall in the stock market -if you are worried about only a big fall, you can buy a put with a very low strike price

Is capital gains tax a good thing?

-capital gains tax is a type of tax that is levied on capital gains -capital gains are profits that an investor gets when he sells a capital asset for a price higher than the purchase price -the taxes are only in effect when the asset is sold -so for a saver, the capital gains is a better deal than dividends because the saver does not pay the capital gains tax until the asset is sold

What is time zone arbitrage? Can you still make money from it?

-capitalizing on anticipated market movements before the market opens (i.e. buying shares on one time zone for a market in a different time zone that hasn't opened up yet) -for ex, one may buy a stock on an American exchange when it has experienced a rally, guaranteeing that the same stock will surge when Asian exchanges open the next day -Ed Tower and Katelyn Donnelly wrote a paper on this phenomenon, discovering that the opportunity for TZA has diminished but not disappeared -so YES, it is still possible to make money from it -one reason that it has not been completely eradicated may be because of the difficulty of implementing fair value pricing

What is better, open end or closed end mutual funds?

-closed end mutual funds are better because their is a fixed amount of share, therefore the manager does not need to trade as often -open is worse because it required the manager to buy more securities whenever he experiences an inflow of capital, raising his transaction costs

The arithmetic average rate of retune is always higher than the geometric average rate of return. Give a numerical example of this

-consider an asset that returns 10% in the first year and 5% in the second: arithmetic average rate of return is (10+5)/2=7.5, geometric average rate of return is (1.1*1.05).5-1 = 7.47% -consider two general returns: arithmetic average rate of return is (r1+r2)/2 and geometric average rate of return is [(1+r1)*(1+r2)].5-1 -an arithmetic average is the sum of a series of numbers divided by the count of that series, while the geometric average takes Ito account the compounding that occurs from period to period -geometric will always be lower than arithmetic so long as the returns are not identical because when the returns are compounded, the size of the asset is constantly growing, so rather than the return to be on the initial investment, it is occurring on an investment that is always growing

What is the Gordon Formula?

-developed by Roger Gordon in 1962 -based on idea that a company is worth today that PV of the FCF it will generate -most valid when a company has a consistent growth rate and little chance of financial difficulties -P= D/r-g -P: price of the bond -D: dividend per share -r: required return on equity (sum of the risk-free rate, the expected rate of inflation, and the equity risk premium) -g: rate of growth of future dividends per share -see derivation of Gordon formula

Distinguish between diversifiable risk and undiversifiable risk. Why is the distinction important?

-diversifiable risk is risk that can be eliminated via diversification -ex: if a portfolio is only invested in healthcare companies, that portfolio is subject to risk in the healthcare industry -the risk can be avoided by investing in companies that are not subject to risks in the healthcare industry (like energy companies) -undiversifiable risk is risk that cannot be avoided through diversification -ex: systematic risks in the market itself -no amount of diversification can revert the inherent risk that exists when investing money -this distinction is important because you can and should eliminate diversifiable risk in you portfolio: always have a well-diversified portfolio

What is the lifecycle hypothesis of saving?

-the life cycle hypothesis of saving is the idea that everyone knows how long they are going to work and how long they will be retired -young people tend to borrow money in their early years since they expect to earn higher income in the future -adults tend to save more in preparation for retirement -retirees spend whatever they have saved

Age Wave def

-the unprecedented rise in the number of individuals in the developed world who will enter retirement (baby-boomer generation)

How would you decide how much of your portfolio to invest abroad?

-diversifying your portfolio is crucial -no advisor would recommend only investing in stocks whose name begins with the letters A through F --> sticking only to US equities would be just such a bet since they will continue to shrink as a share of the world market -only those who have fully diversified world portfolio will be able to reap the best returns with the lowest risk -according to Bill Bernstein, you should invest 1/3 of your portfolio abroad -According to Larry Swedroe, this number should be close to 50% for US investors -construct an efficient frontier and find a combination of assets that keeps risk low or minimizes risk -realize that black swans occur from time to time, so do not invest too much in any one region even if the efficient frontier recommends it

Derive the Gordon formula, intuitively

-dividends are equal to earnings in this context, and the source of cash flow to an investor -assuming the payout ratio remain the same forever, the earnings growth rate will equal the dividend growth rate and the dividend will continue to grow in value into perpetuity -to come to the PV, the FCF must be discounted because cash received in the future is not valued as highly as cash received in the present -each individual cash flow from each year has been discounted by a (1+r) term corresponding to the number of periods removed from the present -since stock valuation is the sum of the FCF, the sum of the perpetuity can be calculated to the give Gordon Growth Model -assume to payout ratio remain the same forever -intrinsic value of a share of a company is its current dividend payout discounted at the required rate of return minus the dividend growth rate

-Compare the following measure of whether the stock market is overvalued: Comparison between them all

-easy to compare P/E to CAPE to CAPER: P/E is very simple and helpful, CAPE is more comprehensive and has tended to be more accurate in predicting whether the market is overvalued -CAPER is superior to CAPE because it adds depth in both duration and dimensionality -However, one could argues that going back too far in a time-series regression may cloud the data since historical returns do not always match up with the current return trends because of the ever-changing economic atmosphere -Tobin's average Q is the least like the others because it uses a completely different metric for valuation, but has emerged as by far the most important of the above four predictors. Very accurate predictor of whether the market is overvalued

What is fundamental indexation?

-in contrast with normal indexation (weighting an index based on market cap) -fundamental indexation selects stocks and weighing based on a particular fundamental metric (low P/E, high book/price ratio, etc.) -fundamentally weighted index in which each stock is weighted by some measure of a firm's fundamental financial data (dividends, earnings, cash flows, book value, instead of the market capitalization of its stock) -assume earnings are chosen as the measure of firm value -E represents the total dollar earning of the stocks chosen for the index -Ej is the earnings of a particular firm j -the weight given to firm j in the fundamental index is Ej/E (share of total earnings rather than its share of the market value as done in capitalization-weighted indexes) -if a stock price rises but the fundamental, such as earnings, does not, then shares are sold until the value of the stock in the index is brought down to the original levels

What policies should the US follow to be sure the age wave does not drown the stock market?

-keep the retirement age up -> increase from 62 to 77 by the middle of this century -keep productivity of those who are not retired up -> better education and health and incentives -keep savings up -keep investment abroad high - foreign assets can be sold off in exchange for goods by retirees -our saving grace is our increase in efficiency: stock market need not crash if productivity if high

What are closed end mutual funds?

-manager buys a bunch of stocks or bonds and creates a claim to them called a closed-end mutual end -number of shares is fixed, but price of share varies and is determined by the market -typically, the fund initially sells at the price of the underlying stocks, but subsequently falls (it is not wise to buy one when its first issued) -this is because eventually the owner gets tired of the high expense ratios

Lesson for policy makers of great financial crisis of 2008 (Siegel)

-monitor the balance sheets of financial institutions more critically (the buildup of risky mortgage-related securities) since house price inflation poses a threat to the economy -warn the public of the increasing risks posed by the unprecedented rise is housing prices -understand that all matters impacting the stability of the financial sector are the responsibility of the Fed, whether they originate in banks or not

64. What is your favorite take away from Swedroe & Grogan: "Your Complete Guide to a Successful and Secure Retirement"

-monte carlo simulation: A Monte Carlo simulation is a method of testing an outcome over a range of possible variables. It can be something like a stress test for your financial future. Monte Carlo simulations are used in retirement planning to predict the likelihood that you will have a particular level of retirement income through life expectancy. -The simulation tests the outcome over possible combinations of portfolio returns considering certain variables. You can change spending, inflation, your time horizon, and your annual withdrawals and see how that affects your likelihood of success. -why important to retirement plan: Monte Carlo simulations test your outcomes over a wide combination of possible market returns, and they typically deliver an answer in terms of your probability of success. The goal in retirement is to have a high probability of success—which is a slightly different goal than that of a younger person who wants to accumulate wealth and assets.

Compare the following measure of whether the stock market is overvalued: Tobin's Q

-ratio between a firm (or the market's) total market value and its total asset value -aims to relate a firm's market value to its asset value -hypothesis: the two should be around the same

Define the following: the arithmetic average annual rate of return

-straight up mean

What is survivorship bias, and how can it mislead investors?

-survivorship bias is the idea that investors only look at fund returns that have survived and do not consider the funds that have been dead for a period of time -the funds that survive are obviously the funds with more success, so an investor is only looking at the cream of the crop and therefore can be misled by thinking a firm is more successful than it actually is

Will the age wave drown the stock market?

-trend of increasing life expectancy and falling retirement age cannot continue -yes, the age wave will drown down the stock market -buyers are savers/workers who consume less than they earn, using the money to accumulate assets they can sell in their retirement -sellers are retirees who need to generate funds to consume during the period when they do not earn income from working -baby-boomer generation retiring -> increase in number of sellers over buyers -as all of these people sell their assets, the value of the assets will fall, which will drown the stock market if emerging markets do not grow at a pace to offset the sell-off from the baby-boomers

Compare the following measure of whether the stock market is overvalued: CAPER

-variant to the CAPE -takes trend earnings calculated by regressions of log earnings on time -similar to the CAPe because it softens outliers by using a time-series, but goes back even further than a CAPE due to the time-series regression formula is employs