FIN 108 Final Exam

Market Cap

# of Shares X Share Price the total value of a corporation's shares; based on the corporation's current earnings

Stock Returns

% Stock Return = % dividend yield + % price change

Roth Style 401k/IRA

(Roth was a Senator from Delaware):a--The contributions are not subtracted from salary before calculating the tax on that salary.b--The account grows free of taxes until withdrawals are taken.c--Withdrawals after age 59.5 are not taxed as income. -If the employer's plan allows it, you can withdraw your own contributions without tax or penalty but not the extra amount if positive returns were earned.

Probate

A legal process for distributing assets after death. It only applies to assets not distributed by title or beneficiary designation or put into a TRUST.

What is 'Money Market Account'

A money market account is an interest-bearing account that typically pays a higher interest rate than a savings account, and which provides the account holder with limited check-writing ability. A money market account thus offers the account holder benefits typical of both savings and checking accounts. This type of account is likely to require a higher balance than a savings account and is Federal Deposit Insurance Corporation (FDIC) insured. Money market investments are short-term (less than 1-year) and can be liqidated for cash very easily. Examples of these investments include T-Bills and bank CD's maturing in less than 1-year.

Index Fund

A mutual fund invested in only the firms of a specific index. An S&P500 fund is invested in only the 500 firms in the index and in the correct proportions. The fund will produce a return equal to the return the index indicates less the expenses of the mutual fund. a type of mutual fund with a portfolio constructed to match or track the components of a market index, such as the Standard & Poor's 500 Index (S&P 500). These funds do not attempt to pick stocks that will provide above average returns. They simply hold the stocks (or bonds) in a particular index.

Probate Assets

Assets distributed through the probate process. distributed by either a will, intestate laws in the state of residency, or a trust

Titling

Assets need legal specification as to the identification of the owner be it a car, home, bank account, 401k account, or whatever. (the word "titling" is created by taking the word "title" meaning a document showing ownership and adding -ing to it.)

Exchange Traded Funds (ETF)

An ETF holds a portfolio of stocks or bonds (usually the stocks correspond to some INDEX).Shares of the ETF are held by small investors (maybe inside either an IRA account or a 401K account). If an investor wants to buy or sell ETF shares, he/she buys them from other investors who want to sell or buy their shares.a) This is different from mutual funds where you deal directly with the fund family (either online or with employees) when you want to buy or sell mutual fund shares.b) Since you buy from or sell to other investors, ETF investors can buy or sell ETF shares 24 hours a day unlike mutual funds where you buy or sell at the next 4:00 P.M. closing price. (see pic of Q&A about these) An opinion: ETFs offer more flexibility for getting into or out of a stock position but this added flexibility can get an average investor into trouble with too much buying and selling since small trading costs are involved.

Transferability

Ownership of shares in large publicly-traded companies can be bought or sold very easily. For Print Everything, Inc. (see above), a stipulation in the corporate charter prevented shares from being sold.

S&P Completion Index

-Intermediate Cap (the U.S. firms ranking in market cap between 501 and 5000) The S&P500 is pretty much the 500 largest U.S. companies by market cap. The S&P COMPLETION Index is the next 4,500 companies ranked by market cap and this index is also a VALUE-Weighted index.The S@P500 is called a "large cap" index b/c market cap is high.The S@P COMPLETION index is called a "small cap index b/c these are smaller companies.If we look at the total market cap of the largest 5,000 firms:The top 500 represent 80% of total market capThe bottom 4,500 firms represent 20% of total market cap

Mutual Funds

-It is a corporation...shares are owned by investors -As an investor, mutual funds (and ETFs) are often the only reasonable choice.You can invest in a large number of firms cheaply.401k plans and IRAs often make mutual funds (and ETFs) the only choice. -Funds are organized into mutual fund families aka asset management companies.

S&P 500

-Large Cap fund (approximately the largest 500 U.S. firms by market cap) -a value-weighted index of approximately the 500 largest U.S. firms ranked by market cap. This index was arbitrarily set at TEN many years ago and the index is changed over time by the same percent as the percent change in the total market cap of all500 companies in the index. (see pic for calculation of return on this index)

401K Info

-Many corporations offer these for their employees - many plans are optional. Employers often match some fraction of the employee contribution (a 50% match means worker puts in $1 and employer puts in 0.50 cents). Corporations typically have a contract with a mutual fund family to manage the plan. -You cannot take money out until 59.5 years old without taking a penalty (exceptions sometimes include health, education, and first-time home-buying) -No matter which funds you select for your contributions, you typically can go online and move money from one fund to another OBSERVING THE 4:00 P.M. pricing convention. If you have access to ETFs, you may be able to transfer money instantaneously.

Front/Back Loads

-One-time mutual fund fees. Do you see much difference between a front load and backload? I don't.Loads typically involve payments to sales people who help you select the fund. Loads usually do not involve payments to those picking investments for the fund.

Roth vs Traditional

-Theorem (a little facetiousness): A traditional is best when your tax rate is lower when the money is withdrawn than the tax rate when the money is contributed and conversely. -Personal Opinion: Parents with a little money might think about giving their lower income adult children money for a Roth account. - For a traditional, the withdrawal is taxed as income. If the withdrawal does not qualify as hardship, there is a 10% penalty. For Roth, you can take your contributions out at any time free of taxes and free of any penalty. -Conclusion: A Roth IRA seems like a good place for an emergency fund. If you have an emergency, the money is available. If there is no emergency, you have the money in your retirement account.

Health Savings Account

-Who may have one: Only those with a HIGH DEDUCTIBLE health insurance plan as defined by the I.R.S. -What are they: They are very similar to a TRADITIONAL account. Money put in is tax deductible. Money taken out after retirement is taxable. There is one BIG EXCEPTION!! Money taken out for healthcare expenditures is NOT taxed. -They are just as good as traditional IRA's/401K's for retirement funding with the added option of being superior if used for medical expenditures.Maximum annual contribution is $3,350 for 2016 or over $6,700 for family.

Annual Mutual Fund Fees

-expressed as a percent of account balance Management fees pay for customer service such as account maintenance and answering of questions about accounts. Dividends and interest payments need added to the appropriate accounts, tax statements must be prepared, and a host of other clerical activities.Investment Advisor fees pay the fairly large salaries of peopled hired to pick stocks.12b-1 fees—when a backload is phased out over time, the annual 12b-1 fee is used to cover the sales commissions instead of the load itself.

Shareholder Rights

1. Voting Rights; 2. Right to share equally in any cash distributions to owners (e.g. dividends); 3. Limited liability; 4. Transferability

Trust

A trust is a legal arrangement typically constructed by lawyers in a law office, a bank (banks have trusts departments), a mutual fund family, a life insurance company, etc. Think of the trust as an account which can hold real estate, stocks, bonds, mutual funds, bank accounts, etc. A trust is managed by the trustee (law office, bank, fund family, life insurance co, etc.). The trustee must follow the instructions set forth in the trust arrangement such as:Use the funds in the trust to support an incapacitated person.Dole out money slowly so as to protect an irresponsible heir from running out of funds.Manage the funds for the support of minor children until they reach a specified age.

Active Management vs Passive Management (aka Indexing or using index funds)

Active management is the use of a human element, such as a single manager, co-managers or a team of managers, to actively manage a fund's portfolio. Active managers rely on analytical research, forecasts, and their own judgment and experience in making investment decisions on what securities to buy, hold and sell. The opposite of active management is passive management, better known as "indexing."

Certificate of Deposits (CD)

CDs are the easiest way to save if you don't need immediate access to your money. They usually pay you a higher interest rate than a traditional savings or money market account and, generally, the longer the term that you invest for, the higher the interest rate.

Right to share equally in any cash distributions to owners (e.g. dividends)

Cash distributions usually come from EARNINGS or PROFITS. Higher salaries mean less is available for dividends.If the shares in the printing company example above were distributed unequally, the controlling family could pay itself more in salary so that sharing equally in cash distributions becomes less meaningful. States have laws designed to protect minority shareholders but they are not very effective.

An increase in the interest rate of 1% leads to a 12% decrease in the value of the bond(s). A decrease in the interest rate of 1% leads to a 12% increase in the value of the bond(s). An increase in the interest rate of 0.5% leads to a 6% decrease in the value of the bond(s).

Duration relationship: If a bond (or bond portfolio) has a duration of 12, then

Limited liability

If the corporation harms anyone, the shareholders cannot be sued. For large corporations, investors who buy shares have limited liability. For smaller corporations, read this link about PIERCING THE CORPORATE VEIL.Don't serve on a board without DIRECTORS' INSURANCE for liability.A negligent employee or board member can usually be sued. For negligence.

More Indexing Info

Index funds typically have lower expense ratios because:i) They don't need to pay experts to select stocks.ii) Holding the stocks that comprise an index requires very little trading and trading increases costs.iii) Almost by definition, for index funds the following must hold:Gross alpha of index fund = -0-Net alpha of index fund = the negative of its expense ratioIndex funds might have an expense ratio between 0.05% and 0.25%.Actively managed funds might have an expense ratio between 0.50% and 1.5%.

interest rates rise = prices fall and yields rise interest rates fall = prices rise and yields fall

Interest Rates vs Yields and Prices

Intestate Laws

Intestate means to have died without a will. States prescribe through intestate laws how assets are to be distributed when there is no will. Pennsylvania law is typical. In PA, the spouse receives the first $30,000 plus half the remainder. Children split the other half evenly. There are lots of other possibilities such as no spouse but children, no spouse and no children but living parents, etc. Most possibilities are specified in a state's intestate laws

Investment in Target Date Funds

It says investors just need to invest in one of these target date funds and stop looking for those elusive extraordinary investments. Everyone can obtain investment results without much effort or knowledge that are as good as what experts get. (Warren Buffet told LeBron James to stick with an index fund rather than investing in stock picking or real estate, etc.)

Net Return

It's the return actually earned by investors AFTER annual expenses are deducted. Net Return = Gross Return - Expense Ratio

Gross Return

It's the return earned by a mutual fund BEFORE annual expenses are deducted.

Why an emergency fund is necessary

Job loss.—This speaks for itselfMedical or dental emergency. Remember that even with good health insurance, there are deductibles and co-insurance needs. Check out the annual out-of-pocket maximum for your health insurance policy.Unexpected home repairs.Car troubles.Unplanned travel expenses. You won't be taking many vacations during a financial emergency but think of friends or relatives with illnesses or worse. The link above at Vanguard recommends the following budgeting priority list IN THIS ORDER for those just beginning their careers:Save for RetirementPay Off Debt (consumer debt and student loans)Start an Emergency Fund (see pic for professor's priority rankings)

longer-term bonds see their prices change by a larger percentage than shorter-term bonds when interest rates change Investing in long-term bonds is risky b/c you might need to sell them early and if interest rates increase dramatically, the price at which you must sell these bonds will be very low. You might even have less than when you started. Investing in 3-month T-Bills is risky b/c if interest rates fall, you will need to reinvest your payments at new interest rates that are much lower than you were expecting. So what's a person to do? Put a little money in short-term and a little in long-term.

Longer-term bonds vs shorter-term bonds

Beneficiary Designation

Many contractual arrangements ask for a beneficiary designation. Examples include 401K accounts, IRAs, and life insurance policies (individual or group insurance from your employer). Typically, the owner is asked to designate a primary and contingent beneficiary:

How much should be in your emergency fund? Where should you hold the money?

Most sources indicate you need 3-6 months of living expenses (i.e. necessities). Professor says your first choice should be a ROTH IRA!! This is a somewhat uncommon recommendation so BEWARE!! You would still need to select investment choices within the Roth IRA

Actively-Managed Funds vs Indexing

Most unbiased financial advisors recommend indexing. Another disadvantage of actively managed funds is that in the pursuit of undervalued stocks, the experts might invest heavily in a narrow sector like technology or pharmaceuticals and thereby reduce the diversification level of your investment. Target date index funds are designed to steer investors towards a set of index funds that provide "proper diversification and risk/return tradeoffs" according to the experts who have designed them. If you invest in a specific target date fund, as you get older that fund will shift its allocation more towards bonds and less towards stock.

NAV (Net Asset Value)

NAV = Market Value of portfolio/# of mutual fund shares

Joint Tenants with Right of Survivorship (JTWROS)

Often, spouses title their checking and savings accounts this way. Each party is an owner with all the rights accorded an owner. If one person dies, the other automatically assumes ownership. Houses and cars can be titled this way too.

Retirement Account Balance Goals

Opinion: If you focus on yourself and your financial needs while hoping to eventually lead a life of leisure, many would judge you as leading a life of questionable moral purpose. Your instructor is one of those people!! However, wealth-building can be motivated by wanting to lead a good life in all of its dimensions including helping others and financing enterprising activities of your own. Please don't take a narrow view (or do I mean "dim view") of RETIREMENT PLANNING. Retirement calculators: The web is full of retirement calculators. We'll look at CNN's and then do our own arithmetic. The calculator assumes an investment return of 6% a year and I think this is a REAL return. Make sure to ask the calculator for a target account balance based on 2018 dollars.

Small Cap Fund

Russell 2000 - approximately the U.S. firms ranking in market cap between 1,001 and 3,000.

SEE INDEX CARD PICTURE

SEE INDEX CARD PICTURE

IRA vs 401K

The 'I' in IRA stands for INDIVIDUAL. The individual makes all decisions as to where the account will be opened. A 401K is EMPLOYER INITIATED and the employer decides upon a plan administrator (sometimes more than one administrator.The money in the account can then be ALLOCATED into various investments selected by the owner of the account....the investor.

More Index Funds

The U.S. Total Stock Market Index—all U.S. stocks represented by their market cap The Vanguard Total International Stock Index fund invests in an index designed to represent the stocks in the rest of the world (outside the U.S). Each firm is represented in proportion to its value or market cap.

Expense Ratio

The annual percent of account balance deducted from your account to cover expenses.

State/county/city Fixed Income Investments

free of federal taxes making this a good deal only for those in highest tax brackets. These are called either tax-exempts or municipals (muni's)Corporates are taxable and offer the threat of default if the firm fails. Opinion: Until you are super high income, avoid tax-exempts. Avoid corporates b/c your returns are sensitive to the performance of the firm issuing them and you will likely already be invested in the stock of that company.

Rebalancing

You invest in a target date fund and the U.S. stock market rises 25%. Does this change the allocation between stocks and bonds in these target date funds?Quick Answer: No....Vanguard quickly sells off some stocks and buys bonds to bring back the desired percentages of stocks and bonds. This is called _

Fixed Income Securities

They promise a fixed (or contractual) number of dollars at specific dates in the future. They have names like Treasury bills, Treasury bonds, Corporate bonds, Bank CD's (certificates of deposit); our federal government will sell these directly to you; your employer's retirement plan will help you find bond investments as well as stock brokers/financial advisors (for a fee)

Sole Owner

This form of ownership does NOT provide directions for transfer of the asset upon the owner's death. Sometimes, a beneficiary can be specified on the ownership document or a payable on death (POD) feature can be added. Federal law requires banks to offer to append either a beneficiary designation or POD to an account if requested by the account owner.

Expense Ratio

This is stated as a percentage and represents the fraction of your balance that is deducted from your account to cover the operating expenses of the fund. These expenses include salaries for fund managers, software designers, and people who answer the phone to help with questions. The average expense ratio is 1.25% but larger funds tend to have lower amounts. If we calculate a weighted average based on fund size, the average dollar is subject to a 0.75% expense ratio. It seems to me that the expense ratio is divided by 365 days in a year and the expense deduction is taken daily. The expense ratio is always stated as an annual percent.

Contingent Beneficiary

This person(s) becomes owner if the primary beneficiary has died before the original owner. Most typically, children are designated contingent beneficiaries and will inherit the asset if the primary beneficiary has died. You must specify the percentage for each child.

Primary Beneficiary

This person(s) becomes owner upon death. Most typically, a spouse is designated primary beneficiary.

Risk In Investing

Usually defined as "dispersion" of future returns.Stock A has an expected return of 10% but it could be as low as -5% or as high as 25%Stock B has an expected return of 10% but it could be as low as -25% or as high as 45%B's return possibilities are more DISPERSED.

Important Concept

We control the risk level (and average return) of our investment portfolio by spreading our investment money between or among investments with different levels of risk

Standard Deviation

a measure of dispersion of future returns; the bigger this is, the riskier the investment position Other things equal, an investment with a lower standard deviation has less chance of a really low return----and less chance of a really high return.Standard financial planning assumes that when all else is equal (i.e. expected return is the same for all choices), investors prefer lower standard deviation thereby giving up the opportunity for really high returns.Diversification is for weenies afraid of taking chances---- like me!

Cash Dividends

a payment many corporations distributes to shareholders every year; these and earnings are often expressed as a "per share" number simply by dividing the totals by the number of shares. When corporations pay these, share price falls by the amount of the _

EAFE Index

a value-weighted index of the firms in the rest of the world (Europe, Asia, Far East)

How Mutual Funds Work

a) Funds sell newly created shares to investors.b) Funds use the money from selling mutual fund shares buy stocks and/or bonds.c) As the value of the fund's portfolio changes, the value of the mutual fund shares changes.d) Funds issue NEW shares for new investors and BUY BACK shares when investors want to take back their money. The price for these transactions is called NAV.If you want to buy shares of any corporation (Apple, Intel, Exxon, Walmart), you buy those shares from another investor who wants to sell his/her shares and you sell shares to some other investors. It's different with mutual funds. You buy and sell directly with the fund.e) NAV (aka net asset value) is Market Value of portfolio / # mutual fund shares f) NAV is calculated at 4:00 P.M. Wall Street Time every business day using closing prices

Traditional 401k/IRA

a--Contributions are subtracted from salary before taxes are calculated on the remainder. In nerd-speak: Contributions are tax-deductible.b--The account grows free of taxes until withdrawals are taken after the age of 59.5.c--Withdrawals after age 59.5 are taxed as income (just like salary) and you must withdraw a minimum amount (as specified by the I.R.S.) after the age of 70.5 years. -At a minimum, the amount withdrawn is taxed as income. If that amount doesn't qualify for some sort of "hardship exemption", there will likely be a 10% penalty imposed too.

Back Load (a mutual fund fee)

e.g. Suppose a fund charges a back load of 5%. When you invest $10,000 your initial account balance is $10,000. In a few years suppose your balance grows to $11,000. You decide to take your money out of the fund but the fund keeps 5% of $11,000 or $550. Backloads are often phased out over time but an annual fee (called a 12b-1 fee) is charged. For example, a backload might be 5% if you take your money back during the first year. This 5% might fall to 4% for 2nd year withdrawals and then 3% for 3rd year withdrawals until after 5 years there is no backload. However, if you are charged an extra 1% of your balance every year for 5 years, you essentially paid the backload of 5% with the 1% per year for 5 years.

Front Load (a mutual fund fee)

e.g. Suppose a fund charges a front load of 5%. When you invest $10,000 your initial account balance will be $9,500.

Federal Fixed Income Investments

considered free of default risk because our federal government can print money

Earnings Per Share (EPS)

divide the totals by the number of shares

Federal Estate Taxes

due on every dollar of your estate in excess of about $5.5million (single) or $11million (married) and you will likely need legal expertise to determine if these taxes can be avoided.

P-E Ratio

equal to Share Price/EPS this is affected by expected earnings growth and whether current earnings are unusually high or low

Actively-Managed Funds

i) The average actively managed fund falls short of its benchmark by its expense ratio. Using ALPHA as a measure:Average Gross Alpha (using gross returns) = -0-Average Net Alpha (using net returns) = -average expense ratioii) Why not just pick an above-average fund? The previous result is about 'averages' meaning some funds are better than average and some funds are worse than average. Turns out that being better than average over one time span is no reason to expect that fund to be above average over the next time span. If you pick a fund that has done well in the past, your best guess is to how it will do in the future is that it will be an average fund. There is no PERSISTENCE of fund performance!

Determines the value of a share

investor beliefs and expectations about future earnings

401K choices when changing jobs

leave it with your former employer if your balance is high enough, rollover your previous account to your new employer's plan, or rollover your previous account to the best IRA provider you can identify A provider to provider rollover of your account balance to an IRA is your best bet. More choices and more personal control are available with your own IRA. This option includes subsequently moving your IRA to yet another provider (provider to provider rollover of course) if you are dis-satisfied with your original choice.A caveat: The opinion above now leaves you with TWO accounts to manage.having two smaller accounts might not be optimal when compared to a single large account

Flow Chart for how to deal with all assets of the deceased

see picture for this

Investment arithmetic and weighted averages

see picture with this information and example problems

Stock Indexes

their purpose is to give a general indication of how the market did over the last 24 hours, or the last month or last year or whatever. Dow Jones Industrial Average is a very famous and popular example (General Electric is the only remaining company out of the original 30). Higher priced shares are more important to determining changes in this index

Mutual Fund Performance

this is measured by alpha If a fund has an average return of 8% and an index of comparable risk (often called a benchmark) has an average return of 6%, we say this fund has an alpha of +2%. A fund with an average return that falls short of its benchmark is said to have a negative alpha.Gross alpha uses gross returnsNet alpha uses net returnsInvestors care about NET ALPHASuppose a mutual fund produces a gross return that is 1% higher than its benchmark (gross alpha = 1%) but charges an expense ratio of 2%. Then: Gross Alpha = +1%Net Alpha = -1%

Voting rights

used to elect a board and vote on some MAJOR issues such as merger

Estate Planning

what happens to a person's belongings or assets) upon death.