Final Study

Demand vs Supply shocks

Demand: lower taxes and int. rates Supply: oil prices rising, wage rate changing, running out or having excess stuff

A mutual fund with a beta of 1.1 has outperformed the S&P 500 over the last 20 years. We know that this mutual fund manager?

May or may not have outperformed the S&P 500 on a risk-adjusted basis

What is economic value?

Measure of dollar value of firm's return in excess of opportunity cost, also known as residual income, spread between ROA and cost of capital x capital invested in firm

Choosing stocks by searching for predictable patterns in stock prices is called?

Technical analysis

A what insurance policy provides death benefits, with no buildup of cash value?

Term Life

Asset allocation refers to?

The allocation of the investment portfolio across broad asset classes

Defensive Industries

soft goods, less tied to the economy and include things like food and gas

Underwriting is one of the services provided by?

Investment Bankers

William Sharpe found out what?

> 90% of variation in return could be explained by the funds allocation to a broader range of asset classes

Which kind of firm has below-average sensitivity to the state of the economy?

A defensive firm

What is defensive stock?

A defensive stock is a stock that provides a constant dividend and stable earnings regardless of the state of the overall stock market: Kraft, Reynolds, Snyders, Sysco, food ones kind of.

Who do you put first when working as an investor? (loyalty)

Customer, firm, then you

My pension plan will pay me a yearly retirement amount equal to 2% of my highest annual salary for each year of service. I must have?

A defined benefit plan.

A stock's alpha measures what?

Abnormal return

How to decompose overall performance into components:

1. Determine specific portfolio choices 2. Broad asset allocation among types of securities 3. Industry weighting in equity portfolio 4. Security choice 5. Timing

Business cycles last for how long?

7-10 years

Implications of a stock's value?

A larger dividend per share, lower market capitalization rate, k, and higher expected growth rate of dividends

If an investor wants to invest 100% of her portfolio in safe assets but does not want to manage her portfolio, she should invest in?

A money market fund and NOT a growth stock fund, several different stocks, or several different money market instruments.

Proponents of the EMH typically advocate?

A passive investment strategy

What kind of investor are you if you invest in the Efficient Market Hypothesis (EMH)?

A passive investor.

If an individual confers legal title to property to another person or institution to mange the property on their behalf, the individual has created?

A personal trust

Intrinsic value is what?

A present value of firm's expected future net cash flows discounted by required RoR.

A portfolio consists of three index funds: an equity index, a bond index, and an international index. The portfolio manager changes the weights periodically according to forecasts for each sector. This is an example of?

Active asset allocation with passive security selection.

Treynor model is used to look at what?

Am I using my beta efficiently? Am I getting enough excess return compared to my beta?

Assumed that a company announces unexpectedly high earnings in a particular quarter, in an efficient market, one might expect?

An abnormal price change immediately after the announcement

A technical analysis is most likely to be affiliated with what kind of investment philosophy?

An active management....while passive management would belong to a fundamental analysis.

The PV of a firm's projected cash flows are $15m. The break-up value of the firm if you werer to sell all the major assets and divisions separately would be $20m. This is an example of what Peter Lynch would call?

An asset play.

If a mutual fund wants to track or be a market segmentation indicator for the S&P 500 for example, what is it?

An index fund

Positive alphas are considered what in a capital asset pricing model?

An underpriced security.

What measure of returns ignores compounding?

Arithmetic Average

What decision should take precedence over another decision?

Asset allocation over stock selection

Which of the following industries would most analysts classify as mature?

Auto manufacturing (not internet service providers, biotechnology, or wireless communication)

What are some lagging indicators?

Average duration of unemployment, ratio of trade inventories to sales, change in index of labor cost per unit of output, average prime rate charged by banks, commercial and industrial loans outstanding, credit outstanding to personal income, and change in consumer price index for services

Which of the following performance measures is the Sharpe ratio?

Average excess return to standard deviation ratio

Sharpe ratio vs. beta

Beta is risk and is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. Beta is used in the capital asset pricing model (CAPM), which calculates the expected return of an asset based on its beta and expected market returns. The Sharpe ratio is the slope of the CAPM line, and a measure that indicates the average return minus the risk-free return divided by the standard deviation of return on an investment.

Where would an illiquid security in a developing country most likely trade?

Broker markets

How can you manage an income statement?

By smoothing earnings. This helps people invest because they want to see steady numbers and not extreme fluctuations.

Which one of the following is the ratio of actual output from factories to potential output from factories?

Capacity utilization rate

Which of the following is not a money market security: U.S. Treasury bills, 6-month maturity CD, common stock, banker's acceptance?

Common Stock

Real assets in the economy include all but which of the following: land, building, customer durables, common stock?

Common stock

At what point in the industry life cycle are inefficiencies in competitors most likely to be removed?

Consolidation Stage

In a defined contribution pension plan, the what bears all of the fund's investment performance risk?

Employee

In a defined benefit pension plan, the what bears all of the fund's investment performance risk?

Employer

What happens when you combine P/E analysis and the DDM?

Estimate stock price at horizon date

Two portfolio managers use different procedures to estimate alpha. One uses a single index model regression, the other the Fama-French model. Would you prefer the portfolio with the larger alpha based on the index of FF model?

FF model because research shows that passive investments will appear to have a zero alpha when evaluated using the multi-index model but not using the single-index one. A single-index alpha can be misleading.

Which of the following stocks represents industries with below-average sensitivity to the state of the economy?

Food and beverage

You are considering investing in one of several mutual funds. All the funds under consideration have various combos of front-end and back-end loads and/or 12b-1 fees. The longer you plan on remaining in the fund you choose, the more likely you will prefer a fund with a what rather than a what, everything else equal?

Front-end load; 12b-1 fee

What is fundamental analysis?

Fundamental analysis is a method of evaluating a security in an attempt to measure its intrinsic value, by examining related economic, financial and other qualitative and quantitative factors.

Fundamental analysis?

Fundamental analysts try to determine a company's value by looking at its income statement, balance sheet, and cash flow statement. In financial terms, the analyst tries to measure a company's intrinsic value by discounting the value of future projected cash flows to a net present value. Big use of financial sheets.

The market value of all final goods and services produced during a given time period is called?

GDP

Which measures time-weighted returns and allows for compounding?

Geometric Average return

To what means to mitigate a financial risk?

Hedge

Do you want a stock with a high or low alpha?

High

In securities markets, there should be a risk-return trade-off with higher-risk assets having what kind of expected returns than lower-risk assets?

Higher

Negative correlation in a portfolio means what?

If an investor is able to find an investment class that moves opposite to another set of assets he is holding, he can invest in both to stabilize his portfolio and you are able to balance from volatility. -1 means perfect negative correlation and variable increases as the other decreases.

If current ratio is 2 and company uses cash to retire notes payable due within one year, would this increase or decrease the current ratio and asset turnover ratio?

Increase both

A mutual fund that attempts to hold quantities of shares in proportion to their representation in the market is called a what fund?

Index fund

Difference between purchasing power and inflation?

Inflation-decreases the amount of goods or services you would be able to purchase because general prices of goods are rising and opposite for when prices are decreasing (deflation) Purchasing power- the value of a currency expressed in terms of the amount of goods or services you would be able to purchase

For a bank, the difference between the interest rate charged to borrowers and the interest rate paid on liabilities is called the?

Interest rate spread

Cash flows from investing activities excludes: cash paid for acquisitions, cash received from the sale of fixed assets, inventory increases due to a new internally developed product line, all of the above?

Inventory increases due....

What is the Treynor black model?

It is the ratio of portfolio excess return to beta and used to evaluate a portfolio that is part of a larger portfolio with different managers The model tries to determine the optimal combination of passively and actively managed assets in an investment portfolio.When determining the optimal allocation of assets, the model focuses primarily on securities' systematic and unsystematic risk. It focuses more on unsystematic risk and less on beta.

A stock with a positive alpha means what? Do you want to buy it?

It is underpriced and yes you want to buy it according to CAPM.

The yield curve spread between the 10-year T-bond yield and the federal funds rate is a what economic indicator?

Leading

Higher profit margins tend to have what kind of turnover?

Less turnover

The asset universe is the?

List of assets approved by the investment committee that may be placed into the investment company's portfolio

The right to buy an asset at a specified price?

Long call

The right to sell an asset at a specified price?

Long put

An increase in the value of the yen against the U.S. dollar can cause the Japanese automaker Toyota to either what on U.S. sales?

Lose market share or reduce its profit margin

How can the Fed boost the economy?

Lower interest rates and by buying bonds to put more money in the system.

What is liquidation value?

Lower than market value bc the seller is in dire need to rid of the item, what you can sell the company for or pieces of a company for, it is the net amount realized by selling assets of firm and paying off debt

What kinds of industries are more or less sensitive to the economy?

Luxury, materials, industrials, and engery are sensitive but utilities, consumer staples, health care, financials, technology, and food are not.

Beta is a measure of security responsiveness to?

Market risk

The risk that a downturn in the market may substantially reduce your investment principal is called?

Market risk

If you are moving assets based on macroeconomics, what are you looking at?

Market timing

Net asset value is defined as?

Market value of assets minus liabilities divided by shares outstanding: (MV of assets-Lia)/shares outstanding

Random price movements indicate that?

Markets are functioning efficiently

Cash cows are typically found in the what stage of the industry life cycle?

Maturity

What is consistent with a steeply upwardly sloping yield curve?

Monetary policy is expansive and fiscal policy is expansive.

Diversification is most effective when security returns are?

Negatively correlated

The primary measurement unit used for assessing the value of one's sake in an investment company is?

Net asset value

Endowment funds are held by?

Nonprofit institutions

The most widely used monetary policy tool is what?

Open market operations

What does the Fed usually use for monetary policy?

Open market operations: Open market operations (OMO) refers to the buying and selling of government securities in the open market in order to expand or contract the amount of money in the banking system, facilitated by the Federal Reserve (Fed).

An investor's degree of risk aversion will determine his or her?

Optimal mix of the risk-free asset and risky asset

What kind of portfolio management calls for holding diversified portfolios without spending effort or resources attempting to improve investment performance through security analysis?

Passive

Someone who invests in the Vangaurd Index 500 mutual fund could most accurately be described as using which approach?

Passive investment

When stock returns exhibit positive serial correlations, this means that what returns tend to follow what returns?

Positive returns follow positive returns

What are used for intrinsic value?

Present value and cash flows

Market anomaly refers to what?

Price behavior that differs form the behavior predicted by the efficient market hypothesis.

A market order has?

Price uncertainty but not execution uncertainty.

An official description of a particular mutual fund's planned investment policy can be found in the fund's?

Prospectus

The possibility that you are too conservative and your money doesn't grow fast enough to keep pace with inflation is called?

Purchasing power risk

What formulas are more important than sales?

ROE and ROA

The two most important factors in describing an individual's or organizations's investment objectives are?

Return requirement and risk tolerance.

Specialized-sector funds concentrate their investments in?

Securities issued by firms in a particular industry.

If you believe the economy is about to go in a recession, you might change your asset allocation by selling what and buying what?

Selling growth stocks and buying long-term bonds

What is sector rotation?

Shifting portfolio into industry sectors expected to outperform others based on macroeconomic forecasts

The obligation to sell an asset at a specified price?

Short call

The obligation to buy an asset at a specified price?

Short put

Reward to volatility ratio is given by?

Slope of the capital allocation line

Highest average historical standard deviation to lowest?

Small stocks, large stocks, long term bonds, and t-bills

Industry Life Cycle

Start-up, consolidation, maturity, and relative decline, buy in start-up before comp. arises in consolidation

What are some leading indicators of a business cycle?

Stock market, yield curve between 10-year bond and federal funds rate, S&P, avg. weekly hours of production workers, initial claims for unemployment insurance, new orders, new private housing units authorized by local building permits, money supply growth rate, index of consumers expectations

If an investor places a what order, the stock will be sold if its price falls to the stipulated level. If an investor places a what order, the stock will be bought if its price rises above the stipulated level.

Stop-loss; stop-buy

According to what economists, the growth of the U.S. economy in the 1980's can be attributed to lower marginal tax rates which improved the incentives for people to work?

Supply-side

High interest rates reduce what?

The present value of future cash flows and it makes it hard for companies to grow

The complete portfolio refers to the investments in?

The risk free asset and risky portfolio combined

Which of the following correctly describes a repurchase agreement?

The sale of a security with a commitment to repurchase the same security at a specific future date and a designated price.

The optimal risk portfolio can be identified by finding?

The tangency point of the capital market line and the efficient frontier and the line with the steepest slope that connects the risk-free rate to the efficient frontier.

The correlation between two assets equals?

Their covariance divided by the product of their standard deviations

When do you use Fama-French model?

To estimate alpha and establish expected return

Why do investors use fundamental analysis?

To try and find mispriced stock.

What is a peak?

Transition from end of expansion to start of contraction

What is a trough?

Transition point between recession and recovery.

Which one of the following would be considered a "cash equivalent" instrument?

Treasury bills

Which one of the following would be considered a "cash equivalent" investment?

Treasury bills

A top-down analysis of a firm's prospects starts with an analysis of the?

U.S. economy/global economy

In a well-diversified portfolio, what risk is negligible?

Unsystematic

On the efficient frontier, you want more risk with more returns. This is located in what section?

Up and left or northwest portion of the graph

The part of a stock's return that is systematic is a function of which of the following variables?

Volatility in excess returns of the stock market and the sensitivity of the stock's returns to changes in the stock market

Technical analysis?

Watching prices. Look at charts-Technical analysts believe that there's no reason to analyze a company's financial statements since the stock price already includes all relevant information. Instead, the analyst focuses on analyzing the stock chart itself for hints into where the price may be headed.

What is an economic calendar?

What you live and die on if you are on a trading desk.

P/E ratio and earnings yield in S&P 500

When earning yield goes down, P/E ratio goes up

The finance committee of an endowment has decided to shift part of its investment in an index fund to one of two porfessionally managed portfolios. Upon examination of past performance, a committee member proposes to choose the portfolio that achieved a greater alpha value. Could a positive alpha be associated with inferior performance?

Yes, but Sharpe measure declines

If you diversify a portfolio, what are you doing? What kind of risk do I still have and do I have left?

You have systemic risk but you don't have unsystematic risk. You should spread among different investment vehicles like stocks, bond, mutual or index funds, cash, etc., securities should vary in risk and in industry, minimizing unsystematic risk to small groups of companies. And buy 10-12 stocks for optimal diversification.

What is the top-down analysis?

You look at macroeconomic factors first, then once you get your macroeconomic opinion, do a sector rotation.

Quality of earnings?

allowance for bad debt, nonrecurring items, earnings smoothing, revenue recognition, off balance sheet assets and liabilities

High P/E ratios?

application software, security software, home improvement, restaurants, home improvement, cable TV, data storage, and pharmaceuticals

In the context of the capital asset pricing model, the systematic measure of risk is captured by?

beta

Alpha

buy when positive and short it if it's negative

Economic earnings vs accounting earnings

economic is projected numbers and accounting is more historical (what we use)

Cyclical Industries

include more durable goods like cars and appliances, sensitive to the economy but last more than 3 years

Leading indicators vs lagging indicators movements

leading goes down in recessions and lagging goes up in peaks

The possibility of arbitrage arises when

mispricing among securities creates opportunities for riskless profits

The market risk premium is defined as

the difference between the return on the risky asset with the lowest returns and the return on t-bills

Fair value accounting?

use of current market values rather than historic costs in firm's financial statements and it relies heavily on estimates but good to look at because you can see what it was worth today and not what it was worth years ago

When ROA > cost of capital?

you get a good EVA (economic value asset) and <, you get a negative EVA