Investments Exam 2

Misstatement of Material Facts

"Self cooling beverage can" : promise is too good to be true but investors put in money and they take the money and run Equity Funding: EF started selling life insurance policies where cash value build up was tied to performance of the stock market, when growth rate of new policies started to decline EF made fake policyholders using computer simulations to have them die faster than normal so the death benefits were sufficient to cover premiums until they were caught Bre-X Mining: core assays of mineral findings were seeded costing investors money by claiming to have found world's largest gold deposit Emulex Corp: college kid filed a fake news report of plane crash with Emulex executives causing stock to drop in order to sell short and but them

Open-End Investment Companies

(aka mutual funds) the number of shares outstanding can increase indefinitely secondary shares are provided by the investment company issues and redeems shares a NAV based on market on close prices

Hedge Fund (Indirect Investment Vehicles)

-pooled investment vehicles that sell shares of a professionally-managed portfolio -private entities typically organized as limited partnerships --general partner commits capital, makes investment and trading decisions and runs it -limitied partners incest funds and are only liable to the extent of their investment

Owning a Bond Fund Rather than Individual Bonds

1. Bond funds own a portfolio of bonds and the interest income will change over time contrasting with fixed income of individual bonds 2. Bond fund has no fixed maturity 3. No YTM since there is no maturity date 4. Bond funds make monthly distributions as opposed to semiannual interest payments

Advantages of ETF's

1. Can be traded at any time during trading day 2. can be sold short even on a down tick and using specialized orders and purchased on margin 3. Listed options are available for many 4. lower expense ratios 5. tax efficient (when the investment company suffers net redemptions it does like kind echoes with brokerage firms or institutional investors exchanging baskets of stock from its portfolio for its own shares 6. trade very close to NAV

What do investment companies offer investors

1. Diversification 2. Professional management (may not consistently outperform the market but can choose from funds offering a variety of objectives (FOR MUTUAL FUNDS) 3. liquidity and divisibility of shares 4. Record Keepings 5. Services (accumulation, automatic deposit and withdrawal plan, fund exchanges and swaps

Unsystematic Risk - Unique to Firm Risk

1. Financial Risk - Uncertainty as to whether the firm will earn sufficient funds to services its outstanding debts and to justify its borrowings and uses debt financing 2. Managerial risk - quality of management as conjured to competitors and as related to the competitive position the firm finds itself in currently 3. Fraud - investor should investigate all investment opportunities carefully, particularly any that seem to good to be true

Ethical considerations in securities market

1. Financial analysts are required to exercise independent judgement 2. Investors CANNOT trade on insider information 3. Commission brokers: cannot overtrade or churn client's accounts to earn more commission nor choose a product that will earn them more commission- must choose product in best consideration for client, and must clear conflict between investor's interest and issuer's interest in terms of pricing and both are clients of the firm 4. Investment advisors cannot double dip in advisory fees and commission

Weak Form Anomalies

1. Market overreaction: extreme loser outperforms extreme winners for following 18 months 2. January effect- on average a large portion of the typical stock's annual return is earned in the month of january, and are on average 5x higher than average monthly returns across the entire year 3. Weekend effect- on average stock lose value on Mondays during the first two hours of trading

Total Risk Components

1. Unsystematic Risk - of any security can be neutralized by including that security in a well diversified portfolio 2. Systematic Risk - represents that security's contribution to the total risk of a well diversified portfolio so it must be compensated by a risk premium

Different Forms of the Efficient Market Hypothesis

1. Weak Form - all available market data is fully reflected in current prices 2. Semi Strong Form- All publicly available information is fully reflected in current prices 3. Strong Form - All info, public and inside, is reflected in current market prices (even using inside information, no player can consistently earn excess returns)

Tax issues of owning managed fund shares

1. managed funds can qualify for pass through tax treatment if they qualify as a regulated investment company (must distribute at least 90% of its net investment income to its shareholders plus ALL capital gains) Regulated IC's only pay corporate tax on any net investment they retain and passes through to the shareholders with the income 2. mutual fund distributions can be takin in cash or reinvested but taxable to shareholder regardless (managed funds sell securities either to fund net redemptions or to reposition their portfolio, the fund realized capital gains or losses) (dividend distributions paid from net investment income (interest + dividends) - fund expenses) 3. Some funds are more tax efficient than others and can be critical for taxable portfolios

Growth Rates (Relative Value Model)

Earnings, Sales Dividends, Book assets

Growth/Value (Semi-Strong Form Anomalies)

Evidence suggests that value investors consistently outperform growth investors on a risk-adjusted basis

Expense Ratio (Annual Expense)

Fees charges annually by all investment companies to cover operating expenses, levied annually on all shareholders

Bond Funds (Fund Sub-Category)

Finds that invest in debt instruments

Asset Valuation methods

Focus upon the assets of the firm and their liquidation or replacement values. Of no v value to individual investor who cannot get hands on asset value. Often the precursor of a merger or hostile take over (if the purchaser can get control of the corporation, the relevant value us what those assets are worth to him) Value of share compared to asset value/share

Income Funds (Fund Sub-Category)

Funds which attempt to provide relatively high and steady current income to shareholder Invest in bonds, preferred stock and common stock with high annual dividend yields

The "guaranteed buy back" scheme

IDE offered investment grade diamonds (late 1970's) if you were ever dissatisfied they promised to pay back original amount but promised a great future return for appreciation of diamonds. Diamond market crashed and investors become anxious and start buying back but IDE did not have the money

Mixed REIT's

Invest both in income-producing properties and mortgages

Real Estate Investment Trust (REIT)

Investment fund designed to invest directly in various real estate properties or real estate loans (does not invest in publicly traded securities)

Telephone Fraud Boiler rooms

Investments sold over the phone that are not "securities" (i.e: diamonds, stamps, etc.), with sense of urgency, too good to be true

Relative Value Models

Look to historical relationships, firm's stock price has had with other financial variable. Also look at ratios for comparable firms

Book Multiple

Market capitalization/book common equity = pps/bvps

Is the stock market absolutely information efficient?

No, market takes several minutes to fully adjust to new information and investors trading during that period of time based on new info may be able to earn excess returns but this can cause the market to become more efficient and less opportunities exist to exploit inefficiencies

Unmanaged Portfolios (Unit Investment Trusts)

Portfolio is not constantly monitored and traded as is the case with managed IC's but it can be supervised by sponsors very rarely

Technical Analysis (Three Common Approaches to Playing the Market)

Premise: price changes result form changes in supply and demand and changes in supply and demand can be detected by analyzing current and past behavior of the market focuses on market data: past prices, price trends, volume, net advances to understand markets behavior try to understand what other players are doing and try to outmaneuver them concerned with timing the market by picking the right time to buy and sell

Unsystematic Risk - Default or Credit Risk

Risk that partly having a legal obligation with respect to the financial asset will not honor that obligations

Neglected Firm Effect (Semi-Strong Form Anomalies)

Small stocks followed by few analysts and owned by few institutions tend to outperform stocks that are followed by many analysts and owned by many institutions

Redeeming Units (Unit Investment Trusts)

UITs are required by law to stand ready to buy back outstanding units at their current NAV

Unsystematic Risk - Political Risk

Uncertainties regarding the political climate for business. Not only important overseas where some gov't may be unstable or might nationalize corporate properties: but also domestic concerns too like deregulation or deregulation, changes in tax laws, etc.

Closed-End Investment Companies

Usually not allowed to issue new shares or redeem their original shares after an initial offering so the number of shares are limited to those sold in that initial offering trade in secondary markets through brokers prices is determined by market forces, the share price of a closed-end fund does not equal NAV Can issue bonds and preferred stock and common stock managers don't face redemptions during bad times so they don't have to sell securities they wouldn't sell just for redemptions or keep cash balances in portfolio

The Value-Line (Semi-Strong Form Anomalies)

Value line ranks stocks from 1 to 5 in terms of timeliness (1 being best and 5 being worst) Evidence is that the Value line rankings do contain valuable info but that market prices adjust quickly to rankings when they are released to the public

Investment Company

a corporation that sells its shared to the public and invests the proceeds in a diversified portfolio of marketable securities

Fund-Sub Categories

a fund ,just have 80% of its total assets in the type of security describes by the funds fame

Test of the Semi-Strong Hypotheses (Efficient Market Hypothesis)

a) Even studies: look into a news events and observe security price movement before and after the event 1. Stock Splits: no excess returns contemporaneous with or after announcement of split, were excess returns prior to announcement? 2. Money supply changes: iff expected prices changes took place before announcement, if unexpected price adjustment was very rapid less than one day and final **in general empirical evidence appears to support the semi-strong form of the EMH

Test of the Weak Form (Efficient Market Hypothesis)

a) Tests for independence of consecutive price changes - test for serial correlation with differing lags, price changes are independent b) test for RUNS (++--) Looks only as a sign, not statistically different from # of odd-even runs that you would expect in a random number series

Test of Strong Form (Efficient Market Hypothesis)

a. Corporate insiders- most studies of the investment performance of corporate insiders find that they do earn excess returns so the strong form appears to be retired b. Professional Portfolio Managers- most evidence suggests that mutual funds have been unable to generate excess returns. Do not consistently outperform the market but earn sufficient returns to cover the management fees

Efficient Market Approach to Investing (Three Common Approaches to Playing the Market)

accepts market's valuation of individual securities as correct, confident that market price reflects all available info about the security and its issuer market is efficient only so long as sufficient numbers of investors believe that it is not efficient

Time-Weighted Rates of Return

analyzing performance of a mutual fund or an investment manager who is managing a fund but has no control over timing of when investors deposit or withdraw funds from that fund

Balanced Funds (Fund Sub-Category)

attempt to maintain a balance between stocks and fixed income securities such as bonds

Brokerage Costs (For ETF's)

can add up for someone investing small amounts once a month, or withdrawing monthly amount and for those who trade frequently among ETF's so it makes sense for investors who are investing substantial lump sums for long periods of time

Management Investment Companies

company whose portfolio of securities is actively managed to achieve a stated investment objective

Market Anomalies

empirical observations that are inconsistent with that of what you would expect from a price efficient market

Earnings Multiple

factors which determine a stock's P/E ration (P/E ratio is a simplistic substitute for a valuation model - leaves important variables out!) Growth rate: higher growth-> high P/E ratio Long-term interest rates: higher rates-> lower p/e ratio

Transaction Fees (Exchange Fees)

fees charged when you shift money from one fund to another within the same family of mutual funds (also may be charges at entry or exit to cover costs of buying and selling securities

12b-1 Fee

fees that any mutual fund can charge to cover distribution costs

"A" Shares

fund shares sold with an initial or front-end load (usually 3%-6%, max is 8.5%) sold through brokers may charge an asset based sales charge but usually less than other share classes

"C" Shares

fund shares that have no front end sales charge and very limited CDSC but charge a 12b-1 fee of 1%/yr

No-Load Funds

funds that are direct marketed by the fund company to the investor without a sales person or brokers, do not have share classes and shares bought and sold at NAV

Asset-Allocation (Fund Sub-Category)

funds that change balance between stock and fixed income to adjust for market opportunities

Disadvantages of unit trusts

high sales commission that represent unmanaged portfolios and don't adjust to changing market and economic conditions

Exchange-Traded Funds (ETF's)

hybrid funds with no load, open end, funds who share trades on organized exchanges

P/E Anomaly (Semi-Strong Form Anomalies)

if the market were efficient one would not expect tot find any relationship between P/E ratios and risk adjusted returns but several studies have show that low P/E NYSE stocks on average out perform high P/E

Index Fund (Fund Sub-Category)

invest in the component stocks of some selected stock market index like S&P 500 attempt to manage portfolio so as to mimic performance of the index itself do not need costly staff of securities analysts and portfolio managers and have lower management fees with lower portfolio turnover to help keep low costs

Construction and development REIT's

lend money to builders and developers during initial construction

Earnings Multiple (P/E Ratio)

market capitalization/NI = PPS/EPS

Sales Multiple

market capitalization/revenue=pps/revenue per share

Unexpected Earnings Announcement (Semi-Strong Form Anomalies)

markets reaction to announcements of earnings that were about what was expect was to have no effect on prices as the EMH would predict buy where announced earnings differed from expectations market reacted immediately but excess returns continued long after the announcements

Global Funds (Fund Sub-Category)

mix of us and international securities

Rates of Return (time-weighted)

most appropriate for analyzing performance of a mutual fund or an investment manager who is managing a fund but has no control over timing of when investors deposit or withdraw funds from that fund also appropriate for measuring average return offered by a particular investment asset over time

Growth Fund (Fund Sub Category)

mutual funds who direct their portfolios towards stocks which are likely to experience rapid price appreciation looking for returns in form of capital gains

Unit Investment Trusts

narrowly defined investment companies that have a fixed portfolio and a stated termination date investor purchases a redeemable trust certificate that represents a share in an unmanaged portfolio of securities that is put together by a sponsor and handed over to an independent trustee

"B" Shares

no front end load but high asset based sales charges than A Shares, impose a contingent deferred sales charge (CDSC) which represents a redemption fee of bank end load if shares redeemed within a certain number of years. and decline every year until it goes away and then the share is converted into an A Share

Diversified Fund (Investment Company Act of 1940) (5&10 Rule)

no more than 5% of portfolio in securities of any one company cannot own more than 10% of the voting securities of any one company

Size Effect (Semi-Strong Form Anomalies)

on average over a long period of time, portfolios made up of a stock of small cap stocks outperform portfolios made up of large cap stocks

Equity REIT's

own various income producing properties: apartment complexes, malls, commercial office buildings, warehouse facilities and allow shareholders to receive capital gains and current income from owning real estate without having to manage property

Expected Return

point estimate for a whole distribution of possible returns (arithmetic mean of possible returns)

Ponzi Scheme

ponzi promised to pay 5% but was keeping the money

Mortgage REIT's

provide long term financing to properties

Investment Company Act of 1940

regulation of disclosure, objectives, fees, portfolio holdings, managers etc

Common Stock

represents an ownership interest in a corporation and have a residual claim on the assets and earning of the corporation along with voting rights

risk for investors

risk is the potential that the actual returns may differ from expected returns

Fundamental Analysis (Three Common Approaches to Playing the Market)

search for intrinsic or true value of a security by analyzing fundamental economic sate about the issuing corporations (focus on financial and economic data about the firm, its products, and its competition) seek to determine if stock is under or over valued by comparing their estimate of intrinsic value with current market value premise: market price and intrinsic value will differ significantly from time to time but eventually market will correct its errors problem: valuation is a subjective process based on subjective assessment of risk and expected future cash flows any analyst can only apply their OPINION as to the value Market value is the only objective value of a financial assets and market price is the consensus of thousand of transactions by well-informed investors back by expert analyses

International Funds (Fund Sub-Category)

specialize in stocks and bonds issued outside the US

Diversification Effect

standard deviation of portfolios' returns is less than the weighted average of the standard deviation of returns of assets in the prtfolio

Covariance

the measure of a securities risk

Coefficient of determination

the percent of the variability of the security's return which is explained by variation in the market's returns

unsystematic Risks - Business or Industry Risk

the risk of being in the business that the firm is in, industry risk is a part of business risk but part of business risk in unique to the firm

Present Value Methods

the value of a financial asset is equal to the present value of the cash flows it is expected to provide so a particular share of stock should be worth the resent value of the dividends it is expected to provide

Mutual Fund Performance in relation to loads

there is no relationship between fund performance and the loads or fees charges -

Systematic Risk - Interest Rate Risk

uncertainty about the general level of future interest rates, actually results in two different risks 1. Price value risk: uncertainty of the value of a bond if it had to be sold before maturity. result of effect changing interest rates have on the prices of financial assets 2. reinvestment risk: uncertainty of reinvestment opportunities, what rates of return will be available when you receive and reinvest future cash flows

Systematic Risk- Purchasing Power Risk

uncertainty about the purchasing power of future monetary returns (inflation)

Systematic Risk - Market Risk

uncertainty concerning future general market movements that effect the prices of all securities

Unsystematic risks

uncertainty due to factors which are unique in some sense to individual securities and are diversifiable and can be virtually eliminated through diversification

Systematic Risk

unpredictability of returns that is due to factors which affect the prices of all securities

Dividends (Relative Value Model)

usually look at dividend yields