Module 3: Investments
Bond
*debt instrument *Periodic interest *Repays principle on maturity Risks: *Interest rate *Reinvestment (if it gets called, you are now looking at new interest rates) *callable *financial risk (Tied to leverage the company utilizes. If a company only uses debt, could be scary) *default risk *Purchasing power (inflation) *Liquidity (Can what extent can it be put back to cash) *Event risk (action in the stock market, fed reserve stuff, political).
Black Scholes Option Valuation model
*determines value of a European call option *Market price increase = call option goes up *Exercise price down= call option goes up *Time to expiration increases= call option goes up *Volatility of returns increase= call option increases *risk free rate of return increases= call option increases
Separately managed accounts
*diversified portfolio of individual securities *professionally and actively managed *min investment requirement *Investor own 100% of securities *Prudent income tax management
Tax on REIT
*Income is investment income *losses are capital losses *dividends taxed as ordinary income Benefits: *portfolio diversification *provide current income in dividends payout
Investment risk
*Investment strategies to limit risk * Diversification and asset allocation can limit investment risk
Wash sale
*Investor purchases same stock within 30 days after recognizing loss on the same song. *add disallowed loss to tax basis in new stock
Stock dividends
*Not cash, given stock instead. * Stock price will decrease because you are giving more stock out. *this is not a taxable event.
Money market mutual funds
*Open end investment company * Usually mature within 1 year. *$1000 min investment *can withdrawal funds without penalty *can be used for emergency fund *Interest rate sensitive
Systematic Risk
*Purchasing power *Reinvestment risk (not there for 0 coupon rates) *interest rate risk *Market risk *Exchange rate risk ACRONYM PRIME
Satellite investments
*REITs *emerging markets *High yield bonds **more risk!
Stock Rights
*Right to maintain proportionate ownership in company *Allows holder to buy new issues before general public *Purchase common stock below current market value *Short term
Normal curve
*Short term= lower rates Long term= higher rates *sometimes can flatten, where interest rates are similar for all maturities
CAPM
*The CML is a representation of the relationship of risk and return for efficient portfolios *Risk free + (MRP)*Beta = Expected return
Time weighted return
*The time-weighted return is the return for a specific security over a specific period of time and does not reflect the purchases and sales of stock that an investor might make over the evaluation period. =IRR *focuses more on how the investments alone did (not outflows from investor taking stuff out)
European option
*You can only exercise on the last day
Intermarket spread swap
*You need to sell your govt bills and upgrade to corporate bonds because the corporate bond rates are increased right now. **not always the case
Equity REITs
*acquire rental real estate *income comes from rents and property sales
Income stocks
*almost always pay dividends
Taxation of futures
*always 60% long term and 40% short term
Share averaging
*averaging down: *only purchase when price goes down *reduces cost basis *may miss on bull market Share averaging: *you purchase same number of shares every time
Value on commercial and residential rental property
*based on NOI Gross rental receipts + Non rental or other income (parking) - Vacancy - Operating expenses (EXCLUDE interest and depreciation) = NOI
Qualified Dividends
*dividends from qualified foreign corporations still get preferable taxation rate *Corporations, whose stock of American Depository receipts is readily tradeable on an established US securities market.
Components of IPS
*before you create IPS, make sure you know the client (risk, loss aversion, liquidity needs, goals, values) 1) set forth clients objectives and gives guidance on whats going on 2) Tells how we will evaluate the portfolio 3) Asset allocation 4) Review guidelines and rebalancing Purpose: *Setting objectives *define asset allocation *establish management procedures *determining communication procedures
Substitution swap
*bond market isnt perfectly efficient, so you can occasionally upgrade
Growth stocks
*bought so it grows and get appreciation. Less dividends
Unsystematic risk (CAN DIVERSIFY)
*busn risk (nature of the busn) *Financial Risk: (leveraged how) *Default risk (on loans) *Political risk (new regulations) *tax risk *Investment manager risk *liquidity risk *Marketability risk
Zero cost collar
*buy a put, sell a call *help borrow money * Sell a call, buy a put. MORE INFO
Closed end mutual fund
*fixed number of shares Benefits: *marketable *Diversify *Professional management Characteristics: *Trade in secondary market *fixed capital strucutre *price based on supply and demand
Taxation of Futures
*cap gains *60% of gain is taxed at long term and 40% short term. this is the rule, does not matter how long you hold it. * At end of year, whether you sell it or not, you pay taxes on the gain or loss. This increases your basis going forward
Interest rate risk
*companies need to borrow money, so this affects them
NYSE
To list you must have 1.1 million public shares out standing
Stop limit order
Turns into a limit order when triggered. NEED MORE
EMH
Weak form- Technical doesn't work semi strong- Technical and fundamental does not work Strong- Technical, fundamental and insider info doesn't work
Holding period return
((1+r) * (1+r2) * (1+r3)... - 1 )
General valuation model
(CF1/ (1+y)^1 ) + (CF2/ (1+y)^2) .....
calculate Beta
(Correlation coefficient of market * SD of portfolio ) / SD market
Treynor ratio
(Return - RF ) / Beta *Treynor's measure, like Sharpe's, is a relative measure of the risk-adjusted rate of return of a given portfolio *Therefore, if a portfolio is fully diversified, both models should yield the same result because diversification will eliminate all unsystematic risk from a portfolio *is relative, needs to be compared to another ratio
Arithmetic mean
(r1 + r2+ r3+r4 ) / n
Correlation coefficient
* (-1 to 1) tells us how related the 2 parties are (r).
American Option
* you can exercise the option at any time in the time period
arbitrage pricing theory
*All info is already incorporated into stock price *NEED MORE
Convertible bonds
*Conversion ratio= Par value of convertible security / conversion price *do the math on if its a good deal to exercise this right, or just buy the stock off the market normal
Foreign Securities
*Diversification *potential High returns RISKS: *Political risk *country risk *foreign taxes *fluctuations in exchange rates
Fund of funds
*Hedge fund that consists of several hedge funds * extra layer of management (extra fees) *more diversification *usually follows indexes Strategic allocation: *long term perspective of capital into different asset categories. shift weights between fixed investments and equities Tactical Allocation: *Deviating from strategic allocation to take advantage of perceived short term opportunities Manager selection: *choosing which specific hedge funds to invest in.
Market order
*I want to buy x number of shares at this price.
Stop order
*If market price reaches certain point, then you can say i want to buy/sell this many stocks *Once you hit 20% loss, you can choose to sell. or what ever number you choose
Dollar-weighted return
*focuses on overall how the investor did while taking stuff out *, the dollar-weighted return considers subsequent purchases and sales. This occurs because the dollar-weighted return focuses on the return that the investor actually received, instead of the return on the investment, assuming that the investment had simply been purchased and held over the evaluation period (which is the time-weighted return).
Information Ratio
*how much alpha do we receive for SD risk we take * (return of portfolio - return of benchmark ) / SD of the difference between portfolio and benchmark
Immunization of bond questions
*if a bond has a coupon, the duration will be shorter. *Ex: weighted time to average maturity = 10 years. Coupon 5%. HELPPPP
Derivatives are used for
*increase portfolio returns * limit portfolio risk *individuals can generate income in flat or volatile environment
Dividend reinvestment plan (DRIP)
*instead of cash, you re invest it into the stock. * automatically done. no commission on this * Reinvested dividends are taxable when put back in *added to tax basis *it is ordinary income (no deductions by firm giving them). they are taxed at long term gains
Macaulay Duration
*inverse relationship between coupon rate and duration
Average cost per share of mutual Fund: Dollar cost averaging
*investing predetermined amount of money at regular intervals *Reduces effect of market price fluctuation *Average cost per share is reduced *do not guarantee positive return
Blue chip stock
*issued by big companies who pay regular dividends
Guaranteed investment contracts (GICs)
*issued by insurance companies *Rate of return is given *Not FDIC insured *employers are main purchasers *pricing influenced by market rates
Pure yield pickup swap
*just switching out bonds. Looking for higher rates by going to longer terms or junk ish bonds
Automatic reinvestment option for mutual funds
*like a DRIP * Once they receive a receipt, they owe taxes
Warrants
*long term (customized call option) *Bought ABOVE market value, but it is usually paired with a bond or preferred stock to make the deal better.
Technical analysis
*market value is determined by supply and demand *driven by rational and irrational behavior *trends persist for long term periods *actual changes in supply and demand can be observed via market price behavior.
Value averaging
*market value of account increases by definite dollar amount *Regular and periodic time intervals *Size of periodic returns vary *Buys more shares when prices are lower and fewer and when prices are higher
ETF
*mimic market index Benefits: *Lower annual expenses *Low asset turn over.. more tax efficient *Redeem shares in exchange for the funds underlying stock (non taxable event) Characteristics: *Price based on supply and demand *passive or active manage *trade on major exchanges Benefits: *exposure to index *low cost, tax efficient *May be bough on margin and sold short
IPO
*no guarantee that all shares will be sold by bank. The bank will pay loss if they cant sell all the shares
Short term securities of deposit instruments tax
*ordinary income
Stock splits
*par value is reduced *number of shares increased by 2 or 3 *Reduces market price *Attractive to smaller investor because they can afford it now *no taxable event * REVERSE STOCK SPLIT: Reduction of outstanding shares. Increases price.
open end investment company
*pools capital from many investors and invests in stocks, bonds.... *Has specific investment objective benefits are: *Diversification *access to professional management Characteristics: *Variable capital structure *Constantly changing ownership *Can raise unlimited capital *Shares purchased directly through fund *Priced daily at Net asset value
Convertible preferred stock
*preferred shares have less risk than common stock, but has the option to change to common if you want to.
Hedging
*reduces risk from fluctuating commodity prices *short Hedge: Helps reduce loss if price goes down *Long Hedge: Helps reduce loss if price goes down
HYBRID REIT
*rent properties and make construction loans
Unit investment trust
*sell secondary market, but not listed on stock exchange *income passed through to investors *Passive invested *Securities generally liquidated upon maturity.
Preffered stock
*similar to bond. You receive regular div payments = to a stated % of the par value of the stock. * Similar to common stock: not guaranteed dividends. no maturity. Benefits: *shareholder rights are better than common stock. You get paid out before common stock in bankruptcy *corporation must pay any unpaid preferred dividends to preferred stock holders before new dividends come out. *usually equity investors buy these. *Corporations go for these because 70% of the dividend received from domestic corporation is an allowed deduction
REITs
*source of long term financing for real estate projects *public or privately traded *Not subject to federal income tax IF: 1) 90% of net earnings are distributed 2) 75% of gross income must be derived from real estate
Correlation coefficient
*standardized relation of return -1 to 1 *(covariance of the 2 variables ) / (SD a * SD b) *The more the number is negative, the better diversified
Fundamental Analysis:
*stats used from economy *interest rates *monetary policy *fiscal policy *industry analysis *stock market tendencies can be a top down approach: goes from economic analysis to industry analysis then to individual company analysis also can use bottom up analysis: *liquidity ratio, activity ratio, profit ratios *Leverage ratios, ratio for bond analysis, ratio for stock analysis
Market risk
*stocks react to items. *
coefficient of determination
*tells us the strength of the relationship between two variables (must be positive) (r^2) *if r2 is low, beta isnt that accurate. you dont want to rely on beta if r^2 is low. if its below .7, not too helpful
Rate anticipation swap
*try to guess what fed reserve is going to do with interest rates and jump the gun (very toughhhh)
Hedge funds
*unregistered privately offered managed pool of capital General partner (Investment manager) = paid on performance Limited partner= investors *Heavy borrowing *short selling Type of investors: *wealthy and sophisticated. * interested in managing risk of possible loss *those concerned about skill and expertise of investment manager
core investments
*us stocks *US Fixed income *developed international equities
Modern portfolio theory
1) Consider each investment based on probability over time 2) Estimate the risk on the basis of return variability 3) Base decision on expected return and risk
Investment planning process
1) Does client has interest to invest 2) Time horizon based on goals 3) Risk and return
Markowitz theory/idea
1) Efficient frontier 2) Risk and return 3) you cant have anything above the efficient frontier
Core and satellite
1) Generally, these investments track a major market index such as the S&P 500, Russell 3000, and MSCI EAFE® 2.) This part of the portfolio uses a passive investment philosophy to achieve market-based returns c. Satellite investments may include REITs, emerging markets, and high-yield bonds 1.) These investments attempt to achieve above market returns through high risk and global exposure d. Investors may choose to implement a core and satellite strategy through a portfolio of mutual funds 1.) The goals of this strategy are to reduce portfolio risk through diversification, generate higher returns commensurate with required returns, minimize costs, and manage taxes
Barbell (dumbbell) strategy
1) Initially acquiring a portfolio of bonds consisting of both very long-term and very short-term maturities EXAMPLE An investor invests $200,000, with $100,000 in short-term bonds and $100,000 in long-term bonds. The barbell strategy provides the advantage of only selling one group of bonds in the event that the structure of the portfolio needs to be changed as a result of fluctuating interest rates. 2.) The barbell strategy will not maintain its original structure because each year the short-term bonds mature and need to be reinvested. Thus, the maturity of the long-term bonds is reduced. An active management strategy is required to periodically rebalance the portfolio.
Intermarket spread swap
1) This swap involves the exchange of one type of bond (e.g., government bond) with another type of bond (e.g., corporate bond). This occurs when investors believe one type of bond is currently mispriced in relation to the other. The goal of this type of swap is to capitalize on a YTM disparity across bond markets. a.) Consider two bonds ■ Bond A: 10-year bond yielding 8% (coupon 8%) selling at par ■ Bond B: 10-year bond yielding 7.5% (coupon 5%) selling at a discount b.) If the 50-basis point spread (0.08-0.075) between A and B is historically small, then there is an opportunity to benefit from a spread swap. Three possibilities exist for the spread to increase from 50 basis points to the historical spread, say 70 basis points. ■ Bond A's yield could rise from 8% to 8.2% ■ Bond B's yield could decrease from 7.5% to 7.3% ■ A combination of both (Bond A could increase and Bond B could decrease) c.) If any of the three options occur, the swap will benefit the investor ■ If Bond A's yield increases 20 basis points, selling it before the change avoids a potential capital loss. (Note the price would have to decline for the yield to increase. This is the capital loss exposure that is avoided.) ■ If Bond B's yield declines 20 basis points, then purchasing it before the change will provide the potential for a capital gain. (Note the price would need to increase for the yield to decline.)
How to pick which fixed income investments:
1) What kind of bonds (muni, corporate...) 2) Interest rates (are they gonna rise or fall?) 3) Marginal tax bracket (Look at tax equivalent yield to compare) 4)Default risk (ratings of bonds) 5) Stability v yield (make sure you dont take on too much risk to achieve a goal) 6) Investing for certain goal (make sure you have money liquid when you need it)
BUY-AND-HOLD
1. A buy-and-hold strategy begins with a set percentage of assets in each asset class. Over time this ratio will change as the value of each asset class changes. 2. The major benefit of a buy-and-hold strategy is that transaction costs and taxes are minimized 3. The use of index funds is one example of a buy-and-hold strategy. Index funds attempt to match the composition of an index, such as the S&P 500. Because indexes are relatively stable, with regard to the stocks that make up the index, transaction costs and taxes are minimized and research costs are virtually eliminated.
Wash Sale
1. A wash sale occurs if the taxpayer sells or exchanges stock or securities for a loss and, within 30 days before or after the date of the sale or exchange, acquires similar securities 2. Basis of the new stock or securities will include the unrecovered portion of the basis of the formerly held stock or securities 3. The wash sale rule is easily avoided in the case of fixed-income securities by substituting a bond with similar or the same characteristics (i.e., coupon, term, and quality) as long as it is issued by a different company
INVESTMENT POLICY STATEMENT
1. A written document that sets forth a client's objectives and limitations on the investment manager 2. Gives guidance to the investment manager and provides a means for evaluating investment performance 3. An allocation among asset classes (and their respective weights) that is congruent with the client's primary investment objective is a part of any credible investment policy. a. Rebalancing frequency should also be addressed 4. The manager's performance should be measured against the constraints and objectives of the investment policy statement.
ACTIVE INVESTING
1. Active portfolio management is based on the concept that above-market returns can be achieved through security selection, market timing, or both. Those who believe that active management can outperform the market do not believe the market is perfectly efficient. 2. Security selection and market timing work in concert with each other. In addition to determining which security should be selected, investors must determine when and under what conditions the investment should be purchased (or sold). The real question is what should be invested in today? 3. Two methods that investors use to make security selections are fundamental analysis and technical analysis
PASSIVE INVESTING (INDEXING)
1. Passive strategies are based on the concept that the markets are efficient in pricing securities and that it is unlikely that an investor will be able to outperform the market on a consistent basis (similar to the efficient market hypothesis) 2. Passive portfolios generally are well diversified and have low turnover rates 3. Another consideration for these passive portfolios is the risk and asset allocation of the investments. By adjusting the asset mix or allocation, the risk level can be matched with the needs of the investor.
unsystematic risk
1. Risk that is unique to a single security, business, industry, or country 2. Can be significantly reduced with portfolios containing as few as 10 stocks 3. Types a. Business risk—the uncertainty of operating income b. Financial risk— the risk that a firm's financial structure will negatively affect the value of an equity investment c. Default risk— the risk that a borrower will be unable to service its debt obligations 1.) Bonds issued by corporations and municipalities are rated by independent rating agencies as to their likelihood of defaulting 2.) Obligations of the U.S. government are considered default-risk free 3.) Does not apply to stocks 4.) Also referred to as credit risk 5.) Bonds with more default risk may also exhibit greater interest rate risk d. Political risk— the risk that the political or economic climate of a country will negatively affect an investment 1.) The United States is generally considered to have low political risk 2.) Foreign investments and domestic corporations whose raw materials or sales rely on trade with a foreign country are affected e. Investment manager risk— the risk associated with the skills and philosophy of the individual manager of an investment fund or account 1.) Changes in investment style (style drift) 2.) Changes in management team f. Liquidity and marketability risk 1.) Liquidity is the ability to sell an investment quickly and at a competitive price, with no loss of principal and little price concession 2.) Marketability is the ability to find a ready market where the investor may sell the investment 3.) Differences a.) Real estate is marketable but usually not liquid b.) Treasury bills are both liquid and marketable c.) Money market deposit accounts are liquid but not marketable d.) Cash is the most liquid and marketable asset 4.) Less liquid and/or less marketable assets exhibit more risk g. Tax risk—the risk that taxation of investment gains or losses will negatively affect investment return
SECTOR ROTATION
1. Sector rotation is an active portfolio management strategy, emphasizing or overallocating certain economic sectors or industries in response to the next expected phase of the business cycle a. This strategy requires investors to time the entry and the exit of specific sectors based on economic business cycles b. For many investors, the ability to accurately identify and transition from one cycle to another may be difficult
TECHNICAL ANALYSIS
1. Technical analysis is an attempt to determine the demand side of the supply/demand equation for a particular stock or set of stocks a. Technical analysis is based on the belief that studying the history of security trades will help predict future price movements b. Technical analysts (or chartists, referring to their reliance on stock charts) believe that the history of the stock price will tell the whole story of the security and that there is no need to be concerned with corporate factors such as earnings, financial leverage, product mix, and management philosophy c. Technical analysis is in direct contradiction to the efficient market hypothesis which, at all levels, states that the current price of a security reflects all historical price data
Open-end investment companies (mutual funds)
1.) Pools money from many investors a.) Invests in stocks, bonds, money-market instruments, and other securities according to a specific investment objective outlined in the prospectus 2.) Shares are purchased and redeemed by the fund or through a broker a.) Not traded in the secondary market 3.) Share price is fund's NAV, plus any fees (sales charges/sales loads) 4.) Continuous public offering a.) Variable market capitalization 5.) Managed by an investment adviser
THE EFFICIENT MARKET HYPOTHESIS
1. This theory suggests that investors are unable to outperform the market on a consistent basis without accepting additional risk a. The basic assumption of the efficient market hypothesis is that current stock prices reflect all available information for a company and that the prices rapidly adjust to reflect any new information b. Since the market's efficiency in valuing securities is extremely quick and accurate, investors are not able to find undervalued stocks on a consistent basis 2. Day-to-day price changes follow a random walk pattern a. This pattern occurs because future events cannot be predicted from past information; current stock prices fully reflect all known information b. Therefore, price changes are unpredictable and random. If prices move in a random fashion, any trading rules or techniques will be useless. c. New information must be unexpected, otherwise it would be reflected in the current stock price. Therefore, if new information is unexpected and random, changes in the stock price will also be random. 3. The EMH has three distinct forms a. The weak form 1.) Holds that current stock prices have already incorporated all historical market data, such as prices, trading volume, and published financial information 2.) Technical analysis is founded on the concept of analyzing past security prices and levels of trading volume in an attempt to predict demand and, therefore, future prices. The EMH and technical analysis are in direct contradiction. 3.) Fundamental analysis and insider information may produce above-market returns under the weak form b. The semistrong form 1.) The current stock price not only reflects all past historical price data but also data from analyzing financial statements, industry, or current economic outlook 2.) Stock prices will adjust quickly to reflect any new information (including market, economic, social, political, and global) 3.) This form suggests that many analysts follow the same stock and that any new information will be quickly incorporated into the current price. Thus, even fundamental analysis is not likely to yield above-market returns. 4.) Insider information may produce superior returns c. The strong form 1.) Holds that stock prices reflect all public information and most private (insider) information. Therefore, even traders using inside information are unlikely to consistently outperform the market. 2.) Technical analysis, fundamental analysis, and insider information will not allow investors to achieve consistently superior performance under the strong form
Price-Weighted Indexes
1.) A price-weighted index is an index in which the value of the index is equal to the sum of the prices of the securities in the index, divided by a predetermined divisor 2.) The divisor must be adjusted whenever a stock split or stock dividend occurs with one of the stocks in the index 3.) A price-weighted index will not accurately reflect the movement of the under-lying market values 4.) An equal but opposite change in the prices of two stocks would offset each other in a price-weighted index 2.) Advantages a.) Highly correlated to other broader market indexes b.) Represents major, frequently traded stocks c.) Widely recognized and followed 3.) Disadvantages a.) Fails to reflect payment of cash dividends b.) Ignores stock dividends under 10% c.) Fails to account for the number of shares outstanding d.) Consists of a biased sample of stocks (mostly blue-chip companies) e.) Industries are not proportionally represented
Substitution swap
1.) A substitution swap involves exchanging bonds with identical characteristics (including credit rating, maturity, coupon interest payment, and call feature) selling for different prices. This price difference is an arbitrage opportunity and will last only until the lower-priced bond is bid upward. These opportunities arise when there are temporary market imperfections. 2.) Several risks associated with substitution swaps should be considered a.) The bonds may not be perfect substitutes for each other b.) The gain may not be sufficient to cover any required transaction costs c.) The workout time, which is the time it takes for the bonds' prices to equal each other, may be longer than originally expected, thereby reducing the realized yield for the swap
Yield to call (YTC)
1.) Bonds will often be issued with a call feature permitting the issuer to pay off the debt obligation at a predetermined call price and time a.) This feature is a benefit to the issuer because it permits the issuer to refinance the outstanding debt in the event that interest rates decline b.) This feature causes the required yield to increase for investors because the investment time horizon is no longer certain
Straddle
1.) Combination of a put and call with the same exercise price and expiration date 2.) Long straddle—both put and call options are purchased a.) Profit if underlying stock price increases or decreases by more than the sum of the premiums paid b.) Maximum gain = unlimited c.) Maximum loss = sum of premiums paid 3.) Short straddle—both put and call options are sold a.) Profit if underlying stock changes little during the contract period b.) Maximum gain = sum of premiums received c.) Maximum loss = unlimited
Types of preferred stock
1.) Cumulative—unpaid preferred dividends from prior years are paid before divi-dends are paid on common stock 2.) Straight (noncumulative)—shareholders are not paid missed dividends 3.) Participating—receive regular fixed dividend plus an additional dividend if common stock dividend exceeds a specified amount 4.) Convertible—issued with the right to convert the preferred shares into a speci-fied number of common shares 5.) Callable—company may repurchase preferred shares from investors at a stated call price after a specified date
To provide effective investment counseling, the following areas should be examined and reviewed:
1.) Financial goals 2.) Risk tolerance and risk exposure 3.) Tax situation 4.) Liquidity and marketability needs 5.) Analysis and evaluation of client financial statements 6.) Client preferences, investment understanding, and experience
Preferred stock
1.) Hybrid security with features of both equity and debt securities a.) Represents an ownership interest in the corporation b.) Usually issued with a fixed dividend c.) Perpetuity—no specified maturity date 2.) Dividends paid based on stated percentage of the par value of the stock 3.) Preferred dividends must be satisfied before paying dividends on common stock 4.) Preferential right over common stockholders to assets of the corporation upon liquidation
Rate anticipation swap
1.) If rates are expected to increase, long-term bonds should be swapped for short-term bonds a.) With rising interest rates, the price for long-term bonds will decline (recall that long-term bonds are more sensitive to interest rate changes than short-term bonds) b.) These rate increases would be consistent with a booming economy and hints of inflation 2.) If rates are expected to decline, long-term bonds should be purchased to capitalize on the price increases for these bonds
Bullet strategy
1.) Investors purchasing a series of bonds with similar maturities that are focused around one point in time 2.) The bullet strategy is one in which the average maturity declines by one each year and may be effective in matching duration to the cash needs of an investor 3.) Like the dumbbell strategy, to maintain the original structure, the entire portfolio may require liquidation, resulting in significant transaction costs EXAMPLE Assume an investor wants all of his bonds to mature in 10 years. Therefore, using the bullet strategy, he buys two bonds immediately, two bonds two years from now, and two more bonds four years from now. As a result, the bonds purchased immediately have a maturity date of 10 years, the bonds purchased two years later have maturity dates of eight years, and the bonds purchased four years later have maturity dates of six years.
Tax swap
1.) Motivated by current tax law 2.) One such swap involves gaining from a capital loss
Hedging
1.) Purpose—to reduce risk associated with fluctuating commodity prices 2.) Involves entering into a futures contract opposite of the position currently held a.) The short hedge—using a short futures position to hedge a long futures position
Unit investment trust
1.) Self-liquidating a.) Interest, dividends, and principal passed through to investors b.) Usually makes an initial public offering of only a specific, fixed number of units 2.) Passively managed a.) Securities selected initially and held until maturity or termination date 3.) Invests in stocks or bonds a.) Traditionally invested in municipal bonds 4.) Shares may be redeemed by the trust at their current net asset value (NAV) 5.) No board of directors, corporate officers, or an investment adviser to render advice during the term of the trust
Closed-end investment companies
1.) Shares trade in the secondary market a.) Price based on supply and demand b.) Shares purchased from and sold to other investors c.) Shares may trade at a premium or discount to NAV (calculated and pub-lished daily) 2.) Fixed capitalization a.) Additional shares not generally issued after initial public offering (IPO) b.) Shares not redeemed by the fund c.) Lower liquidity requirements than mutual funds 3.) May have varying investment objectives, strategies, and investment portfolios a.) Subject to risk, volatility, fees, and expenses
Exchange fund (NOT ETF)
1.) Some financial institutions sponsor exchange funds (not to be confused with exchange-traded funds) that allow investors with concentrated portfolios of publicly traded stock with an established market value to contribute the stock to the fund. In exchange, the investor will receive a proportional interest in the overall fund. Because the fund holds numerous securities, the investor receives an interest in a fund that is diversified. 2.) The benefits of the exchange fund is that an undiversified portfolio is exchanged for an interest in a diversified portfolio without incurring a tax liability
Pure yield pickup swap
1.) This swap involves exchanging a lower YTM bond with a higher YTM bond 2.) The new bond that replaces the old bond will have to be either a longer-term bond or a lower quality bond to make this swap effective
Zero-cost collar
1.) Used to protect a gain in a long position with no cash outlay a.) Investor gives up stock price appreciation above the exercise price of the call option 2.) Consists of a.) A long position in stock b.) A long put option ■ Protects against downside risk c.) A short call option ■ Generates income to pay premium on long put EXAMPLE An investor purchases a stock for $29 and a put on the same stock for $0.20 with an exercise or strike price of $27.50. The investor also sells a call on this stock for $0.20 with an exercise, or strike, price of $30. This is a zero-cost collar because the premiums on the call and put are equal (the 0 in the equations below). ■ Maximum profit = $30 - $29 - $0 = $1 ■ Maximum loss = $29.00 - $27.50 + $0 = $1.50 ■ Breakeven price = $29 + $0 = $29
Standard deviation %
68= 1 sd 95= 2 sd 99= 3 sd
Sharpe ratio
= (avg rate of return - Rf) / SD *This ratio is a relative measure of the risk-adjusted performance of a portfolio based on total risk (systematic and unsystematic risk) *is relative, needs to be compared to another ratio
Jensen's alpha
= Return for portfolio x - CAPM Sharpe and Treynor are relative measures, whereas Jensen's alpha is an absolute measure of performance.
Return on assets (ROA)
= net income ÷ total assets *ROE is just divided by Equity
Dividend growth rate=
=ROE * Earnings retention rate Earnings retention rate= 1- div pay out rate
liquidity of hedge funds:
A hedge fund generally does not have daily liquidity, but instead has certain periods of time where the total returns are generated for investors
Investment grade of bonds?
AAA-BBB
Options:
Call options: *Long, Buyer, holder *You purchase an option *Hope price goes up. Put options: *Hope price goes down. *Short, seller, writer *one contract= 100 shares
Limit order
Can buy or sell at a specific price. Usually better than the market price when the deal is made
Gains and losses
Buy call= *Gain is unlimited *Loss is premium paid Sell a call= *gain is premium *loss is unlimited Sell a put: *gain is premium *loss is unlimited buy a put: *Gain is Exercise price - premium (limited) *premium paid
Current yield (CY)
CY = annual interest payment ÷ current market price 3.) As a bond's price increases, its current yield declines 4.) As a bond's price decreases, its current yield increases
Inventory turnover ratio
COGS / Avg inventory (2 years)
Cyclical stocks
Certain stocks perform better in certain stages of the economic cycle
Back end load
Class B Pay at the end
Level load fund
Class C Given equally through time
Front end load
Class a *You pay fees at the beg
Conservative v moderate v aggresive:
Conservative: 1) Bonds 2) Money Market 3) Large cap equity Moderate: 1) Bonds 2) Large Cap equity 3)International equity 4) Small Cap Aggressive: 1) Large Cap 2)International 3) Bonds 4) Small cap
HOLDING PERIOD RETURN
HPR = (ending value - beginning value +/-cash flows) / beginning value
Perpetuity
D1/R = value *c. An example of a perpetuity is preferred stock
Margin call
Debit balance / (1 - maintenance margin)
Margin Call
EXAMPLE Harry pays $20,000 to purchase shares of Solvent Company (trading at $25 per share). If Harry uses a margin account (50% initial margin) to purchase this stock, he can buy 1,600 [(20,000 × 2) ÷ 25] shares. An amount of $20,000 is borrowed from the broker. Harry is concerned about receiving a margin call. At what point will Harry receive a margin call (assume a maintenance margin of 35%)? margin call = (25*.5)/(1-.35)= = 19 23 Harry will receive a margin call when the price of the stock declines to $19.23. EXAMPLE Assume the same facts as the previous example. If the stock price dropped to $15, how much money would Harry be required to deposit to meet the margin call? Required Equity: Stock price= 15 Equity %= 35% Required equity=5.25 Current Equity: Stock price=15 Loan amount (50% of original purchase): 12.5 Current equity: 2.5 (15-12.5) Harry will be required by the broker to deposit $2.75 per share to maintain the equity position of 35%. To determine this, the current equity position must be compared to the required equity position.
Difference between option premium and intrinsic value
EXAMPLE A put option on Alpha stock is selling for $5. The exercise price is $60. Alpha is currently selling for $67. The intrinsic value of the put is zero. The time value of the put is $5—the premium less the intrinsic value. A call option on Omega stock is selling for $7. The exercise price is $38. Omega is currently selling for $42. The intrinsic value of the call is $4 ($42 - $38). The time value of the call is $3 ($7 - $4)
growth dividend discount model
EXAMPLE XYZ Corporation has a current dividend of $2 per share. This dividend is expected to grow for three years at 6% annually and at 7% annually thereafter. Assume that the investor's required rate of return is 9%. What is the intrinsic value of the stock? Note that all numbers are rounded to the nearest cent. 1. Compute the value of each future dividend until the growth rate stabilizes (Years 1-3). D1 D2 D3 = $2.00 × 1.06 = $2.12 = $2.12 × 1.06 = $2.25 = $2.25 × 1.06 = $2.39 2. Use the constant growth dividend discount model to compute the remaining intrinsic value of the stock at the beginning of the year when the dividend growth rate stabilizes (Year 4) D4= $2.39 × 1.07 = $2.56 V = $2.56 ÷ (0.09 - 0.07) = $128.00 3. Use the uneven cash flow method to solve for the net present (intrinsic) value of the stock. CF0 CF1 CF2 CF3 CF0= $0 CF1= $2.12 CF2= $2.25 CF3= $2.39 + $128.00 = $130.39 I/YR = 9% Solve for NPV = $104.52 In this example, the intrinsic value of the stock is $104.52.
Natural resources
Has a lot of risk because of politics and so on. *can add extra level of diversification because they aren't always directly correlated with stock market
formula for companies that dont have dividends
FCF(per share) / (r-g)
Mortgage REITs
Financing real estate ventures. Financing construction *pay outs are part interest and principle
In the money At the money Out of the money
ITM= Have intrinsic value ATM= EP=FMV OTM= Negative intrinsic value
Business Risk
If an airline has new regulations put down for flying
Inverted yield curve
If inflation gets very high, then inverted can happen Short term= Higher Long term = lower
Tax on stocks
If you dont have specific identification, then you have to use FIFO (this leads to biggest capital gains first)
Medicare contribution tax
Imposed on tax payers with net investment income (includes gross income from interest, dividends,
Taxation of Mutual funds
Income comes from: Ordinary taxable dividends Exempt interest dividends Capital gain distributions (reported as Long term capital gains)
Futures
Require: *initial margin *Maintenance Margin *Mark to market *Losses realized daily *you can be long (buyer) of short( Seller)
Taxation of put
LONG Exercised: Exercise price - premium= basis Expires: Cap loss. Closed: Cap gain SHORT Exercised: Basis= Exercise price - premium Expires: Cap gain Closed: cap loss
Taxation of call options
LONG- Exercised: Take the call premium and add it to basis Expires: The call premium is a capital loss (almost always short term) Closed: Capital gain/loss (almost always short term) SHORT- Exercised: Add premium to the exercise price, that is amount realized. Expires: Amount received is capital gain Closed: Doesn't affect anything
Net profit margin =
Net profit margin = net income ÷ sales
Value stocks
Lower growth rate, but is trading below value. You see it mispriced
Operating fees
Management fees *12b1 fees (marketing fees) *other expenses Expense ratio: Funds annual operating expenses / average annual assets
real estate valuation
NOI / Disc rate *take out vacancy, and operating expenses. Potential income will be counted (like a parking lot for apartments and you are gonna charge them for the spot). * dont take out depreciation
Intrinsic value for property
NOI / Estimated cap rate
Barbell
One side- Short term maturity bonds Other side- Long term maturity bonds *active management strategy *tries to spread risk out. *middle sometimes has staggered maturities
Bond bullets
Purchase different maturities, but designed to mature at same time
Leaps
Puts and calls with longer than 9 month expiration date
Rebalancing
Rebalancing is periodically adjusting a portfolio back to its target asset allocation
Net investment income
Reduced by certain deductible investment expenses. (like early withdrawal)
Warrants
Right to purchase a certain amount of shares at a specific price at a specific time
Market Capitalization Weighted Indexes
S & P 500 1.) Comprised of 500 large-cap stocks 2.) Sums the market value (share price multiplied by number of shares outstanding) of the 500 companies, divides by the base year value, and then multiplies this amount by 10 (the initial index value) a.) Automatically adjusts for stock splits and dividends
Coefficient of variation
SD/Expected return *smaller number= less variation, you want this
AR turnover
Sales / Avg AR ( 2 years)
Bond swaps
Selling one debt security and replacing it with another. Usually try to switch it out for a higher performing bond *Increase bond portfolio *Save income taxes *Reduce interest rate risk
Cash dividends
Shareholder must own share on record date. (oct 3) *Ex dividend date = first busn day after dividend was give (oct 2) **investor must own the stock by Oct 1
Bond ladders
Staggering maturities to keep risk spread out and have cash come available at different times
Bottom up
Start with company. looking for under valued stocks
The investment planning process
Step 1—Determine whether the client has the means and commitment to invest Step 2—Determine the time horizon for investment based on the client's financial objective(s) Step 3—Determine the appropriate level of risk and return for the portfolio based on the investor's risk tolerance and required return Step 4—Select investments suitable to the investor's time horizon, return requirements, and risk tolerance Step 5—Compare the actual realized returns against the expected returns a. Compare returns to a benchmark, such as the S&P 500 Index b. Periodically reevaluate investments in light of changes to a client's situation and changes in the markets Step 6—Adjust and rebalance the client's portfolio, as necessary
Defensive stocks
Stocks unaffected by current business cycles.
Total risk=
Systematic and unsystematic risk or SD
Systematic
Systematic- 1. Risks inherent in the investment market 2. Cannot be eliminated through diversification (nondiversifiable risk) 3. Types a. Purchasing power risk (inflation risk)— the risk that inflation will erode the real value of an investor's assets 1.) Fixed-income assets are particularly subject to inflationary pressure b. Reinvestment rate risk— the risk that proceeds available for reinvestment must be reinvested at a lower rate of return than that of the investment vehicle that generated the proceeds d. Market risk- Changes in economy e. Exchange rate, or currency, risk— the risk that a change in the relationship between the value of the dollar and the value of the foreign currency during the period of investment will negatively affect the investor's return
trading strategies of hedge funds:
a. Leverage, long, short, and derivative positions in both domestic and international markets b. Invest in a broad range of investments, from shares, debt, and commodities to works of art c. Each fund will have its own unique portfolio strategy
top down
They go from industries they like, then to companies.
Coefficient of determination
This is r^2 *the strength between two variables *if r^2= 70% the unsystematic risk is 30% *you always want at least 70%
Financial risk
What extent do they use debt
Growth Investing
a. Growth investors assume the P/E ratio will remain constant over the near term and the stock price in an efficient market will increase as the forecasted earnings growth of the issuing company is realized b. Such investors look for growth stocks, that is, stocks of companies that have a significant ability to develop products with a minimum of marketplace competition c. These stocks usually have a superior rate of earnings growth (e.g., 15% per year or more), low dividend payouts, and an above-average price-to-earnings ratio d. Growth stocks are generally more volatile and, as a result, exhibit higher beta than other stocks e. Growth approach is more aggressive
Value investing
a strategy that tends to concentrate on the numerator (or price) of the P/E ratio
Value investing
a. Assumes the current P/E ratio is below its natural level and that an efficient market will soon recognize this situation and drive the stock price upward b. Value approach could be considered slow and steady
futures
a. Contract between two parties to make or take delivery of a specific commodity or financial asset of a specified quality at a future time, place, and unit price 1.) Using commodity futures is the easiest and most common way to gain economic exposure to commodities b. Classifications 1.) Financial—currency, interest rates 2.) Agricultural—wheat, sugar, lumber 3.) Mineral—oil and gas, gold c. Contract completion 1.) Delivery can be made or taken 2.) Reversing out a position—more common EXAMPLE Stacy purchases a futures contract for lumber with a December delivery date. She can choose to receive the lumber or to sell a futures contract for lumber, thereby reversing out her position. 3.) Only about 1% of all futures contract positions involve the delivery of the underlying commodity *traded on exchanges (New York mercantile exchange and Chicago mercantile exchange) e. Requires a margin account 1.) Initial deposit (initial margin) 2.) Required minimum balance (maintenance margin) 3.) Mark-to-market a.) Daily settlement ■ Losses must be realized in cash—decreases below maintenance margin result in margin call to restore account to level of initial margin ■ Gains may be withdrawn from account **Investors are usually required to have strong balance sheets and deposited funds with the broker, in addition to sufficient knowledge of the risks, before they are permitted to trade futures
Risks of hedge funds:
a. Leverage—a hedge fund will typically borrow money, with certain funds borrowing amounts exponentially greater than the initial investment b. Short selling—due to the nature of short selling, the losses that can be incurred are potentially unlimited c. Higher risk investments—by their nature, hedge funds are more likely than other types of funds to take on underlying investments that carry high degrees of risk, such as debt obligations based on sub-prime mortgages d. Lack of transparency—hedge funds have few public disclosure requirements
Problems with clients that own a large amount of one stock (ISOs):
a. Limited market for the security b. The basis in the security is low relative to its value c. The client has a desire to keep the asset
Averaging down
a. Purchasing additional shares only when the market price of the shares declines b. The investor reduces the cost basis of an investment by buying more shares as the price of that security decreases c. The investor will be rewarded if the price of the security subsequently increases
real estate valuation methods:
a. Sales comparison approach 1.) This approach is most appropriate when there are several properties in a market that have recently been sold that have similar characteristics as the property being valued b. Cost approach 1.) Estimates the value of a property by determining how much it would cost to replace the property and then making any adjustments for depreciation or deterioration of the property 2.) The first step is to separate the value of the land from the value of the building. The value of the land can be estimated by looking at comparable properties. The next step is to estimate the current cost of constructing such a building. To this value, any adjustments should be made to reflect deterioration of the property. 3.) The cost approach is appropriate when valuing special-use buildings (e.g., a church) and also newly constructed property because the value of the property should not have changed dramatically in a short time and there should be little depreciation or deterioration to consider c. Income capitalization approach 1.) Bases the value of the property on the income that can be generated from the property 2.) This income stream is approximated and then discounted to determine an estimated value of the property 3.) Two methods for applying this approach: a.) Direct capitalization b.) Discounted cash flow analysis 4.) Direct capitalization a.) Most basic method of income capitalization b.) Formula V = net operating income / discount rate ■ Net operating income (NOI) is defined as net income before depreciation and mortgage debt service (refer to upcoming NOI discussion) ■ The discount rate is the rate at which the cash flows will be discounted. This rate could be the cost of capital, an opportunity cost, or a required rate of return and may also be a rate that is based on the sales of other properties. EXAMPLE A property that recently sold for $12 million and generated net operating income of $2.16 million per year has an implied capitalization rate of 18% ($2.16 million ÷ $12 million). *■ The assumption generally inherent in this model is that the income will remain constant 5.) Discounted cash flow analysis a.) Appropriate when the assumption that income will remain constant into the future is not reasonable b.) In such a case, the valuation of the property would begin by forecasting net operating income (in many cases this is done by forecasting income and then forecasting operating expenses) for several years into the future c.) At the point at which it is no longer reasonable to forecast net operating income, the assumption would be made that this income level would remain constant from that point into the future d.) The direct capitalization method would be used to value the income stream at the point net operating income is assumed to remain constant ■ These cash flows would then be discounted at an appropriate capitalization (discount) rate to determine the value of the property *it is just NPV
Arbitrage pricing theory (APT)
a. Supporters of APT believe that returns for securities are based on a variety of factors that affect different groups of investments 1.) Some factors will affect all securities such as inflation, interest rates, and popu-lation growth 2.) Other factors may only affect a specific industry; thereby affecting only a subset of securities 3.) Finally, certain events or factors, such as a factory burning down, may only affect a single company
Asset allocation should be built with the following characteristics:
a. The client's risk tolerance level and time horizon b. The client's level of sophistication with regard to investment alternatives c. The required rate of return necessary to meet the client's objectives d. The client's financial position and tax situation
Share averaging
a. The investor purchases the same number of shares every time b. Dollar amount of investment varies c. Not easy to automate (e.g., by way of automatic monthly investing) because the amounts invested are seldom the same
Dollar cost averaging (DCA)
a. The process of purchasing securities over time by investing a predetermined amount at regular intervals b. The goal is to reduce the effects of market price fluctuations 1.) When the market is rising, shares benefit from price increases 2.) When the market is declining, additional shares are purchased at lower prices and will yield more shares per dollar invested 3.) Does not guarantee a positive return to the investor c. Works best when markets are declining or fluctuating d. Does not work well when the market is steadily increasing because in that event, the investor would be better off buying as many shares as possible up front when the price per share is lower
Dividend Reinvestment Plans
a. The term dividend reinvestment refers to dividends being automatically reinvested back into the investment from which they were earned b. DRIPs are offered as a service to shareholders. Participation is usually permitted to shareholders of one or more shares of stock. These plans provide several benefits. 1.) Dividends are automatically reinvested back into the company's stock 2.) Additional purchases of shares can be made without a broker and/or for minimal or no commissions c. Reinvested dividends are treated the same for tax purposes as cash dividends
Discounted free cash flow model
a. This model is used when a firm is not currently paying a dividend. The company's free cash flow to equity is discounted to find the intrinsic value of the stock. EXAMPLE PLV Corporation has an estimated FCFE for next year (FCFE1 ) of $3 per share. In addition, its FCFE is expected to grow at a constant rate of 3% per year for the foreseeable future. Your client has a required rate of return of 10%. Therefore, the intrinsic value of PLV Corporation's stock is $42.86 per share: V= 3/ (.1-.03)= $42.86
issues of Mutual fund
a.) Changing asset size ■ Limited number of small and mid-size companies in which to invest ■ Mutual funds have restrictions on amounts that can be invested in a single company ■ When a small-cap mutual fund dramatically increases its asset base, it may no longer be able to invest additional assets efficiently or effectively and returns may suffer B)Turnover rate ■ If a fund has a turnover rate of 100% or more, the fund generally is holding its securities for less than one year ■ Turnover rate affected by investment style of fund ■ Higher turnover rate results in higher transaction costs and may accelerate taxable income to investors c.) Style drift ■ Changes in fund's investment style affect the investor's asset allocation strategy d.) Changes in fund management/advisory team ■ Changes may increase risk and reduce future returns e.) Built-in gains—realized but not yet recognized capital appreciation of fund assets ■ When assets are sold, capital gains are passed through to investors ■ Investors who purchase shares of mutual funds holding built-in gains subject themselves to potential taxable income without any associated economic gain
issues with futures
a.) Fixed quantity characteristic of futures contracts limits the ability of producers and manufacturers to perfectly hedge EXAMPLE A farmer produces 275,000 bushels of cotton. Cotton futures contracts specify 50,000 bushels of cotton per contract. The farmer can over-hedge (six contracts for 300,000 bushels) or under-hedge (five contracts for 250,000 bushels b.) Quality or type of commodity/ financial asset held or needed may not exactly match quality or type of commodity/financial asset designated in futures contract c.) Expiration date of futures contracts may not match desired date for delivery/receipt of the commodity/financial asset d.) Transaction costs h. Taxation 1.) Gains and losses on futures contracts are capital gains and losses 2.) Net gains or losses are treated as 60% long term/40% short term, regardless of the actual holding period 3.) Capital losses may be used to offset the investor's capital gains from other securities 4.) Open positions at the end of the tax year are treated as if they had been closed on the last day of the year for tax purposes a.) Gain or loss inherent in the futures contract is reported annually
Blue-chip stocks
a.) Issued by highly regarded, cash-flow stable companies b.) Pay dividends regularly c.) Representative index: Dow Jones Industrial Average (DJIA)
Collar
a.) Options can be used to create a collar around the value of the stock. For example, writing a call option on a stock can generate premium to pay for the premium on a put option. b.) The call option creates a ceiling on the value of the security, while the put establishes a floor for the value of the security c.) This type of arrangement is generally referred to as a zero-cost collar because there is no cost to the investor; however, the option contracts will expire and the collar would have to be put back in place after expiration
Interest-sensitive stocks
a.) Stocks affected by changes in market interest rates ■ Impacts the cost of corporate debt b.) Industries include: ■ Financial institutions ■ Construction ■ Real estate
Defensive stock
a.) Stocks relatively unaffected by economic fluctuations b.) Characterized by steady growth c.) Industries include: ■ Groceries ■ Pharmaceuticals ■ Tobacco
Cyclical stocks
a.) Stocks that tend to prosper during economic expansion and perform poorly during contractions b.) Typically have large investments in plant and equipment (i.e., fixed costs) c.) Industries include: ■ Automobile ■ Construction ■ Air travel
Holding period return
add 1 to percentages. Then multiply them all. Then subtract 1
Time value
call Premium= 7 FMV= 75 EP= 68 Intrinsic value= 7 Time value= 0
Constant growth dividend discount model
d1/ r-g = value *d0= today! *This model is best used for a mature, well-established company
Tactical Asset Allocation
deviating from a portfolio's target asset allocation weights in the short term to take advantage of perceived opportunities in specific asset classes
Dividend payout ratio
dividends ÷ net income
Know how to figure out duration change in bond
duration * ((change in %) / (1 + YTM))
Operating profit margin
earnings before interest and taxes ÷ sales
Preemptive right—
entitle existing common stockholders the right to maintain ownership percentage ■ A rights offering allows stockholder to purchase common stock below the current market price ■ Protects investors' ownership percentage ■ Short-term privilege—usually 30-45 days
Real estate investment trusts (REITs)
es are traded on exchanges or over-the counter 3.) Types a.) Equity trusts—invest in income-producing properties (e.g., office buildings, shopping malls) b.) Mortgage trusts— make loans to develop property and/or finance construction c.) Hybrid trusts—manage real estate and transact mortgages 4.) Taxation a.) Dividend distributions are generally treated as ordinary income ■ May be classified as qualified dividends for purposes of the preferential 0%/15%/20% capital gains tax rates b.) Capital gain distributions are classified as long-term capital gains regard-less of holding period
Investors who want :
income= bond fixed income Safety= Govt bonds liquidity= money market Growth= stocks
Strategic asset allocation
is determining the target asset allocation percentages for a portfolio.
Market cap
market price per share multiplied by number of shares outstanding
Geometric mean
n SQRT((1+r) * (1+r2)* (1+r3)..) - 1
Derivative is
options and futures
Yield to maturity (YTM)
solve for Interest rate *A major assumption when calculating the YTM is that all interest payments are reinvested at the calculated YTM. Therefore, if the calculated YTM is 6%, any interest payments generated from the bond are assumed to be reinvested at 6%
Dividends are Taxed at ordinary income tax rates, unless considered a qualified dividend. what is a qualified dividend?
the dividend must have been paid by a U.S. corpo-ration or a qualified foreign corporation, and the shareholder must generally have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date) then taxed at preferential capital gains rates (0%/15%/20%)
Call Option
the right (not the obligation) to purchase the underlying security for a specified price within a specified period a.) Covered call option— when the writer of the option owns the underlying security *This strategy is ideal for an investor who believes the underlying price will not move much over the near-term. b.) Naked call option— when the writer of the option does not own the underlying security (extremely risky)
Put Option
the right (not the obligation) to sell the underlying security for a specified price within a specified period *Portfolio insurance—purchase of a put index option, reflective of the portfolio, to protect an investor's portfolio against a market downturn
Emerging markets
these countries usually have: *Low GDP *Lowe levels of equity cap *Questionable market liquidity *potential Restrictions on currency conversions *prospect for economic growth *stabilizing govt is good if you can find it *lower regulatory standards (hidden info)
Debt ratio
total debt ÷ total assets
Front-end load sales charge
—sales charge deducted from the initial investment
Intrinsic Value
■ Call: Intrinsic value = greater of (market price less exercise price) or zero ■ Put: Intrinsic value = greater of (exercise price less market price) or zero EXAMPLE A put option on RST stock has an exercise price of $25. RST is currently selling for $28. The intrinsic value of the put is zero; the market price is greater than the exercise price. A put option on MNO has an exercise price of $30. MNO is cur-rently selling for $29. The intrinsic value of the put is $1. A call option on ABC has an exercise price of $50. ABC is currently selling for $45. The intrinsic value of the call is zero; the exercise price is greater than the market price. A call option on UVW has an exercise price of $72. UVW is cur-rently selling for $78. The intrinsic value of the call is $6.
12b-1 fees
■ Fees for marketing and advertising expenses ■ Up to 0.75% of the net asset value per year
Administrative expenses or management fees
■ Pays for general operating expenses of the mutual fund (e.g., fund manager's salary) ■ Generally 1-2% of net asset value per year
Back-end load or deferred sales charge
■ Sales charge imposed upon withdrawal from a fund ■ Applicable sales charge is reduced ratably to zero over a period of time, generally five to eight years
