FINA 4321
Annual return from quarterly returns
( (1+r1) (1+r2) (1+r3) (1+r4) ) - 1 assumes re-investment of the dollar and earnings
Feasible set
(also known as the opportunity set) from which the efficient set can be identified. The feasible set represents all portfolios that could be formed from a group of N securities. That is all possible portfolios that could be formed from N securities lie either on or within the boundary of the feasible set.
Interest rate risk
(consider an investor with a three-month holding period who purchases a Treasury security maturing in 20 years. This security is risky because the investor does not know what it will be worth at the end of the holding period. Because interest rates will likely change in an unpredictable manner during the investor's holding period, the market price of the security will likewise change in an unpredictable manner.
FINRA
(financial industry regulatory authority)
SEC
(securities exchange commission) 5 commissioners Three including chair from party in white house
Typical patterns of stock repurchases
- open-market repurchases are typically made after the stock price has had an abnormal decline -fixed price and dutch-auction repurchases are made after a period of fairly normal returns. -stock price jumped upward on the announcement of the repurchase offer for all three types. - after the repurchases offer expired, the stock price did not fall back to its preannouncement level
stock split
- similar to a stock dividend in that the stockholder owns more shares afterward. However there is no dollar adjustment in stockholders equity account - stock split = owner recieves 2x shares but half the price - reverse stock split = owner cuts # of stocks in half but prices are doubled.
Three general observations of correlations between markets
- with the exception of Canada, the correlations of foreign stocks with U.S. stocks are low, suggesting there are sizable potential diversification advantages to a U.S. stock investor of investing in the stocks of these five countries -correlations of foreign bonds are low, with the exception of Canadian bonds - the correlations of foreign bonds with U.S stocks and the correlations of foreign stocks with U.S bonds are all generally low.
Largest markets for common stocks
-United States, Japan, UK, Germany, France
indifference curves
-cannot intersect -represents a set of risk and expected return combinations that provide an investor with the same amount of utility. The investor is indifferent about the risk-expected return combinations on the same indifference curves - A risk-averse investor will find any portfolio lying on an indifference curve "farther northwest" more desirable. -investor has an infinite number of indifference curves -assumptions of nonsatiation and risk aversion cause indifference curves to be positively sloped and convex -more risk averse investor has higher sloped indifference curves
ex dividend date
-identifies who receives a dividend -two business days prior to the date of record -investors purchasing shares before an ex dividend date are entitled to receive the dividend in question; those purchasing on or after the ex dividend date are not entitled to the dividend.
why do firms repurchase their stock?
-one motive is to repel a takeover attempt -management may be attempting to send a signal to the shareholders that the corporation's stock is undervalued in the marketplace -management may want to alter its debt-to-equity ratio -it may be beneficial taxwise to the current shareholders for the firm to use excess cash to repurchase stock instead of using it to pay a cash dividend.
market model vs CAPM
-the market model is a factor model, to be more specific, it is a single factor model i which the factor is a market index. Unlike the CAPM, it is not an equilibrium model that describes how prices are set for securities.
Reasons for portfolio revision
-viewed as suboptimal by the investment manager -either the weights in the different securities have changed as their market prices have changed, or the client's attitude towards risk and return has changed, or more likely, the managers forecasts have changed. -
avg operating expense ratio
.80-1.70%
steps to determining a portfolio's ex post alpha, beta, and characteristic line (5 steps)
1. Determine the periodic rates of return for the portfolio and market index over the time interval as well as the corresponding riskfree rates. 2. determine the average market return and riskfree rate 3. Determine the portfolios ex post beta 4. Determine the portfolios ex post alpha 5. insert these values into the ex post characteristic line.
6 foreign investable categories that make up the world portfolio
1. Japan Equity 2. Other equity 3. Emerging market equity 4. Emerging market debt 5.Other bonds 6. Japan bonds
Five-step procedure for making investment decisions
1. set investment policy 2. perform security analysis 3. construct a portfolio 4. Revise the portfolio 5. Evaluate performance of portfolio
Dollar weighted return
A money-weighted rate of return is a measure of the rate of return for an asset or portfolio of assets. It is calculated by finding the rate of return that will set the present values of all cash flows and terminal values equal to the value of the initial investment. analogous to the internal rate of return does not work if cash flows are unevenly spaced over time
Stock Split - Adjusting the divisor
A stock split is accounted for in a price-weighted index by adjusting the divisor whenever a split takes place. In the example, the divisor is adjusted by examining the index on day 1, the day of the split. More specifically, the following equation would be solved for the unknown divisor. (13+11)/d = 17.5 d= 1.37 the new divisor continues in use after day 1 until there is another split or index composition change, when it will again be recalculated. The index level on day 0 was 100, so the change from day 1 would be 16.67 (=.1667 X 100) resulting in a level on day 1 of 116.67. This step is equivalent to dividing the average price on day 1 (17.5) by the average price on the beginning date (15) and then multiplying the result by the index's level on the beginning day (100) APt = average price on day t and It denotes the index level on
S&P 500 (Standard and Poors Stock Price Index)
A value weighted average price of 500 large stocks
Random variable
According to markowitz, the investor should view the return associated with any one of these portfolios as what is called in statistics a random variable. Can be described by their moments which are expected (mean) value and standard deviation He asserts investors should base their portfolio decisions solely on mean and standard deviation
deposit or withdrawal happens directly before the end of the period (returns)
Adjust the ending market value in the case of a deposit, the ending market value should be reduced by the same amount in the case of a withdrawal, the ending market value should be increased by the same amount
separation theorem (CAPM)
Although the chosen portfolios will be different (because of different acceptances of risk - different indifference curves) each investor will choose the same combination of risky securities in the same relative proportions, adding riskfree borrowing or lending in order to achieve a personally preferred combination of risk and return. The optimal combination of risky assets for an investor can be determined without any knowledge of the investor's preferences toward risk and return because - with CAPM, everyone faces the same linear efficient set, meaning that each person invests in the same tangency portfolio in which everyone else is investing (there will also be a certain amount of either riskfree borrowing or lending that depends on that person's indifference curves) it follows that the risky portion of all investors will be the same another important feature of the CAPM is that in equilibrium each security must have a nonzero proportion in the composition of the tangency portfolio.
domestic return vs foreign return
American and Swiss investor purchase shares of swiss company that is only traded in Switzerland. Domestic return = rD = (P1-P0)/P0 P0=10 P1=12 rD=20% Foreign return = rF = (X1P1 - X0P0)/(X0P0) beg. exchange rate .50 franc per $1 end exchange rate .55 franc per $1 rF=32%
Efficient set theorem
An investor will choose his or her optimal portfolio from the set of portfolios that 1. Offers maximum expected return for varying levels of risk and 2. Offers minimum risk for varying levels of expected return. The set of portfolios meeting these two conditions is known as the efficient set (also known as the efficient frontier)
when deposits or withdrawals occur between the beginning and end of the period, the calculations are more difficult. One method to solve the return is the dollar-weighted return (beginning value is set equal to the discounted value of all cash flows associated with the portfolio as well as the ending value. formula = _______
Beginning value = X/(1+r) + ending value/(1+r)^n
Book-value-to-market-value ratio
Book value/market value most recent balance sheet data, most recent market price for the firms common stock and multiplying it by the number of shares outstanding. Relatively low values of this ratio characterize growth stocks and relatively high values characterize value stocks
2 financial measures that distinguish between growth and value stocks:
Book-value-to-marktet-value ratio BV/MV Earnings-to-price ratio E/P
maintenance margin requirement (margin account)
Brokers require investors to keep collateral in their accounts that is worth more than the amount of the loan. = Loan/ 1-maintenance margin requirement
Bull vs bear market
Bull - Market moving up Bear - Market moving down
operating expense ratio
Combination of fees and expenses results in total annual operating expenses typically ranging from .8-1.7 of the average total assets.
reinvestment-rate risk
Consider a treasury security that matures before the end of the investor's holding period, such as a 30-day treasury bill for the investor with the three-month holding period. In this situation, the investor does not know at the beginning of the holding period what interest rates will be in 30 days. As a result, the investor does not know the interest rate at which the proceeds from the maturing treasury bill can be reinvested for the remainder of the holding period.
capital market line (CAPM)
Efficient portfolios, which plot along the line going form the risk-free through the market portfolio, consist of alternative combinations of risk and expected return obtainable by combining the market portfolio with riskfree borrowing or lending. This linear efficient set is known as the capital market line (CML). slope of CML = (expected return of market portfolio) - (expected return of riskfree security)/ (risk of market portfolio) CML = rf + ((rM-rf)/(std. dev M) x Std.P intercept of cml = price of time slope of cml = price of risk
Important international indices used for comparative performance measurement
Financial Times - Stock Exchange 100 index (footsie) for the london stock exchange Nikkei 225 average for the tokyo stock exchange Tse 300 composite index for the toronto stock exchange
risk premium
It is the expected increase in terminal wealth (expected return) over the certain investment required to compensate the investor for the risk incurred.
Net asset value (NAV)
Market value of all assets held by the investment company at the end of each business day. Use closing prices then multiply by the number of shares outstanding and dividing the resulting difference by the number of outstanding shares of the investment company NAVt = MVAt - LIABt/NSOt
In general calculating the standard deviation for a portfolio consisting of N securities involves performing the double sum
N^2 terms
step 2 of investment process
Performing security analysis Passive vs. active management Passive = index investing Active = search for mispriced securities
Step 5 of investment process
Portfolio performance evaluation and reporting - consider ex post risk and return -comparisons with benchmarks - try to distinguish skill from luck (or lack of skill from bad luck)
step 1 of investing process
Prepare investment policy statement (IPS) Defines client's investment objectives, constraints, time horizon, and risk attitude -describes strategies to be employed to meet them -includes: asset allocation targets and ranges liquidity requirements and income needs tax considerations -identifies 'benchmark portfolio' -indicates frequency and types of portfolio reporting and evaluation -contains procedures for reviewing and amending IPS
Fama and French concluded that there are at least two missing factors that are needed to explain differences in stock returns and that those factors are closely related to size and the bv/mv ratio. (true of false)
True
charter
a corporation exists only when it has been granted a charter, or certificate of incorporation by a state. This document specifies the rights and obligations of stockholders. It may be amended with the approval of the stockholders, perhaps by a majority or a two thirds vote, wherein each share of stock generally entitles its owner to one vote.
Limit order definition
a limit price is specified by the investor when the order is placed with the broker. If the order is to purchase shares, the broker is to execute the order at a price less than or equal to the limit price.
Standard deviation definition
a measure that estimates the likely divergence of an actual return from an expected return
how does a shareholder benefit taxewise from a repurchase (two ways)
a smaller amount is taxed at a capital gains tax rate that is potentially lower than the ordinary income tax rate that is applicable to cash dividends
ex post
after the fact
Hypothecation agreement
allowing shares to be used as collateral
Earnings-to-price ratio
also known as earnings yield accounting value of the firms earnings per share is determined using the most recent income statement and dividing the firm's earnings after taxes by the number of shares outstanding. Second, the market price of the firm's common stock is determined from the most recent price at which the firm's common stock is determined from the most recent price at which the firm's common stock was traded. earnings per share is divided by the market price of the stock to arrive at the E/P ratio. Relatively low ratios characterize growth stocks and relatively high ratios characterize value stocks. On average the larger the size of the E/P ratio, the larger the rate of return. Stocks or smaller firms tend to have higher returns than stocks of larger firms
open order definition
also known as good-till-canceled orders(GTC), remain in effect until they are either filled or canceled by the investor fill-or-kill orders are canceled if the broker is unable to fully execute immediately discretionary orders= allow the broker to set the specifications for the order. The broker may have complete discretion on all the order specifications, including which stocks to buy and sell, or limited discretion in which case he decides only on the price and timing of the order
open-end investment companies
an investment company that stands ready at all times to purchase its own shares at or near their net asset value. Most of these companies, commonly known as mutual funds.
efficient set (efficient frontier)
an investor will choose his or her optimal portfolio from the set of portfolios that 1. Offers maximum expected return for varying levels of risk 2. Offers minimum risk for varying levels of expected return can be located by applying the efficient set theorem to the feasible set. investor should plot his or her indifference curves on the same figure as the efficient set and then choose the portfolio on the farthest northwest indifference curve.
diversification leads to an ______ of market risk
averaging diversification can substantially reduce unique risk
ex ante
before the fact
beta coefficient (CAPM)
beta coefficient = covar(Im)/ varM an alternative way of representing the covariance of a security
Broker call money rate definition
broker borrows money elsewhere in the money market (usually drawing a line of credit at a bank and pledging securities as collateral. Brokers add anywhere from 1% to 2% to the call money rate to determine the interest rate charged to their margin purchase customers.
market order definition
broker is instructed to buy or sell a stated number of shares immediately. The broker is obligated to act on a "best efforts" basis to get the best possible price when the order is placed. An investor will be certain that the order will be executed but will be uncertain of the price. (day order)
Another method to solve for returns when deposits or withdrawals occur between periods is the time-weighted return. This method uses the market value just before each cash flow occurs. (generally more preferable)
calculate the return before the cash flow and also after the cash flow.
Purpose of the market model
capturing the relationship of a stock and an index (index value goes up, stock goes up) ri=(intercept term) + (slope term X return on market index) + (random error term)
covariance in finance vs variance
covariance is the term used to describe how two stocks will move together use variance to measure a stock's volatility. Being able to express in a single number just how far a given stock's value can travel away from the mean is a very useful indicator of how much risk a particular stock comes with.
efficient market
defined as one in which every security's price equals its investment value at all times will exist
Two types of self-tender offers when companies repurchase shares.
fixed price self tender offer - corporation offers to repurchase a stated number of shares at a set, predetermined price Dutch-auction - corporation offers to repurchase a stated number of shares but at a price determined by inviting existing shareholders to submit offers to sell.
Stockholder preemptive rights
give current stockholders the right of first refusal for the purchase of the new shares when new shares are to be sold. Each current stockholder is issued a certificate that indicates the number of new shares he or she is authorized to purchase. This number is proportionate to the number of existing shares currently owned by the stockholder. Usually, the new shares are priced below the current market price of the stock, making such rights valuable. The stockholder can exercsie the rights by purchasing his or her alloted amount of new shares, thereby maintaining his or her proportionate ownership in the firm, but at the cost of providing additional capital. Alternatively, the rights can be sold to someone else
stop limit order
helps investors know with more certainty the execution price associated with a stop order. the investor specifies not one but two prices - a stop price and limit price.
Step 3 Portfolio construction
how much to invest in each security -balancing risk and return -consider trading costs - spread, commissions, price impact
externally efficient market
information is quickly and widely disseminated, which allows each security's price to adjust rapidly in an unbiased manner to new information so that it reflects investment value
security selection style
investment organization that engages in a type of management that places active bets on individual securities
stop order
investor must specify a stop price. if it is a sell order, the stop price must be below the market price when the order is placed. If it is a buy order, the stop price must be above the market price when the order is placed.
nonsatiation
investors are assumed to always prefer higher levels of terminal wealth to lower levels if terminal wealth
normative economics
investors are tied what they should do (investment in the tangency portfolio along with a certain amount of either riskfree borrowing or lending)
Risk-averse
investors will choose the portfolio with the smaller standard deviation, meaning the investor, when given a choice, will not want to take fair gambles, where a fair gamble is one that has an expected payoff of zero. For example, flipping a coin, with heads meaning you win 5, and tails meaning you lose 5. the coin has a 50:50 chance of being heads or tails the expected payoff is 0$ (0.5X$5) + (0.5 X (-$5). The risk averse investor will avoid this gamble
internally efficient market
is one in which brokers and dealers compete fairly making the cost of transacting low and the speed of transacting high.
the standard of comparison for all money market interest rates is ________
is the rate paid on short-term U.S Treasury securities called U.S. Treasury bills
The contribution of each security to the standard deviation of the market portfolio depends on the size of its covariance with the market portfolio. securities with ____values of covariance contribute more to the risk of the market portfolio. However securities with larger standard deviations do not necessarily add more risk to the market portfolio than securities with smaller std. devs.
larger equilibrium between risk and return ri= rf + ((rM-rf)/varM)cova(im) indicates that larger covariances with the market will be priced so as to have larger expected returns. This relationship is known as the security market line (SML) a risky security with covar(im)=0 will have an expected return equal to the rate on the riskfree security rf because this risky security, just like the riskfree security will not affect the risk of the market portfolio when a marginal change is made in its weight. This is true even though the risky security has a positive standard deviation and the riskfree security has a std dev. of zero. it is even possible for some risky securities to have expected returns less than the riskfree rate. According to the CAPM this situation will occur if covar(im) < 0, thereby indicating tht the securities contribute a negative amount of risk to the market portfolio
investors with higher levels of risk aversion will engage in _____ borrowing (or _____ lending) than investors with less risk aversion
less & more
margin account
like a checking account with overdraft privileges, loan available. investor must sign hypothecation agreement. it allows the brokerage firm to pledge the investors securities as collateral for bank loans, provided the securities were purchased using a margin account.
cash account
like a regular checking account
sharpe ratio (reward-to-variability ratio)
measure of risk-adjusted performance that uses a benchmark based on the ex post capital market line. It measures returns relative to the total risk of the portfolio, where total risk the standard deviation of portfolio returns. one must determine the location of the ex post CML.
security's beta
measures the security's sensitivity to future market movements. In principle the possible sources of such movements should be considered when estimating beta. Then the reaction of the security's price to each of these sources should be estimated, along with the probability of each reaction. In the process, the economics of the relevant industry and firm, the impact of both operating and financial leverage on the firm, and other fundamental factors should be taken into account.
restricted (letter) stock definition
must be held for at least one year and can be sold during the next year only if ample information on the company is available and the amount sold is relatively small percentage of the total amount outstanding. It is called a letter stock because the purchase must provide the SEC with a letter indicating that the shares will be held as an investment and will not be for resale. (Large institutional investors can trade Nonpublic securities issued under this rule among themselves at any time after their issuance
with risk-free lending, the efficient set becomes a straight line from the riskfree rate to a point tangent to the curved Markowitz efficient set, in addition to the portion of the Markowitz efficient set that lies ____ of this tangency point
northeast
Stock split - Price weighted method
on day 1, B splits two-for-one and closes at 11 per share, while A closes at 13 per share. It's clear that the market has risen because both stocks have a higher price than on day 0 after adjusting B for the split. if nothing were done with the split, its value on day 1 would be 12 = ( (13+11) /2 ) a drop of 20% = (12-15)/15 which is incorrect. The index 17.5 = (13 + (11X2) a gain of 16.7% (17.5- 15)/15
equity swap definition
one counterpart agrees to pay a second counterparty a stream of variable-size cash payments that is typically based on the rate of return of an agreed-on-stock market index. In return, the second counterparty agrees to pay the first counterparty a stream of fixed cash payments that is based on current interest rates. Both sets of payments are to be made for a given time period and are based on a certain percentage of an underlying notional principal. Through an equity swap the first counterparty has, in essence, sold stocks and bought bonds, whereas the second counterparty has sold bonds and bought stocks. Both of them have effectively restructured their portfolios without paying transaction costs, other than a relatively small fee to a swap bank that set up the contract.
interest rate swap
one counterparty agrees to pay a second party a stream of cash payments, the size of which is reset regularly based on the current level of a highly visible interest rate. in return, the second counterparty agrees to pay the first counterparty a stream of fixed cash payments based on the level of interest rates in existence at the time the contract is signed. Through the interest rate swap the first counterparty has in essence sold short-term fixed income securities and bought long-term bonds
Step 4 of investment process
portfolio revision -cost-benefit analysis to see if it is worthwhile
portfolio's ex post alpha (differential return)
portfolio's risk -adjusted performance is the difference between its average return and the return on its corresponding benchmark portfolio. arbp= arf + ((arM-arf)xBp)
Positive economics
presents a descriptive model of how assets are priced
simple return formula
r = (V2-V1)/V1
expected return on a portfolio formula
rP = X1R1 + X2R2 ........ x= proportion of the portfolios initial value invested in security i r= expected return of security rp=expected return on portfolio
mutual fund return
rT= (Nav1-Nav0) + I1 + G1/ Nav0
feasible set (opportunity set)
represents all portfolios that could be formed from a group of N securities.
In extending the Markowitz feasible set to include risk-free lending, investors are assumed to allocate their funds among a riskfree asset and a portfolio of _____ assets
risky
Ex post characteristic line
rp-rf = intercept term + BetaP(rM-rf) similar to the market model, except that the portfolios returns and the market index's returns are expressed in excess of the riskfree return.
certainty equivalent calculation
rp=9.75 sd=7.5 risk tolerance = 50 (9.75-(56.25/50))
Load charge
sales force paid commission based on number of shares it sells - commission involves adding a percentage load charge to the net asset value. By law, the charge cannot exceed 8.5% of the amount invested. 3.5% or less load = "low-load funds" All mutual funds need to provide an investor with a copy of the fund's prospectus before shares can be purchased. the prospectus provides information to an investor, describing the fund's performance, holdings, and financial statements. A few funds charge a redemption fee, which is usually no more than 1% of the funds net asset value and typically is not levied if the investor has owned the shares for more than a specified time, such as one year. funds may charge a distribution. fee annually "12b-1" fee. legally not allowed to exceed 1% of the average market value. Contigent deferred sales charge (paid when investor sells shares) of 5% declining 1% reaching zero after the fifth year. Investment performance of no-load funds as a whole does not differ in any notable way from that of load funds.
short selling
sell high, buy low by borrowing stock certificates for use in the initial trade, then repaying the loan with certificates obtained in a later trade. short sales may not be made when the market price for a security is falling because the short seller could worsen the situation = uptick rule (10a-1) states that a short sale must be made on a plus-tick or zero plus tick
No-load funds
sell their shares at a price equal to their net asset value
random error term (market model)
shows that the market model does not explain security returns perfectly. the random error term is a random variable that has a probability distribution with a mean of zero.
ex distribution date
similar to the process used to pay cash dividends, -for stock dividends less than 20%, the procedure is identical to the one for cash dividends. -for larger stock dividends and all stock splits, the procedure is different because the ex distribution date is usually the business day after the payment date
Money market funds
special type of mutual fund that invests in short-term, fixed-income securities, such as treasury bills, commercial paper, and bank certificates of deposit.
Capital asset pricing model (cap)
specifies the relationship between expected return and beta. Assumptions added in CAPM - all investors have the same one-period horizon - The riskfree rate is the same for all investors -Information is freely and instantly available to all investors -investors have homogeneous expectations, meaning that they have the same perceptions regarding the expected returns, standard deviations, and covariances of securities Everyone has the same information and agrees about the future prospects for securities. Examining the collective behavior of all investors in the marketplace enables one to develop the resulting equilibrium relationship between each security's risk and return.
Covariance between two random variables is equal to the correlation between the two random variables time the product of their_______
standard deviations (correlation coef. rho X standard deviations)
Price weighting method used in computing a market index
starts by summing the prices of the stocks that are included in the index and ends by dividing this sum by a constant (the divisor) in order to calculate an average price. Market index based on two stocks A (1500) & B(2000) $10 and $20 respectively If the index only includes only stock A and B and was started on day 0, the divisor would be 2.
covariance definition
statistical measure of the relationship between two random variables. shows how two variables "move together". Positive value shows the securities tend to move in the same direction
Growth stocks
stocks of companies that have experienced, or are expected to experience, rapid increases in earnings on average, the larger the size of the BV/MV ratio, the larger the rate of return.
Value stocks
stocks whose market price seems to be low relative to measures of their worth.
debit balance (margin account)
the amount borrowed from the broker as a result of such a margin purchase
deposit or withdrawal happens directly after the start of the period (returns)
the beginning market value needs to be adjusted in the case of a deposit, the beginning market value should be increased by the same amount in the case of a withdrawal, the beginning market value should be increased by the same amount
Call money rate (margin account)
the call money rate is the rate paid by the broker to the bank that loaned the broker the cash that ultimately went to the investor to pay for part of the purchase.
Covariance formula for two assets
the covariance between the returns on any two assets i and j is equal to the product of the correlation coefficient between the assets and the standard deviations of the two assets
correlation definition
the covariance between two random variables is equal to the correlation between the two random variables times the product of their standard deviations cov=(rho x std. dev1 x std. dev2) rho=correlation coefficient
Yield spread definition
the difference between what the treasury pays to borrow money and what other borrowers pay is known as the yield spread.
investor's utility of wealth function
the exact relationship between utility and wealth. under nonsatiation, all investors prefer more wealth to less wealth. Each investor has a unique utility of wealth function. As a result, each incestor may derive a unique increment of utility from an extra dollar of wealth. That is the marginal utility of wealth may differ among investors. A common assumption is that investors experience diminishing marginal utility of wealth.
risk premium
the expected increase in terminal wealth (or expected return) over the certain investment required to compensate the investor for the risk incurred.
initial margin requirement (margin account)
the minimum percentage of the purchase price that must come from the investor's
Dow Jones Industrial Average (DIJA)
the most widely quoted market index is the Dow Jones, based on the performance of only 30 stocks and uses a less satisfactory averaging procedure than the other indices use, but it still provides a fair idea of what is happening to stock prices. Price weighted
investment value
the present value of the security's future prospects, as estimated by well - informed and skilled analysts who use the info that is currently at hand
Value weighting (capitalization weighting)
the prices of the stocks in the index are multiplied by their respective number of shares outstanding and then added to arrive at a figure equal to the aggregate market value for that day. This number is then divided by the corresponding figure for the day the index was started. With the resulting value multiplied by an arbitrarily determined beginning index value. $55,000 (=($10X1,500) + ($20X2,000). The aggregate value on day 1 is equal to 63,500 = ($13X1,500) + ($11X400). Dividing ($63.500/$55,000) X 100 gives the index value for day 1 of 115.45. No special procedures for stock splits because the resulting increased number of shares for a company is automatically used after a split in calculating its market value
Nominal return definition
the rate at which a citizen can trade current money for future money depends on the investment In times of changing prices, the nominal return on an investment may be a poor indicator of the real return obtained by the investor. This situation occurs because part of the additional dollars received from the investment may be needed to recoup the investor's lost purchasing power due to inflation that occurred during the investment period. As a result, adjustments to the nominal return are needed to remove the effect of inflation to determine the real return. CPI is 150 at beginning of the year, then at the end of the year its 160. Nominal return is 9% 150X1.09 = $163.50 ($163.50/160)-1=2.19% or (160/150)-1=6.67% (1.09/1.0667) -1 = 2.19% (investors concerned with real returns. securities in the market place will be priced so that expected nominal returns incorporate the expected rate of inflation.
beta (market model)
the slope in a security's market model measures the sensitivity of the security's returns to the market index's returns. = covariance of stock/variance of returns on the market index stocks with beta greater than 1 = aggressive
what causes the indifference curves to be positively sloped and convex?
the two assumptions of non satiation and risk aversion (
certainty equivalent
the value of terminal wealth that if offered with certainty, would provide the same amount of expected utility as the risky investment.
beta of a portfolio
the weighted average of the betas of its component securities
asset allocation style
those that engage in the type of management that places active bets on asset classes
financial leverage
using debt to fund part of the purchase price, the investor can increase the expected return on the investment.
different forms of market efficiency and definitions
weak = previous prices of securities reflected semistrong=all publicly available info strong=all info both public and private