Investment Analysis Exam 1.

What is the differnece between asset allocation and security selection?

Asset allocation is the allocation of an investment portfolio across broad asset classes. Security selection is the choice of specific securities within each asset class.

AN investor is in a 30% combined federal plus state tax bracket. If corporate bonds offer 9% yields, what must municipals offer for the investor to prefer them to corporate bonds.

The after-tax yield on the corporate bonds is: 0.09 x (1 - 0.30) = 0.063 or 6.3%. Therefore, the municipals must offer at least 6.3% yields.

If the home currency greatly appreciated against the foreign currency (where company A is competing) what would happen to the competitive position of company A?

The appreciating home currency would make Company A's products more expensive abroad and impact its ability to be competitive.

Why would you expect securitization to take place only in highly developed capital markets?

*Securitization requires access to a large number of potential investors. To attract these investors the capital market needs: 1. a safe system of business laws and low risk of confiscatory taxation/regulation. 2.A well-developed investment banking industry. 3. A well-developed system of brokerage and financial transactions. 4. Well developed media (financial reporting).

If you believe the US dollar is going to depreciate more dramatically than do other investors, what will your stance be on investments in US auto producers?

A depreciating dollar makes imported cars more expensive and American cars cheaper to foreign consumers. This should benefit the US auto industry.

What is the difference between a stop loss order, a limit sell order and a market order?

A stop order is a trade is not to be executed unless stock hits a price limit. The stop-loss is used to limit losses when prices are falling. an order specifying a price at which an investor is willing to buy or sell a security is a limit order, while a market order directs the broker to buy or sell at whatever is available in the market.

Suppose that in a wave of pessimism, housing prices fall 10% across the entire economy. A. Has the stock of real assets of the economy changed? B. Are individuals less wealthy? C. Can you reconcile your answers to A&B

A. Only the perception of value has changed, the assets have not. B. Yes, the value has changed and their balance sheet will reflect such. C. This shows the difference between real and financial assets by showing how one can change financially and not impact the unit.

What are agency problems? What are some approaches to solving them.

Agency problems are conflicts of interest between managers and stockholders. They can be addressed through corporate governance mechanisms such as the design of executive compensation, oversight by the board and monitoring by institutional investors.

What are the differences between equity and fixed income securities.

Equity has a lower priority claim and represents an ownership share in a corporation, whereas fixed income (debt) security pays a specific cash flow at a specified rate for a certain time. Equity has infinite life.

How does investment banking differ from commercial banking?

Investment bankers are firms specializing in sales of new securities to the public, typically by underwriting the issue. Commercial banks accept deposits and lend the money to other borrowers.

The right to buy a stock at a certain price

Long Call

Right to Sell at a certain price

Long Put

What happens to IBX @ $200, 100shares being short sold with a stop stop buy order at 210?

Max loss would be 10*100=1000

Plowback Ratio

Plowback ratio in fundamental analysis measures the amount of earnings retained after dividends have been paid out. It is sometimes referred to as the retention rate.

What are the differences between a primary asset and derivative asset?

Primary assets have a claim on the real assets of a firm, whereas a derivative asset provides a payoff that depends on the prices of a primary asset, but not the claims on the real asset.

What are the differences between real assets and financial assets?

Real assets are used to produce goods and services. Financial assets are claims on real assets or the income generated by them.

Do you expect top 10% performing mutual funds to be in the top 10% again next year?

Research shows past performance does not equal future performance. Good performers lean towards performing well again, but it's no guarantee. If a MF is doing poorly though, it is likely to continue to do so, likely due to turnover rate and high fees.

Obligation to buy at a certain price

Short put

What are major components of the money market?

T-Bills, CD's, commercial paper, bankers' acceptances, eurodollars, repos, federal funds.

Ask Price vs Bid Price

The ask price is what sellers are willing to take for it. If you are selling a stock, you are going to get the bid price, if you are buying a stock you are going to get the ask price. The difference (or "spread") goes to the broker/specialist that handles the transaction

What happens to local banks when securitization occurs.

The default risk is shifted from intermediataries to investors of the security. Local banks profit from making and selling the loan, incentivizing more loans to occur.

What reforms to the financial system reduce systemic risk?

The dodd frank reform and consumer protection act limits the risky action banks can take, stricter capital, liquidity, and risk management practices. It also unifies and clarifies regulatory requirements. The act mandates increased transparency, especially in derivatives markets.

Firms raise capital from investors by issuing shares in the primary markets. Does this imply that corporate financial managers can ignore trading of previously issued shares in the secondary market?

The stock price reveals information about how investors view the firm's projects. If the stock price rises after announcing a plan, it might be a good sign that the plan is going to be profitable.

Why would it be a challenge to properly compare the performance of an equity fund to fixed-income mutual fund?

They contain different types of securities. Therefore, there are numerous differences that make it difficult. Equity funds invest primarily in the common stock of publically traded firms. Fixed income funds invest in corporate bonds, treasury bondss, mortage backed securities or municipal bonds. The risk associated with stocks are economic conditions and the success of the business. The risks associated with fixed income securities are primarily interest rate risk and credit risk.

Wall street firms have traditionally compensated their traders with a share of the trading profits they generated. How might this practice have affected traders'willingness to assume risk? What is the agency problem this practice engendered?

Traders will take extra risk to increase profits, but will not take a penalty on losses. Traders may also sell to other traders which can create multiple moral conflicts.

A market order has...

price uncertainty but not execution uncertainty

Obligation to sell at a certain price

short call