What percentage of funds should be allocated to stocks?60%What percentage of funds should be allocated to bonds?30%What percentage of funds should be allocated to alternative assets?6%What percentage of funds should be allocated to money market securities?4%What is security selection & analysis?Choosing specific securities w/in an asset classWhat is the primary determinant of a portfolio's return?The asset allocation decisionWhat is securitization?Loans of a given type such as mortgages are placed into a 'pool' and new securities are issued that use the loan payments as collateralWho are the main purchasers of securities like mortgaged back securities?Shadow banking systemTrue or False: Securitization spreads loan credit risk among more institutions.TrueWhy has securitization grown rapidly? (4)1. Changes in financial institutions and regulation permitting its growth 2. Lower capital requirements on securitized loans 3. Improvement in information capabilities 4. Credit enhancement provided by pool issuers has improved marketabilityWhat are money market instruments? (9)1. Treasury Bills 2. Certificates of Deposit 3. Commercial Paper 4. Bankers' Acceptances 5. Eurodollars 6. Repos and Reverses 7. Broker's Calls 8. Federal Funds 9. LIBOR (London Interbank Offer Rate)What is the call money rate?Investors who buy stock on margin borrow money from their brokers to purchase stock. The borrowing rate is the call money rate.True or False: Yields on money market instruments are not always directly comparableTrueWhat are the three factors influencing "quoted" yields?1. Par value vs. investment value 2. 360 vs. 365 days assumed in a year (366 leap year) 3. Simple vs. Compound InterestWhat are three popular yield measurements used in quotations?1. Bank Discount Rate 2. Bond Equivalent Yield 3. Effective Annual YieldDiscount or BEY? Treasury billsDiscountDiscount or BEY? Certificates of depositBEY*Discount or BEY? Commercial PaperDiscountDiscount or BEY? Bankers AcceptancesDiscountDiscount or BEY? Bankers AcceptancesDiscountDiscount or BEY? EurodollarsBEY*Discount or BEY? Federal FundsBEY*Discount or BEY? Repurchase Agreements (RPs) and Reverse RPsDiscountWhat is the formula for converting "add on" to BEY?BEY = Add on * (365/360)True or False: CD, Euro and FF all use add on which is not quite the same as BEYTrueWhat are the common denominations of treasury bills?$100, commonly $10,000When do treasury bills mature?4, 13, 26, or 52 weeksHow liquid are t-bills?Highly liquidDo t-bills have default risk?noAre t-bills issued at par, discount, or premium?DiscountWhat taxes are paid on t-bills?Federal taxes owed, exempt from state and local taxesWho issues certificates of deposit (CD)?Depository InstitutionsWhat are the common denominations of CDs?Any, $100,000 or more are marketableWhen do CDs mature?Varies, typically 14 day minimumHow liquid are CDs?3 months or less are liquid if marketableDo CDs have default risk?First $100,000 ($250,000) is insuredWhat type of interest are CDs?Add onWhat taxes are paid on CDs?Interest income is fully taxableWho issues commercial paper?Large creditworthy corporations and financial institutionsWhat are the common denominations of commercial paper?Minimum $100,000When do commercial paper mature?Maximum 270 days, usually 1 to 2 monthsHow liquid are commercial paper?3 months or less are liquid if marketableDoes commercial paper have default risk?Unsecured, Rated, Mostly high qualityWhat type of interest are commercial paper?DiscountWhat taxes are paid on commercial paper?Interest income is fully taxableWhat is the formula to find tax exempt?r tax exempt = r taxable x (1 - tax rate) r = interest rateFind the after tax rate of return to a corporation that buys preferred stock at $40, holds it one year and sells it at $40 after collecting a $4 dividend. The firm's tax rate is 30%.(Pretax rate or return = 4 / 40 = 10% ) The total before-tax income is $4. After the 70% exclusion, taxable income is: 0.30 x $4 = $1.20 taxable income Therefore Taxes owed are Tax rate taxable income Taxes = 0.30 x $1.20 = $0.36 After-tax income = $4 - $0.36 = $3.64 After-tax rate of return = $3.64 / $40 = 9.10%An investor has a 30% tax rate and corporate bonds are paying 9%. What must Corey pay to offer an equivalent after tax yield?r tax exempt = r taxable x (1 - tax rate) r tax exempt = 9% x (1 - .3) = 6.3%True or False: When one company owns stock in another, the dividends are taxed fully.False the dividends have partial tax exemptionYou buy a share of stock for $50, hold it for one year, collect a $1.00 dividend and sell the stock for $54. What were your dividend yield? (Ignore taxes)Dividend yield: = Dividend / Pbuy $1.00 / $50 = 2%You buy a share of stock for $50, hold it for one year, collect a $1.00 dividend and sell the stock for $54. What were your capital gain yield? (Ignore taxes)Capital gain yield: = (Psell - Pbuy)/ Pbuy ($54 - $50) / $50 = 8%You buy a share of stock for $50, hold it for one year, collect a $1.00 dividend and sell the stock for $54. What were your total return? (Ignore taxes)Total return: = Dividend yield + Capital gain yield 2% + 8% = 10%If you rent a car to your friend then sell it to someone else after 1 year, is the rent a capital gain or dividend yield?dividend yieldIf you rent a car to your friend then sell it to someone else after 1 year, is the final sale a capital gain or dividend yield?capital gain total return is the gain and the yield togetherDoes price weighted average, value weighted average, or equal weighted average assume buying 1 share of each stock and invest cash and stock dividends proportionatelyPrice weighted averageWhat does value weighted consider when purchasing stock?-considers not only price but also the number of shares outstanding -money invested in each stock are proportional to the market value of each stockWhat does equal weighted consider when purchasing stock?-considers not only price but also the number of shares -invest same amount of money in each stock regardless of market value of stockTrue or False: Value weighted and equal weighted are often considered "True Indexes" because they measure value today with value at a prior point in time.TrueWhat are underwritten banking arrangements?banker makes a firm commitment on proceeds to the issuing firmWhat are best efforts banking arrangements?bankers helps sell but makes no firm commitmentWhat is a negotiated bid?issuing firm negotiates terms with investment bankerWhat is a competitive bid?issuer structures the offering and secures bidsWhat is SEC Rule 415? (shelf registration) (4)1. Security is preregistered and then may be offered at any time within the next two years 2. 24 hour notice, any part or all of the preregistered amount may be offered 3. Introduced in 1982 4. Allows timing of the issuesWhat is private placement? (5)1. sale to a limited number of sophisticated investors not requiring the protection of registration 2. Allowed under SEC Rule 144A 3. Dominated by institutions 4. Very active market for debt securities 5. Not active for stock offeringsWhat is the IPO Process?issuer and banker put on the "Road Show" for the purpose of book building and pricingWhat is underpricing? (3)1. Post initial sale returns average about 10% or more 2. "Winner's curse" problem 3. Easier to market the issue, but costly to the issuing firmWhat are the two big complaints of the IPO process?1. cutting out individual investor (winner's curse idea) 2. limiting underpricingWhat is a direct search market?Buyers and sellers locate one another on their ownWhat are the four types of markets?1. Direct Search Markets 2. Brokered Markets 3. Dealer Markets 4. Auction MarketsWhat is a brokered market?3rd party assistance in location buyer or seller don't have inventoryWhat is a dealer market?3rd party acts as intermediate buyer/seller have inventoryWhat is an auction market?Brokers & dealers trade in one location, trading is more or less continuousWhat is the bid?price dealer will buy from youWhat is the ask?price dealer will sell to youYou place a buy market order when limit inside quotes are Bid $20.00, Ask $20.10 What will your buy market order be?20.10 against the bookYou place a buy market order when limit inside quotes are Bid $20.00, Ask $20.10 What will your sell market order be executed at?20 against the bookHow does short sales work?1. Borrow stock from a broker/dealer, must post margin 2. Broker sells stock and deposits proceeds and margin in a margin account (you are not allowed to withdraw the sale proceeds until you 'cover') 3. Covering or closing out the position: Buy the stock and broker returns the stock title to the party from which it was borrowedWhat is naked short sales?a trader sells shares that have not yet been borrowedWhat is a short position (short sale)Sell first and then buy laterWhat is required for a short sale?1. Required initial margin: usually 50% but more for low priced stocks 2. Liable for any cash flows: Dividend on stockYou sell short 100 shares of stock priced at $60 per share. The proceeds of $6000 must be pledged to broker. You must also pledge 50% margin. How much do you put up?3,000You sell short 100 shares of stock priced at $60 per share. The proceeds of $6000 must be pledged to broker. You must also pledge 50% margin. How much (total) do you have invested in the margin account?9,000What is the formula for short sale equity?Short Sale Equity = Total Margin Account - Market ValueWhat is the formula for market value?Market Value = Total Margin Account / (1 + Maintenance Margin %)You sell short 100 shares of stock priced at $60 per share. The proceeds of $6000 must be pledged to broker. You must also pledge 50% margin. Maintenance margin for short sale of a stock with price > $16.75 is 30% of market value. How much excess funds do you have?30% x $6,000 = $1,800 3,000 (you had to invest) - 1,800 = 1,200You sell short 100 shares of stock priced at $60 per share. The proceeds of $6000 must be pledged to broker. You must also pledge 50% margin. Maintenance margin for short sale of a stock with price > $16.75 is 30% of market value. At what stock price do you get a margin call?Market Value = $9,000 / (1 + 0.30) = $6,923 $6,923 / 100 shares = $69.23You sell short 100 shares of stock priced at $60 per share. The proceeds of $6000 must be pledged to broker. You must also pledge 50% margin. Maintenance margin for short sale of a stock with price > $16.75 is 30% of market value. How much is equity?$9,000 - $6,923 = $2,077You sell short 100 shares of stock priced at $60 per share. The proceeds of $6000 must be pledged to broker. You must also pledge 50% margin. Maintenance margin for short sale of a stock with price > $16.75 is 30% of market value. If you get a margin call, how much extra must you deposit?You may have to restore the 50% initial margin. If so you must deposit an additional ($6,923 / 2) - $2,077 = $1,384.5What are unit investment trusts (UITs)? (4)1. Unmanaged, fixed composition portfolios 2. Any interest and/or dividends are distributed immediately to trust certificate holders. 3. Provide diversification within one sector or area and low cost entry. 4. Often levered, rates of return can be extremeWhat are managed investment companies (mutual funds)? (3)1. Managed, usually changing composition portfolio. 2. The fund's board of directors typically hires an investment advisor to select and manage the fund assets according to some specific goal(s) set by the board and any regulatory requirements. 3. The investment advisor usually creates the fund and selects the investments. Most funds are of this type.What are the two types a managed investment company (mutual fund) may be?1. Open end 2. Closed endWhat is an open ended mutual fund? (3)1. shares are bought from the fund and redeemed by the fund 2. charges when new shares are sold or old shares are redeemed 3. Fund share price = Net Asset Value (NAV)What is a close ended mutual fund? (3)1. shares are bought and sold among investors in the marketplace (NASDAQ or an exchange) and the fund itself is not involved 2. no charges unless new stock is offered 3. Fund share price may trade at a premium or discount to NAVWhat are the two advantages of the open end form of a mutual fund?1. Liquidity for the investor 2. Fund's ability to grow (advantage for the fund or sponsor)What are the two disadvantages of the open end form of a mutual fund?1. The need to keep a cash reserve 2. Vulnerable to panicsWhat are commingled funds? (3)1. Partnerships of investors that pool their funds 2. Designed for trusts or larger retirement accounts to get professional management for a fee 3. Operates similar to a mutual fundWhat are Real Estate Investment Trusts (REITs)? (3)1. Similar to closed end fund. Invest in real estate and real estate loans 2. Equity trusts purchase real estate 3. Mortgage trusts invest in mortgage and construction loansWhat are hedge funds? (4)1. Similar to mutual funds, but not registered and not subject to SEC regulations 2. Available to institutional and high net worth investors 3. Can pursue investment strategies that are not allowed for mutual funds 4. Grew from about $50 billion in 1990 to about $2 trillion in 2008What is the Net Asset Value (NAV)? (3)1. Used as a basis for valuation of investment company shares 2. Selling new shares 3. Redeeming existing sharesWhat is the formula to find the Net Asset Value (NAV)?(Market Value of Fund Assets - Fund Liabilities) / Fund Shares OutstandingWhat is the fee structure when it comes to investing in mutual funds?Front-end load: A commission or sales charge paid when you buy into a fund. Generally given to the broker who sells the fund Back-end load or redemption fee: These may be more useful since there are costs to all investors when investors cash out of the fundWhat are the operating expenses when it comes to investing in mutual funds? (3)1. Buying and selling commissions 2. administrative expenses 3. advisory fees for the managersWhat are the 12 b-1 charges when it comes to investing in mutual funds? (7)1. Marketing costs paid by the fundholders 2. Alternative to a load, but assessed annually 3. Maximum is 1% of assets 4. 12b-1 max used to be 1.25%. Actually now 0.75%, but you can have a service fee of 0.25% 5. In mutual fund quotes, r = redemption fee, p means there is a 12b-1 fee and T means there are both 6. Quotes do not identify front end loads 7. High fees generally lower returnsIf you invest $10,000 in a fund with an 8.5% front-end load, how much are your actual shares worth?$9,150 the other $850 goes to the brokerIf you invest $10,000 in a fund with an 8.5% front-end load, you actually acquire shares worth $9,150; the other $850 goes to the broker. What is the effective load?The effective load is greater than the stated load: $850 / $9150 = 9.3% which is greater than stated loadWhat is the expense ratio?Funds charge annual operating expenses and annual advisory or management fees against the NAVWhat is the formula for the expense ratio?Annual Expenses / Average NAVA "well managed" fund probably should have an expense ratio of less than _____?2%What are exchange traded funds (ETFs)?allow investors to trade index portfolios like shares of stockWhat are the 5 potential advantages of the exchange traded funds (ETFs)1. Trade continuously throughout the day 2. Can be sold short or purchased on margin 3. Potentially lower taxes 4. No fund redemptions 5. Large investors can exchange their ETF shares for shares in the underlying portfolioWhat are the 2 potential disadvantages of the exchange traded funds (ETFs)1. Small deviations from NAV are possible 2. Must pay a brokerage commission to buy an ETF but a no load index fund may be purchased online for no commissionWhat is the formula for holding period return (HPR) on mutual funds?(NAV sell - NAV buy + Capital Gain distribution + Dividend distribution) / NAV buyTrue or False: All distributions are taxable, even if reinvested in the fund.TrueWhat is the formula for holding period return (HPR) on a one period investment?HPR = (Sale Price - Buy Price + Cash Flow during holding period) / Buy Price2000; -21.56% 2001; 44.63% 2002; 23.35% 2003; 20.98% 2004; 3.11% 2005; 34.46% 2006; 17.62% What is the geometric average return?(1 + HPRt)^(1/n) - 1 (.7844 x 1.4463 x 1.2335 x 1.2098 x 1.0311 x 1.3446 x 1.1762) ^ (1/7) - 1 = 15.61%What is the formula for the average HPR for a portfolio?(HPR1 x (amount invested in asset 1 / total amount investment)Suppose you have $1000 invested in a stock portfolio in September. You have $200 invested in Stock A, $300 in Stock B and $500 in Stock C. The HPR for the month of September for Stock A was 2%, for Stock B the HPR was 4% and for Stock C the HPR was - 5%. What is the average HPR for the month of September for this portfolio?(.02 x (200/1000)) + (.04 x (300/1000)) + (-.05 x (500/1000)) = -.9%What is the formula for subjective expected return?expected return = probability of a state x return if a state occursWhat is the formula for the real rate?rreal = [nominal % x (1 - tax bracket %)] - inflation rate %

FIN 4504 (12:30) Test 1

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