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investment managenet test 2
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Key Concepts:
Terms in this set (138)
What type of index is the DOW?
Price-weighted average
S&P is what type of index?
Market-Weighted
Equally Weighted Index
- equally weighted average of returns of each stock
- Adjusts based on gains and losses to make sure to have an equal investment in all companies (not based on market weight by actual stock price and re-balances frequently)
Problem with bond market indices?
- infrequency of bond trading makes true rates of return hard to compute.
- in practice some bond prices must be calculated using bond valuation models
derivative assets
these assets derive their value from other assets
derivative assets are sometimes called contingent claims assets, why?
because their payoffs are contingent on the value of other values
call option
gives the holder the right to purchase an asset for a specified (exercise/ strike) price
put option
gives the holder the right to sell an asset for a specified (exercise/ strike) price
futures contract
calls for the delivery of an asset at a specified delivery or maturity date for an agreed upon price
futures contract long position
held by the trader who commits to purchasing the asset on the delivery date
futures contract short position
trader who commits to delivering the asset at contract maturity
Open end investment companies are more commonly known as?
Mutual Funds
Investment Companies
Financial Intermediaries that collect funds from individual investors and invest those funds in a potential wide range of securities or other assets
Functions performed by investment companies
- Record Keeping and ad,ministration
- Diversification and divisibility
- Professional management
- lower transaction costs
Investors buy share in investment companies and ownership is in proportion to?
the number of shares bought
The value of each share in an investment company is called?
Net Asset Value
Net Asset Value =
(Market Value of Assets - Liabilities) / Shares Outstanding
Types of investment companies as described by the Investment Company Act of 1940?
- Unit Investment Trusts
or
- Managed Investment Companies
Managed Investment Companies are classified as?
- Open End
or
- Closed End
Open End Funds Investors buy and shares from?
directly from the investment fund based on NAV
Close End Funds Investors buy and shares from?
From other investors on organized exchanges. They are bought and sold at market price and thus can trade over or under the NAV
Unit Investment Trusts
pools of money invested in a portfolio that is fixed for the life of the fund
How is a unit investment trust formed and how are shares sold
- A sponsor (usually a brokerage firm) buys shares in a portfolio of securities and deposits them in a trust
- The sponsor sell units of the trust (called redeemable trust certificates) to investors
- the sponsor makes their money by selling the shares at a premium to the cost of acquiring the assets
- Shares can be bought or sold back to the sponsor/trustee by the investor
How are managed investment companies formed and managed?
Shareholders elect a board of directors which hires a company to manage the fund
Can a open end fund fall below NAV?
No
What is meant by a fund carrying a load?
it is a sales charge. Usually from the securities brokers and/or directly by the mutual fund group
Commingled Funds
partnership of investors that pool money together and is managed by a bank, insurance company, etc for some kind of fee
A typical commingled funds may be a trust or retirement account with portfolios that are much larger than most individual investors but still too small to warrant managing on a separate basis
a bank or insurance company may offer an array of different commingled funds such as?
money market funds, bond funds, and common stock funds
REITs
similar to closed end funds but they invest in real estate
REIT equity trusts
invest in real estate directly
REIT mortgage trusts
invest in mortgage or construction loans
REIT's are generally established by?
banks, insurance companies, or mortgage companies who then manage the reit for a fee
Hedge funds
typically only open to wealthy and institutional investors so they face little SEC regulation
Hedge Funds facing little SEC regulation allows them to?
pursue investment strategies using heavy use of derivatives, distressed firms, currency speculation, convertible bonds, emerging markets, merger arbitrage, etc
Most Hedge Funds require investors to agree to "lock-ups" meaning?
this is a period, as long as several years, in which investments cannot be withdrawn
Each mutual fund has its own investment policies outlined in?
its prospectus
Types of mutual funds:
Money market funds
invest primarily in commercial paper, repurchase agreements, and CDs.
these assets tend to have a maturity date of about 1 year and net asset value is fixed a $1 per share
Types of mutual funds:
Equity Funds
primarily in stock with 4-5% of total assets in money market securities to provide liquidity of redemption of shares
Types of mutual funds:
Equity Funds - Income Funds
focus on stocks with consistent high dividends
Types of mutual funds:
Equity Funds - Growth funds
focus on capital gains prospects
Types of mutual funds:
Sector Funds
equity funds that focus on a particular sector
Types of mutual funds:
Bond Funds
Focus on fixed income securities (the types of bonds invested in will depend on the objectives of the firm)
Types of mutual funds:
International Funds
funds with an international focus
Types of mutual funds:
International Funds - Global funds
invest in securities worldwide
Types of mutual funds:
International Funds - international funds
invest in securities of firms located outside the US
Types of mutual funds:
International Funds - Regional Funds
focus on particular parts of the world
Types of mutual funds:
International Funds - emerging market funds
invest in companies of developing nations
Types of mutual funds:
Balanced Funds
Hold equities and fixed income securities
Types of mutual funds:
Balanced Funds - life cycle funds
balance funds where asset mix can range from aggressive for younger investors to conservative for older investors
Types of mutual funds:
Balanced Funds - Static Life Cycle Funds
allocation among stocks and bonds is fixed
Types of mutual funds:
Balanced Funds - targeted maturity life cycle funds
become more conservative as the investor ages
most balanced funds are?
funds of funds
funds of funds
mutual funds invested in other mutual funds
Asset Allocation and Flexible Funds
similar to balanced funds but their allocation is based on the fund manager's forecast so they are engaged in market timing and not considered low risk
index funds
match the performance of an index
How are mutual funds marketed/sold to investors?
- Direct Marketing by the fund underwriter
or
- indirectly through brokers and financial advisers
How are funds marketed directly?
mail, various offices of the fund, over the phone
Indirect funds marketing
Do brokers and financial advisers receive a commission from mutual funds for selling their shares to an investor?
Yes
Types of Mutual Fund Fees
- operating expenses
- Front end Load
-Back end load
- 12b-1 charges
Types of Mutual Fund Fees
Operating Expenses
Fees periodically deducted from the assets of the fund for administrative expenses, advisory fees paid to investment manager, marketing fees, distribution costs
Types of Mutual Fund Fees
Front end load
commission paid by the investor when you purchase shares
What is considered a low front end load fee?
3% or less
a fund with a front load of 0% is called a?
No Load fund
Types of Mutual Fund Fees
Back-End Load
Redemption of exit fee incurred when you sell the shares
Types of Mutual Fund Fees
12b-1 Charges
managers of 12b-1 funds are allowed to use funds to pay for distribution and marketing and promotional literature but these costs cannot exceed 1%
Many mutual funds offer classes which means?
All classes are ownership in the same securities but that each class has a different fee structure
Does the rate of return based on NAV formula include load fees?
No
Explain mutual fund soft dollar expenses
A fund manager earns soft dollars with a brokerage firm by directing trades, and paying commissions to that broker. In return the broker pays for expenses such as databases, computer hardware, or stock quotation systems.
This impact of higher paid commissions is shown through investment performance and not through expenses
Investment Returns of mutual funds are granted what tax status?
pass-through status. This means taxes are only paid by the investor.
How are taxes passed on to the investor from a mutual fund?
a fund's short term capital gains, long term capital gains, and dividends are passed through to the investor as if the investment was earned directly
a mutual fund with high portfolio turnover rate can be?
tax inefficient
fund turnover measures?
the amount of the fund that is "replaced" each year
what is the turnover of the fund?
100 in assets
50 in sales
50/100 = 50% turnover
ETFs
are like mutual funds but they are traded on the stock market
Differences between ETFs and Mutual Funds?
- mutual funds are quoted and can only be bought at a set price once per day. In contrast ETFs are traded constantly throughout the day
- An investor only realizes taxes when he sells his shares. A mutual fund may have to sell shares early if there are lots of redemptions creating taxes for the other investors.
- Large investors can trade their ETF shares for the actual underlying shares of the fund. Mutual funds this cannot be done
- ETFs have no load fees and typically have smaller management fees because they spend less on marketing because they are easier to acquire by investors on the public market
- ETFs can depart from NAV and must be purchased from a broker for a trading fee
Factors that determine the level of interest rate?
- The supply of funds from savers (primarily households)
- The demand for funds by business to purchase real assets
- The government's net demand for funds as modified by the federal reserve
- The expected rate of inflation
nominal interest rate
the growth rate of your money
real interest rate
the growth rate of your purchasing power
Bank CD's promise a nominal rate of interest, what interest rate risk is still unaccounted for?
Because inflation is uncertain, the real rate of return you will earn is risky?
How can you infer the expected real rate on an investment that pays a nominal rate of interest?
adjusting your nominal rate for the expected rate of inflation
The nominal rate is the real rate plus?
inflation
Three basic factors that determine real interest rate
- supply
- demand
- government actions
What is implied by the Fisher Hypothesis?
When real rates are stable, changes in nominal rates ought to predict changes in inflation rates (the nominal rate should increase 1 for 1 with inflation)
Although this is debated, it does seem that nominal interest rates predict inflation
The difference between EAR and APR grows with?
compounding
Effective annual rate is defined as
percentage increase in funds invested over a 1 year horizon
Annual Percentage Rates are computed using?
Simple rather than compounding interest
What is the expected rate of return?
A probability-weighted average of the rates of return in each scenario
Expected return is also referred to as the?
mean return
variance measures?
dispersion of possible outcomes around the expected value
A futures contract is based on how many items?
5,000
The tick for an options contract is divided by what number?
8
Long Call
The right to buy an asset at a specific price
Long Put
The right to sell an asset at a specified price
Short Put
The obligation to buy an asset at a specific price
Short Call
The obligation to sell an asset at a specified price
Dividend Yield =
dividend yield = (dividend / Investment)
Formula for book value of equity
Total Assets - Intangible Assets (goodwill) - Total Liabilities = Book Equity
Are options a zero sum game?
Yes
An option is in the money if?
Exercise of the option will produce a positive payoff (this does not include the cost of buying the option)
An option is out of the money if?
exercise of the option will not produce a positive or zero payoff if the option is exercised (this does not include the cost of buying the option)
An option is at the money if
Exercise of the option will produce a zero payoff to the holder of the option (this does not include the cost of buying the option)
american options can be exercised?
on or before the expiration date
A European option can be exercised on?
Only on the date of expiration
Key differences between options and futures?
- Futures are the obligation to buy or sell where as options are the right to buy or sell
- Options must be purchased for a premium where as futures contracts have no cost
Real Return
Your return adjusted for changes in buying power
The slope of the Capital Allocation Line is given by?
Share Ratio of the Risky Asset
True or False,
It is very likely that you will not have a probability of distribution of returns
True
How does leverage impact asset allocation of a portfolio?
Leverage allows you to have a weight of the risky asset of greater than 1 and the expected return of the leveraged portfolio can be greater than or equal to the leveraged portfolio
Individual investors with different levels of risk aversion, will
choose different positions in the risky asset. This is true given?
Given an identical capital allocation line
Two Step Process for the investment decision
Step 1: Find the best risky asset portfolio
Step 2: Find your allocation between risky assets and risk free assets
For Weight in the risky portfolio,
If the risk premium increases for the risky portfolio then?
Higher weight for the risky portfolio
For Weight in the risky portfolio,
If risk aversion is higher then
then lower weight inthe risky portfolio
For Weight in the risky portfolio,
If riskiness of best asset portfolio (higher portfolio variance) then
lower risky portfolio weight
individual securities have a high level of ______________ risk
idiosyncratic risk
passive investment strategy is based on what premise?
That securities are fairly price and avoids security analysis
investing in a broad stock index and risk free investment is an example of a?
passive strategy
The Capital Allocation line that employs the market as the optimal risky asset is call the?
Capital Market Line
The Capital Market Line (CML)
The capital allocation line using the market index portfolio as the risky asset
The risk free asset commonly used for the CML is?
the one month T Bill
Active investment strategies entail more ______________ costs than passive strategies
trading costs
Passive investors ______________ on the activies of active investors in a competitive investment environment
"free-rides"
Why does Risk Measurement for non-symmetric distribution get very difficult?
because now you need to account for variance, skewness, kurtosis, etc
Skewness measures
asymmetry of probability of distributions
Left Negative Skewed
long tail of negative and low returns
Right positive skewed
long tail of positive and high returns
Kurtosis
too many observations in the tails
high kurtosis
extreme outcomes very likely
Why can returns never truly be normally distributed (think in terms of returns)?
Returns and be positive infinite but they cannot be negative infinite (they are limited to -100%)
Risk
the chance that outcomes of returns can be different than expected
Arithmetic returns are higher than?
geometric returns
Arithmetic and Geometric Returns
Which should be used for evaluating past performance?
Geometric Average Returns
Arithmetic and Geometric Returns
What is used for forecasting expected returns?
Arithmetic average
Arithmetic and Geometric Returns
Greater volatility of returns, increases or decrease the difference between Arithmetic and Geometric Returns?
Increases
Effective Annual Rate
Annual rate of interest that accounts for the effect of compounding once a year
Annual Percentage Yield is based on?
365 days in a year
Effective annual rate is the same as annual percentage yield if you assume?
365 days in a year
APR, the annual rate of interest is usually based on?
compounding more than once a year
Key difference between holding period return and dividend reinvestment return?
Dividend reinvestment return assumes you use your dividend to buy more shares during the investment period. So, the main difference is you will receive more recurring dividends and your final capital investment will be worth more based on the dividend amount relative to the change in price.
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