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Danko - Investments
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Key Concepts:
Terms in this set (131)
FDIC Insurance - Joint Accounts
-each person is insured up to $250K
FDIC Insurance - Revocable Trusts
$250k of coverage per beneficiary
Commercial Paper
-short-term unsecured promissory note issued by large companies
-start at $100K
-270 day or less maturities
Banker's Acceptance
-finance imports and exports
-bearer securities, can be held to maturity
-maturity is 9 months or less
-trades at discount to face value
Eurodollars
-deposit in any foreign bank denominated in dollars
Yankee Bonds
dollar-denominated bonds issued in the US by a foreign issuer
T-Bill
-3, 6, and 12 month maturities
-$100 - $1,000,000 (discount yield basis)
-no risk
-no coupon
-subject to fed income tax
-weekly auction
T-Note
-1 to 10 years
-$1,000 to over $100,000 at par
-RIP risk
-non-callable
-semiannual interest
-subj to fed income tax
-monthly auctions
T-Bonds
-10 to 30 years
-$1,000 to more than $1M at par
-subject to RIP risk
-callable potentially at 15 years
-semiannual interest
-subj to fed income tax
-quarterly auctions
Treasury STRIPS
-zero coupon bonds
-direct obligation of the fed gov't
-discount is taxable income earned yearly
CATS/TIGRS
-created by large BDs that buy block of T-Bonds and sell investors a coupon or principal at maturity
-obligation of BD, not Fed gov't
-same taxability as STRIPS
TIPS
Treasury Inflation Protected Securities
-marketable securities
-face value adjusted semiannual to keep pace with inflation; measured by CPI over 6-month period
-sold in $1,000 denominations
TIPS Tax Treatment
-taxed anually on interest payment plus appreciation in face value
-only fed tax applies
-interest and increase in face value taxed as OI
EE Bonds issued after 2005
-non-traded debt of US gov't, non marketable, non transferable, nonnegotiable, can't be pledged as collateral
-issued at face value; earn fixed rate of interest
-30 year life which includes 10 year extension
-as low as $50 denomination
-rates for new issues each 5/1 and 11/1
-int accrues monthly, compounded semiannually
-must be held minimum one year, 3 month int penalty applied if held less than 5 years from issue
-at min, face value doubles after 20 years
EEs in UTMA
-owned by child
-taxed as OI at redemption
EE "education" bonds
-normally owned by the parent
-tax free if the parents AGI is less than the phaseout at redemption
HH bonds
-were available only by exchanging $500+ in EE bonds
-pay interest semiannually by check
-non-marketable
-after Aug 2004, no longer exchangeable
I Bonds
-Inflation indexed accrual securities of the US govt. -Nonmarketable, non transferrable, nonnegotiable, and cannot be pledged as collateral.
-Issued at face value; accumulate interest monthly. -Interest is compounded every 6 mo, no guaranteed interest rate (different from EE bonds) -interest rate is compounded in 2 parts: fixed base rate and an inflation adjustment.
-The rate stays the same for the life of the bond.
-Inflation adjustment is adjusted every 6 months. The owner can choose to defer tax like series EE.
GNMA
Gov't National Mortgage Association
-buys FHA, VA, and Farmer's Home Admin insured mortgages from banks, puts them in pools
-issues modified mortgage backed pass through certificatest
-direct-guarantee of US gov't
-interest is taxable at all levels
-min certificate is $25K
-exposed to interest rate risk and reinvestment rate risk
Other Agency Securities
-backed implicitly through lines of credit
-Fed Home Loan Bank
-Fed Nat'l Mortgage Association (FNMA)
-Fed Home Loan Mortgage Corp (FHLMC)
Municipal Bond Insurers
-AMBAC
MBIA/National
BAM
Indenture Agreement
-form of bond
-amount of issue
-property pledged (if any)
-protective covenant, sinking fund
-working capital and current ratio
-redemption rights, call, put, conversion provisions
Speculative Grade
Junk Bonds, High Yield
-BB and below
-Ba and below
Bond Coversion Value
Par value divided by conversion price times current market price of underlying stock
Floor Value
-convertible securities have a floor value
-won't sell for less than larger of value as a bond or conversion value
Capitalization
-Large cap: $10B+
-Mid Cap: $2B - $10B
-Small Cap: less than $2B
-Micro Cap: less than $300M
10Q
quarterly reports from corporate management to the SEC
10K
annual reports from corp management to SEC
Preferred stock
-if cumulative, all divs must be paid in full to preferred shareholders before common stock divs paid
-typically bought by corporate treasurer with excess funds on hand; 50% of dividends are generally excluded from taxation
Qualified Dividends
-for preferred stock that pays annual div, for it to be qualified, stockholder must own for 90 days in 181 day period that begins 90 days before ex-dividend date
ADRs
American Depository Receipts
-shares of foreign-based corp held in vault of US bank
-prices quoted in US dollars
-dividends paid in USD, but declared in currency of country of origin
Unit Investment Trusts
-IC with no day-to-day portfolio management
-created by sponsor and handled by independent ttee
-assets aren't traded
-collects income and eventually repayment of prin
-self-liquidating
-sponsor makes market for sellers and buyers
-units generally redeemed at NAV
Hedge Funds
-require majority of investors in the fund to be accredited ($1M net worth, income level, etc)
Financial Reform Bill
-hedge fund managers with AUM of $100M+ required to register with SEC
GICS
Guaranteed Investment Contracts
-basically CDs issued by insurance companies
-2 to 5 years with guaranteed interest rate
-value doesn't fluctuate with int rates
-value depends on financial strength of issuer
-popular investment for DB plans
Net Operating Income
Gross Rental Receipts
+ Non-rental income
= Potential Gross Income
- Vacancy and collection losses
= Effective gross income
- Operating expenses (includes int & depr)
= net operating income
divided by cap rate = intrinsic value
Operating Expenses
-only includes cash expenses, not depreciation or amortization
-doesn't include debt service on mortgages
REIT
Real Estate Investment Trust
-equity REITS invest in income-producing properties then lease the property; use modest leverage to finance
-mortgage REITS make loans to develop prop or finance construction; carry higher default risk; vulnerable to purchasing power risk
-75%+ income must be from RE investments; 15% can come from securities
-if distributes 90%+ of net income, only pays tax on undistributed; conduit to owners
-shareholders can deduct 20% of pass-through inc
Real Estate Limited Partnership
-1986 tax act limited deductibility of losses
-nonpublicly traded partnerships
-relatively illiquid; think secondary market
-last about 10 to 20 years, until props liquidated
REMIC
Real Estate Mortgage Investment Conduit
-limited life, self liquidating entity
-invests exclusively in mortgages or in securities back by real mortgages
-more flexibility than CMOs
-can separate pools into different maturity and risk classes; range of risk levels
LEAPs
Long-Term Equity Anticipation Securities
-maturities 2 years +
Spot Price
current market price of a commodity in the cash market
Open Interest
number of futures contracts in existence for a particular commodity on any given day
Daily Limit
-maximum permissible price increase or decrease relative to the settlement price on the previous day
Long Futures
-wants to buy the commodity/financial (bullish)
Short Futures
wants to sell the commodity/financial (bearish)
Private Placement
Regulation D
-exempt from formal registration
-can be sold to max of 35 "non-accredited" investors & unlimited # of accredited investors
-non-accredited must be sophisticated or have purchaser representative
-full disclosure through offering memorandum
Accredited Investor
$1M net worth, $200K income single, $300K income join
Systematic Risk
non-diversifiable risk
Unsystematic Risk
can be effectively eliminated by portfolio diversification.
Liquidity
-can be sold or purchased without delay and without a substantial change in price absent new information
Marketability
refers only to the speed of the transactions
-must be purchase or sale, not redemption
Normal Distribution
-useful if considering the possible range of return (in %) for a portfolio
-could produce positive or negative returns
-return is symmetrical about the mean
-mean is centered within the bell curve
-period returns %, leveraged $
Lognormal Distribution
-useful for considering the possible ending portfolio value in $ as of some future date
-unleveraged portfolio can't be less than zero
-distribution is positively skewed, most values near the lower limit
-mean is to the right of the highest point of the curve
Correlation Coefficient
-expresses extent to which movements of securities in the same portfolio are similar or not
-uses specific range: +1 to -1
=covariance/(SD1xSD2)
Covariance
-extent to which movements of securities in portfolio are similar or not
-considers infinite possibility of outcomes
-extent to which 2 stocks are related to each other or how the price movements of one relate to the movements of the second
=correlation coefficient x SD1 x SD2
Perfectly Positively Correlated
-correlation coefficient = +1
-standard deviation of portfolio equals the weighted average of the standard deviations of the two assets
-maximum risk of portfolio
Perfectly Negatively Correlated
-correlation coefficient = -1
-move exactly opposite, no risk
-portfolio standard deviation = 0
Coefficient of Variation (CV)
the standardized measure of the risk per unit of return; calculated as the standard deviation divided by the expected returns
-standard deviation divided by average return
-risk per unit of expected return
Standard Deviation
measures variability of returns used in a nondiversified portfolio and is a measure of total risk
-find on calculator using sigma, shift 8
Beta
measures volatility of returns used in a diversified portfolio and is a measure of systematic risk
Standard Deviation Shortcut
depending on percentage weighting, just average the SDs of the two securities and look for the next lowest answer (unless perfectly positively correlated, SD of portfolio must be less than the weighted average SD)
Beta Formula
=covariance / SD of market squared
=(correlation coefficient x SD of stock)/SD of market
Risk Adjusted Return
-divide funds realized return by beta
Simple Return
-arithmetic mean
Compound Return
-involves adding interest to principal in order to calculate interest in the next period
Geometric Mean
-reflects compound returns over more than one time period
-time-weighted return
-often used to find avg for numbers as %
-evaluate performance of portfolio mgr
-not affected by cash flows
Geometric Mean Calculation
1. add 1 to the returns
2. multiply the returns
3. result become the FV
4. PV = -1
5. N = number of period
solve for i
Time-Weighted Return
-measures investment performance as a % of capital "at work"
-eliminates the effects of additions and withdrawals and their timing
Dollar-Weighted Return
-Measures changes in total dollar value, treating additions / withdrawals of capital as part of the return along with income, cap gains / losses.
-Same as IRR/ NPV.
-Manager to manager comparisons are not possible.
-Uses reinvestment rate.
Holding Period Return
-total return over the period from purchase to end of period or sale, divided by the price of the investment (out of pocket cost)
-fails to consider timing of cash flows
IRR
Internal Rate of Return
-discount rate at which PV or future cash flows equals the cost of the investment
-uses CFj
YTM
Yield to Maturity
-takes into acct mkt price as well as gains or losses if held to maturity
-always use semiannual compounding
-assumes coupons being reinvested at rate equal to YTM
TEY
Taxable Equivalent Yield
-shows the interest rate on taxable bonds necessary to provide same after-tax return as muni
=tax-exempt yield / (1 - marginal tax rate)
Tax Exempt Yield
= TEY x (1 - marginal tax rate)
Bond Duration
-measures weighted average maturity of the bond's cash flow on PV basis
-PV of cash flows are used as weights in calculating the weighted avg maturity
-most important measure of how risky bonds are, measures sensitivity to interest rate changes
-reveals how bond will react to particular change in interest rates
Duration formula
Dur = [(1 + y) / y] - [([1 +y] + t[c - y]) / [c([1 + y]supt - 1) + y]
y = Yield-to-maturity per period (CY on comparative bonds)
c = Coupon rate per period
t = Number of periods until maturity
Duration Usage
-can compare price volatility of bonds with equal coupons but different terms on basis of time
-risk averse means lower duration
-aggressive investors prefer high duration only when they anticipate rates will decline
Duration Trends
-High coupon, low duration (inverse)
-Long maturity, high duration (directly related)
Immunization
-duration of portfolio equals the time horizon
Change in Bond Price - Duration Formula
= -D x [change in interest rates / (1 + YTM)]
-answer is a percentage change
Using Duration to Manage Bond Portfolios
-interest rate will rise, shorten duration
-interest rate will fall, lengthen duration
Bond Price Volatility Guidelines
-smaller coupon, greater price fluctuations
-term to maturity longer, greater price fluctuations
-mkt interest rate lower, greater price fluctuations
Covexity
-degree to which duration changes as a bond's YTM changes
-largest for low coupon, long-maturity bonds and low YTM bonds
Zero Dividend Growth Model
Price = Dividend / Required Rate of Return
Constant Growth Model
Price = D1 / (r - g)
Price = [D0 x (1 + g) / (r - g)]
Summary of Dividend Discount Model
-if mkt lowers required rate for a stock, value of common stock will rise
-and vice versa
Two Layer Dividend Growth Rate
Step 1: add up the PV of the dividend for each year of the first growth rate
Step 2: Use constant growth model for the year that the rate changes and find the PV
Step 3: Add the PVs from Step 1 & Step 2 together
Two Layer Dividend Growth Shortcut
-use the DDM beginning with the second growth rate
-if the 1st growth rate is lower than the 2nd one, choose the next lowest number as the answer
-if the first growth rate is higher than the 2nd, choose the next highest number
Price/Earnings
Current Market Price = Earnings x P/E ratio
Price/Free Cash Flow
Value = FCF1 / (r -g)
ROE
Return on Equity
= EPS / Common Equity (net worth/book value)
-determined after preferred stock dividends but before common stock dividends are paid out
Dividend Payout Ratio
= common dividends paid / EPS
EPS
Earnings Per Share
= ROE x Book Value or Net Worth
MPT
Modern Portfolio Theory
-seek to quantify relationship between risk & return
-assumes compensation for taking on risk
-security valuation, asset allocation decision, portfolio optimization, performance measurement
Capital Market Line
-macro aspect of MPT
-specifies relationship between risk and return on a portfolio rather than one investment
-straight line, tangent to efficient frontier at 1 point
-y axis = expected return %; x axis = risk (SD)
-reveals expected return on fully diversified portfolio, diversified portfolio should fall along CML, individual securities or inefficient portfolios fall below CML, can't be used to evaluate performance of single security or non diversified portfolio, Rf is risk free return (100% T-Bills)
-slope is market price of risk for efficient port
SML
Security Market Line; micro
-relationship between risk and return for an asset
-doesn't matter if portfolio is diversified or non-diversified
r = Rf + (Erm - Rf) x B (CAPM)
- y axis = expected return, x-axis = beta
Market Risk Premium
= Erm - Rf
Random Walk Theory
The theory that there are no predictable trends in securities prices that can be used to "get rich quick."
-activity technical strategy adds no value
Anomalies
-P/E Effect (low P/Es perform better)
-Small-firm effect
-January Effect
-Neglected-firm effect
-Value Line phenomenon
Activity Ratio
-how rapidly a firm is able to convert various accounts in cash (or sales)
Technical Analysis Approaches
-Dow theory
-Barron's Confidence Index
-Odd lot theory
-Investment Advisor Opinions
-Advance/decline line
-200-Day moving average
-Mutual fund cash position
Dow Theory
A method for predicting market direction that relies on the Dow Industrial and the Dow Transportation averages.
Barron's Confidence Index
An index designed to identify investors' confidence in the level and direction of security prices
-presumes differential between returns on quality bonds and bonds of lesser quality will forecast future price movements
Dow Jones
-30 industrial, 20 transportation, 15 utility
-price-weighed average
S&P 500
-float weighted index
-largest issues that trade on NYSE and a few OTC
Russell 2000
-popular capitalization weighted index
-smallest 2000 stocks in Russell 3000
Wilshire 5000
-broadest measure of activity
-value weighted
-over 7000 issues that trade on NYSE, AMEX, OTC
Value Line
-equally weighted index
-1,700 issues on NYSE, AMEX, OTC
NASDAQ
-broadest measure of OTC trading
-capitalization weighted index
-all issues on NASDAQ
EAFE
Europe, Australasia, Far East
-typically compared to S&P to show relative perforamcne of US and international equity markets
Stock Splits
-distributions of more than 25% of the outstanding shares
-accounted for as adjustment to par value
Ex-Dividend Date
-date of record is first business day after the ex-dividend date
-get get dividend, but purchase stock before ex-dividend date
Sharpe Ratio
-ratio of excess return of the portfolio to its SD
= (rate of portfolio - risk free rate) / standard deviation of portfolio
Treynor Ratio
-ratio of excess return of portfolio to its beta
= (rate of portfolio - risk free rate) / portfolio beta
Jensen ratio (alpha)
-calculates the portfolio return actually attained and subtracts what the return should have been based on risk assumed in portfolio
= return of portfolio - [risk free rate + (return on market - risk free rate) x Beta of portfolio]
Best ratio to compare funds
-Jensen and Treynor only used if portfolio is diversified
-Sharpe applies for non-diversified portfolios
-if R squared is 60+, use high alpha first, or highest Treynor second
-if low alpha, use highest Sharpe
Information Ratio
-expresses portfolio returns above the returns of a benchmark to the volatility of those returns
-measures portfolio manager's ability to generate excess returns relative to a benchmark, and attempts to identify consistency
= (asset return - return on benchmark) / SD of asset return
Stock Option Collar
-sell a call at one strike price and buy a put at lower trike price
-long stock, short call, long put
Marginable Securities
-Securities listed on a stock exchange (NYSE, AMEX)
-NASDAQ National Market System issues
Maintenance Margin Formula
= [(1 - initial margin %)/(1 - maintenance margin %)] x Purchase price of stock
Short Sale
-must be done in a margin account
-net proceeds plus required margin are held by broker
-no time limit
-dividends declared must be covered by the short seller
Option Straddle
Simultaneous purchase (or sale) of both a put and a call on the same underlying common stock, same strike price
Strategic Asset Allocation
-once every few years
-use simulation procedures to determine likely range of outcomes with each mix
-establishes a long-run/strategic asset mix
Risk Tolerant Characteristics
-high debt ratios
-small amounts of insurance
-changes jobs/locations
-makes quick decisions
-high level of wealth for age
-optimistic
-handles stress well
-experienced
Risk Averse Characterics
-no debt
-a lot of insurance
-stable employment
-deliberate
-low level of wealth for age
-pessimistic
-handles stress poorly
-inexperienced
Rebalancing
-change in wealth
-change in liquidity requirements
-change in legal/regulatory considerations
-change in time horizons
-change in tax circumstances
-change in needs or circumstances
Tactical Asset Allocation
-performed routinely as part of asset management
-driven by changes in predictions on returns
-market timing approach
Arbitrage Pricing Theory
-pricing of securities in different markets can't differ for any significant length of time
-unexpected inflation
-unexpected changes in the level of industrial production
-unanticipated shifts in risk premium
-unanticipated changes in the structure of yields
Black-Scholes Option Valuation Model
used to value option of non-dividend paying stock
-price of underlying stock
-exercise price of option
-time remaining
-interest rate
-volatility of underlying stock
Binomial Option Pricing
-assumes a stock's price can be 2 possible values at option expiration
-will either increase to a given higher price or decrease to a given lower price
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