Investments and Portfolio Management
Investments and Portfolio Management BUS 422
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This 3 page Class Notes was uploaded by Bethel Graham on Thursday October 15, 2015. The Class Notes belongs to BUS 422 at North Carolina State University taught by Charles Jones in Fall. Since its upload, it has received 20 views. For similar materials see /class/223670/bus-422-north-carolina-state-university in Business Management at North Carolina State University.
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Date Created: 10/15/15
Review for Exam 1 1 Rational investors do not attempt to either maximize their returns or minimize their risks they attempt to optimize the tradeoff between the two 2 The ex ante investing tradeoff must always be upward sloping the long run ex post investing tradeoff has been upward sloping 3 Investors should decide on their risk tolerance and then seek to maximize their returns subject to this risk tolerance position and any constraints that may apply such as taxes 4 Treasury bills have no stated interest rate 5All interest rates are stated on a before tax basis except for municipal bonds 6 AAA rated bonds the highest rating category should be associated with the lowest interest rate among rated bonds 7 Common stock has no speci ed return that must be paid 8 All mutual funds are openiend investment companies money market funds are mutual funds closediend funds are investment companies but not mutual funds 9 All funds charge an annual expense ratio under normal cincumstances Load funds charge a sales charge 10 A 57star Morningstar rating for amutual fund today does not ensure good performance for this fund over the future 11 ETFs are investment companies whose shares trade on exchanges They are tax efficient and have the lowest costs 12 Class A mutual fund shares charge a frontend sales load while Class B and Class C shares do not 13 The approximate annual expense ratio for equity mutual funds is about 15 For bonds 1 for MMF 12 14 Disregarding any load charges the Net Asset Value per share for a mutual fund is the price investors pay to buy or sell mutual fund shares 15 A mutual fund has a return of742 for the first year and 42 for the second year Using three decimal places is the geometric mean for this fund for these two periods positive 16 A 1 change in one of the DowJones Industrial Average stocks will change this index 1 point 17 If you were to construct a stock price index today it would be capitalizationiweighted as opposed to price weighted 18 An investor with a portfolio of small stocks should judge its performance by comparing it to the Russell 2000 Index 19 The DJIA has a divisor of about 13 that results in amultiplier between 7 and 8 if one of the 30 stocks moves 1 point the DJIA moves between 7 and 8 points 20 A limit order ensures execution of the order while a market order assures the investor of a specified price 21 An investor wishes to make 3900 by shorting 300 shares of stock at 54 per share Ignoring transaction costs the investor must cover this short sale at 41 per share 22 The initial margin requirement is set by the Fed while the maintenance margin requirement is set by exchanges or brokerage houses 23 Ignoring all costs margin trading magnifies percentage gains and losses equally 24Using an initial margin requirement of 40 the magnification factor is 25 with a 60 requirement the magnification factor is 1667 25 If the initial margin requirement is 40 and a stock sells for 50 an investor with 2000 of equity who wants to use the full 2000 in a margin transaction can purchase a maximum of 100 shares by borrowing 3000 from the broker 26 The Total Return for a stock bought at 52 held for one year during which a dividend of 3 is paid and sold for 48 is 7192 27 The range ofreturns for bonds government and corporate for the period 192672009 on a geometric mean basis has been between 5 and 6 28 The geometric mean is the best measure of historical returns but it is not the best estimate of next period s return 29 For U S investors if the dollar strengthens against a foreign currency their returns from investments denominated in that currency are decreased 30 The Geometric Mean is mathematically related to the Arithmetic Mean and the Standard Deviation 31 The standard deviation on the SampP 500 returns for 19262009 has been about 20 while the standard deviation for corporate bond returns has been in the 879 range 32A return relative of 987 is the same thing as a Total Return of 700130 33 If in ation were to average 36 on a compound annual basis the purchasing power of money will be cut in half in approximately 20 years 34 For the period 192672009 large common stocks returned a compound annual average return of about 98 while small common stocks returned approximately 2 percentage points more measured on the same basis 35 Given that the compound annual rate ofinflation for 19262009 was about 3 the real return on Treasury bills was negative CORRECT OR INCORRECT CI N V39 9 9 D O39 N gt gt gt UI bl ON 00 Asset allocation is the most important determinant of investor retums Using the equation g br ensures that the correct growth rate in dividends is calculated I All three growth rate cases of the DDM involve a present value process Valuation is an art and not a science C ROE is a function of ROA and leverage C ROA is a measure of pro tability for a company ROA NetIncomeSales SalesTotalAssets ROE ROE Leverage what do stockholders EARN All things held equal more leverage results in higher EPS Debt is cheaper than equity but more leverage makes a company more risky Leverage Total AssetsStockholdersEquity EPS ROE Book Value per share BVps stockholdersequitysharesoutstanding An investor s required rate of return can also be called a discount rate and a market capitalization rate C The major risk that stock investors face is market risk C You can diversi away the majority of the other risks Can never get rial of market risk For a given stock an investor would buy if the required return is less than the expected return C Given the DDM the value of a stock depends upon the time period one plans to hold the stock I The DDM states that the estimated value per share of a stock today is the discounted value of all future dividends The estimated value for a stock today is best thought of as the discounted value of all future earnings I dividends The required rate of return for a stock is the same as its discount rate C In general there is an inverse relation between interest rates and P E ratios C Using the Markowitz analysis the ef cient frontier at times can be a straight line I One of the strong points in favor of using the DDM is that estimates of intrinsic value are not very sensitive to estimates of the expected growth rate in dividends I They ARE very sensitive While there are several relative valuation techniques there is only one DCF technique the DDM I There are some other ones that use various de nitions of cash ows and alternative required rates of return Ex SampP s Outlook C Always an estimate The ROE might not be exact The CAPM can be used to calculate the required rate of return for the market as a whole as well as the required rate of return for an individual stock C Because of the controversy about security analysts in recent years their reports and information as well as their earnings estimates and price targets should not be used at all I Still good for indepth reports about industry or company Ignore forecasts and sellbuy suggestions Those investors who choose to pursue an active strategy should concentrate on stock selection and or market timing techniques I ACTIVE Passive does Buy amp Hold approach 7 rely on e iciency ofthe market C 0 NM o N N Both a preferred stock and the zero growth rate case of the DDM are examples of perpetuities If intrinsic value is greater than current market price you should not buy the stock I Two investors have the same required rate of return They also have identical expectations about ABC Corp with regard to its expected dividend and growth rate and both agree it is a constant growth company However investor A plans to hold the stock for only one year while investor B plans to hold it for 10 years Both investors should derive the same value for this stock when they value it C According to the determinants of the P E ratio other things equal a higher required rate of return should lead to a lower PE ratio C
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