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27 Cards in this Set
- Front
- Back
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Define: 1)Risk 2)Stand-alone risk |
1)Uncertainty 2)Putting all your money in a single investment |
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What is the risk/return trade off? |
The greater the risk, the greater the potential reward. |
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What are the two components of total return? |
Income + Growth = Total return |
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How is the expected rate of return calculated? When compared to the required return, if the expected rate is higher or lower should we invest? |
Multiply the expected rates by their probability, and then sum the values to find the expected rate of return. If the expected return is greater than the required return, invest. If the expected return is less than the required return, do not invest. |
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How can you calculate the expected return of a portfolio? |
Each security's percentage of the portfolio is multiplied by its expected return, and by summing the results we find the expected return for the portfolio. |
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Define: Efficient portfolio |
Either a portfolio that offers the highest expected return for a given level of risk, or a portfolio with the lowest level of risk for a given expected return. |
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How is correlation used to build portfolios? |
By selecting investments that have negative or non-correlated correlation coefficients, an investor can drive down the risk in their portfolio. |
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What is the difference between company-specific risk and market risk? What are other names for both of these? |
Company-specific risk, a.k.a diversifiable risk, is risk that hurts a particular company and can be eliminated by diversifying. Market risk is simply the risk of investing in the market and it cannot be eliminated by diversifying. |
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What are other names for fundamental value? |
Intrinsic or theoretical |
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Is finance focused on the future, or on the past? |
The future |
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Is financial account focused on the future, or on the past? |
The past |
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What are other terms for future? |
Projected, estimated, or forecast |
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What is the definition for required return? What is the general formula for required return? |
The minimum acceptable potential return, given the risks required return = nominal risk-free rate + risk premiums |
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How is the fundamental value (V) calculated? |
Identify the asset's cashflows, use a timeline to forcast the amount and timing of the cashflows, use the appropriate formula to find the present value of the cashflows. |
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Define: 1)Undervalued 2)Overvalued 3)Fairly valued 4)Bullish 5)Bearish |
1)When the market price for an investment is less than the theoretical value, invest 2)When the market price for an investment is greater than the theorectical value, divest 3)When the market price for an investment is equal to the theoretical value, neutral 4)When investors think an investment is undervalued, invest 5)When investors think an investment is overvalued, divest |
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How is current yield calculated? |
Annual interest / current market value |
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Which components of return are measured by current yield, yield to maturity (YTM), and yield to call (YTC)? |
Current yield only measures income (interest), not growth (capital gains) YTM measures total return until maturity YTC measures total return until call |
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What does comparing YTM and YTC to the theoretical value tell investors about the investment? |
If YTM/YTC is greater than the theoretical value, then the investment is overvalued and its outlook is bearish If YTM/YTC is less than the theoretical value, then the investment is undervalued and its outlook is bullish |
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What does comparing the YTM or YTC to the required rate of return tell investors? |
If the YTM/YTC is greater than the required rate of return, then invest. If the YTM/YTC is less than the required rate of return, then do not invest. |
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How is YTM calculated? How is YTC calculated? |
YTM and YTC = 'i' |
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What is intrinsic value compared to? |
Market price |
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What happens at equilibrium? |
Intrinsic value = Market price |
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What does 'proceeds' mean? |
The amount received from selling something. |
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What is the dividend discount model? |
P0 = D1 / (Rs - g) P0 = intrinsic value at the beginning of year 1 D1 = dividend at the end of the year Rs = required rate of return g = annual growth rate |
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Are corporations required to pay dividends? |
No. |
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Define and provide examples of: 1)Relative valuation 2)Asset-based valuation |
1)Defines the value of an investment based on it's relation to another similar investment, i.e. GM shares are overpriced at $30 if Ford shares are $20. 2)A company's fundamental value is basd on the assets it own, i.e. office buildings and furniture. |
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How is the market cap calculated? |
Current market price of stock * Number of shares outstanding |
