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260 Cards in this Set
- Front
- Back
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Return
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Level of profit from an investment, reward for investing
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Most common source of return
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1. Current income
2. Capital Gain |
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sources of return
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usually cash or near cash that is periodically received as a result of owning an investment
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Examples of current ioncome
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Dividends from stock, interest recieved on bonds, or dividends from mutual funds
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Capital gain
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the amount by chich the proceeds from the sale of an investment exceed its origional purchase price
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Capital gains and lossses are preferable as percentage returns than in dollar form why?
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allow direct comparison of different sizes and types of investments
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Total Return=
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Capital gain + current income
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Returns should be
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shown in percentages
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Why are returns important
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variables in investing decisions, allow the comparison of various investments, allow us to keep score
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Why we measure returns
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Historical performance or measure future expectations
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Historical performance measurement of return
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evaluation of past investment returns determines average and anazlye the trend
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expected return measurement of a return
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measure of performance. This is what you think the investment will earn in the future and has a heavy weight on what youll be willing to pay for it.
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Key Factors that affect the level of return
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1. internal characteristics
2. external forces |
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internal characteristics of level of return
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-the type of investment
-quality of management -financing -issuers customer base |
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external forces of level of return
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fed's actions
shortages war price control political events general level of price |
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general level of price's affect on returns
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inflation and deflation
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inflation
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up's the price level
positive impact on stocks and fixed income securities rising interest rates accompany it |
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deflation
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down's the price level
worse than inflation |
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inflation and interest levels movement
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move together
inflation rises interest rates rise |
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general rule of time value and money
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the sooner you recieve a return on a given investment the better
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why the sooner you recieve a return the better?
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because it allows you the option to reinvest and earn more income or the option
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computational aids for use in time value caculations
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1. financial tables
2. financial caculators 3. electronic spreadsheets |
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satisfactory investment
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one for which the present value of benefits equal or exceeds the present value of its cost
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required rate of return
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the rate of return that fully compensates for an investments risk
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three componenets of the required rate of return
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1. real rate of return
2. risk premiums 3. expected inflation premium |
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required rate of return=
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real rate or return + expected inflation premium + risk premium
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real rate of return
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the rate of return that could be earned in a perfect world where all outcomes were known and certain (no risk)
equilibrium between supply and demand |
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what causes changes in the real rate of return
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economic conditions
tastes preferences |
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the average range of the real rate of return
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.05%-2%
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expected inflation premium
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the average ration of inflation expected in the future, based on change in % of CPI
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Risk Free Rate=
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real rate of return + expected inflation premium
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risk free return
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the rate of return that can be earned on a risk free investment
(ex US treaseury bill) |
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most common risk free investment
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3 month US treasury bill
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Required Return=
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risk free rate + risk premium
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risk premium
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A risk premium is the minimum amount of money by which the expected return on a risky asset must exceed the known return on a risk-free asset, in order to induce an individual to hold the risky asset rather than the risk-free asset. Thus it is the minimum willingness to accept compensation for the risk.
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the issue and issuer factors cause investors to require:
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risk premium above the risk free rate
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holding period
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the period of time over which one wishes to measure the return of an -investment vehicle
(must be the same length for accuracy) -captures both periodic benefits and changes in value |
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realized return
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the portion of current income recieved by the investor during the period
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capital gains returns realized when?
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only when the investment is actually sold at the end of the holding period
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paper return
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the capital gain that is achieved yet not realized
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negative current income
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requires you to pay out cash to meet an obligation
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negative capital gains
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capital loss from an invesment that declines in market value
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Holding period return
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the total return earned from holding an investment for a specified period of time (the holding period)
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HPR is used
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with holding periods less than one year
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HPR=
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(current income during a period – capital gain (or loss) during a period)
/ Beginning investment value |
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Capital Gain or Loss=
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ending investment- begining investment
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HPR equation is used for either:
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measuring the total realized return
estimiating the expected total return |
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HPR advantages
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easily, understandable, considers both current income and capital gains compared to beginning investment value
overcomes problems of investments of differing sizes offers relative comparision by dividing the total return by the amount invested shows the highest return per invested dollar |
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HPR disadvantages
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fails to consider the time value or money
and is inappropriate for invesments over 1 year |
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Yield or Internal Rate of Return
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present-valued based measure to determine the compounded annual rate of return earned on investment held for longer than one year
directly compare two investments b/c discounts back to zero |
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if the yield on its investments exceeds or is equal to the required return
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investment is acceptable
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if the yield on its investment is lower than the required return
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unacceptable investment
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yields can be used to measure
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single future cash flow
or a stream of future cash flows |
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yield for a single cash flow
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no periodic income but to provide a single future cash flow at maturity or when the invesment is sold
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reinvestment rate
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the rate of return earned on interest or other income received over the relevant investment requirement
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risk
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the chance that the actual return from an investment varies from the expected return
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risker investments make
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higher returns
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the broader range of possible returns makes
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greater the investment risk
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risk return tradeoff
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the relationship between risk and return in which investors attempt to minimize risk for a given level of return or to maximize return for a given level of risk
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sources of risk
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1. Business Risk
2. Financial Risk 3. Purchasing Power Risk 4. Interest Rate Risk 5. Liquidity Risk 6. Tax Risk 7. Market Risk 8. Event Risk (*currency exhange rates*) |
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business risk
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the degree of uncertainty associated with an investments earnings and the investments(the business) ability to pay the returns to owed investors
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financial risk
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the degree of uncertainty of payment resulting from a firms mix of debt and equity
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whats the effect on financial risk if a firm has a larger portion of debt
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greater financial risk
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purchasing power risk
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the chance that changing price levels (inflation and deflation) will adversly affect investment returns
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rising prices (inflation) affect on purchasing power
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reduce purchasing power risk
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the amount a given commodity that can be purchased with a dollar
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purchasing power
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falling price levels (deflation) and its affect on purchasing power
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increases purchasing power risk
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purchasing power risk is low with
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investments whose values move with the general price levels and are most profitable during periods of rising prices
stocks of durable goods |
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purchasing power risk is high with
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those that provide fixed return and are most profitable during periods of low inflation or declining prices
deposit accounts and bonds |
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interest rate risk
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the chance that a change in interest rates will adversely affect a securities value
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interest rate risk especially affects
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securities that offer fixed periodic returns and reinvestment of income
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interest rate changes result from
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changes in the general relationship between demand and supply of money
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interest rates and fixed security prices
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inversely related
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liquidity risk
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the risk of not being able to liquidate an investment conveniently and at a reasonably price
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less liquid markets are markets where...
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where demand and supply are small
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tax risk
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the chance that congress with make unfavorable changes in tax laws
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greater tax rates
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The greater the chance that such changes will drive down the after tax returns and market values of certain investments
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investments vulnerable to tax risk
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viritually all
YET especially tax-advantaged investments such as municipal and other bonds, real estate, and natural resources |
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market risk
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the risk that investments returns will decline because of market forces independent of the given investment
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examples of market risk
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political, economic, social events and changes in investor’s tastes and preferences
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market risk embodies
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tax risk
purchasing power risk interest rate risk |
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event risk
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occurs when something happens to a company that has a sudden and substaintial impact on its financial condition
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standard deviation
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the most common single indicator of an assets risk that measures the dispersion (variation) of returns around an assets average expected return
provides a quantitive tool for comparing investment risk based on historical data |
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whats an absolute measure of risk
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standard deviation
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whats a relative measure of risk
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coefficient of variation
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measuring risk of a single asset
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standard deviation
coefficient of variation |
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coeffecient of variation
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the measure of the relative dispersion of an assets returns useful in comparing risk of assets with differing average or expected return
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coeffecient of variation
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(standard deviation )/(average or expected return )
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the higher the coefficient of variation..
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the greater the risk
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coefficient of variation considers
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relative size or average return of each investment
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relationship between the investments returns and standard deviation and coefficient of variation
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investments with higher return have higher standard deviation and coefficients of variation
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risk indifferent
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an investor who does not require a change in return as compensation for greater risk
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risk adverse
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investor who does require greater return in exchange for greater risk
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Risk Seeking
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-an investor who will accept lower return in exchange for greater risk
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Steps in the Decision Process: combining return and risk
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1. Estimate the expected return using present value methods and historical/projected return rates
2. Assess the risk of the investment by looking at historical/projected returns using standard deviation or coefficient of variation of returns 3. Evaluate the risk-return of each investment alternative to make sure the return is reasonable given the level of risk 4. Select the investment vehicles that offer the highest expected returns associated with the level of risk you are willing to accept |
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relationship between expected return and price
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inverse
prices rises expected return lowers |
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expected inflation=
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risk free rate - real rate of return
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expected inflation premiums look at inflation in terms of...
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the entire economy not a particular good
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advantages of IRR
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uses time value and money
allows investments of different investment period to be compared with each other if the yield is= to or greater than the required return its ok |
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disadvantages of IRR
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complex cacluation
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residual owners
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common stock holders
stockholders that are entitled to dividend income and share of the company's earnings only after all other corporate obligations have been met (not guaranteed) |
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appeal of common stocks
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allow investors to tailor investment to meet needs and preferences
may provide a steady stream of current income thru dividends may increase in value over time thru capital gains |
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what draws most people in to investing in common stocks
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capital gain (big returns)
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stock returns
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take into account both price behavior and dividend income
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routine decline
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a drop of 5% or more in one of the major market indexes
ex: dow jones |
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correction
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a drop of 10% or more in one of the major market indexes
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bear market
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a drop of 20% or more in one of the major market indexes
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Advantages of stock ownership
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return opportunities (higher)
easy to buy and sell modest transaction cost because of price and market info unit cost is usually in reach for individual investors |
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disadvantages of stock ownership
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risk (most significant)
earning and general performance are subject to wide swings (hard to predict) sacrifice in current income |
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marturity date of common stock
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none
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equity capital
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evidence of ownership position in a firm in the form of shares of common stock and participation in corporate earnings and dividends, an equal vote, and and equal voice in management
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publicly traded issues
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the shares that are readily available to the general public and that are bought and sold in the open market
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issuing new shares:
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init. public offering
rights offering |
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init. public offering
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the most widely used to issue shares
the corporation offers the investing public a certain number of shares of stock at a certain price |
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rights offering
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offering existing shareholders the first opportunity to the new shares
gives them the right but not obligation |
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net result of rights and public offering
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the same
firm ends up with more equity in its capital structure and the number of shares outstanding |
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stock spin off
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occurs when a company gets rid of one of its subsidaries or divisions and creates a new standalone company and distributes stock in that company to its existing shareholders
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when are stock spin offs executed
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when companies believe the subsidary is no longer a good fit or if they feel theyve become too diversified and want to focus on their core products
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stock split
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increasing the number of shares outstanding by exchanging a specified number of new shares for each outstanding share of stock
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when is stock splitting used
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when it wants to enhance its stocks ability trading appeal by lowering its market price
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2 for 1 split
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2 new shares for 1 old
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treasury stocks
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the shares that have been sold and repurchased by the issuing firm
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why a company uses treasury stocks
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reduce the number of shares when they view shares as undervalued in the market place makes the stocks more attractive investment
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reasons treasury stocks are kept by the firm
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merger and acquisitions
to meet employee stock option plans means of paying stock dividends prop up the price of an undervalued stock (public reacts) |
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classified common stock
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denote different voting rights
denote different dividend payouts allow a small group to control |
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round lot
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100 shares of stock or mulitples there after
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odd lot
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less than 100 shares of stock
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the worth of a share of common stock
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par value
book value market value investment value |
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par value
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the state or face value of a stock
relatively useless |
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book value
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the amount of a stockholder equity in the firm
used in stock valuation indicates the amount of stock holders funds to finance in firm |
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book value=
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firms assets-firms liabilities
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market value
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the current market price of an issue in the market currently
indicates market as a whole have assessed the value of a stock |
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market capitalization
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the market value of the firm itself found by multiplying the market price of the stock by the number of shares outstanding
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investment value
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indicates the work that investors place on a stock (what they thing that the stock should be traded for)
most important for stockholder based on expectation of risk and return max price they should pay |
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over the long haul what provides the bigger source of return for common stock?
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capital gains but can be uncertain and lead to capital loss
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more certain source of return for common stock
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dividends (miight be more attractive cause they are less risky)
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tax rate of dividends and long term capital gains
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15%
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dividend payment
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quarterly basis
decided how much by firms board of directors and payment dates |
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what does the board look at when deciding dividend payment
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1. The firms earnings (EPS)
2. The firms growth prospects (needs earnings to help finance expected growth) 3. The firms cash position 4. Meeting all legal and contractual constraints 5. Consider certain market effects and responses (after internal matters) 6. Meet the dividend expectations of its share holders |
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Earnings per share
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the measure of the amount of annual earnings available to stockholders stated in a per share basis
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EPS=
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(net profit after taxes-preferred dividends)/(number of shares of common stock outstanding )
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date of record
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the date on which the investor must be a registered shareholder of the firm to be entitled to a dividend
the day the firm looks at it |
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holders of record
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the stockholders that hold it on the date of record
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payment date
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the actual date of payment of dividends
set by the board of directors that follows the date of record by one or two weeks |
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Ex dividend date
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dictates whether you were an official shareholder and therefore eligibile to recieve the declared dividend
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sold on or after the ex dividend date
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old owner recieves the dividend
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if sold before the ex dividend date
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new owner/ buyer will recieve the dividend
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types of dividends
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1. cash dividends
2. stock dividends 3. rarely but can be stock spinoffs or samples of a companies products |
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cash dividends
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payment of dividend in cash
most common tend to increase over time as earnings grow |
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dividend yield
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a way of assessing the amounts of dividends recieved
the measure of the dividends on a relative (%) basis rather than an absolute ($) basis |
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dividend yield=
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annual dividends received per share
/ current market price of the stock |
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dividend pay out ratio
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describes the portion of earnings per share (EPS) that is paid out in dividends
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stock dividend
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payment of a dividend in the form of additional shares of stocks
really has no value because they represent a reciept of somethig already owned total market value remains the same |
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when are stock dividends taxed
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when you sell the stock
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Dividend Reinvestment plan
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DRIP corporate sponsored programs in which shareholders can have their cash dividends automatically reinvested into additional shares of the companys common stock
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Advantages of DRIPS:
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conveient and inexpensive way to accumulate capital
free of brokerage comission fees over 1,000 comapnies offer use dollar cost averaging |
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dollar cost averaging
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opposite of market timing done through dividend reinvestment plans
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DRIPS and taxes
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even though the dividends take the form of new additions of stock you must still pay taxes on them as if they were cash dividends
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types of stocks
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1. Blue chip stocks
2. Income stocks 3. Growth stocks 4. Tech stocks 5. Speculative stocks 6. Cyclical stocks 7. Defensive stocks 8. Mid cap stocks 9. Small cap stocks |
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blue chip stocks
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stocks that are unsurpassed in quality and have a long and stable record of earnings and dividends
issued by large well established firms and have impeccable financial credientials |
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income stocks
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stocks with high and sustained records of paying out higher than average dividends
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growth stocks
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shares that have experienced and are expected to continue experiencing consistently high rates of growth in operations and earnings
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tech stocks
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represent the technology sector of the market
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speculative stocks
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shares that lack sustained records of success but still offer the potential for substantial price appreciation
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cyclical stocks
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issued by companies whose earnings are closely linked to the general level of business activity
move up and down with the business cycle |
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defensive stocks
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stocks whose prices remain stable or even increase when general economic activity is tapering off
less affected than average issue by downsizing in the business cycle |
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market capitilzation caculated
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as the market price of the stock times the number of shares outstanding
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stock size is based on
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market cap
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categories in $ of small cap, mid cap and large cap
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small cap: less than $1 billion
mid cap: $1 billion to $4 or $5 billion large cap: more than $4 or $5 billion |
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large cap stocks
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fewest yet take up 80-90%
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mid cap stocks
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offer investors attractive return opportunities
good sized companies offer some of the safety of large caps solid balance sheets, modest levels of debt, histories of steady profit growth |
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small cap stocks
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small companies to be in a class by themselves in terms of attractive return opportunities
generally less than $250 million not a lot of outstanding stocks arent widely traded |
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category of small cap stocks
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initial public offerings (IPO's)
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IPO's in terms of small caps
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difficult to buy
high risk investments investors who can tolerate substaintial risk exposure |
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US equity market makes up
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50% of the world markets
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six countries make up
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80% of the worlds market
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largest equity market in the world
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US
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going global in investing
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buying shares directly in foreign markets
buying american depository shares buying international mutual funds |
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international investing requires investors to be right on these factors
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the right stock
the right market the correct direction for currecny exchange rate flucuations |
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common stocks can be used as: (relating to investment strategies:
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investment strategies:
1. A “storehouse” of value 2. As a way to accumulate capital 3. As a source of income |
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storage of value
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rank safety of principle as most important stock selection criteria
Quality conscience Gravitate toward blue chips and other non speculative shares |
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accumulation of capital
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use capital gains and/dividends that stocks provide to build up their wealth
Growth stocks or income shares or both to do so |
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source of income
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dependable flow of dividends is essential
High yielding, good quality income shares are preferred |
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investment strategies:
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1. Buy and hold
2. Current income 3. Quality long term growth 4. Aggressive stock management 5. Speculation 6. Short term trading |
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investment strategies for storage of value:
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buy and hold
current income quality long term growth |
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buy and hold
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most basic
most conservative placing money in secure investment outlet and watch it grow over time high quality stocks value oriented investors |
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current income strategy
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diserable because dividends increase over time
safety of principle and stability of income are vital capital gains secondary of imporance quality income shares earn high and safe returns |
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quality long term growth
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less conservative
capital gains are primary source of income fair amount of trading high quality growth stocks chance for price appreciation greater risk amount of return>source of return |
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total returns approach
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variation of quality long term growth strategy
long term returns considering dividends and capital gains |
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aggressive stock management
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seeks attractive rates of return through a fully managed potfolio
trades in and out returns from capital gains shorter investment horizon substaintal risk and trading costs |
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speculation and short term trading
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least conservative
sole objective is capital gains shorter the better constantly switching so much risk yield little or no profit |
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mutual fund
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a type of financial service organization that recieves money from its shareholders and then invests those funds in a diversified portfolio of securities
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mutual fund investors
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become part owners of a widely diversified portfolio of securities
only have to decide on which fun the rest up to the professional money manager |
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professional money manger and mutual fund
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make the decisions for the investor in a mutual fund
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mutual funds appeal to
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inexperience and experienced
all types of investors |
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pooled diversification
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process where individuals pool their resources for the collective benefit of all the contributors
-reduces risk |
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as the securities move up and down in price, the market value of a mutual fund
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moves accordingly
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advantages of mutual funds
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1. portfolio diversification
2. full time professional management 3. modest capital outlay 4. convenience |
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advantage of mutual fund full time professional management
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dont have to watch it on a day to day basis, management offers better expertise
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advantage of mutual fund modest capital outlay
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services taht mutual funds offer make them appealing to many investors
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services that mutual funds offer that make them appealing (modest capital outlay)
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automatic reinvestment of dividends
withdrawal plans exchange priveldges |
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disadvantages of mutual funds
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1. costly and involve transaction costs
2. mutual fund performance depends on market performance |
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disadvantage of mutual funds costly and involve transaction costs
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sizable commission fees
load charges management fees etc |
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management fees (disadvantage)
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annual fee for professional mutual fund services provided
paid regardless of mutual fund performance |
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good deal of mutual fund returns can be traced back to
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strong market conditions
and/or the reinvesment of dividends and capital gains |
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mutual funds are split:
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the fund itself
major key players |
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major key players involved in mutual funds
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management company
investment advisior distributor custodian transfer agent |
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investment advisor includes
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money manager
securities analyst traders |
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management company
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runs the funds daily operations, create the funds, serve as an investement advisior
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investment advisor
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buys and sells stocks or bonds or otherwise oversees the portfolio
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money manager
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runs the portfolio and makes the buy and sell decisions
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securities analyst
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analyzes the securities and look for viable investment candidates
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traders
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buy and sell big blocks of securities at the best possible price
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distributor
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sells the funds shares, either directly to the public to thru authorized dealers
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custodian
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phyiscally safeguards the securities and other assets of the fund without taking a role in the investment decision (independent party)
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transfer agent
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keeeps track of purchase and redemption requests from shareholders and maintains other shareholder records
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importance of mutual fund separation of duties
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protect mutual fund shareholders
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open end investment company
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investors buy and sell their shares from and sell them back to the mutual fund company without a secondary market
never trading between individuals no limit to # of shares |
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dominant type of mutual funds
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open ended mutual funds 90%
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purchase and selling price of open ended mutual funds
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set by Net Asset Value NAV
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net asset value NAV
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value of the shares of stock in a particular mutual fund; caculated at least once per day
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NAV=
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(total market value of all assets - any liability)/number of fund shares outstanding
OR value of all securities - liabilities of all shares outstanding |
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all purchases and sales of open end mutual funds
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completed at the end of the day after the stock market has closed
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Exchange traded funds EFTs
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type of open ended mutual fund that trades as a listed security on one of the stock exchanges
a basket of securities designed to track a specific market |
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EFTs are structured like
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mutual fund indexes
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ETFs are structured in three ways
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1. Open-end mutual fund (90%)
2. Unit investment 3. Grantor trusts |
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ETF are traded mostly on which exchange
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spiders
diamonds qubes |
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spiders
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biggest and oldest based on the S&P500
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qubes
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based on NASDAQ 100
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diamonds
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based on the DJIA
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differences between EFT and open mutual funds
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EFT- traded on exchanges and at any time of the day
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EFT advantages
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1. can buy at any time
2. low cost 3. low porfolio turnover 4. low taxes |
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mutual fund taxes
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taxes on capital gains but mutual fund will throw it out to shareholders so that the fund doesn’t have to pay it and the shareholders do have to pay the tax on the capital gain even though they are not receiving it (disadvantage because of TVM cant recover from that no additional funds paid out) ETF’s do not do advantage
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load charge on an open end mutual fund
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the comission you pay when you buy shares in a fund
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load fund
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a mutual fund that charges comission when shares are bought
can be substantial 8.5% |
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no load fund
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charge no sales charges
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back end load
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the fund that charges commissions when shares are sold yet tend to decrease over time and most likely be gone after 5/6 years
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purpose of back end loads
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to enhance fund stability by discouraging you from trading in and out of funds over a short investment horizon
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12(b)-1 fund
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hidden loads
mutual fund fee that is assessed annually for as long as you own the fund to help cover their distribution and management costs can be 1% per year whether good or bad market must pay |
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management fees
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compensation paid to the professional managers who administer the funds portfolio paid regardless, charged annually on average net asset
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administration costs
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operating the fund
fairly modest represent the normal costs of doing business (commissions) |
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other than open ended, close ended, ETFs 4 other additional types of investment companies for mutual funds
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1. Real Estate Investment Trusts
2. Hedge Funds 3. Unit Investment Trusts 4. Annuities |
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Real Estate investment trust
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REITs- a type of closed ended investment company that invests money in mortgages and various types of real estate investmetns
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three basic types of REITs
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1. property/equity
2. mortgage 3. hybirds |
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mortgage REITs
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tend to be the more income oriented emphasize their high current yield
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property/equity yield
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shopping centers, houses, etc.
potiential for earning varying amounts of capital gains (properties appreciating in value) |
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hybird REITS
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contain both mortgage and property
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appeal of REITs
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enables investors to recieve both capital appreciation and the current income form real estate ownership without the headaches of property management
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REITs are popular with
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income oriented investors because of their very attractive dividends they provide
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REIT taxes
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income earned on REIT is NOT taxed
income distributed to the owners is desiginated and taxed at ordinary income tax rate |
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hedge fund
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private entities usually in the form of limited partnership that are not regulated and not really mutual funds
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general partner of a hedge fund
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runs the fund and directly participates in the funds profits and charfes a performance fee of 10, 20, 30% of the profits as well as a base fee of 1-2% of assets under mangement
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limited partners of a hedge fund
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the investors (consists mainly of institutions like pension funds, private banks, high income investors)
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because hedge funds are unregulated they require
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accredited investors
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accredited investor of a hedge fund
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net worth in excess of $1 million
and/or annual income of $200,000-$300,000 |
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types of mutual funds
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1. Growth Funds
2. Aggressive Growth Funds 3. Value Funds 4. Equity Income Funds 5. Balanced Funds 6. Growth and Income Funds 7. Bond Funds 8. Money Market Funds 9. Index Funds 10. Sector Funds 11. Socially Responsible Funds 12. Asset Allocation Funds 13. International Funds |
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growth funds
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primary goals are capital gains and long-term growth
Invest in large, well-established companies with above-average growth potential Little or no dividend income Moderately risk investments for more aggressive investors |
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aggressive growth funds
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highly speculative mutual fund that seeks large profits from capital gains
Invest in small, unseasoned companies with high price/earnings ratios Often look for turnaround situations Prices are often highly volatile High risk investments for very aggressive investors |
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value funds
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seeks stocks that are undervalued in the market
Focus is on intrinsic value of stocks and requires extensive fundamental analysis Invest in stocks with low P/E ratios, high dividend yields and promising futures Looks for undiscovered companies with potential for future growth Less risky investments for relatively conservative investors looking for moderate growth |
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growth and income funds
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seeks both long-term growth and current income, with primary emphasis on capital gains
Focus is on long-term capital appreciation with some high income to provide limited stability Invest in blend of commons stocks and fixed-income securities, with up to 90% in common stocks Moderate risk investments for investors who can tolerate moderate price volatility |
