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FIN 432 – Investment Analysis and Management Review Notes for Midterm Exam

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FIN 432 – Investment Analysis and Management Review Notes for Midterm Exam Chapter 1 1. Investment vs. investments 2. Real assets vs. financial assets 3. Investment process Investment policy, asset allocation, security selection and analysis, portfolio construction and analysis, and portfolio rebalance 4. Players in investment markets 5. Homework problems and examples discussed in class Chapter 2 1. Money markets 2. Bond markets 3. Equity markets 4. Market indexes and averages: concepts and calculations 5. Derivative markets 6. Homework problems and examples discussed in class Chapter 3 1. New issues 2. Market structure Direct search, brokered, dealer, auction markets 3. Transactions Bid price, asked price, and bid-asked spread Types of orders: concepts and applications Types of transactions: long vs. short 4. Margin trading and short sales Margin requirements; Initial margin; Maintenance margin Margin call Up-tick, down-tick, and zero-tick 5. Homework problems and examples discussed in class Chapter 4 1. Investment companies and mutual funds 2. Characteristics of investment companies NAV (net asset value) Open-end funds vs. closed-end funds Load funds vs. no-load funds Low-load funds Redemption fee (back-end load) and other fees 3. Types of mutual funds 4. Mutual fund performance 5. Investing in mutual funds 6. Homework problems and examples discussed in class 1 Chapter 5 1. Risk and return 2. Risk premium 3. Mean and standard deviation 4. Inflation and real return 5. Asset allocation: concepts and calculations 6. Homework problems and examples discussed in class Chapters 6&7 1. Portfolio construction with two risky assets: concepts and calculations 2. Diversification Why portfolios can reduce total risk 3. Modern portfolio theory: concepts and applications With n risky assets (no risk-free asset) Efficient portfolios Efficient frontier and MVP Indifference curves Choosing the optimal portfolio If a risk-free asset exists and borrowing and lending are allowed Efficient portfolios Efficient frontier and MVP Indifference curves Choosing the optimal portfolio 4. Beta coefficient: concepts and calculations 5. CAPM: concepts and calculations 6. Capital market line and security market line 7. Single index model 8. APT model 9. Multi-factor models 10. Homework problems and examples discussed in class Chapter 8 1. EMH: three forms, concepts, and implications 2. Evidence of market efficiency: concepts and tests 3. Evidence of market anomalies: concepts and tests 4. The role of portfolio manager in efficient market 5. Interpretation of EMH 6. Homework problems and examples discussed in class 2 Sample Problems 1. Consider the following limit order book of a specialist. The last trade in the stock occurred at a price of $45.55. Limit Buy Orders Limit Sell Orders Price Shares Price Shares $45.50 500 $45.75 100 45.25 600 45.80 200 45.00 800 46.00 500 If a market buy order for 300 shares comes in, at what price(s) will it be filled? Answer: first 100 at $45.75 and next 200 at $45.80 2. Intermediate 2.12-2.14, 2.18-2.19 from the textbook 3. Assume that you bought 100 shares of stock X at $50 per share in your margin account that has an initial margin of 60%. What would be the debt balance? How much equity capital should you provide? What would be the actual margin if the price rises to $70? If the maintenance margin is 30%, how low the price could drop before you receive a margin call? Answer: Total cost = $5,000 Loan = $2,000 (debt balance) Equity = $3,000 (equity capital) 100*70 – 2,000 Actual margin = --------------------- = 71.43% if the price rises to $70 100*70 Critical price = $28.57, if the price drops below $28.57, you receive a margin call 4. You are bearish on stock ABC and decide to sell short 100 shares at the price of $50. If the initial margin is 50%, how much cash should you provide? How high can the price of the stock go before you receive a margin call if the maintenance margin is 30%? Answer: Short sale proceeds = $5,000 Initial margin = $2,500 Total assets = $7,500 7,500 – 100P Margin = ------------------- = 0.30, solve for P = $57.69 100P 3 5. Intermediate 4.11-4.14 and 4.21 from the textbook 6. Choose the portfolio from the following set that is not on the efficient frontier. a. Portfolio A: expected return of 12% and standard deviation of 13% b. Portfolio B: expected return of 18% and standard deviation of 15% c. Portfolio C: expected return of 38% and standard deviation of 28% d. Portfolio D: expected return of 15% and standard deviation of 12% Answer: a By comparing a and d, we find that d provides a higher return and a lower risk. Therefore, if d is available we will never choose a 7. Given the utility function: U = E(r) – 0.5A 2 , where A = 4 and four investments, choose the one that maximizes your utility. Investments Expected return Standard deviation 1 .12 .30 2 .15 .50 3 .21 .16 4 .24 .21 Answer: Investment 3. For each portfolio: Utility = E(r) – (0.5 4 2) Investment E(r) U 1 0.12 0.30 -0.0600 2 0.15 0.50 -0.3500 3 0.21 0.16 0.1588 4 0.24 0.21 0.1518 You should choose the portfolio with the highest utility value. If you are risk neutral what investment should you choose? Answer: Investment 4. When an investor is risk neutral, A = 0 so that the portfolio with the highest utility is the portfolio with the highest expected return. 8. Intermediate 5.12-5.16 from the textbook 9. Intermediate 6.8-6.12 from the textbook 10. Intermediate 7.17-7.19 from the textbook 11. Intermediate 8.10- 8.17 from the textbook 12. All assigned CFA questions 4.
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