FINE 441 - midterm

what are the fundamentals of investing

• diversify

• don’t buy high and sell low

• watch your expenses

Why does the IRR not give a good idea of the actual return for investors

• Not realistic to assume you can reinvest at IRR consistently

• ignores scale (50% could mean only 100 dollars) while 12% could mean 100,000

• can be manipulated through leveraging

what is a forward contract vs futures

• forward is unregulated private contract with usual no margins

• future is regulated contract and is exchange tranded to create liquidity and manage risk

european versus american option

• exercised only on its maturity date

• exercised any time before or on its maturity date

what does a protective put mean

• buy an dassets and also buy a put option

• if stock falls below strike price, the put increases in value and can be exercised but if the stock rises investor has gains minus the cost of the premium

what does a long straddle mean

• purchase a call and put option for same asset and same strike price and expiration date

• used on stocks with high volatility or for major event

what is the primary market

• where firms issue socks to the public

• investment banks

what is the secondary market

• where investors trade stocks with eachother

• NYSE, NASDAQ

what are the four models of trading markets + describe

• Direct search - no intermediary just buyer and seller

• Dealer - an investor with an investory and trades profits from bid-ask spread

• Broker - matches buyers and sellers profits from commissions

• Auction - traders converge at one place to trade e.g. exchanges

The three order types

• market order

  • execute at market price

• limit order

  • limit buy - if price falls you buy (maximum buy price)

  • limit sell - if price rises you execute order (minimum sell price)

• stop order

  • stop-buy order - buy when the price rises (to protect for a short)

  • stop-loss sell - sell when price falls (limit the loss of a position)

bid versus ask price

• bid - the price the dealer buys from you

• ask - the price the dealer sells to you
  
  a>b

what are the costs of trading

• brokerage commissions

• bid-ask spread

• price impact (large orders move prices)

• taxes

what is the intial margin

• the proportion of the purchase price you are contributing from your own money when you buy the share - the broker checks to make sure you put enough money

what is the margin requirement

• the minimum percentage of equity you must keep for this asset

• if it goes below you recieve a margin call and you must restore the account to the required level (deposti cash, deposit securities, sell some shares)

what are the difficulties of short selling

• not always possible to borrow security

• must pay lending fee

• risk that security is re-called

• short squeeze

• compaies fight short sellers

• stocks go up more often than not

arithmetic average versus geometric average and when would you use them

• arithmetic - average of annual percentage returns

  • single period or to estimate expected return

• geometric - constant annual rate consistent with you total investment growth

  • for long term investments

geometric avergae is always lower than arithmetic - the higher the volatility the higher the difference

what is a in the utility calculation and what does utility calculate

the index of risk-aversion - higher means the investor dislikes risk more but lower means they are comfortable in taking risks
- utility is how attractive the investment is to the investor

what is the slope of CAL equal to

Sharpe ratio

why are short sellers good?

• have moderat influence, long investors who are too optimistic have more influence

• they often discover fraud

• more liekly that the average investors should pay is a reasonable price

• short sellers are often right - make markets more efficient

what is the fee that you can charge investors

the sharpe ratio of the fund equal to that of the market

what is wrong with the CAPM

• not very accurate

• other characyeristics beyond beta that explain average returns

• market portfolio is a good starting point (but not the best you can do)

  • not everyone holds it

  • should have more customisation to reduce risk in income but not possible in capm

• CAPM is too simple

Why would stocks with lower betas do better than others

• many big investors would like to borrow to use leverage but cannot do so due to regulation

• instead of investing in the market as the theory says, they overinvest in high beta stocks pushing their prices up and the returns down

• therefore low beta stocks become relatively attractive and beat the market