BUS 172A M1

Financial Assets

claims on real assets or incomes generated by them

Examples of Financial Assets

Equity, bonds, derivatives

Real Assets

the assets the directly used to produce goods and services

Which type of assets determines the ultimate capacity of national wealth?

Real assets involves production of goods and services

Examples of Money Market Securities

T-Bills, Certificate of Deposit, Commercial Papers, Bankers' Acceptance Notes

Asset Allocation

investment strategy that attempts to balance risk versus rewards by adjusting the percentage of each asset in an investment portfolio according to risk tolerance, goals, and investment time frame

Security Selection

decision is the choice of which particular securities to hold within each asset class

Top-down Strategy

asset allocation -> security selection

Top-down Strategy Advantage

Diversification

Top-down Strategy Disadvantage

Maximizing expected ROR is secondary

Bottom-up Strategy

security selection -> asset allocation

Bottom-up Strategy Advantage

Focus on expected ROR

Bottom-up Strategy Disadvantage

"Undiversification"

No-free Lunch

mispriced assets quickly disappear from the markets due to the competitive markets

Free-lunch relevance to risk/return

low risk and high return

No Free-lunch relevance to risk/return

low risk and low ROR

Risk-return tradeoff

high risk->high return

Efficient market hypothesis

Markets gather all available information quickly because markets are very competitive

Passive Management

buys and holds a diversified portfolio without attempting to identify mispriced securities

Efficient market assumes

passive management

Active Management

attempts to identify mispriced securities or forecast broad market trends

Inefficient market assumes

active management

Active Management

tries to find out insider information

Weak Form

past information reflected into stock price

Semi-strong form

reflect past and current

Semi-strong form

Reality of market efficiency

Semi-strong form

Both passive and active managements useful

Strong form

reflect past, current, future information(insider information)

Strong form

No mispricing

Strong form

Only passive management useful(No mispricing)

When computing the bank discount yield and the bond equivalent yield, you would use ____ and _____ days in the year, respectively.

360, 365

Given the trade price of $9,875 for a T-bill with the par value of $10,000 and 90 days to maturity, find out the actual discount rate, BDY, BEY and EAY respectively (6 decimal points).

0.012500, 0.050000, 0.050694, 0.051671

An investor buys a T-bill at a bank discount quote (BDY) of 4.80 with 150 days to maturity. The investor's actual annual rate of return (BEY) on this investment is _____.

4.97%

Which of the following is a financing instrument for non-financial firms?

T-bills, Certificate of Deposits, Commercial Papers

Commercial Papers

Which of the following is actively used for international trades?

T-bills, Certificate of Deposits, Commercial Papers, Bankers' Acceptance Notes

Bankers' Acceptance Notes

Calculations regarding Municipal bonds

If the after tax rate = r(1 − t) > rm, then purchase taxable bonds.

Suppose your tax bracket is 28%. Would you prefer to earn a 6% taxable return or a 4% tax-free yield? What is the equivalent taxable yield of the 4% tax-free yield?

4.32% > 4%

American Depository Receipts (ADRs)

Certificates of foreign company stock traded in US markets

Price-weighted US indexes

DJIA

S&P 500 Index is price or market-valued weighted?

Market-valued weighted

Derivative Markets

the financial market for derivatives, financial instruments like futures contracts or options, which are derived from other forms of assets

Call Option

gives the holder the right without obligation to buy the underlying asset at a specified price (called "strike price" or "exercise price") before or on the expiration date

Put Option

gives the holder the right without obligation to sell the underlying asset at strike price before or on the expiration date

Role of derivatives

risk hedge

Strike-price call

buy

Strike-price put

sell

12. Options: calculating profit and loss in relation to exercise decision

An investor is anticipating a rise in Apple stock ("AAPL") over the next three months. The current Apple stock price is $93.5. She purchases 10 call option contracts of AAPL with the strike price of $94. The price of a call option on AAPL is $ 2.90.

The stock price became $100 in three months at maturity, respectively. What are the exercise decisions and profits of the option position?

Option: $3100.00

Spot: $201.50

Primary Market

market for new issues of securities

Primary Market

Investment banks manage the issuance process

Primary Market Example

IPO, artists selling

Secondary Market

market for already-existing securities

Secondary Market

AKA auction/dealer market

Secondary Market Example

NYSE, Nasdaq, CBOE, CME

Initial Public Offering (IPO)

first issue of shares to the general public

Firm-commitment Underwriting (IPO)

underwriters purchase the whole IPO share from a privately traded company

Firm-commitment Underwriting (IPO)

Investment bankers buy

Firm-commitment Underwriting (IPO) best when?

the more in demand the offering

Firm-commitment Underwriting (IPO) risk?

puts money at risk if they can't sell the securities to investors

Short-term IPO performance

good

Long-term IPO performance

bad

Limit Order

buy/sell price contingent orders

Market Order

non-price contingent orders

Market Order Advantage

Market order can be matched quickly and best execution

Market Order Disadvantage

Uncertainty in executed price

Where is information available from the limit order book?

Inside spread, Market depth, Traders' information

Inside spread(information)

(best unfilled ask)-(best unfilled bid)

Market depth(information)

the amount of unfilled limit orders

Traders' information(information)

the price at which the trader want to trade

Relationship between market depth and volatility

Market depth increases volatility decreases

Bid-ask spread analysis

implicit transaction costs and the measure of market liquidity

Inside Spread

difference between inside quotes

Best Quotes

highest unfilled bid; lowest unfilled ask

Direct Search Market Example

Craigslist

Brokered Market Example

real estate market, securities brokerage firms, IPO markets

Brokered Market

no inventory of assets

Brokered Market

charge servicing fees/commissions

Dealer Market

Dealers trade assets on their own accounts

Dealer Market

They have inventories of assets

Dealer Market

Dealers quote bid and ask prices; customers negotiate with dealers

Dealer Market Examples

Most bond markets, automobiles, stocks via NASDAQ dealers

Auction Market

buyers and sellers enter competitive limit bids and offers to a concentrated place

Auction Market

Buy and sell limit orders with the same prices win the trade

Auction Market

Specialists in NYSE as auctioneers, ECN markets in NYSE, NYSE Arca, NASDAQ, antique markets

Are the specialists in the NYSE auctioneers and/or dealers?

market - auctioneer

no market - dealer

Which type of market do ECNs belong to?

Auction

Which type of market does NASDAQ stock market belongs to?

ECN

Which type of market does the NYSE belong to?

Dealer market, Auction market, ECN, Hybrid

Hybrid

All major stock markets today are effectively (which type of market?).

Direct search market, dealer market, Auction market, specialist market, ECN

ECN, 80%

Margin

portion of the purchase amount contributed by the investor

Initial Margin

The percentage of the purchase price of securities (that can be purchased on margin) that the investor must pay for with his or her own cash or marginable securities

Maintenance Margin

The minimum amount of equity that must be maintained in a margin account

Margin Call

a demand by a broker that an investor deposit further cash or securities to cover possible losses

Stock decreases below the maintenance margin(triggers this)

Margin Call

Calculation of initial percentage margin

You sold short 300 shares of common stock at $30 per share. The initial margin is 60%. How much do you borrow from the broker to trade on margin _________.

3600

You purchased 200 shares of ABC common stock on margin at $50 per share.

Assume the initial margin is 50% and the maintenance margin is 30%. You will get a margin call if the stock drops below ________. (Assume the stock pays no dividends, and ignore interest on the margin loan.)

35.71429

Calculation of the ROR in trading on margin Example An investor bought the IBM stock at $170 with the total $34,000 purchase on 60% margin. The broker's call loan rate is 4% per year. Suppose that the price went from $170 to $185 in a year. Then the ROR is

12.04%

Short sale

sale of shares not owned by the investor but borrowed through a broker and later purchased to replace the loan

Share Sale Profit = (short price - buyback price - dividend per share) x Number of shares

(Example) Suppose the stock price decreased from $30 to $25. During the short position, the dividend of $0.5 per share was paid. If you have 200 shares then:

900

Short sellers should post the _____ (cash or other securities) as collateral before the short sale

initial margin

1) Calculation of Net Asset Value (NAV) of a mutual fund

The composition of the Fingroup Fund portfolio is as follows:

Stock Shares Price

A 200,000 $35

B 300,000 40

C 400,000 20

D 600,000 25

The fund has not borrowed any funds, but its accrued management fee with the portfolio manager currently totals $30,000. There are 4 million shares outstanding. What is the net asset value of the fund?

10.49

2) Calculation of Turn over rate

The composition of the Fingroup Fund portfolio is as follows:

Stock Shares Price

A 200,000 35

B 300,000 40

C 400,000 20

D 600,000 25

If during the year the portfolio manager sells all of the holdings of stock D and replaces it with 200,000 shares of stock E at $50 per share and 200,000 shares of stock F at $25 per share, what is the portfolio turnover rate?

35.71%