Finance - Investment Analysis and Management

Investment Analysis and Management Review Notes for Final Exam 1. 2. 3. 4. 5. 1. 2. 3. 4. 5. 6. 7. 8. 9. Chapter 8 EMH: Three forms, concepts, and implications Evidence of market efficiency: concepts Evidence of market anomalies: concepts The role of portfolio manager in efficient market Homework problems and examples discussed in class Chapters 10&11 Characteristics of bonds Coupon rate and interest payment Maturity date Call provision Call premium and call price Face value Zero coupon bonds Required rate of return Interest rate risk: price risk vs. reinvestment risk Interest rate price risk: risk that the bond price will fall if interest rates rise Interest rate reinvestment risk: risk that reinvestment value will fall if interest rates drop Bond rating Bond valuation: concepts and calculations P (intrinsic value); YTM; YTC; CY Term structure theories Principles of bond price behavior Duration: concepts and calculations T CFt /(1  y ) t Macaulay duration, D =  t * wt , where wt  P0 t 1 Relationship between duration and bond price volatility (1  y ) D P =-D = - D*  y, where D* = , is the modified duration P 1 y 1 y Bond immunization: concepts and applications Homework problems and examples discussed in class Chapter 12 1. 2. Global economy Domestic economic analysis: concepts Business cycle and GDP Demand and supply side shocks Unemployment rate Fiscal policy: government spending, budget deficit, and taxes Monetary policy: interest rate, inflation and money supply 1 3. 4. 5. 1. 2. 3. 4. 5. 6. 7. Consumer spending Exchange rate Other factors Industry analysis: cyclical vs. defensive Company analysis Fundamental analysis: concepts Chapter 13 Characteristics of common stock: concepts Common stock earnings and dividends Net income, retained earnings, and cash dividends EPS, DPS, dividend payout ratio and profit retention ratio Valuation by comparable: concepts and calculations Dividend discount models: concepts and calculations Zero growth model: V = D / k Constant growth model: V = D1 / (k-g) Variable growth (multi-stage growth) model Other alternative models Free cash flow approach: concepts Preferred stock valuation: concepts and calculations Preferred stocks are valued in the same way as common stocks with no growth Homework problems and examples discussed in class Sample Problems 1. The weak form of the EMH states that ________ must be reflected in the current stock price. (a) a. b. c. d. 2. Random price movements indicate ________. a. b. c. d. 3. All past information, including security price, return and volume data All publicly available information All information, including inside information All costless information Irrational markets. That prices cannot equal fundamental values. That technical analysis to uncover trends can be quite useful. That markets are functioning efficiently. CFA questions 1-6 in Chapter 8 2 (d) 4. Find the duration of a 3-year bond with annual coupon payments of $80 and a par value of $1,000. The current market price of the bond is $950.25. If the YTM of the bond dropped by 1%, what would happen to the bond price? Answer: PV = -950.25, N = 3, FV = 1,000, PMT = 80, solve for i/y to get YTM = 10% Using the duration formula to get D = 2.78 years Using the modified duration formula to get D* = 2.53 years Bond price will increase by 2.53%, or the new price is $974.27 5. Consider two bonds, A and B. Both bonds presently are selling at their par value of $1,000. Each pays interest of $120 annually. Bond A will mature in 5 years, while bond B will mature in 8 years. If the yields to maturity on the two bonds change from 12% to 13%, _________. (d) a. b. c. d. 6. A coupon bond that pays interest of 4% annually has a par value of $1,000, matures in 5 years, and is selling today at $785. The actual yield to maturity on this bond is _________. (d) a. b. c. d. 7. Both bonds will increase in value but bond A will increase more than bond B Both bonds will increase in value but bond B will increase more than bond A Both bonds will decrease in value but bond A will decrease more than bond B Both bonds will decrease in value but bond B will decrease more than bond A 7.20% 8.80% 9.10% 9.62% A callable bond pays annual interest of $60, has a par value of $1,000, matures in 20 years but is callable in 10 years at a price of $1,100, and has a value today of $1055.84. The yield to call on this bond is _________. (a) a. b. c. d. 6.00% 6.58% 7.20% 8.00% 8. CFA questions 1-5 in Chapter 10 and CFA questions 10 in Chapter 11 9. A top-down analysis of a firm's prospects starts with an analysis of the ____. (b) a. Firm's position in its industry b. U.S. economy or even the global economy c. Industry d. Specific firm under consideration. 3 10. Which one of the following stocks represents industries with below-average sensitivity to the state of the economy? (c) a. b. c. d. 11. Which of the following would not be considered a supply shock? a. b. c. d. 12. Financials Technology Food and beverage Cyclical firms (d) A change in the price of imported oil Frost damage to the orange crop A change in the level of education of the average worker An increase in the level of government spending Multi-stage growth model If N = 3 years, gs = 30%, gn = 8%, D0 = $1.15, RRR = 13.4%, what should be the value of stock today? What are the expected dividend yield and capital gains yield today? How about in 5 years? Answer: D1 = $1.495 D2 = $1.9435 D3 = $2.52655 D4 = $2.728674 V3 = $50.53 (value of the stock in 3 years from the constant growth model) V0 = $39.21 (by discounting all the cash flows to the present) Dividend yield = 3.81% Capital gains yield = 9.59% In 5 years Dividend yield = 5.4% Capital gains yield = 8% 14. A share of stock is now selling at $40.00. It will pay a cash dividend of $2.00 at the end of the year. The stock has a beta of 0.8. The expected return on the market is 10% and the risk-free rate is 5%. What should be the expected stock price in one year? Answer: expected rate of return = 9% (CAPM), g = 4%, P1 = $41.60 15. Problems 13-15 in Chapter 13 4