Review for exam 1

1
Review for exam 1

• Chapter 1 - 4

2
Example GAP Variance Std Dev.

• Given the three annual returns on GAP stock,
  calculate the mean, the variance, and the
  standard deviation of the stock return.
• Draw the probability distribution of the stock
  return.
• What is the return range within you expect the
  return to be with 95 probability?

3
Example GAP Variance Std Dev.
Variance (Var) 2396.27/21,198 (in squared
percentage) Standard Deviation (Std. Dev.)
34.61 With 95 Prob. the expected return range
2 Std. Dev. range from the mean 12.15 (2 x
Std.Dev) - 57.07 and 12.51 (2x Std. Dev)
81.37
4
Review Total return

• A stock had a price at the beginning of the year
  of 48.20. You sell the stock after 6 months.
  During this investment period you received 1.15
  dividend on this stock.
• If your total percentage return was -8.15 what
  was price of the stock at the end of the sixth
  month?
• What is the EAR on this investment?
• EAR(1holdingret)m-1 (1-.0815)2-1 -15.6

return (Endprice Income Begprice) /
Begprice return Div yield Capital gains
yield D/P0 (P1-P0)/P0 -8.15 1.15/48.2
capital gains yield (CGY) ? thus, CGY
-10.54 Now, if CGY-10.54 (P1-P0)/P0 , we can
solve for P143.12
5
Review Forecasting return

• You find a stock that has a geometric return of
  10.2 percent and an arithmetic return of 12.4
  percent over the past 30 years.
• What is your best estimate of the annual return
  over the next 15 years?

11.34
6
Review IBM Margin accounts (1)

• You have 30,000 in a margin account that
  requires 60 initial margin.
• You can buy _______ of stock with this account.
• Your borrowing rate from your broker is 6.00.
• Suppose you buy 500 shares of IBM, for
  100/share.
• Assume no dividends, and that your borrowing rate
  is still 6.00, what is your return if
• In one year, IBM stock is selling for 110 per
  share?
• In one year, IBM stock is selling for 110 per
  share, but you did not borrow money from your
  broker?

50,000
7
Review IBM Margin accounts (2)

• A) Now, the IBM stock is selling for 110 per
  share (10 increase).
• Your investment is worth 55,000.
• You owe 6 interest on the 20,000 margin loan,
  that is ______.
• If you pay off the loan with interest, your
  account balance is 55,000 _____________
  _______.
• You started with 30,000 while your income (gain)
  is 3,800.
• Thus, the returns is 3,800, while the
  return is
• Income/ Investment ________ / 30,000
  _____.
• Suppose IBM stock was selling for 90 per share
  instead of 110 per share? What is your return?

1,200
(20,000 1,200) 33,800
(3,800 ) 6
8
Review IBM investment (3)

• B) IBM stock is selling for 110 per share, but
  you did not borrow from your broker.
• You started with 30,000, which means you were
  able to buy ______ shares (recall original price
  was 100).
• Your investment is now worth (IBM trades at 110)
  _________.
• The return on the investment without margin
• Therefore, your return is __________________.
• Suppose IBM is selling for 90 share instead
  of 110 per share. What is your return in this
  case?

300
33,000
3,000/30,000 10
Recall that return gain/investment, here gain
is 6,000
9
Review of margin purchases

• You purchase 200 shares at 45 per share. You put
  up 5000 and borrow the remainder. Show your
  balance sheet. What is your initial margin?
  Suppose the maintenance margin is 35.
• A) If the stock price falls to 35, what is your
  margin?
• B) At what price would you receive a margin call?

• See answer on the next slide.
• To answer part B, you use the formula P for long
  positions from the formula sheet.
• P 4,000/200 /.65 30.77.
• Thus, if the price declines to 30.77 then there
  is a margin call.

10
Review of margin purchases contd
Orig. balance sheet

• You purchase 200 shares at 45 per share, that
  cost 9,000. However, you put down only 5,000
  in cash, thus you borrow 4,000 from your broker.
  Thus, initial margin is 5,000/9,00055.5.
• If the price falls (from 45 to 35), then the
  value of the 2,000 shares declines from 9,000 to
  7,000. The margin loan (you always have to pay
  back the 4,000) does not change, thus on the
  right side of the balance sheet the equity value
  declines.
• New Equity New total value of shares Loan
  7,000 - 4,0003,000.
• The new margin equity / total shares value
  3,000/7,00042.8

11
Review of short sales

• You sell short 500 shares at 30 per share. The
  initial margin requirement is 50 and the
  maintenance margin is 30.
• Show your initial balance sheet.
• What happens if the price rises to 35 per share?
• What price would trigger a margin call for you?

• See next slide
• See next slide for calculating new equity and
  return
• To answer part C, use the formula P for short
  position.
• P 22,500 / 500 / 1.3 34.6

12
Review of short sales contd
Original balance sheet

• A) The short proceeds 500 shares sold at 30
  15,000
• The margin if 50 of the short proceeds 50
  15,000 7,500.
• B) If the price rises to 35 you are losing money
  because you have a short position and the price
  decline is not beneficial for you. You likely
  entered the short position because you expected
  price decline.
• The new value of the equity position Total
  Short positions 5,000
• You originally put down 7,000. Now you have
  5,000, thus you lost about 33.33

13
Review futures

• Real Silver futures quote from CBOT (May 11, 2006)

In the exam, the quote is the traditional format
as in Fig. 3.3 or here below Silver 5,000 troy
oz. cent per troy oz.

• While gold contracts are quoted in dollars, the
  silver contracts are quoted in cents per oz.

14
Review futures continued

• Use the above Silver futures quote.
• What is the dollar value of the Sept silver
  futures contract based on the closing price of
  the day.
• You purchased 7 Sept silver futures (5,000 oz.)
  at the low price for the day and sold them at the
  last price for the day. What was your dollar
  profit?

The value of 1 contract .14365,000 718 The
purchase value 7 5,00014.28(cents) 499,800
cents 4,998 Sales value 7 5,00014.36(cents)
502,600 cents 5,026
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Google use this table for practice
Suppose you buy 10 Feb 380 put options (premium
8.20). A) What is your profit if GOOG sells for
400 at expiration? B) What is your profit if
GOOG sells for 415 at expiration? C) What is
your profit if GOOG sells for 425 at expiration?
16
Google use this table for practice
Suppose you buy 10 Feb 410 call options (premium
10). A) What is your profit if GOOG sells for
400 at expiration? B) What is your profit if
GOOG sells for 415 at expiration? C) What is
your profit if GOOG sells for 425 at expiration?
17
Review Mutual funds

• Which of the following is false regarding money
  market mutual funds? Money market funds
• A) are generally insured by the FDIC.
• B) can be taxable or non-taxable.
• C) are generally insured by the SIPC.
• D) are generally considered safe investments.
• E) adjust their NAV to one dollar daily.

18
Review Mutual funds

• A contingent deferred sales charge is also know
  as a(n)
• A) management fee.
• B) 12b-1 fee.
• C) back-end load.
• D) front-end load.
• E) exchange fee.

19
Review Mutual funds

• You invest 10,000 in a mutual fund at the
  beginning of the year at a NAV of 32.80. The
  fund makes a dividend distribution of 0.18 and a
  capital gains distribution of 0.38. If the NAV
  at the end of the year is 36.21, what was your
  return for the year?
• Here, we assume that you bought 305 shares.
• Solution
• Income per share (36.21-32.80).18.38 3.97
• On the 305 shares you earn 3053.971,210.85
• Return Income / Investment 3.97/32.80 12.1

20
Review MMMF tax effect

• A non-taxable money market mutual fund has a
  return of 2.8 percent. If you are in a 36 percent
  tax bracket, what is the return you would require
  on a taxable fund?
• If you can earn 4.8 on a taxable fund (and your
  tax bracket is 32) when would you prefer a
  nontaxable fund (with what return)?

2.8 X(1-36) where X is the return on
taxable fund 2.8 / (.64) X
4.375X You need to earn 4.375 before tax
return to have 2.8 after tax return.
After tax return (on 4.8) 4.8(1-32) 3.26
You should prefer any nontaxable fund that offers
return higher than 3.26.
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Further review

• This is an incomplete review. You should be
  familiar with many other concepts and
  calculations that are not included in this exam
  review.
• An indicative but incomplete list of other
  concepts that you should review for the exam is
  as follows
• Options - definitions
• The use of options
• Risk - return tradeoff
• Risk premium
• Fixed income securities
• Common stocks and preferred stocks