Finance 301 Final Exam (summary of the important things)Alpha of a portfolio:- measure of how a stock performed relative to its expected performance- stocks that perform worse than their expected return will have a negative alphaEfficient Markets:- stocks/stock prices respond immediately to publicly available news and relevant newsWeak form market efficiency:- stock prices reflect the information contained in the history of past stock prices and trading volumeStrong form market efficiency:- stock prices reflect all information (past, public, private) including private informationRandom Walk Hypothesis:- stock prices are random- cannot be predicted solely on the basis of past movements- react immediately to news- price changes are randomReinvestment Risk:- income earned from a bond’s coupon payment will earn a different rate of returnInterest Rate Risk: - changes in market rates will affect the value of a bond- longer the maturity, the higher the interest rate risk of that bond- lower the coupon rate, the higher the interest rate risk of that bondRisk:- higher the standard deviation of returns, the higher the expected returns- risk and return have a direct relationshipBonds:- issue repayment of principal at their maturity- debt instruments Systematic Risk:- cannot be diversified away- market riskUnsystematic Risk:- can be diversified away- firm- specific riskUpward Sloping Yield Curve:- require higher returns for longer maturity treasuriesDownward Sloping Yield Curve:- expect interest rates to declineBeta:- measure of market related systematic risk of an assetAlpha:- measure of the difference between the observed and expected return of an assetFama French Study:- stocks with small market caps outperform stocks with large market caps- stocks with low P/E ratios outperform stocks with high P/E ratiosPure Expectations Hypothesis:- yield curve represents a series of expected future short-term interest ratesLiquidity Premium Hypothesis:- investors would prefer to hold short-term securities and so are paid higher interest rates as a premium for holding long-term securities Fundamental Analysis:- studying financial statementsTechnical Analysis:- charting historic stock price movements and trading volumes- argues that prices are driven by psychology and emotions of the crowdCallable Bonds vs. Non-Callable Bonds:- callable bonds usually have higher yieldsCallable Bond:- attractive to the issuer because it allows the issuer to prepay outstanding debt if new debt can be issued at lower ratesMost likely to call their bonds:- issuer’s credit rating improvesLeast likely to call their bonds:- issuer’s credit rating deterioratesPar Bond:- coupon rate is equal to the market yieldA bond that is selling at a discount:- requires that the yield must be greater than the coupon ratePremium Bond:- coupon rate is greater than the market yieldFloat-Rate Bonds:- issuer retains the interest rate riskCollateral Risk:- not associated with investing in fixed-income securitiesRisk associated with investing in fixed-income securities:- interest rate risk- default risk- reinvestment risk- prepayment riskLeast amount of risk reduction:- pick one with the highest correlationMost amount of risk reduction:- pick one with the lowest correlationShortest Duration:- want the highest coupon rateLongest Duration:- want the lowest coupon rate Bond Prices:- move inversely to changes in interest ratesValue of your bond:- if the Federal Reserve decides to lower interest rates, the value of your bond increases- if the Federal Reserve decides to raise interest rates, the value of your bond decreasesWith diversification:- an investor can reduce unsystematic riskWith hedging:- an investor fixes the sale price of an assetDerivative Securities:- derivative markets often more efficient than the spot markets- liquidity is often greater in the derivative markets than in the spot marketsStock Valuation:- profits and stock values have a direct relationship- interest rates and stock values have an inverse relationshipSell stock when:- the price is greater than the value- stock is currently overvaluedBuy stock when:- the price is less than the value- stock is currently undervalued Glass Steagal Act of 1933:-Created by FDIC-Forced the separation of traditional commercial banking and investment bankingDodd Frank Bill-Avoided situations that were too big to failEfficient Frontier-Used to achieve highest possible return for a given riskUse call option: when interest rates dropDuration-Measure of price volatilityDuration = (- change in P/P) / Change in YCoupon  Duration Maturity  Volatility Beta VolatilityInterest Rate Risk-Changes in market interest rates will negatively impact the value of the bondMarket Price  Market Interest Rates Spread to Treasuries-How likely a corporate bond is to default compared to a treasury bondSpread To Treasuries = Yield on Corp. Bond – Yield on Treasury bond with Same MaturityEquations (you will need to memorize):Beta = (stock return / market return)Market Risk Premium = Avg. return rate – T-Bill rate = (S&P 500) – T-BillCompany Risk Premium = Beta x (market avg. % - T-bill %)CAPM (capital asset pricing model) Expected Return = T-Bills + Beta x (marketavg. % - T-bill %)Alpha = actual return % – expected return %to get expected (in order to solve Alpha) = [T-Bills + Beta x (market avg. % - T-bill %)]Alpha (with prices) = [(end price – beg. price) + div.]/ beg. priceReturn Received over year = [(selling price – buying price) + dividends] / buying priceReal Rate of Return = nominal interest – inflationLevel of Inflation = nominal interest – real treasury yield WACC = [% equity x cost of equity] + [% debt x after-tax rate x cost of debt]Taxable Equivalent Bond = interest rate yield / (1 – tax bracket)Value of Perpetuity = payments / interest rates = annual cash flows / discount rateStockholder’s Return = (div. + change in price) / beg. price change in price = end price – beginning priceTime Value = Strike – MarketIntrinsic Value = Current –