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FIN 432 Investment Analysis and Management

Review Notes for Midterm Exam

4.
5.

Chapter 1
Investment vs. investments
Real assets vs. financial assets
Investment process
Investment policy, asset allocation, security selection and analysis, portfolio
construction and analysis, and portfolio rebalance
Players in investment markets
Homework problems and examples discussed in class

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Chapter 2
Money markets
Bond markets
Equity markets
Market indexes and averages: concepts and calculations
Derivative markets
Homework problems and examples discussed in class

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Chapter 3
New issues
Market structure
Direct search, brokered, dealer, auction markets
Transactions
Bid price, asked price, and bid-asked spread
Types of orders: concepts and applications
Types of transactions: long vs. short
Margin trading and short sales
Margin requirements; Initial margin; Maintenance margin
Margin call
Up-tick, down-tick, and zero-tick
Homework problems and examples discussed in class
Chapter 4
Investment companies and mutual funds
Characteristics of investment companies
NAV (net asset value)
Open-end funds vs. closed-end funds
Load funds vs. no-load funds
Low-load funds
Redemption fee (back-end load) and other fees
Types of mutual funds
Mutual fund performance
Investing in mutual funds
Homework problems and examples discussed in class

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Chapter 5
Risk and return
Risk premium
Mean and standard deviation
Inflation and real return
Asset allocation: concepts and calculations
Homework problems and examples discussed in class

Chapters 6&7
Portfolio construction with two risky assets: concepts and calculations
Diversification
Why portfolios can reduce total risk
3. Modern portfolio theory: concepts and applications
With n risky assets (no risk-free asset)
Efficient portfolios
Efficient frontier and MVP
Indifference curves
Choosing the optimal portfolio
If a risk-free asset exists and borrowing and lending are allowed
Efficient portfolios
Efficient frontier and MVP
Indifference curves
Choosing the optimal portfolio
4. Beta coefficient: concepts and calculations
5. CAPM: concepts and calculations
6. Capital market line and security market line
7. Single index model
8. APT model
9. Multi-factor models
10. Homework problems and examples discussed in class
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Chapter 8
EMH: three forms, concepts, and implications
Evidence of market efficiency: concepts and tests
Evidence of market anomalies: concepts and tests
The role of portfolio manager in efficient market
Interpretation of EMH
Homework problems and examples discussed in class

Sample Problems
1.

Consider the following limit order book of a specialist. The last trade in the stock
occurred at a price of $45.55.
Limit Buy Orders
Limit Sell Orders
Price Shares
Price Shares
$45.50
500
$45.75
100
45.25
600
45.80
200
45.00
800
46.00
500
If a market buy order for 300 shares comes in, at what price(s) will it be filled?
Answer: first 100 at $45.75 and next 200 at $45.80

2.

Intermediate 2.12-2.14, 2.18-2.19 from the textbook

3.

Assume that you bought 100 shares of stock X at $50 per share in your margin
account that has an initial margin of 60%. What would be the debt balance? How
much equity capital should you provide? What would be the actual margin if the
price rises to $70? If the maintenance margin is 30%, how low the price could
drop before you receive a margin call?
Answer:
Total cost = $5,000
Loan = $2,000 (debt balance)
Equity = $3,000 (equity capital)
100*70 2,000
Actual margin = --------------------- = 71.43% if the price rises to $70
100*70
Critical price = $28.57, if the price drops below $28.57, you receive a margin call

4.

You are bearish on stock ABC and decide to sell short 100 shares at the price of $50.
If the initial margin is 50%, how much cash should you provide? How high can the
price of the stock go before you receive a margin call if the maintenance margin is
30%?
Answer:
Short sale proceeds = $5,000
Initial margin = $2,500
Total assets = $7,500
7,500 100P
Margin = ------------------- = 0.30, solve for P = $57.69
100P

5.

Intermediate 4.11-4.14 and 4.21 from the textbook

6.

Choose the portfolio from the following set that is not on the efficient frontier.
a. Portfolio A: expected return of 12% and standard deviation of 13%
b. Portfolio B: expected return of 18% and standard deviation of 15%
c. Portfolio C: expected return of 38% and standard deviation of 28%
d. Portfolio D: expected return of 15% and standard deviation of 12%
Answer: a
By comparing a and d, we find that d provides a higher return and a lower risk.
Therefore, if d is available we will never choose a

7.

Given the utility function: U = E(r) 0.5A 2 , where A = 4 and four investments,
choose the one that maximizes your utility.
Investments
Expected return
Standard deviation
1
.12
.30
2
.15
.50
3
.21
.16
4
.24
.21
Answer: Investment 3. For each portfolio: Utility = E(r) (0.5 4 2)
Investment
1
2
3
4

E(r)
0.12
0.15
0.21
0.24

0.30
0.50
0.16
0.21

U
-0.0600
-0.3500
0.1588
0.1518

You should choose the portfolio with the highest utility value.
If you are risk neutral what investment should you choose?
Answer: Investment 4. When an investor is risk neutral, A = 0 so that the portfolio
with the highest utility is the portfolio with the highest expected return.
8.

Intermediate 5.12-5.16 from the textbook

9.

Intermediate 6.8-6.12 from the textbook

10. Intermediate 7.17-7.19 from the textbook


11. Intermediate 8.10- 8.17 from the textbook
12. All assigned CFA questions