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Chapter 1 Risk and Return History 1.1 Returns Total dollar return: Return on an investment measured in dollars that accounts for all cash flows and capital gains; Total dollar return = dividend income + capital gain (or loss); Dividend income = no. of shares x price/share; Capital gain = (increase in price/share – original price) x no. of shares Capital loss = (decrease in price/share – original price) x no. of shares. Total Percent(age) Return: the return on an investment measured as a percentage of the original investment. Percent Return on a Stock = (dividend income + capital gain or loss)/beginning stock price OR Percent Return = total dollar return on stock/beginning stock price (or investment) Effective Annual Return: Return of an investment expressed on a per-year or “annualized” basis (Annualizing Returns) Pt = PRICE/SHARE AT START OF YEAR m = holding period time (12 months/3 months = 4 months or 1 year/3 years) Holding Period Percentage Return =

(Pt+1 – Pt) / Pt Effective Annual Return: 1 + EAR = (1 + holding period percentage) return)m____________________________________ _____ 1.3 Average Returns: First Lesson Risk-free rate: the rate of return on a riskless investment Risk Premium: the extra return on a risky asset over the risk-free rate; reward for bearing risk. THERE IS A REWARD FOR BEARING RISK GREATER THE POTENTIAL REWARD, MORE RISK_______________________________________ ___ 1.5 More on Average Returns; R=returns Arithmetic Average Return: the return earned per year over a multiyear period (R1+R2+…Rn)/n Geometric Average Return: average compound return earned/year over a multiyear period

[(1+R1)+(1+R2)+…1+Rn)]1/n-1 Combining Averages T = T year average R(T) = [(T-1)/(N-1})] x Geometric Average + [(NT)/(N-1)] x Arithmetic Average Dollar-Weighted Average Returns Average compound rate of return earned per year over a multiyear period accounting for investment inflows/outflows Chapter 2 Investment Process 2.3 Types of Accounts (Brokerage) Cash Account – a brokerage account in which securities are paid for in full; transactions are made on a strictly cash basis Margin Account – a brokerage account in which, subject to limits, securities can be bought and sold (short) on credit. The portion of the value of an investment is not borrowed is called the margin Portion incurs and interest of charge: Call money rate – rate that brokers pay to borrow money (bank funds) to lend to customers in their margin accounts. Margin = Account Equity (A/E)/value of stock Amount Borrowed = value of stock – A/E Minimum margin – initial margin Maintenance margin – must be present at all times in market account Margin call – a demand for more funds when margin in account drops below maintenance margin New Margin = A/E / # of shares price Maintenance Margin Level = [(no. of shares x p*) - amount borrowed)]/no. of shares x p* P* = (amount borrowed/number of shares)/1maintenance margin level t = time period in a year (3/12) Amount repaid = amount borrowed x (1 + interest rate year)t Sale Proceeds = Cash from Sale – amount repaid Profit = Sales Proceed – Investment 1+EAR = see formula from Ch. 1 If last answer is 1.3285, the percentage is 32.85% Hypothecation – pledging securities as collateral against a loan Street Name – an arrangement under which a broker is the registered owner of a security________________________ 2.4 Types of Positions Short sale (position) – a sale which the seller does not actually own security that is sold; benefits from price decreases; sell high and buy low and you profit). Critical price on short sale: p* = [(initial margin deposit + short proceeds)/number of shares]/1+maintenance margin Short interest – the amount of common stock held in short positions

Ch. 3 Overview of Security Types 3.3 Equities Common Stock - Represents ownership in a corporation. A part owner receives a pro rated share of whatever is left over after all obligations have been met in the event of a liquidation (IBM shares, Microsoft Shares, Intel shares, Dell shares) Preferred Stock – The dividend is usually fixed and must be paid before any dividends for the common shareholders. In the event of a liquidation, preferred shares have a particular face value_______________________________________ 3.5 Option Contracts Call Option – gives owner right but not obligation to buy something Put Option – gives owner the right but not obligation to sell something. Option Premium – Price you pay today to buy an option Strike Price/Exercise Price – the specified price at which the underlying asset can be bought or sold Chapter 4 Mutual Funds/Other Investments 4.1 Advantages and Drawbacks of Mutual Fund Investing Advantages: Diversification – a mutual fund is a portfolio, or basket of securities. Professional management – professional money managers make decision of when to add or remove particular securities from the mutual fund; investor does not have to make the crucial decisions. Minimum Initial Investment – Most mutual funds have a minimum initial purchase of $2,500, but some are as low as $1000 or even $250 in some cases. After initial purchase, subsequent purchases are sometimes as low as $50. Vary from fund to fund. Drawbacks: Risk - Unlike a bank deposit, mutual fund values can fall and be worth less than your initial investment; No government or private agency guarantees the value of a mutual fund. Costs - investing in mutual funds entails fees and expenses that do not usually accrue when purchasing individual securities directly; We detail most of these costs later in the chapter. Taxes - You will pay taxes on mutual fund distributions (dividends and capital gains). You will pay taxes on profits you make when you sell mutual fund shares________________________________ 4.2 Investment Companies/Fund Types Investment Company - a business specializing in pooling funds from individual investors and making investments Open-end fund - is an investment company that stands ready to buy and sell shares in itself to investors, at any time. Closed-end fund - is an investment company with a fixed number of shares that are bought and sold by investors, only in the open market. Net asset value(NAV) = (the value of the assets held by a mutual fund)/(by the number of shares) or NAV = (Assets – liabilities)/no of shares; premium or discount = (current priceNAV)/NAV__________________________________ 4.4 Mutual Fund Costs/Fees 12b-1 fees - SEC Rule 12b-1 allows funds to spend up to 1% of fund assets annually to cover distribution and marketing costs. 0.25% is most common. Management Fees - Usually range from 0.25% to 1.50% of the funds total assets each year; Fund companies often report expense ratios—which is an all-inclusive fee. Trading Costs - Not reported directly; Funds must report "turnover," which is related to the amount of trading; The higher the turnover, the more trading has occurred in the fund; The more trading, the higher the trading costs. CDSC – a sales charge levied when investors redeem shares (also a back-end load). Turnover – measure of how much trading a fund does; Turnover = less of total purchases or sales/average daily assets Expense Reporting – basically reporting expenses_____________________________________ 5.1 Private Equity versus Selling Securities to Public Venture capital – financing for new often high-risk ventures Private equity - is used in the rapidly growing area of equity financing for nonpublic companies; Banks are generally not interested in making loans to start-up companies, especially ones; Start-up companies search for venture capital (VC), an important part of the private equity markets; include middlemarket firms and large leveraged buyouts. Two types of investment companies: Private equity and Hedge funds Venture capital firms – Individuals, Pension funds, Insurance companies, Large corporations, Primary market - is the market where investors purchase newly issued securities. Initial public offering (IPO): An IPO occurs when a company offers stock for sale to the public for the first time. Ch. 12 Return, Risk, and Sec. Market Line 12.2 Risk: Systematic and Unsystematic Systematic risk – risk that influences a large number of assets (aka market risk) B = BETA Unsystematic Risk – risk that influences a single company or a small group of companies (aka unique or asset-specific risk) Components of Return – R – E(R ) = U = Systematic portion +Unsystematic portion or R-E(R ) = U = m+e . U = surprise portion________________________________ 12. 3 Diversification, Systematic Risk, and Unsystematic Risk Total Risk = systematic risk + unsystematic risk 12.5 Security Market Line Beta and the Risk Premium

Seasoned equity offering (SEO): If a company already has public shares, an SEO occurs when a company raises more equity. Secondary market – is the market where investors trade previously issued securities. Can trade with other investors and indirectly through a broker; someone who buys/sells securities from inventory. General cash offer – an issue of securities offered for sale to the general public on a cash basis. Rights offer – a public issue of securities in which securities are first offered to existing shareholders Investment banking firm – a firm specializing in arranging financing for companies Underwrite – to assume the risk of buying newly issued securities from a company and reselling them to investors Underwriter spread – compensation to the underwriter determined by the difference between the underwriter’s buying and offering price Syndicate – a group of underwriters formed to share the risk and help sell an issue SEC (Sec and Ex com) – financial regulations Prospectus – document prepared as part of a security offering detailing a company’s financial position, its operations, and investment plans for future The bid price: The price dealers pay investors; The price investors receive from dealers. The ask price: The price dealers receive from investors. The price investors pay dealers. 5.3 NYSE Operation DMM post – designer market maker (DMM); fixed place on the exchange floor where DMM operates Market order – a customer order to buy or sell securities marked for immediate execution at current market price Limit order – buy at best price available but not more than the preset limit price. Forgo purchase if limit is not met. Sell at best price but not less than preset like. Forgo sale if limit unmet Stop order – convert to a market order to buy when stock price crosses the stop price from above (below for sell); aka: Stop loss Stop Limit Order – convert to a limit order to buy when the stock price crosses from price below (above for sell) Circuit breakers - Sometimes the market wide order flow is such that regulators have deemed that a trading cease for a short time to “calm the market”; all methods used by stock exchanges during large sell offs Price Weighted Index

Return % = [(Beg. Company 1 + Beg. Company 2)]/Beg index value Value Weighted Index Return % = [(Beg Company 1 x shares)+(Beg company 2 x shares)]/(Beg Company 1 x shares)_______________________________ ___ Ch. 6 Common Stock Valuation 6.1 Security Analysis: CAREFUL! Fundamental analysis - is a term for studying a company’s accounting statements and other financial and economic information to estimate the economic value of a company’s stock; The basic idea is to identify “undervalued” stocks to buy and “overvalued” stocks to sell. In practice however, such stocks may in fact be correctly priced for reasons not immediately apparent to the analyst. ___________________________________________ _______ 6.2 Dividend Discount Model (DDM) Dividend Discount Model – method of estimating the value of a share of a stock as the present value of all expected future dividends.

P0 = the present value of all future dividends Dt = the dividend to be paid t years from now k = the appropriate risk-adjusted discount rate Suppose that a stock will pay three annual dividends of $100 per year; the appropriate risk-adjusted discount rate, k, is 15%.

Assume that the dividends will grow at a constant growth rate g. The dividend in the next period, (t + 1), is:

Constant Perpetual Growth Model =

Constant dividend growth model – a version of a dividend discount model in which dividends grow forever at a constant rate, and growth rate is less than disc rate. For constant dividend growth for “T” years, the DDM formula is:

Geometric Average Dividend Growth – A dividend growth rate based on a geometric average of historical dividends.

G = (Dn/D0)1/n – 1 Arithmetic average dividend growth rate – a dividend growth rate based on an arithmetic average of historical dividends.

Sustainable Growth Rate = ROE x Retention Sustainable growth rate – a dividend growth rate that can be sustained by a company’s earnings Ratio = ROE x (1-Payout Ratio) ROE – NI/Equity Payout Ratio - Proportion of earnings paid out as dividends Retention Ratio = Proportion of earnings retained for investment (i.e., NOT paid out as dividends); earnings retained within the firm to finance growth. Analyzing ROE ____________________________________ ___ 6.3 Two stage dividend growth model formula – a dividend discount model that assumes a firm will temporarily grow at a rate different from its long-term growth rate.

Supernormal Growth

Discount rate = time value of money + risk premium = U.S. T-bill Rate + (Stock Beta x Stock Market Risk Premium) Nonconstant Growth In the First Stage – (dividend growth model) P n = Dn x

(1+g)/(k-g) = Dn+1/(k-g) P0 = worth in n years/1+ disc % beta – measure of a stock’s risk relative to the stock market average_____________________________. 6.5 Free Cash Flow Model – FCF = EBIT(1 – Tax Rate) + Depreciation – Capital Spending – Change in Net Working Capital_______________________ 6.6 Price Ratio Analysis Price-earnings (P/E ratio) – current stock price/annual earnings per share (EPS) Earnings yield (E/P) – inverse of the PE ratio: EPS/price per share Growth stocks – a term often used to describe high-PE stocks. Value-stocks – a term often used to describe low P/E stocks Price-cash flow (P/CF) ratio – current stock price/current cash flow per share. Cash flow – In the context of the price-cash flow ratio, usually taken to be net income plus depreciation Price-Sales (PS) Ratio – current stock price/annual sales per share Price-book (PB ratio) – market value of a company’s stock/book value of equity Enterprise value - the market value of firm’s equity + market value of the firm’s debt-cash EV to EBITDA ratio Income Statement = Rev. – COGS = EBITDA – Dep and Amort. – interest = Pretax income – taxes (%) = NI____ Ch. 7 Stock Price Behavior and Market Efficiency 7.1 Intro to Market Efficiency Efficient market hypothesis (EMH) – the hypothesis stating that as a practical matter investors cannot consistently beat the market 7.2 Excess Return/What Does Beat the Market Mean? Excess return – a return in excess of that earned by other investments having the same risk 7.3 Foundations of Market Efficiency 1. Investor Rationality 2. Independent Deviations from Rationality 3. Arbitrage 7.4 Forms of Market Efficiency (inner to outer)

NYSE uptick rule – rule for short sales requiring that before a short sale can be executed, the last price change must be an uptick Long sale (position) – benefits from high price increases; buy high and sell low and you profit!_________________ 7.7 Informed Traders and Insider Trading Informed trader – an investor who makes a buy or sell decision based on public info and analysis Material nonpublic information – private knowledge that can substantially influence the share price of a stock______ Ch. 10 Bonds 10.1 Bond Basics Straight-bond – “so called” bond that is an IOU that obligates the issuer to pay the bondholder a fixed sum of money at the bond’s maturity along with constant periodic interest payments during bond’s lifetime. Coupon Rate = a bonds annual coupon/par value. Also known as coupon yield or nominal yield. Current Yield = a bond’ annual coupon/bond price_____ 10.2 Straight Bond Prices and Yield to Maturity Bond Price = C/2 – [ 1-_1_____] + ___FV____ YTM/2 (1+YTM/2)2M (1+YTM/2)2M Or C – [ 1-_1_____] + ___FV____ YTM (1+YTM/2)2M (1+YTM/2)2M C = Annual coupon, the sum of two semiannual coupon FV = Face Value M = maturity in years YTM = Yield to Maturity Premium Bonds (Price > Par) Coupon Rate > Current Yield > YTM Disc. Bonds (Price < Par) Coupon Rate < Current Yield...