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Investments Suggested Problems
Investments Suggested Problems
Behavioral paradigm:
ARE THEY?
SHOULD THEY?
IS FAMILIAR BETTER?
Investment banks.
Mutual funds and hedge funds ($2.7 trillion now).
Pension funds: defined benefit,401KBanks and Insurance
Companies: Tend to be in high quality fixed assets, bonds,
mortgages and MBS (all mat).
Colleges and foundations
100 120
0 1
b) with div.
100 120
Div 5
0 1 2
0 1 2
0 1 2
100 50 100
-50% +100%
10% 1 10% 2
After-tax = 114.49
Together
6%/(1-0.4) = 10%
Individuals can carry losses forward beyond the $3000 deduction from
ordinary income. In addition, firms can also carry it back for 3-years
back.
TAX-LOSS SELLING
To sell a losing position in order to realize a loss for tax purposes. If you
like the security, you can always buy it back (wait 30 days, else IRS
decrees it a “wash” sale and the deduction is disallowed.
0 r = 9%(nominal) 1
|
100 nominal grows at 9% to 109
Cost of
“basket” =100 (with 7% inflation) = 107.
1 + nominal rate
Or, real rate of return = ------------------------ - 1
1 + inflation rate
Common approximation:
Real rate = Nominal rate – Inflation rate
Structured so that face value adjusts with the CPI and the coupon is a
fixed percentage of that “changing amount.” So as inflation increases,
you get a higher dollar periodic payment. Principal is protected from
declines, so it stays constant in a deflationary state.
YIELDS
T-bills sell at a discount from face value. A $10,000 face value bill may
be selling at $9,600 with maturity in 182 days (half-year). Or at a
discount of $400.
Outside the IRA: Both principal and income taxed each year.
Q: TOO LITTLE?
Note that $40,000 is nominal and $7870 are REAL (or inflation-
adjusted) dollars.
ISSUES:
a) Life expectancy
b) Inflation Adjustment
c) Redo in real terms?
d) Other Savings
e) Fidelity/Vanguard Software, moneycentral.com,
quicken.com, Torrid-tech.com, esplanner.com,
wealthwhen.com
0.5 50%
0.3 10%
0.4 –20%
RISK
Business Risk
Financial Risk
Exchange rate/Country risks
Systematic and unsystematic risks
E(return)
SML (CAPM)
Risk (beta)
E(Rj) = Rf + [E(Rm)-Rf] * j = 2 + 6 j
Rf 4% 0.0 0
For A, the expected return of 14% from current price levels implies
an expected future price of $17.1
Here the risk-reward ratio has a specific form and using it,
[E(Rj) – Rf]/j = [E(Rm) – Rf]/1.0 = 8, Rearranging:
b) What about a stock that plots above the CAPM line (actual
returns end up higher than expected => price was lower than
expected => undervalued => positive alpha).
c) Assumes that only market factor (index) matters and that other
risks are priced away. How good is such a model?
Money managers think in terms of beating the S&P 500 (is this
risk-adjusted ? shouldn’t it be? )