Study Session 18

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Study Session 18
2012-04-24 18:18:18
Study Session 18

Study Session 18
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  1. Distinguish between open end and closed end fund and explaing how net asset value of a fund is calculated and nature of fees charged by investment companies?
    Open end fund stands ready to redeem shares at closing value on trading day for underlying securities. Closed end funds are traded in secondary markets. Liquidity of an open end fund is provided by the investment company that mages it, while close end funds are determined by market rates.

    Open end funds have a load (fee) that can either be front loaded back end load or none at all. Additionally, all funds will charge ongoing fees on annual basis referred to as 12b-1 fees.

    Closed End funds will be issued at premium for cost of issuances, but close end funds do not have load fees.

    Net asset value is the assets minus liabilities, stated on a PER SHARE Basis.The net asset value of an open end share can only be the value of the underlying shares, but close end funds may not equal NAV bc share price is determined by the market.

    Annual fees may cover mgmt fees which go to portfolio manager, admin expenses, distribution fees, 12b-1 fees. Funds expense ratio is ratio of operating expense to average assets.
  2. Distinguish among style, sector, index, global, and stable value strategies?
    • -Style describes basic characteristic of underlying asset, such as growth vers value, large cap vs small cap.
    • -Sector strategy - investment fund concentrate its assets in a specific industry
    • -index fund strives to match returns to an index
    • -global fund will invest in secruties all over world including home country of fund
    • -stable value fund invests in short term govt secuities or other investments providing timely principla paymentes at a set rate.
  3. Distinguash among equity investment and ETFs, traditional mutual funds, and closed end funds.
    -ETF special fund invests in porftolio of stock or bonds and designed to mimic index. Traded in secondary market like closed-ended. Feature unique to ETF is use of IN-KIND CREATION AND REDEMPTION.Authorized particiapnts can create new shares in ETF by depositing $ with trustee a portfolio of stocks that track an index. The particiapnt receives from the trustee new ETF shares to be sold in open market. Participant can also redem shares to trustee in exchange for stocks.

    In-Kind process has 2 advantaged, first keeeps market prices of ETF shares close to NAV and avoids premiums and discounts typical for closed end funds. Also tax advantage bc if someone redeems indiivual shares in ETF, everybody doesn't have to pay.
  4. Describe forms of real estate investment.
    • -outright ownership - entitles holder to full ownership for indefinite period
    • -leveraged equity position - investor have entitlements but must be subjected to loan requiriements/payments.
    • -Mortgages - investing in mortgages and receiving monthly payments is a form of real estate investment.
    • -aggregation vehicle - allow investors to increase diviersication in direct real estate holding by investing in groups of projects. (REIT)

    -Real estate is unique bc immoble, not divisible, and each property is unique.

    -Indexes based on appraised values of real estate have issues bc appraisal values tend to smooth returns relative to market prices. appraislal based indexes tend to have very large wieghts bc of low volatility and low correlation with importatn asset class proxies. Considered serious drawback.

    Portfolio diversification of REITs is very small, bc correlation of REIT index and stock index are very close to one.
  5. Various paproaches of valuing real estate?
    • -Cost method, value determined by replacement cost of improvements plus estimate for value of land.
    • -Sales comparison method - uses price of similar property or properties from recent transactions. Prices must be adjusted for changes in unique characteristics of each property. NOI DOES NOT TAKE INTO ACCOUNT DEPRECIATION AND FINANCING COSTS.
    • -Income method - uses discounted cash flow model to estimate present value of future income. Net operatin Income (NOI) is simplified estimate based on annual gross rental revenues minus operatin expense. NOI divided by market reuired rate of return, resulting in appraisal price. Does not take into accoutn investor income tax implications

    4. Discounted after tax cash flow model links value of a property to an investors specific marginal tax rate.

    -sales comparison approach based on sale price of comaprable properties. Hedonic price estimation, involves creating statistical mode of sales prices of properties showing how prices are related to certain key characterisitcs.

    -Income approach takes stream of annual NOI, and usign the required cap rate, divides NOI by cap rate.
  6. Stages in venture capital investing,
    • -Seed stage provide cash to research and develp product ideas
    • -Early stage - start up financing- referst to capital used to compelte a product
    • -First stage - referst to fundign of transioin to commercial production and sales of product
    • -Formative Stage - Broad catebgory ecompasses seed stage and early stage
    • -later stage- goods in production and sales efforts udnerway, but company still private. Within later stage period, secon stage describes investment in a company prodcuing and selling a product but not yet profitable.

    • Third stage would fund major expansion
    • Mezzanine or bridge financing would enbale company to take seteps to go public.
  7. VC mgr considering investing 2.5 million in new project he beleives will pay 12 million at end of five years. cost of equity is 15%.

    Estimated probability of failure year 1- .2, year 2 -.2. year 3 - .17, year 4 - .15, year 5-.15.

    Calculat eNPV
    • Determin probability of suc ess which equals
    • .8*.8*.83*.85*.85 = 38.38%. Take (.3838*12 million/(1.15^5))+-2.5 Million= -210,203
  8. Describe objectives, legatl structure fee structure of hedge fund?
    Hedge fund objective stive for absolute returns. Seek to maximize returns in all marekt scenarios.

    Typically set up as limited partnership, limited liability or offshore corp. Exempt from SEC regulation.

    Typically take 1% of assets under mgmt + performance. High Watermark provision stipulates incentive fees are only based on returns above highest value achieved over life of fund. May push to take risks.

    Long/Short Funds - largest category in term of size. these funds take long and short common stock position, use leverage, and invested globally.

    Market-neutral funds - type of long/short fund that stfive to hedge against general market moves. Fund may still have long and short positions but positions offeset each other so effect is anet zero exposure to market.

    • Global macro funds - make bets on direction of market, currency interest rate, or other factor. Typicall highly leveraged rely on derivatives.
    • -Event driven funds capitalize on unique opportunity like distressed company or merger.
  9. Drawbacks of fund of fund investing?
    fund of fund investing is a pool of funds that are used to invest in multiple hedge funds that an individual investor may not have ahd the capital to invest in by himeself. Drawback is that you may be able to select funds just as well as a fund of funds and you pay more mgmt fees bc of investment in multiple funds.
  10. Unique risks of hedge funds
    • illiquidity - derivatives and instruments hedge funds trade in markets may be illiquid
    • Potential for mispricing - investing in murky securities that trade infrequently lead to difficulty in determing true current value. May have to pay more margin than actually necceasry
    • Conuterparter credit risk
    • settlement risk
    • margin calls
  11. biases prevalent in hedge funds
    • -hedge funds demonstrated lower risk profile than traditional equity investments
    • -sharpe ratio has been higher for hedge funds
    • -low correlation btwn performance of hedge fund and convential invements

    • -however biases exist:
    • -self selection biases- Hedge fund are not mandated to reporte results. Can choose t only disclose well performaing funds and not for badly
    • -backfilling bias - fund managers with respectabel track record would be willing to include in index.
    • -survivorship bias - funds that are currently alive are the one's that survivfed. the ones that went under are not included.
    • -smoothe pricing of infrequently traded assets - bc of illiquid markets of securities, values tend to be higher.

    Option like strategies - some hedge fund invesmtents have limited upside potiential but unlmiited downside, therefore sharepe ratio doesn't work as well bc standard deviation not a good method

    -Gaming - some fund strucutre only pay when there are gains. This pushes managers to take a lot of risk to get gains.
  12. Closely held companies?
    companies held by relativley small group of owners. Valuation is based on either forecast, actual past cash flows, or combination of both. Legal situations make it hard to value a closely held company and differ among jurisidintons.
  13. Alternative valuation methods for closely held companies?
    Cost approach - cost to replace company's assets at present state

    comparables approach - value relative to appropriate benchmark

    Income approcah - net present value of company based on discounted cash flows

    Another factor includes whether or not you have controlling interest in company. Discount for minorioty shareholders. Additionally can be compared with simliar publicly tradec ompanies, however, must be discounted if there is less liquididty in selling of shares which must accoutn for discount.
  14. Distressed securities investing?
    Buying debt of a company , pre reorganization, then get debt converted to equity in resturucting and sell equity after changes have made to company and resturucturing done
  15. Motiviation for investing in commodities, comdoitiy derivatives, and commodity linked securities?
    Overall swing in commodity prices, likely large than changes in finished good s prices.

    Passive investors who hold commodities as asset class for diversification, or those who hold commodities as long term inflation hedge are more likely to invest in collaterlaized future position. Combination of investment in commdoity futures and treasury securities.

    Active investors invest in commodity futures to profit from economic growth assocaited with higher commodity prices.
  16. Collateralized commodit futures position soruce of return?

    Passive manager purchases position of 50 million in futures contract. also buys 50 million in 10 year trasury at 5% interest rate. Compute gain in value of psoition if at end of year future contract position is worth 51 million, and price of treasury stay same.
    Collaterlaized commodity futures position require simulatneous purcdahsing of sepcivc futures and purchasing govt secruities. Market value of tbills must equal contract value of future contract. Total return will equal change in price of futures plus percent interest earned on government securities.

    Gain of futures is 1 million. Gain on treasurys is 5 percent of 5 million = 2.5 million. 3.5 million(2 added)/50 million (price of futureSecurity) is 7 million.
  17. Rlationship between spot prices and expected future prices in terms of contango and backwardation?
    Contango is when future price is greater than spot price. Indicates more people longing futures.

    Backwardation is when Spot price is greater than future price. Indicates more people shorting futures.
  18. Describe sources of return and risk for commodity investment and effect on porftolio adding an allocation to commodities?
    To take position in forward or futures, a speculator or hedger must post collateral. IF us treasury bills depostied as colalteral, the COLLLATERAL YIELD is simply the yield on T-bills.

    PRICE RETURN on a long only investment can be positive or negative depding on direction in spot price for commodity. Price return is the change in spot price over life of forward or futures contract.

    Rol Yield can be postiive or negative. Refred to as rolling over position from one future contract to next keeping same psotion, which can lead to gains or losses. If Spot prices are above future prices (Backwardation) and you long a future when bought and spot remains unchaged, you paid less for the futures price and will have a positive roll yield. If Market is in contango, you but at future price which is above spot price, and spot prices stay the same, you will have paid more for future, and negative roll yield.
  19. Why is a commodity index stragy considered active investment?
    bc you constantly have to roll over futures, and restablish your derivatives. Managers can add value to long only commodity index strategy by choosing maturities of derivative contracts and by decisions about when to roll over their positions. Additionally you must weigh the amount of commoodities in a protfolio.