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Dr. Rhoades Finance 331 Applied Investments SPRING 2018 (Structure…

- - - - What are the "factors"?
        
        By market capitalization ("size" factor)
        
        Small cap
        
        Micro cap
        
        Mid cap
        
        Large cap
        
        What is the "small-cap (risk) premium" or "small cap factor"?
        
        How robust is the small-cap factor? In other words, going forward, in any normal long-term (20-year) period, what is the most likely expected additional return from investing in small company stocks, as opposed to large company stocks?
        
        How persistent is the factor? What is the probability of the factor occurring over: 1-year, 5-year, 10-year, and 20-year periods?
        
        What are the two basic rationales for why the size factor exists?
        
        By relative price ("price factor")
        
        High-priced ("growth") stocks
        
        Low-priced ("value") stocks
        
        "Core" or "balanced" when used to describe where asset class sits
        
        What is the "value (risk) premium" or "value factor"?
        
        What is the basic rationale behind the existence of the value effect, or "value factor"? (Distinguish between the "risk-based" answer, and the "behavioral finance" answer.)
        
        How robust is the factor? How much additional returns will "value stocks" possess, relative to "growth stocks" or relative to all stocks?
        
        How persistent is this factor? In other words, what are the probabilities of seeing additional (added) returns from the use of this factor in any 1-year, 5-year, 10-year, or 15-year period of time?
        
        Profitability
        (High vs. Low)
        
        Describe the profitability factor in your own words
        
        How are stocks grouped as to "high-profitability" and "low-profitability"?
        
        What is the explanation for why this factor exists? Is this a "risk-based" factor?
        
        How robust is this factor? In other words, over the future 20-years, how much added return might be generated by the use of this factor, relative to the returns of all stocks in the market?
        
        How persistent is this factor? In other words, over any 1-year, 5-year, 10-year, or 15-year periods of time, what is the probability of seeing additional returns from the use of this factor?
        
        Why might the use of the profitability factor in a portfolio that is "value-tilted" be helpful?
        
        Investment
        Factor
        
        What is the investment factor?
        
        Why does the investment factor exist?
        
        How robust is this factor? In other words, over the future 20-years, how much added return might be generated by the use of this factor, relative to the returns of all stocks in the market?
        
        How persistent is this factor? In other words, over any 1-year, 5-year, 10-year, or 15-year periods of time, what is the probability of seeing additional returns from the use of this factor?
        
        Momentum
        
        Defined:
        
        Why is the momentum effect hard to capture?
        
        How might the momentum factor be captured by a mutual fund manager without incurring excessive trading costs?
        
        Quality (as factor)
        
        Over 600 "factors" exist, but most are not "investable": THE "FACTOR ZOO"
      - By Geography:
        U.S. vs. International
        
        Foreign Developed Markets
        
        Foreign Emerging Markets
        
        Foreign Frontier Markets
        
        US Stocks
        
        What percentage of sales (revenue) do U.S. corporations receive from overseas operations/sales?
        
        Large companies:
        
        Small companies:
        
        Stocks of companies with their headquarters in the U.S.
    - - Government
        bonds
        
        U.S. government bonds
        
        U.S. Treasury bonds
        
        U.S. Treasury bills
        
        Inflation-protected securities
        
        TIPS
        
        What are TIPS?
        
        Why might investors prefer them?
        
        In what types of accounts should TIPS, or TIPS bond funds, normally be held? Why?
        
        I-bonds
        
        U.S. Treasury notes
        
        30-day U.S. Treasury notes are often regarded as "risk-free." What is the long-term rate of return of U.S. Treasury notes, net of taxes on interest income received, and after subtracting inflation? (I.e., what is the after-tax "real return" for U.S. Treasury notes?)
        
        When a bond is backed by the "full faith and credit" of the United States, what does this mean?
        
        U.S. government agency bonds
        
        Where do you buy U.S. government notes/bonds/TIPS?
        
        www.TreasuryDirect.gov is the place to go to buy U.S. debt obligations without using a broker. You can establish an account. You then "participate" in auctions.
        
        You can purchase U.S. Treasury securities in the Treasury auction market (primary market, at time of issue), or in the secondary market, through brokerage firms.
        
        (U.S.) State/local (municipal) bonds
        
        Investment-grade vs. high-yield
        
        Rated vs. non-rated
        
        Tax-free vs. non-tax-free (for federal income tax purposes, and for state income tax purposes depending upon state of residence of the owner of the bond)
        
        Foreign government bonds
        
        What is "currency risk"?
        
        What is "foreign government risk"?
      - Corporate bonds
        
        By maturity (or duration)
        
        If interest rates rise, what happens to bond prices?
        
        What is duration? How is it affected by the cash flows generated by a bond?
        
        Ranked by credit ratings
        
        Investment-grade
        
        What are investment-grade bonds? What are the ratings for investment grade-bonds assigned by Standard and Poors? :
        
        High-yield (junk) bonds
        
        What are high-yield bonds? What are the ratings for high-yield bonds assigned by Standard and Poors?
        
        U.S. vs. foreign (developed vs. emerging markets)
        
        What is a "credit"?
        
        U.S. vs. foreign corporate bonds
        
        If foreign bond is not denominated in U.S. dollars, "currency risk" exists. What is "currency risk"?
      - Collateralized debt obligations (CDO's)
        
        MBS (mortgage-backed securities)
        
        Other asset-backed securities (car loans, student loans, credit card account receivables, etc.)
      - Certificates of deposit; share certificates
        
        Federal Deposit Insurance Company (FDIC) for banks and savings and loan institutions; National Credit Union Share Insurance Fund (NCUSIF) for credit unions; What are "FDIC-insured investments"? Are they safe? What is the "Full Faith and Credit" of the U.S. government?
        
        Non-insured CDs (or portions of CDs): Should they ever be utilized? What type of fixed income security are they essentially the same as?
      - What is a "yield spread"?
      - Preferred stock as a fixed income investment (unless convertible into stock)
      - BASIC
        BOND
        CONCEPTS
        
        Coupon date
        
        Current yield
        
        Bond coupon
        
        Yield-to-maturity
        
        Maturity date
        
        Credit risk a/k/a default risk
        
        Explain this: Expected return of a corporate bond = T-bill yield plus risk premia (both default risk premium, and risk premium arising from longer maturity (higher duration)).
        
        What is "credit risk" or "default risk"?
        
        Yield curves
        
        Normal
        
        Flat
        
        For a yield curve to be called "Flat" - does it have to be perfectly flat?
        
        Inverted
        
        What often happens when the yield curve becomes inverted?
        
        What is a yield curve?
        
        Why might an investor desire to invest in lower-yielding short-term bonds (or bond funds), rather than higher-yielding longer-duration bonds (or bond funds), if interest rates are expected to rise?
        
        Are interest rates in the U.S. expected to rise over the next year?
    - - REITs
        
        Defined:
        
        General Types
        
        Mortgage
        
        Hybrid
        
        Equity
        
        Why might many investors not desire to add REITs to their investment portfolios?
        
        REIT distributions are taxed as "ordinary income." However, see the discussion of the impact of the new tax law, below.
        
        Most investors already have exposure to real estate, via their homes.
        
        Publicly traded vs. non-publicly traded
        
        What are "publicly traded" REITs? Are there a great many of them?
        
        What is a "non-publicly traded REIT"?
        
        What are some of the reasons you should normally avoid investing in non-publicly traded REITs?
        
        How is the correlation of publicly traded REITs with other asset classes?
        
        The correlation of REITs to the stock market can change. REITs were once considered highly uncorrelated to stocks. However, in 2008, once the economy entered recession, the correlation gap narrowed. In that year, the Vanguard REIT Index Exchange Fund, which is representative of trading in the REIT sector, lost 38 percent, which was just as much as the largest companies that trade in the stock market, according to a 2012 "Wall Street Journal" article. In fact, in the 10-year period leading up to 2012, the correlation between REITs and the stock market doubled, the article indicated.
        
        What are the Internal Revenue Code requirements for an investment company to qualify as a REIT?
        
        The new (Dec. 2017) U.S. tax law legislation could be a boon for real estate investment trusts and REITs-related exchange traded funds as they will foot a smaller tax bill on dividends under the new plan.
        The new tax plan comes with a deduction for pass-through businesses or income derived from commercial activities that their owners or shareholders pay on persona income taxes, reports Esther Fung for the Wall Street Journal.
        This deduction for pass-through businesses also covers the income that flows to REIT investors through dividends as rent or mortgage payments are translated into shareholder dividend payouts.
        The new plan allows investors to deduct 20% of income with the remainder of the income taxed at the investor’s marginal rate, and it is available even if one does not itemize the deductions. Consequently, REITs investors who use to pay the top income-tax rate of 39.6% on dividends received will now see that rate dip to 29.6%, according to NAREIT, the National Association of Real Estate Investment Trusts.
        
        What is the expected long-term rate of return of REITs, relative to stock index funds, and relative to bond index funds?
        
        REITs have a long history of producing good returns. From 1975 through 2006, U.S. REITs had an annualized return of 16.7% — hence their popularity in 2007. From 1975 through 2014, the figure was almost as favorable: 14.1%. That’s more than the 12.2% return of the Standard & Poor’s 500 Index SPX, +0.94% but less than the 15.1% return of U.S. large-cap value stocks.
        At times, however, the short-term performance of REITs can be awful. The Dow Jones Wilshire REIT Index WILREIT, +0.12% lost half its value in just two years, falling 17.6% in 2007 and another 39.2% in 2008.
      - Limited partnerships; LLCs (private)
        
        What professionals often invest, privately with other professionals, in Limited Partnerships and Limited Liability Companies (taxed as partnerships)?
        
        What is required to invest in a private LP or LLC? Can anyone do it? Or only "accredited investors"?
      - Direct ownership
        
        Personal use residences
        
        Primary home
        
        Second (and third, etc.) homes
        
        Timeshares
        
        Should your primary home be included in your investment portfolio's "asset allocation"?
        
        Other residential real estate (rental)
        
        Commercial real estate
        
        Undeveloped land
        
        Commercial offices
        
        Shopping Centers
        
        Apartments
        
        Other
      - Some emerging risks for real estate investors
        
        The rise of Amazon (and online shopping, generally) poses a risk for owners of shopping malls and other retail store locations.
        
        Climate change (sea level rise, affecting the valuation of properties located along the coast). This change in valuation may occur sooner rather than later if banks and other mortgage lenders decide not to issue 30-year loans (mortgages) on real estate in certain coastal areas, due to sea level rises. A related risk is higher insurance premiums on coastal properties. Another related risk is higher real estate taxes for communities located along the coast, as they try to improve their infrastructure to handle sea level rises.
    - - Hard assets (gold coins, etc.)
        
        What cost might be associated with investments in precious metals, gems, etc.?
      - Futures contracts
        
        How does one make a profit when investing in a futures contract?
        
        What is the long-term rate of return for commodities indexes?
        
        What commodities make up most of the commodities index at present?
    - - Bank/S&L/credit union checking accounts
        
        Interest-bearing
        
        Non-interest bearing
      - S&L savings accounts
      - Bank-sponsored FDIC-insured money market accounts
      - Mutual fund-sponsored money market funds
    - - What is "2 and 20"?
      - Can anyone invest in a hedge fund?
      - Do hedge funds provide superior returns? What does the recent academic research demonstrate?
      - Are hedge funds as "safe" as mutual funds? In other words, do hedge fund managers ever steal their investors' funds?
    - - We don't go into detail as to "private equity" investments in this class. But more about it can be found in this Blackstone explanation.
      - Private equity is, by definition, highly illiquid. Sophisticated (wealthy) investors who devote a portion of their investment portfolio to private equity investors should demand a higher return for this illiquidity. But does private equity outperform publicly traded U.S. stocks? This 2014 study examined this, concluding: "This paper investigates the performance and capital inflows of private equity partnerships. Average fund returns (net of fees) approximately equal the S&P 500 although there is substantial heterogeneity across funds." Different studies show different results, however.
  - - - Standard & Poors' 500 Index
      - Dow Jones Industrial Average (DJIA)
      - Morningstar Total Market Index
      - MSCI U.S. Broad Market Index
      - Russell 3000 Index
      - Wilshire 5000 Index
      - CRSP 1-10 Index
      - Russell 2000 Index
      - S&P 1500 Index
      - Russell 1000 Index
      - S&P Smallcap 600 Index
    - - EAFE (Europe Australia Far East) (developed markets)
      - EAFE EM (EAFE emerging markets index)
- - - - Defined
      - Benefits of correlation
      - Measuring correlation
        
        Positive correlation
        
        Non-correlated assets
        
        Negative correlation
      - Changes to correlation of assets or asset classes over time
      - Is it easy to find asset classes with negative correlation to each other that are "investable"?
  - - - What is the Markowitz "efficient portfolio"?
      - What is the "Northwest Quadrant" and why is this were you "want to be"?
    - - Defined
      - Software to undertake MVO
      - Limits of MVO
- - - - Defined:
      - Usefulness:
- - - - While the Rule of 72 is not always accurate, in this case - assuming a steady 2.5% inflation rate - it is very close.
      - There are many inflation calculators on the web that can be used for free. This one calculates the equivalent value of the U.S. dollar in any year from 1914 to 2018. Calculations are based on the average annual CPI data in the U.S. from 1914 to 2017.