Portfolio Theory
No matter the number of assets in a portfolio they all have to add up to?
100%
What is the difference between holding a stock and a stock option
Holding a stock represents the equity of a company while holding the option gives you the right but not the obligation to buy or sell the stock.
What is a Bond? What are its most prominent features/traits?
A Bond is a debt security in which the principal is paid to an entity in exchange for a fixed number of payments. This is known as the coupon rate, which can be held valid until its maturity date. A Bond is a debt security where the principal is paid to an entity,
What are the three valuation methodlogies
Company comparables is a relative valuation, where you compare companies through metrics like size, business models, and geographic locations. Transaction comps are similar to company comparables but you compare from the value of a transaction instead. Discounted cash flow is an intrinsic valuation that values a business and their cash flow.
Walk me through the three financial statements
Income statement, Cash flow statement, and balance sheet. Income statement represents the profitability, revenue, and expenses over a period of time. Cash flow statement shows the cash in flow and out flow of a business. Balance sheet shows a snapshot of a company’s financials, resources, fundings at a specific point in time
Risk-to-Reward Ratio/Risk Adjusted Returns. The formula is the return of an asset minus the risk free rate all over the standard deviation of the asset.
Given that a stock at its current price is worth $100, and that after one time interval the price rises to $130. If you purchased a call option with a strike price of $90 what is your profit.
$40
What is Yield to Maturity?
Yield to Maturity is the "true rate of return" investors seek from purchasing a bond, as the formula incorporates the market price differential alongside the annual coupon payments, assuming it is held until maturity.
Do you use Levered or Unlevered cash flow for a typical DCF (Finding Enterprise Value. Explain
Unlevered Cash Flow because its the true cash flow that is provided for all investors, shareholders and debtholders included. This correlates to finding the intrinsic value of Enterprise value, which is the value of the business itself. Levered Free cash flow would be used in a DCF analysis aiming to find equity value, as levered means the cash flow available for only shareholders
What do Equity Value and Enterprise Value MEAN?
Equity value represents the value of everything a business owns caters towards its shareholders, while Enterprise value is the value of the day to day business operations for all investors, both debt and equity
Given a two-asset portfolio with asset A and B. if asset A returns 8% with a standard deviation of 4.3 and asset B returns 9% with a standard deviation of 6.2. Which asset is the superior investment?
Asset B has a higher sharpe ratio
Define the option's theta
Time decay of the option's price
What term defines the rate of change of a Bond's Price in relation to the rate of change of a Bond's Yield?
Duration (Modified)
Walk me through a DCF
DCF is an intrinsic value, based on the present value of a company’s future cash flow and terminal value. Project the company’s free cash flow over the next 8-10 years until it is stable, discount the projected cash flow to the present value using the WACC, then find the terminal value through either the multiple method or gordon growth method. Discount the terminal value and finally sum up the present value of the free cash flows and terminal value.
If there is an increase in net working capital represents a sourcing of cash or a spending of cash?
Increase in net working capital indicates an increase in assets based on the formula current assets - current liabilities. Since assets are increasing, an increase in NWC represents a spending of cash.
Given an efficient frontier, point A is located on the line of the frontier but not the tangency. Describe the state of point A.
Point is a suboptimal portfolio which isn't perfectly efficient.
Given an option contract at its current price of $100, and that after 30 days the price has a 50% of falling 40%. What is the option’s approximate theta?
0.66666666666667 or (2/3)
The elevated yield reflects the higher risk premium (demand for a higher reward for greater uncertainty) that investors seek for locking their cash for a longer period of time.
If I have a strawberry farm, what and how are the ways you value it?
If I were valuing a strawberry farm, I would first determine whether it generates stable cash flow. If it does, I could use a discounted cash flow analysis based on expected amounts of strawberries produced, then discounting it back to the present value. I could also look at similar strawberry farms through metrics like size, type of strawberry produced, or the environment it’s produced in. You could also value it by comparing it to other agricultural transactions.
When valuing the future cash flows of an asset we need to discount them to present time in order to reflect the current value. True or False? Explain
True - TVM, a dollar today is worth more than a dollar tomorrow, therefore to account for unpredictable circumstances, challenges, and the potential returns on your asset investment, you must discount the future value back to the present value
Given two portfolios chosen by your financial manager, portfolio A and portfolio B, if both have the same level of return (r), yet portfolio A has a correlation coefficient of -0.67 and portfolio B has a correlation coefficient of 0.54. Which portfolio is the superior investment?
Portfolio A is a superior investment as it has a lower correlation coefficient.
Given that the option's value on time t was $40 and the underlying stock price was at $100 at time t. Given that the delta of the option remained constant at 0.5, and that after one time interval (t+1) the stock price rose to $130. What is the new option value after one time interval?
$55
Today is January 2nd, 2027, and Bond A is currently being sold at a market premium of 1037.4. Assuming the maturity date on this bond is January 1st 2032, the YTM is currently at 4.5%, and coupons are paid semi-annually, what is the coupon rate? What can you suspect of interest rates today than what they were when the bond was originally issued?
Coupon Rate of Approx. 4.17%.
Knowing the bond is at a premium at 103, we can assume rates today are lower than what rates were at the date of bond issuance
The company's market cap and share price only represents the current value according to “the market as a whole”, the market might be wrong. Therefore you value the company to see if the market is wrong or not.
Yes, equity value can be negative in theory. This occurs when a company’s liabilities exceed the value of its assets, meaning shareholders would receive nothing—or owe money—if the company were liquidated. In practice, public equity value rarely trades negative because stock prices can’t go below zero.
When discounting the terminal value of a high-growth tech company? Using the perpetuity growth method, what types of discount factor do you use?
Discount rate is a universal transaction driver, the discount factor is based off the year # when calculating the present value of the FCF. To calculate the terminal value onwards after the projection period, you must use the final year FCF discount factor.