3. Investment Planning Flashcards
US Dollar-denominated time deposits in banks outside the US.
Eurodollar CDs or Eurodollar Deposits?
Eurodollar Deposits
Large short-term investment denominated in US Dollars and issued by banks outside the US. These are negotiable and have FDIC insurance.
Eurodollar CDs or Eurodollar Deposits?
Eurodollar CDs
Which index is price-weighted? Which is value/cap-weighted?
S&P 500 / Dow Jones
Price-Weighted: Dow Jones
Value/Cap Weighted: S&P 500
May be distributed to stockholders in lieu of a stock or cash dividend or sold directly as a new security issue. It is a call option (contract for the option to buy shares at a fixed price) issued by a company with its stock as the underlying security.
Warrant or Right?
Warrant
It is like a call option issued by the firm whose stock serves as the underlying security. Are issued to give existing stockholders their preemptive right to subscribe to a new issue of common stock before the general public is given an opportunity.
Warrant or Right?
Right
Debt instruments where the investor is lending money to a corporation in return for a fixed amount of income (interest).
Promissory Notes
Financial assets issued by U.S. banks. They represent indirect ownership of a certain number of shares of a specific foreign firm that are held on deposit in a bank in the firm’s home country.
American Depositary Receipts (ADRs)
What risks are Systematic vs. Unsystematic?
Business Risk
Interest Rate Risk
Tax Risk
Investment Manager Risk
Reinvestment Risk
Financial Risk
Liquidity Risk
Inflation Risk
Political & Regulatory Risk
Sovereign Risk
Market Risk
Call (Prepayment) Risk
Exchange Rate Risk
Systematic:
Interest Rate Risk
Reinvestment Risk
Inflation Risk
Market Risk
Exchange Rate Risk
Unsystematic:
Business Risk
Tax Risk
Investment Manager Risk
Financial Risk
Liquidity Risk
Political & Regulatory Risk
Sovereign Risk
Call (Prepayment) Risk
Measures how well the data points fit on the regression line
Correlation Coefficient
What does this mean in correlation coefficient:
-1…
0…
1…
-1…the asset and market move in opposite directions at the same level at the same time
0…the asset and market have no correlation to each other
1…the asset and market will move in the same direction at the same level at the same time
Measures the portion of the asset’s performance attributed to the returns of the overall market.
R-Squared
What does this mean in R-Squared:
0…
1…
0…asset’s return has nothing to do with the market’s return
1…asset’s return is perfectly correlated with the return of the market
What is this? You must memorize this formula!
((Price at end – Price at beginning) / Price at beginning)) + (Dividends, Interest & Coupons / Price at beginning)
Holding Period Return
What is this?
((1 + rate of return) / (1 + rate of inflation)) – 1
Real (Inflation Adjusted) Return
Measures annual cash flow relative to the bond’s current market price
Current Yield
Positive NPV means the PV of all expected cash flow is _______ than the cost of making the investment
______ = positive
Positive NPV means the PV of all expected cash flow is _______ than the cost of making the investment
______ = negative
Bond Pricing Theorems (One to Five):
Theorem ____: If a bond’s yield does not change over its life, then the size of its discount or premium will decrease at an increasing rate as its life gets shorter.
Theorem ____: The percentage change in a bond’s price as a result of a change in its yield, will be smaller if the coupon rate of the bond is high.
Theorem ____: If a bond’s market price increases, then its yield must decrease. Conversely, if a bond’s market price decreases, then its yield must increase.
Theorem ____: A decrease in a bond’s yield will raise the bond’s price by an amount that is greater in size than the corresponding fall in the bond’s price that would occur if there were an equal-sized increase in the bond’s yield. (That is, the price-yield relationship is convex.)
Theorem ____: If a bond’s yield does not change over its life, then the size of its discount or premium will decrease as its life gets shorter.
Theorem Two
Theorem Five
Theorem One
Theorem Four
Theorem Three
A more accurate measure of the risk of a bond. ________ helps to determine how quickly your money is returned. It is expressed in number of years. All things being equal, the higher the coupon, the shorter the ________, and vice versa. Also, the lower the ________, the less responsive the market price of a fixed-income security to interest rate changes.
Duration
If the intrinsic value – purchase price = a ________ number (or if NPV ___ 0), then the bond is underpriced or undervalued, and the bond should be purchased.
o If the intrinsic value – purchase price = a negative number (or if NPV ___ 0), then the bond is overpriced or overvalued, and the bond should not be purchased.
Positive (>)
Negative (<)
Liquidity Ratios (Cash Ratio, Current Ratio, Working Capital & Quick/Acid Ratio?):
Current Assets - Current Liabilities
Current Assets / Current Liabilities
(Current Assets - Inventory) / Current Liabilities
(Cash + Marketable Securities) / Current Liabilities
Current Assets - Current Liabilities = Working Capital
Current Assets / Current Liabilities = Current Ratio
(Current Assets - Inventory) / Current Liabilities = Quick/Acid Ratio
(Cash + Marketable Securities) / Current Liabilities = Cash Ratio
Activity Ratios (Working Capital, Inventory Turnover, Days to Sell Inventory, Accounts Receivable Turnover, Receivable Collection Period, Working Capital Turnover, Total Asset Turnover, Fixed Asset Turnover & Equity Turnover?)
Current Assets – Current Liabilities
Cost of Goods Sold / Average Inventory
365 / Inventory Turnover
Sales / Average Accounts Receivable
365 / Accounts Receivable Turnover
Sales / Average Working Capital
Sales / Average Total Assets
Sales / Average Fixed Assets
Sales / Average Equity
Current Assets – Current Liabilities = Working Capital
Cost of Goods Sold / Average Inventory = Inventory Turnover
365 / Inventory Turnover = Days to Sell Inventory
Sales / Average Accounts Receivable = Accounts Receivable Turnover
365 / Accounts Receivable Turnover = Receivable Collection Period
Sales / Average Working Capital = Working Capital Turnover
Sales / Average Total Assets = Total Asset Turnover
Sales / Average Fixed Assets = Fixed Asset Turnover
Sales / Average Equity = Equity Turnover
Profitability Ratios (Gross Profit, Operating Profits (EBIT), Earnings Before Taxes (EBT), Earnings After Taxes (EBT), Total Assets/Capital, Gross Profit Margin, Operating Profit Margin, Net After Tax Profit Margin, Net Before Tax Profit Margin, Return on Assets (ROA), Return on Total Capital (ROTC), Return on Equity (ROE)?)
Net Sales – Cost of Goods Sold
Gross Profit – Expenses
Operating Profits (EBIT) - Interest
EBT – Taxes
LT & ST Debt + Total Equity
Gross Profit / Sales
EBIT / Sales
EAT / Sales
EBT / Sales
EAT / Total Assets
(EAT + I) / Total Capital (Where I = Interest Expense)
EAT / Equity
Net Sales – Cost of Goods Sold = Gross Profit
Gross Profit – Expenses = Operating Profits (EBIT)
Operating Profits (EBIT) - Interest = Earnings Before Taxes (EBT)
EBT – Taxes = Earnings After Taxes (EBT)
LT & ST Debt + Total Equity = Total Assets/Capital
Gross Profit / Sales = Gross Profit Margin
EBIT / Sales = Operating Profit Margin
EAT / Sales = Net After Tax Profit Margin
EBT / Sales = Net Before Tax Profit Margin
EAT / Total Assets = Return on Assets (ROA)
(EAT + I) / Total Capital (Where I = Interest Expense) = Return on Total Capital (ROTC)
EAT / Equity = Return on Equity (ROE)
Debt/Solvency Ratios (Total Debt to Equity, Debt to Equity, Assets to Equity, Times Interest Earned?)
Total Liabilities / Equity
Total LT Debt / Equity
Total Assets / Equity
EBIT / Interest Expense
Total Liabilities / Equity = Total Debt to Equity
Total LT Debt / Equity = Debt to Equity
Total Assets / Equity = Assets to Equity
EBIT / Interest Expense = Times Interest Earned
EAT / Sales
Sales / Total Assets
Total Assets / Equity
Net Profit Margin x Total Asset Turnover x Leverage Multiplier
EAT / Sales = Net Profit Margin
Sales / Total Assets = Debt to Equity
Total Assets / Equity = Leverage Multiplier
Net Profit Margin x Total Asset Turnover x Leverage Multiplier = Return on Equity (DuPont Method)
Price/Free Cash Flow: The lower the ratio, the better.
Price/Sales: Want to be below 2.
Price/Earnings Growth = P/E Ratio / Earnings Growth Rate
Book Value = (Assets – Liabilities) / # of Shares Outstanding
Sustainable Growth Rate (g) = ROE x (1- Dividends/Earnings)
Price/FCF is free from accounting assumptions and P/E is not
None
Plan diversification is most effective when the correlation us more, equal or less than 0?
Less than 0
Sharpe Ratio or Treynor Ratio?
Used to combine return and risk to compare portfolio returns
Measures the reward-to-volatility trade-off by dividing the average portfolio excess return over the systematic risk of the market.
Sharpe Ratio: Used to combine return and risk to compare portfolio returns.
Treynor Ratio: Measures the reward-to-volatility trade-off by dividing the average portfolio excess return over the systematic risk of the market.
Bottom-Up Forecasting Approach or Top-Down Forecasting Approach?
The financial analysts are first involved in making forecasts for the economy, then for industries and finally for companies.
The financial analysts begin with estimates of the prospects for companies and then build to estimates of the prospects for industries and ultimately the economy.
Top-Down Forecasting Approach: The financial analysts are first involved in making forecasts for the economy, then for industries and finally for companies.
Bottom-Up Forecasting Approach: The financial analysts begin with estimates of the prospects for companies and then build to estimates of the prospects for industries and ultimately the economy.
Weak Form Efficient, Semi-Strong Form Efficient, or Strong Form Efficient?
It is impossible to make abnormal profits (other than by chance), by using publicly available information to formulate buying and selling decisions. In semi-strong form, both technical analysis and fundamental analysis are rendered worthless.
It is impossible to make abnormal profits (other than by chance), by using any information (public or private) to make buying and selling decisions. In strong form, all types of analysis are rendered worthless, including insider information.
It is impossible to make abnormal profits (other than by chance), by using past prices to formulate buying and selling decisions. In weak form, technical analysis is rendered worthless.
Semi-Strong Form Efficient: It is impossible to make abnormal profits (other than by chance), by using publicly available information to formulate buying and selling decisions. In semi-strong form, both technical analysis and fundamental analysis are rendered worthless.
Weak Form Efficient: It is impossible to make abnormal profits (other than by chance), by using past prices to formulate buying and selling decisions. In weak form, technical analysis is rendered worthless.
Strong Form Efficient: It is impossible to make abnormal profits (other than by chance), by using any information (public or private) to make buying and selling decisions. In strong form, all types of analysis are rendered worthless, including insider information.
Arbitrage Pricing Theory: Alternative to CAPM for asset pricing. One primary assumption is that each investor, when given the opportunity to increase the return of his or her portfolio without increasing its risk, will proceed to do so. The mechanism for doing so involves the use of arbitrage portfolios. An arbitrage portfolio is defined by three conditions:
Self-Financing: Does not require additional funds from investor.
Riskless: There is no sensitivity to any factor; there is zero variance and covariance with other portfolios; and there is negligible nonfactor risk.
Positive Return: The riskless arbitrage will result in a positive return.
*If the exam mentions factors and sensitivity to factors, it is referring to APT.
None
This theory says investors build portfolios as “pyramids of assets.” Each layer in the pyramid (e.g., emergency funds, investment portfolio, qualified retirement funds, etc.) carries different attitudes toward risk. This is completely different than the Markowitz model (CAPM), which is based on consistent attitudes toward risk.
Behavioral Portfolio Theory
When opening a margin account with a brokerage firm, a client must sign a _________ agreement.
Hypothecation Agreement
Straddle, Strangle, Long Strangle, Short Strangle, Bull Spread, Bear Spread, Butterfly Spread, Long Butterfly Spread, Short Butterfly Spread, Zero-Cost Collar, Short Sale, Covered Call, Spread, Vertical Spread, Horizontal Spread, Diagonal Spread, Credit Spreads, Debit Spreads
Writing a call option against securities you already own
Covered Calls
Straddle, Strangle, Long Strangle, Short Strangle, Bull Spread, Bear Spread, Butterfly Spread, Long Butterfly Spread, Short Butterfly Spread, Zero-Cost Collar, Short Sale, Covered Call, Spread, Vertical Spread, Horizontal Spread, Diagonal Spread, Credit Spreads, Debit Spreads
Purchasing an equal number of puts and calls on the same underlying asset. These puts and calls must all have the same exercise price and same maturity.
Betting on volatility in the underlying asset
Straddle
Straddle, Strangle, Long Strangle, Short Strangle, Bull Spread, Bear Spread, Butterfly Spread, Long Butterfly Spread, Short Butterfly Spread, Zero-Cost Collar, Short Sale, Covered Call, Spread, Vertical Spread, Horizontal Spread, Diagonal Spread, Credit Spreads, Debit Spreads
Purchase one option and sell another option that is similar but different. Must be two puts or two calls.
Spread
Straddle, Strangle, Long Strangle, Short Strangle, Bull Spread, Bear Spread, Butterfly Spread, Long Butterfly Spread, Short Butterfly Spread, Zero-Cost Collar, Short Sale, Covered Call, Spread, Vertical Spread, Horizontal Spread, Diagonal Spread, Credit Spreads, Debit Spreads
Spread that has same expiration date but different exercise prices.
Vertical Spread
Straddle, Strangle, Long Strangle, Short Strangle, Bull Spread, Bear Spread, Butterfly Spread, Long Butterfly Spread, Short Butterfly Spread, Zero-Cost Collar, Short Sale, Covered Call, Spread, Vertical Spread, Horizontal Spread, Diagonal Spread, Credit Spreads, Debit Spreads
Spread that has same exercise price but different expiration dates.
Horizontal Spread
Straddle, Strangle, Long Strangle, Short Strangle, Bull Spread, Bear Spread, Butterfly Spread, Long Butterfly Spread, Short Butterfly Spread, Zero-Cost Collar, Short Sale, Covered Call, Spread, Vertical Spread, Horizontal Spread, Diagonal Spread, Credit Spreads, Debit Spreads
Spread that is a mixture of vertical spread and horizontal spread. Include options with both different expiration dates and exercise prices.
Diagonal Spread
Straddle, Strangle, Long Strangle, Short Strangle, Bull Spread, Bear Spread, Butterfly Spread, Long Butterfly Spread, Short Butterfly Spread, Zero-Cost Collar, Short Sale, Covered Call, Spread, Vertical Spread, Horizontal Spread, Diagonal Spread, Credit Spreads, Debit Spreads
Spread that generates premium income that exceeds their related costs.
Credit Spreads
Straddle, Strangle, Long Strangle, Short Strangle, Bull Spread, Bear Spread, Butterfly Spread, Long Butterfly Spread, Short Butterfly Spread, Zero-Cost Collar, Short Sale, Covered Call, Spread, Vertical Spread, Horizontal Spread, Diagonal Spread, Credit Spreads, Debit Spreads
Spread that initially cost the investor a net cash outflow.
Debit Spreads
Straddle, Strangle, Long Strangle, Short Strangle, Bull Spread, Bear Spread, Butterfly Spread, Long Butterfly Spread, Short Butterfly Spread, Zero-Cost Collar, Short Sale, Covered Call, Spread, Vertical Spread, Horizontal Spread, Diagonal Spread, Credit Spreads, Debit Spreads
Uses a call and a put, typically with the same expiration date, but different exercise prices.
Strangle
Straddle, Strangle, Long Strangle, Short Strangle, Bull Spread, Bear Spread, Butterfly Spread, Long Butterfly Spread, Short Butterfly Spread, Zero-Cost Collar, Short Sale, Covered Call, Spread, Vertical Spread, Horizontal Spread, Diagonal Spread, Credit Spreads, Debit Spreads
Uses a call and a put, typically with the same expiration date, but different exercise prices. Purchases all options used so no premium income.
Long Strangle
Straddle, Strangle, Long Strangle, Short Strangle, Bull Spread, Bear Spread, Butterfly Spread, Long Butterfly Spread, Short Butterfly Spread, Zero-Cost Collar, Short Sale, Covered Call, Spread, Vertical Spread, Horizontal Spread, Diagonal Spread, Credit Spreads, Debit Spreads
Uses a call and a put, typically with the same expiration date, but different exercise prices. Writes all options used so receives premium income.
Short Strangle
Straddle, Strangle, Long Strangle, Short Strangle, Bull Spread, Bear Spread, Butterfly Spread, Long Butterfly Spread, Short Butterfly Spread, Zero-Cost Collar, Short Sale, Covered Call, Spread, Vertical Spread, Horizontal Spread, Diagonal Spread, Credit Spreads, Debit Spreads
Two calls that have the same expiration date. The call written (sold) brings in less premium than the purchased calls premium.
Believes stock will rise, but won’t rise a lot.
Bull Spread
Straddle, Strangle, Long Strangle, Short Strangle, Bull Spread, Bear Spread, Butterfly Spread, Long Butterfly Spread, Short Butterfly Spread, Zero-Cost Collar, Short Sale, Covered Call, Spread, Vertical Spread, Horizontal Spread, Diagonal Spread, Credit Spreads, Debit Spreads
Two calls that have the same expiration date. The call written (sold) brings in less premium than the purchased calls premium.
Bear Spread
Straddle, Strangle, Long Strangle, Short Strangle, Bull Spread, Bear Spread, Butterfly Spread, Long Butterfly Spread, Short Butterfly Spread, Zero-Cost Collar, Short Sale, Covered Call, Spread, Vertical Spread, Horizontal Spread, Diagonal Spread, Credit Spreads, Debit Spreads
Combination of Bear Spread and Bull Spread.
Butterfly Spread
Straddle, Strangle, Long Strangle, Short Strangle, Bull Spread, Bear Spread, Butterfly Spread, Long Butterfly Spread, Short Butterfly Spread, Zero-Cost Collar, Short Sale, Covered Call, Spread, Vertical Spread, Horizontal Spread, Diagonal Spread, Credit Spreads, Debit Spreads
Maximum gain when price does NOT fluctuate
Long Butterfly
Straddle, Strangle, Long Strangle, Short Strangle, Bull Spread, Bear Spread, Butterfly Spread, Long Butterfly Spread, Short Butterfly Spread, Zero-Cost Collar, Short Sale, Covered Call, Spread, Vertical Spread, Horizontal Spread, Diagonal Spread, Credit Spreads, Debit Spreads
Maximum gain when price DOES fluctuate
Short Butterfly Spread
Straddle, Strangle, Long Strangle, Short Strangle, Bull Spread, Bear Spread, Butterfly Spread, Long Butterfly Spread, Short Butterfly Spread, Zero-Cost Collar, Short Sale, Covered Call, Spread, Vertical Spread, Horizontal Spread, Diagonal Spread, Credit Spreads, Debit Spreads
Buys a put and sells a call to cover risk of owning a lot of one stock and is cheaper than portfolio insurance.
Zero-Cost Collar
Straddle, Strangle, Long Strangle, Short Strangle, Bull Spread, Bear Spread, Butterfly Spread, Long Butterfly Spread, Short Butterfly Spread, Zero-Cost Collar, Short Sale, Covered Call, Spread, Vertical Spread, Horizontal Spread, Diagonal Spread, Credit Spreads, Debit Spreads
A position where the # of contracts sold > # of contracts bought
Short Sale
Current Model: Gives the future value of an investment having:
Only after-tax dollars invested
The earnings on the investment are taxed annually.
What type of accounts do these qualify?
Brokerage Accounts, Taxable Bonds, money Market Funds, etc.
Deferred Model: Gives the future value of an investment having:
Only after-tax dollars invested
The earnings on the investment are NOT taxed annually, and not taxed at all.
Earnings are also tax-deferred
What type of accounts do these qualify?
IRA
Exempt Model: Gives the future value of an investment having:
Only after-tax dollars invested
Earnings are exempt from taxation
What type of accounts do these qualify?
Roth IRA
Pension Model: Gives the future value of a Qualified Retirement Plan having:
Only before-tax dollars invested
The earnings on the investment are NOT taxed annually, thus growing tax deferred.
Earnings are also tax-deferred
Provides two levels of tax-deferral
None
The stock’s market value that is deferred from taxation until the stock is sold. In a tax-advantaged account, it is not taxed as capital gains, but rather as ordinary income upon distribution.
Net Unrealized Appreciation (NUA)
Qualified Dividends are taxed at…
Non-Qualifying Dividends are taxed at….
Qualified Dividends are taxed at Capital Gains rates
Non-Qualifying Dividends are taxed at Ordinary Income rates
Revaluation of a currency refers to the __________ in the currency’s value.
Increase
Bond yield steepens, then the ________ structure benefits the most.
Bullet Structure
