66-12 Flashcards
_________ stock pays higher than average dividends.
Income
What is the proper order of liquidation for a corporation at bankruptcy?
Unpaid workers, IRS, secured creditors, unsecured creditors, preferred, and then common.
What is the formula for calculating current yield?
Annual Interest ÷ Current Market Price
True or False: When interest rates go up, bonds prices go up, and when interest rates go down, bond prices go down.
False
Given a yield change, ____________ bonds move more in price.
long-term
Define real interest rate (real rate of return).
Interest rate minus the inflation rate (e.g., Bond yielding 8% when inflation is 3% has a real interest rate of 5%).
Which interest rates are generally more volatile?
short-term
Describe inflation or purchasing power risk.
The risk that today’s investment will not be worth as much when the money is received in the future.
What orders benefit the entire syndicate by percentage of liability?
group net orders
Stop and stop-limit orders are triggered when a round lot trades at, or through, the _____________.
stop price
If long stock, a sell stop order can be used to limit ___________ risk.
downside
If short stock, a buy stop order can be used to limit _________ risk.
upside
Stop orders become _________ orders once triggered/activated.
market
Stop-limit orders become ________ orders once triggered/activated.
limit
If a stop order is activated, at what price will the trade be executed?
the next traded price after activation
Do stop orders guarantee a specific price when buying or selling?
no
True or False: Stop-limit orders are guaranteed execution if the trigger is touched.
False
Which market is the decentralized, negotiated market?
OTC
How is a firm acting if it is trading for, or from, its own inventory?
as a principal/dealer
How is a firm acting if it effects trades on behalf of its customers, without taking the other side of the trade?
agent or broker
The _____________________ has the authority to regulate margin requirements.
Federal Reserve Board
____________ governs the extension of credit by BDs.
Regulation T
Does the payment date requirement of Regulation T apply to cash or margin accounts?
both. payment is required in 5 days
A _______-based index measures the market as a whole.
broad
A _______-based index measures the movement of a particular sector or industry.
narrow
___________________ is the balancing of investment classes according to an investor’s investment objectives.
asset allocation
______ is the measure of an asset’s volatility compared to the market as a whole.
Beta
What is the beta of the market (S&P 500)?
1
If an asset outperforms the market when prices are up/underperforms when prices are down, its beta is _____ than 1.00.
greater
This tests a company’s ability to pay its current liabilities with its current assets but does not include inventory.
Quick Asset Ratio ( The acid test)
(Current Assets - ____________) ÷ Current Liabilities = Quick Asset Ratio (or Acid Test)
inventory
Working Capital, Current Ratio, and the Quick Asset Ratio (Acid Test) are examples of ____________ ratios.
liquidity
To find a stock’s current yield, the formula is: ____________ ÷ ____________
Annual Dividend ÷ Current Market Price
What is the Capital Asset Pricing Model (CAPM)?
A model of the relationship between expected risk and expected return
True or False: According to CAPM, a security’s return equals a risk-free return (T-Bill return) plus a risk premium.
True
True or False: Inflation is a persistent rise in the general level of prices.
true
Would inflationary periods be characterized by rising or falling interest rates?
rising
The _______________________ is often considered the most important measure of inflation.
CPI - Consumer Price Index
The ________________ the duration, the greater the bond’s price sensitivity.
longer
Define duration.
The measure, expressed in years, of a bond’s price sensitivity to interest rate changes
May a cash account be opened without the customer’s signature?
yes
May a margin account be opened without the customer’s signature?
no
True or False: The initial transaction in a margin account requires a written margin agreement promptly after the trade.
True
A securities firm that executes trades for its own account or the accounts of others is deemed a _______________.
broker-dealer
__________ value is the dollar amount to be invested today to meet a specific dollar objective at a set future point.
present
__________ value determines how much a dollar amount invested today will be worth at a set point in the future.
future
What is used to determine how a given present value will become a needed future value.
The Internal Rate of Return (IRR)
$10,000 has become $80,000 in 36 years. What is the internal rate of return?
The money doubled every 12 years. The 10 grew to 20, the 20 to 40, and the 40 to 80. Using the Rule of 72, 72 ÷ 12 = 6%.
Assuming a 12% rate of return, how long will it take $50,000 to double?
6 years. Using the Rule of 72, 72 is divided by the rate of return to determine the number of years (72 ÷ 12 = 6 years).
Modern Portfolio Theory (MPT) focuses on differing __________ of assets rather than on _____________ securities.
classes of assets rather than individual securities
What are the three main concepts underlying the Modern Portfolio Theory?
Expected return, standard deviation, and correlation
Define expected return.
The possible return of an asset multiplied by the likelihood of occurrence
Standard deviation is a measure of the dispersion of ____________ returns.
expected
What is the likelihood of an investment’s return falling within 1, 2, and 3 standard deviation units?
67% within 1 standard deviation, 95% within 2 standard deviations, and 99% within 3 standard deviations
What is used as the basic measure of risk for an investment?
standard deviation
The greater the dispersion of historical returns of a security, the _________ its standard deviation
higher
______________ measures the degree to which the movements of two variables are related.
correlation
If two investments closely track one another, this is referred to as ___________ correlation.
positive
If two investments go in opposite directions from one another, this is referred to as ___________ correlation.
negative
If there is no relationship between the movement of two investments, they are considered to be _______________.
uncorrelated
True or False: Perfect negative correlation is -1.00, while a perfect positive correlation is 1.00.
True
True or False: Securities with a correlation coefficient of zero would be considered uncorrelated.
True
MPT has found that having asset classes with a slight ___________ correlation provides the best long-term performance.
negative
What is the efficient frontier?
The line representing portfolios (excluding risk-free alternatives) showing the lowest risk for a given level of return
Strategic asset allocation assumes that the markets are ____________.
efficient
True or False: Tactical asset allocation is changing a portfolio’s asset mix because of market and economic factors.
True
True or False: With a buy and hold strategy, investors are consistently rebalancing their portfolios.
False
Tactical asset allocation assumes that markets are ______________.
inefficient
What is another name for diversifiable risk?
non-systematic risk
What is another name for non diversifiable risk?
systematic
True or False: Diversification is one method by which an investor may avoid non-systematic risk.
True
What type of risk does beta measure?
systematic/non-diversifiable
If a security’s beta is more than 1, is it considered more or less volatile than the market as a whole?
more. The higher the Beta, the higher the volatility
What types of securities would generally have a high beta?
growth stocks
What types of securities would generally have a low beta?
defensive stocks
During a declining market, would you expect a high beta security to out perform or under perform the market as a whole?
under perform
During a rising market, would you expect a low beta security to out perform or under perform the market as a whole?
under perform
True or False: Alpha represents an investment’s actual return in excess of its expected return.
true
A stock with a positive alpha would generally be considered a _________ opportunity by an analyst.
buying
Another name for a security’s risk-adjusted return is its ________.
alpha
List some forms of business risk when investing in individual equity securities.
Poor management, obsolete products, changing market conditions
True or False: The longer an investor’s time horizon, the more concerned he is with market fluctuations.
False
Do long-term bonds have higher or lower interest-rate risk?
higher
What is the risk of having an excessive portion of a portfolio invested in one particular security or asset class?
concentration risk
____________ risk is the inability to sell an investment easily.
liquidity
What uses computer simulations to present random outcomes of an investment strategy?
Monte Carlo Simulation
What is considered an optimal portfolio?
One that has the highest expected return given the client’s tolerance for risk
What measures risk-adjusted return?
Alpha and the Sharpe Ratio
Which type of risk is non diversifiable?
market risk
Is market risk considered a form of diversifiable or non-diversifiable risk?
non-diversifiable
Is business risk considered a form of diversifiable or non-diversifiable risk?
diversifiable
Identify the risk of existing bond prices declining while interest rates are rising.
interest rate risk
To determine a bond’s real interest rate, the bond’s yield is subtracted by the rate of ___________.
inflation
True or False: A low beta security would be expected to rise more than a high beta security in a bull market.
False
An investor’s net return is the gross return minus ________ paid.
taxes
Define holding period return.
The total return received from holding an asset or portfolio of assets
A security has appreciated from $10 to $15 over 3 months and has paid no dividend. What is the annualized return?
200%, which is calculated by multiplying the holding period return (50%) times 4 quarters
What is the formula for determining a bond’s current yield?
Annual interest ÷ current market value of the bond
What is the formula for determining a stock’s current yield?
Annual dividend ÷ current market value of the stock
True or False: The longer a bond’s duration, the less sensitive the bond’s price will be to changes in interest rates.
False. The longer the duration, the greater a bond’s price sensitivity to changes in interest rates.
Would investing in stocks or bonds be a better hedge against inflation?
stocks
An investor buys stock that returns 2% for the year instead of a T-Bond yielding 6%. The ______________ cost is 4%.
opportunity
Identify the acronym: CPI
Consumer Price Index
When acting in a ____________ capacity, a firm is assuming risk.
principal
When acting in an ________ capacity, firms assist customers, but do not assume risk.
agency
Describe the inverse relationship between market interest rates and the prices of existing bonds
interest rates go up, bond prices go down.
interest rates drop, bond prices go up
What type of mean is used to calculate the expected return?
The weighted arithmetic mean
An investment earns 10%, 50%, and 30% in three years. How would the annualized average rate of return be calculated?
When calculating an annualized rate of return over time, the geometric mean is used.
Identify the acronym: CAPM
Capital Asset Pricing Model
Identify the acronym: MPT
Modern Portfolio Theory
What rule can be used to determine how long it takes for an amount of money to double at a given rate of return?
The rule of 72
What rule can be used to determine the annual rate of return needed for funds to double if given a number of years?
The rule of 72
Jim invested $25,000 in an annuity with a 6% return. How long will it take for the money to double?
12 years (72/6)
12 years ago, Tina invested $25,000 which has now grown to $100,000. What is the annual growth rate of her investment?
12 %.
Rule of 72 says divide 72 by the years needed for money to double. In 12 years, money has doubled twice (72 ÷ 6 = 12%).
_________ value projects what an investment will be worth at some point in the future.
future
__________ value is the amount of money that must be invested today to result in a certain sum at a future time.
present
A bond’s inflation-adjusted rate of return may also be referred to as the _______ interest rate.
real
True or False: Tactical asset allocation is considered a passive asset allocation approach.
False
True or False: Strategic asset allocation is considered an active asset allocation approach.
False
Do those who favor passive strategies believe markets are efficient or inefficient?
efficient
Do those who favor market timing (active strategies) believe markets are efficient or inefficient?
inefficient
What is an advantage to buy and hold portfolio management?
Transaction costs and tax consequences are minimized.
Identify the risk: Investors miss out on receiving a better return by placing their funds elsewhere.
opportunity risk
Identify the risk: A particular enterprise may not perform well due to poor management or increased competition.
business risk
Is indexing considered an active or passive portfolio management strategy?
passive
What method of investing is characterized by regularly investing a set amount of money, regardless of share prices?
dollar cost averaging
Describe a growth investor.
One seeking stocks of companies with an above-average growth rate, high P/E ratios, and low dividend payout ratios
Describe a value investor
One seeking stocks that are undervalued in relation to their earnings and have low P/E ratios
How is market capitalization (cap) determined?
A company’s current share price multiplied by the number of shares outstanding
What are Large-Cap stocks?
Stocks of mature companies with a long history of dividend payments
What are Mid-Cap stocks?
Stocks of companies that are more volatile and growth-oriented than the Large-Cap stocks
What are Small-Cap stocks?
Typically stocks of new companies with more volatility, but more growth potential as well
What are Micro-Cap stocks?
Stocks of emerging companies that would generally be suitable only for speculative investors
Over the last 3 months, Jim’s stock rose from $50 to $51 and he received a $.25 dividend. What is the annualized return?
The 3-month return is 2.5% ($1.25 ÷ $50). A quarterly return may be annualized by multiplying by 4 (2.5% x 4 = 10%).
Sue bought a 6% bond at par. One year later, her bond’s value has fallen to $970. What is her annual return?
Sue received the 6% rate of interest, but her bond lost 3% of its value. (-$30 + 60) ÷ $1,000 = 3%.
A bond is yielding 8%, when the rate of inflation is 3%. What is the real interest rate?
5%
Bond A yields 7.5% when inflation is 3%. Bond B yields 8% when inflation is 4%. Which has a higher real interest rate?
Bond A, 4.5%
What is a principal trade?
A trade involving a firm (BD or IA) buying or selling securities for its own account at its own risk
“A dollar received today is worth more than a dollar received tomorrow” describes what concept?
the time value of money
If a bond is trading at a discount to its value based on DCF, will an investor earn more or less than a comparable bond?
more
If a bond is trading at a premium to its value based on DCF, will an investor earn more or less than a comparable bond?
less
What are two assumptions of MPT?
Investors want to minimize risk and maximize returns
What is the name for the graph of optimal portfolios?
The efficient frontier
Which would have the least risk—large-, mid-, or small-cap companies?
large
Which would have the most risk—large-, mid-, or small-cap companies?
small
True or False: Systematic rebalancing involves buying and selling on a periodic basis.
true
True or False: Systematic rebalancing assumes markets are inefficient.
false
What is an efficient market?
A market in which prices reflect all known information; therefore, nothing will be overvalued or undervalued.
Name the three forms of market efficiency.
Strong-, Semi-Strong and Weak-Form
True or False: In a weak-form efficient market, technical analysis will be useful.
False, only fundamental analysis is
True or False: Strong-form market efficiency advocates believe they can beat the market.
False
Which form of market efficiency declares only insiders can regularly beat the market?
semi-strong
What type of trading strategy would be used if you believe markets are efficient?
Passive strategies, such as indexing or systematic rebalancing
True or False: The S&P 500 is a large-cap index
True
True or False: The S&P 400 is a large-cap index.
False, it is a mid-cap index
What type of trading strategy would be used if you believe markets are inefficient?
Active strategies, such as tactical asset allocation or sector rotation
Define sector rotation.
A strategy that anticipates the next turn in the business cycle and shifts assets into the sectors that will benefit.
Define capital structure.
A company’s issuance of debt and equity securities (both common and preferred stocks) to finance operations
What are two measures of liquidity?
Current ratio and the quick asset ratio (acid test) both measure a company’s liquidity.
What is the difference between the current ratio and the quick asset ratio?
The quick asset ratio is more stringent since it excludes inventory from the current assets.
A company with more debt than equity outstanding is considered ____________.
leveraged
True or False: A bottom up approach to investing uses the economy as a main factor in determining which stocks to buy.
False, bottom up investing uses company specific items, such as earnings and dividend payments to pick stocks.
_______ investors look for stocks of companies that are intrinsically undervalued.
value
What are some of the characteristics of a value stock?
Low P/E ratios, history of profitability, high dividend payout, and low market-to-book ratio
What is the formula for the P/E ratio?
Price ÷ EPS (Earnings Per Share)
_______ investors are concerned with a company’s future earnings potential.
growth
The __________ style of investing is one that bets against market trends.
contrarian
What is a dollar-weighted return?
A dollar-weighted return is a geometric mean (average) used to measure how a portfolio performed over time.
What is a time-weighted return?
A time-weighted return is a geometric mean (average) that eliminates the effect of varying cash inflows (dividends).
What is a major disadvantage when using an arithmetic mean to measure investment performance?
Arithmetic means (averages) can misrepresent compounding effects on an investment’s return.
True or False: Systematic risk may be avoided through diversification.
False
Market, interest rate, and inflation risk are all types of ___________ risk.
systematic
Business, regulatory, political, and liquidity risk are all types of ____________ risk.
unsystematic
What is the risk that certain circumstances or factors may have a negative impact on the profitability of a company?
business risk
What is the risk of foreign investors losing money due to changes with a country’s government or regulatory environment?
political risk
What is the risk that investors may be unable to dispose of a securities position quickly and at a fair price?
liquidity risk
True or False: Investors who are planning to hold bonds until maturity have no risk
False. Opportunity risk (the risk of missing out on a superior investment) would be a risk this type of investor faces.
Define reinvestment risk.
The risk that an investor will not be able to reinvest their principal at the same interest rate.
True or False: A country with high interest rates will generally have a stronger currency.
True
Define currency risk.
The risk that foreign investments will be worth less in the future due to changes in exchange rates.
What would happen to the U.S. trade deficit if the dollar is weakening?
A trade deficit would be shrinking as U.S. goods would be cheaper for foreign consumers
To what risk would structured debt products (e.g., CMOs) be subject?
Complexity risk is high in structured debt investments, such as CMOs.
What is the formula for the Sharpe Ratio?
(Return on Investment - Risk-Free Return) ÷ Standard Deviation
What is the Sharpe Ratio used to determine?
The Sharpe Ratio is used to determine if returns are from wise investments or the result of excess risk.
Buy limit orders are placed ________ the market.
below
Sell limit orders are placed ________ the market.
above
How is a company’s market capitalization calculated?
(Number of common shares outstanding) x (Market price of shares)
Name four asset classes.
Stocks, Bonds, Real Estate, Cash
Equities (stocks), fixed income (bonds), real estate, money markets (cash) are examples of _____________.
asset classes
True or False: The S&P 500 is an asset class.
False
What return will an investment have if its net present value is greater than zero?
positive return
What return will an investment have if its net present value is less than zero?
negative return
What return will an investment have if its net present value is equal to zero?
zero
What is required to make the dollar weighted return and the time weighted return equal?
Remove or subtract deposits into and withdrawals out of the portfolio
True or False: Dollar weighted return (DWR) takes into account the deposits into or withdrawals out of the portfolio.
true
What is the present value of an annuity that pays $2,000 per year and earns 5% per year?
$40,000 = $2,000/.05
A ____________ is an annuity that never stops paying money.
perpetuity
What is a Perpetuity?
an annuity that pays out forever
