Alternative Investments

Question 1

Active or passive: what kind of asset is undeveloped land?

Answer 1

Passive. Provides no or negative cash flow, but has potential for development and significant cash flow

Question 2

Taxes on undeveloped land?

Answer 2

Capital gains at sell. Interest payments tax deductible.

Question 3

What is the formula for commercial property Net Operating Income (NOI)?

Answer 3

Gross rental receipts + non rental or other income = Potential Gross Income (PGI)

PGI - vacancy and collection losses = Effective Gross Income (EGI)

EGI - operating expenses (excluding interest and depreciation) = NOI

Question 4

NOI cap rate formula…go!

Answer 4

V = NOI / cap rate

If V is larger than amount paid, property was undervalued (good thing)

Question 5

What are real estate limited partnerships (RELPs)?

Answer 5

A syndicate of two - one promoter who is the general partner and has 100% liability with limited partners who receive appreciation value and/or payments which can be tax sheltered by deductions in mortgage interest and depreciation.

Question 6

What are real estate investment trusts (REITs)?

Answer 6

A REIT pools capital together in a manner similar to an investment company.

A REIT is a closed-end investment.

It is not subject to federal income tax as long as it distributes 90% of its net annual earning to shareholders each year.

75% of its gross income must derive from real estate.

Types: equity (purpose of renting space); mortgage (financing real estate); hybrid (contains elements of both)

Question 7

REITs vs RELPs characteristics

Answer 7

RELPs - not liquid or marketable, investor must sell entire interest, single manager

REITs - Good inflation hedge, very liquid and marketable, can sell as many or as little shares, owned/managed by a company

Question 8

What is a real estate mortgage investment conduit (REMIC)?

Answer 8

A self-liquiditating, flow through entity, that invests exclusively in real estate mortgages or mortgage-backed securities and terminates when the underlying REMIC mortgages have been repaid.

Usually issued in bonds, REMICs typically provide set monthly payments ranging from $1000-$25000, depending on the issuer.

Question 9

What are collateralized mortgage obligation (CMO)?

Answer 9

A type of REMIC. CMOs are bonds and similar to mortgage-backed securities, except CMOs divide repayment periods into tranches. The first tranche (A) gets repaid first and has the least interest rate risk. The farther back the tranche, the most interest rate risk.

Question 10

What are derivatives?

Answer 10

Investment vehicles whose value is based on that of another security such as a list stock. Good for income during extremely flat or volatile markets.

The most common derivatives are futures and options. For each of these, an investor may take a:

• long position: buying or owning the underlying security
• short position: selling or wanting to buy the underlying security

Question 11

What are options?

Answer 11

A two-party contract that allows the holder the right, but not obligation, to:

-buy (call): gives the buyer the right to purchase underlying security
OR
-sell (put): gives the buyer the right to sell the underlying security

…shares of an underlying security at a specified price on or before the expiration date.

Each option contract represents 100 shares.

Question 12

How long are options contracts?

Answer 12

Usually no more than 9 months unless a long-term equity anticipation securities (LEAPS) which can extend beyond two years.

Question 13

What are the four positions an options WRITER generally will take given a bearish or bullish view?

Answer 13

Bullish: purchase a call or write a put
Bearish: write a call or purchase a put

Question 14

What does it mean when an option is “at the money”?

Answer 14

The strike (exercise) price equals the market price of the underlying stock. Neither a call or put has any intrinsic value

Question 15

What is an option intrinsic value?

Answer 15

The minimum price at which the option will trade on the market
Calls C.O.M-E = positive number
Puts P.O.E-M= positive number

M= market
E= exercise price

Question 16

What is the time value of an option?

Answer 16

It is the dollar amount above the market value of the underlying stock when you add the market value of the option and the intrinsic value together.

Ex: ABC stock trading at $80 and ABC $76 call is trading at $5. The intrinsic value is $4 and time value is $1

Question 17

What are the four exercise options:

Answer 17

Purchasing (or being long) a call
Writing (or going short) a call
Purchasing (or being long) a put
Writing (or being short) a put

Question 18

What is the binominal Pricing Model?

Answer 18

A model that attempts to estimate the price of a call option. This model assumes that the price of the option will go up or down in desecrate increments.

Binominal tree: $100 can move up to $110 or down to $90. From there, those two prices can go up or down and so forth.

Question 19

What is the Black-Scholes Option Valuation Model?

Answer 19

Unlike the binominal model, the Black-Scholes model assumes that the price of the options will change constantly because the market price of the underlying security changes constantly.

Question 20

What happens if there is an increase in an option’s exercise price?

Answer 20

The value of the option decreases because now the underlying stock must increase further before the option has intrinsic value

Question 21

What is Put-Call Parity?

Answer 21

This is the premise that the premium of a call implies a certain fair price that should be matched by the put and vice versa. Otherwise it creates an arbitrage opportunity - the ability to earn a diskless return without any investment of personal funds.

P-C-P= difference between market price of stock and PV of the exercise price

Question 22

What options will investors purchase if they believe the market is going to go up?

Answer 22

Calls (Call up, put down)

Question 23

What options will investors purchase if they believe the market is going down?

Answer 23

Puts (call up, put down)

Question 24

What are naked options?

Answer 24

Either writing a call or put options for stocks you don’t own. Meaning, if they get called, you must then purchase those stocks at the strike price (put) or market price (call)

Question 25

What is an options straddle?

Answer 25

A strategy which combines a call and put option with the same exercise price and expiration date.

A long straddle is written if an investor believes there will be a lot of volatility in the market by which that extreme movement would pay for both premiums.

A short straddle is written if the investor believes the market will not change or change little, with the writer keeping both premiums in that case.

Question 26

What is a zero-cost collar?

Answer 26

This is a purchase of a put option to protect against value decline and a simultaneous writing of a call option to generate the income that covers the premium cost of the put - zero dollars.

Question 27

What are futures?

Answer 27

A contract between two parties to take possession of a commodity or financial asset at a specified time, price, and place.

Question 28

What is a short hedge?

Answer 28

When you own something you want to protect or hedge, you must short. It locks in the rate.

Question 29

What is a long hedge?

Answer 29

When you are short something and you want to hedge, you must buy (long). It locks in the price.

Question 30

How are futures taxed?

Answer 30

As capital gains at the end of each year at 60% long term and 40% short term, regardless.

Question 31

What are tangible assets?

Answer 31

These take the form of either collectibles or sometimes precious metals.

Question 32

How are tangible assets good tax shelters?

Answer 32

Most don’t distribute income as they appreciate - no income tax
If held to death, they step up to market value at transfer, avoiding capital gains

Question 33

What are country risks associated with foreign securities?

Answer 33

Political such as revolutions or coups, structural risks such as confiscatory policies towards profits, capital gains, and dividends

Question 34

What are emerging foreign markets?

Answer 34

Countries which are less developed and carry more risk, although can have rapid growth rates which make them tempting.

Question 35

What are developed foreign markets?

Answer 35

Those associated with countries with highly developed economics structures

Question 36

What is an American Depository Receipt (ADR)?

Answer 36

A trust receipt issued by a US bank for shares of a foreign company purchased and held by a foreign branch of the bank.

Foreign investment in US dollars

Question 37

What does buying a call get you?

Answer 37

The right, but not the obligation to buy a stock at a specific price by a specific date - bullish: hope the stock goes higher than the strike price

Question 38

What does selling a call get you?

Answer 38

The obligation (if exercised) to sell a stock at a specified price by a specific date - bearish: hope the stock stays below the strike price

Question 39

What does buying a put get you?

Answer 39

The right, but not obligation to sell a stock at a specific price by a specific date - Bearish: hope the stock price goes to $0

Question 40

What does selling a put get you?

Answer 40

The obligation, if exercised, to buy a stock at a specified price by a specified date - bullish: hope for the stock price to at least remain above the strike price

Question 41

What is the risk to purchasing a call or put?

Answer 41

That you will lose your premium

Question 42

What is a covered call?

Answer 42

Writing a call for a stock that you own. The risk is that it gets exercised and now you lose the upside potential

Question 43

What is open interest?

Answer 43

The number of futures contracts outstanding for a commodity on any given trading day.

Question 44

The daily limit of a commodity futures contract is the maximum

A) price increase or decrease relative to the settlement price the previous day.

B) amount by which the maintenance margin can change per day.

C) number of contracts allowed to be traded that day.

D) percentage by which the futures price can increase from the previous day.

Answer 44

A) price increase or decrease relative to the settlement price the previous day.