Austin Investment Planning Deck

Question 1

Value Line and Morningstar Rankings

Answer 1

Value Line:
* Ranks Stocks
* Scale (High - Low): 1 - 5

Morningstar:
* Mutual Funds; Stocks; ETFs; Bonds
* Scale (High - Low): 5 Star -1 Star

Question 2

Ex Dividend Date; Date of Record

Answer 2

1. Ex Dividend Date is 1 day before date of record
2. An investor must purchase the stock before the ex-dividend date or 2 business days prior to the date of record.
3. Remember: An investor must buy the stock prior to the ex-dividend date to receive the dividend.

Question 3

Commercial Paper

Answer 3

Short term loans between corporations.
Maturities of 270 days or less.
Not registered with the SEC.
Commercial paper has denominations of $100,000 and are sold at a discount.

Question 4

Bankers’ Acceptance

Answer 4

Facilitates imports/exports.
Maturities of 9 months or less.
Can be held until maturity or traded.

Question 5

Eurodollars

Answer 5

Deposits in foreign banks that are denominated in US dollars.

Question 6

Weighting on Indexes

Answer 6

Price Weighted Index:
1. Only takes stock price into consideration when calculating the average.
2. Dow Jones Industrial Average

Value (CAP) Weighted Index:
1. Takes market capitalization (shares outstanding x price) into account.
2. S&P 500; Russell 2000
3. Wilshire 5,000: Best index for large, mid, and small cap stocks

Question 7

Describe “time-weighted” and “dollar-weighted” returns.

Answer 7

Time-weighted:
1. Time-weighted returns DO NOT consider cash inflow or outflow.
2. Measure performance without inflow/ outflow
3. Mutual funds report on a time-weighted basis.

Dollar-weighted:
1. Dollar-weighted returns take an investor’s cash flow into consideration.
2. Investors report returns on a dollar-weighted basis.

Question 8

What do technicians consider in their analysis?

Answer 8

1. Charting
2. Market Volume
3. Short Interest
4. Odd Lot Trading
5. The Dow Theory
6. Breadth of the Market
7. Advance Decline Line

Question 9

What does Fundamental Analysis consider?

Answer 9

1. Financial statement analysis through ratio analysis.
2. Economic data such as GDP, inflation and interest rates.
3. Provides a method for determining a securities price based upon future cash flows.

Question 10

Agency Bonds

Answer 10

1. Agency bonds are not backed by the full faith and credit of the U.S. government They are a moral obligation of the U.S. government.
2. Exception to the rule - GNMA bonds are backed by the full faith and credit of the U.S. Government

Question 11

Three Types of Municipal Bonds

Answer 11

General Obligation Bonds
1. backed by the taxing authority that issued the bond.

Revenue Bonds
1. backed by the revenues to be generated by the project for which the bond was issued (e.g. – toll roads).

Private Activity Bonds
1. used to fund private activities such as stadiums.

Question 12

What companies insure municipal bonds?

Answer 12

American Municipal Bond Assurance Corp. (AMBAC)
Municipal Bond Insurance Association Corp. (MBIA)

Question 13

Bond Duration

Answer 13

1. It measures a bond’s price sensitivity to changes in interest rates.
2. The bigger the duration, the more price sensitive or volatile the bond is to interest rate changes.
3. Duration is the moment in time the investor is immunized from interest rate risk and reinvestment rate risk.
4. It’s the weighted average time until an investor receives all the coupon payments and principal.
5. A bond portfolio should have a duration equal to the investor’s time horizon to be effectively immunized.

Question 14

Duration Relationships

Answer 14

Direct Relationship with Duration:
1. Term
Inverse Relationship with Duration:
1. Coupon Rate
2. Yield

Question 15

Characteristics of Option Pricing Models

Answer 15

Black Scholes Model
1. Used to determine Value of a CALL Option
2. Current price of the underlying asset. Time until expiration. The risk-free rate of return. Volatility of the underlying asset
Put/ Call Parity:
1. Used to determine Value of a PUT Option
Binomial Pricing Model:
1. Explains prices based upon the underlying asset price moving in two directions.

Question 16

Security Market Line (SML)

Answer 16

The SML represents the tradeoff between systematic risk and return for a security.
The intersection of the SML on the y-axis represents a risk free rate of return.
The SML also graphically represents the CAPM.
Beta is the risk measure used.

Question 17

Yield Curve Theories (3)

Answer 17

Liquidity Preference Theory
1. Investors are willing to accept a lower yield on short term bonds because of their preference for liquidity.
2. Results in an upward sloping yield curve (up and to the right).
Market Segmentation Theory:
1. The yield curve depends on supply and demand for bonds and various maturities.
2. When supply is greater than demand, rates are higher to incentivize investors.
3. When demand is greater than supply, rates are lower since issuers don’t have to pay as much to attract investment.
Expectations Theory:
1. The yield curve reflects investors’ inflation expectations.
2. When inflation is expected to be higher in the future, long term rates will be higher than short term bonds.

Question 18

Heuristics/ Biases

Answer 18

1. Overconfidence:
Hindsight Bias:
* Hindsight bias is a form of overconfidence related to an investor’s belief that they had predicted an event that, in fact, they did not predict.
** Cognitive Dissonance:**
* Cognitive dissonance is also a form of overconfidence because an investor’s memory of past performance is better than the actual results.
Anchoring:
* Anchoring represents the investor’s inability to objectively review and analyze new information. The investor is “anchored” to the first information they reviewed.

Question 19

Types of Straddles and Why

Answer 19

1. Long Straddle: Buy a call and buy a put; this is when an investor Stock to go way up or way down, but unsure of which direction (expects volatility)
2. Short Straddle: Sell a call and sell a put; this is when an investor is anticipating a trading range (no volatility)

* Think Long = long way down or long way up

Question 20

Preferred Stock

Answer 20

1. Both Equity and Debt Features
2. Stated at par value and dividend is stated as percentage of par
3. Price of bond will fluctuate with common stock
4. Deduction for all dividends received

Question 21

Types of Real Estate Investment Trusts

Answer 21

1. Equity Reits: Invest in real estate for capital appreciation; Income is from rental income and appreciation
2. Mortgage Reits: Invest in mortgages and construction loans; makes spread between lending and borrowing
3. Hybrid Reits

Question 22

Real Estate Investment Trust (REIT): General

Answer 22

General Information about REITs
* REITS must pay out 90% of investment income to shareholders to maintain tax exempt status
* Attractive due to low correlation with stock market
* Behve similar to a closed ended mutual fund
* Add to portfolio when INFLATION is expected

Question 23

Options Strategies

Answer 23

Question 24

R-Squared (R^2)

Answer 24

Define:
1. statistical measure that represents the percentage of a fund or security’s movements that can be explained by movements in a benchmark index
2. Measure of how well diversified a portfolio is and how closely tied it is to the movements of index
3. If r^2 is GREATER THAN .7; Beta IS A GOOD MEASURE of risk
Equity Benchmark: SandP 500
Fixed Income Benchmark: T-Bill
Formula
R-Squared = Correlation^2

Question 25

Futures Contracts

Answer 25

General:
1. A futures contract is a legal agreement to buy or sell a particular commodity asset, or security at a predetermined price at a specified time in the future
2. Futures contracts are STANDARDIZED
3. unlike options; buyer is OBLIGATED (long the contract)

Hints:
1. If you are LONG the commodity; you OWN the orange
2. if you are SHORT the commodity; you WANT the product
3. if you are long the commodity, then you are short the contract

*REMEMBER: if you are long a stock; then you OWN the stock….if you are LONG the orange, you OWN the orange

Question 26

Warrants:

Answer 26

General:
1. Options that are written by large corporations
2. Warrants typically have longer durations
3. When a warrant is exercised, then shares are delivered
4. Always hold on to warrant to see if it is worth cashing in…wait to maturity
5. As underlying stock goes up; so does the value of the warrant

Question 27

Traditional IRA Contribution Rules

Answer 27

Categories for DEDUCTIBLE contributions:

Taxpayer and Spouse ARE NOT active participants:
1. No AGI Limit for contributions to IRAs (no income limit to contribute)

Taxpayer is active participant in retirement plan:
1. Single AGI Phaseout: 68k-78k
2. MFJ AGI Phaseout: 109k-129k

Taxpayer IS NOT active participant, but spouse IS active (Spousal IRA)
1. Roth IRA Phaseout Rules for taxpayer
2. Phaseout: 204k-214k
3. ONLY taxpayer can make deductible contribution

General:
1. Active Participant in a retirement plan is when someone is either Deferring into a retirement plan at work OR they are receiving some type of benefit (nonelective contribution or profit share bonus)
2. Someone CAN be eligible in a plan and NOT be an active participant

Question 28

Modern Portfolio Theory

Answer 28

General Principles:
1. The risk, return and covariance of assets are important input variables in creating portfolios.
2. Performance ABOVE the SML (Cap M) line is POSITIVE alpha; Below is NEGATIVE alpha
3. Optimum portfolio occurs at the point of tangency of Efficient frontier and indiference curve
4. Standard Deviation:
* 99% = 3 standard deviations
* 95% = 2 standard deviations
* 68% is 1 standard deviation
5. Ideal Portfolio has correlation of -1

Question 29

Prospectus Disclosures:

Answer 29

Disclosures found in Mutual Fund Prospectus:
1. Top holdings of the funds
2. Investment Objectives
3. Funding Manager or Management Team

NOT INCLUDED:
1. Trading Commissions