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CFP > Book 3 Pages 52-100 > Flashcards

Book 3 Pages 52-100 Flashcards

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1
Q

uncertainty of an investment’s realized (actual) rate of return will not equal its expected or forecasted rate of return

A

investment risk

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2
Q

total risk is measured by _______

A

standard deviation

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3
Q

true or false?

total risk includes both systematic risk and unsystematic risk

A

true

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4
Q

true or false?

total risk does not include diversifiable risk

A

false

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5
Q

as more securities are added to the portfolio the level of unsystematic risk ____

A

decreases

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6
Q

purchasing power risk is a ____ risk

A

systematic

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7
Q

reinvestment rate risk is a ____ risk

A

systematic

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8
Q

financial risk is a ____ risk

A

unsystematic

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9
Q

market risk is a ____ risk

A

systematic

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10
Q

business risk is a ____ risk

A

unsystematic

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11
Q

political risk is a ____ risk

A

unsystematic

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12
Q

tax risk is a ____ risk

A

unsystematic

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13
Q

interest rate risk is a ____ risk

A

systematic

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14
Q

exchange rate risk is a ___ risk

A

systematic

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15
Q

default risk is a ___ risk

A

unsystematic

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16
Q

investment manager risk is a ____ risk

A

unsystematic

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17
Q

liquidity risk is a ____ risk

A

unsystematic

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18
Q

risk that are inherited by investing in the market

A

systematic risks

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19
Q

the risk the inflation will erode the real value of an investor’s assets

A

purchasing power risk

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20
Q

the risk that proceeds available for reinvestment must be reinvested at a lower rate of return than that of the investment vehicle that generated the proceeds

A

reinvestment rate risk

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21
Q

investments with longer terms to maturity have ____ reinvestment rate risk

A

greater

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22
Q

are zero coupon bonds subject to reinvestment rate risk?

A

no

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23
Q

are non-dividend paying stocks subject to reinvestment rate risk?

A

no

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24
Q

the risk that changes in interest rates will affect the value of a security

A

interest rate risk

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25
Q

as interest rates rise the value of a bond will ___

A

decrease

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26
Q

true or false?

rising interest rates usually have a positive effect on stocks

A

false

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27
Q

the risk that a change in the relationship between the value of the dollar and the value of the foreign currency during the period of investment will negatively affect the investor’s return

A

exchange rate risk

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28
Q

calculate an investors gain in the following scenario:

John invests $1 million in ABC corp which is based in Mexico. The current exchange rate for pesos to dollars is 10 to 1. Jon sells his investment for 15 million pesos but the exchange rate has chanaged to 12 to 1.

A

John will get 15 million / 12 = $1,250,000 which is a $250,000 gain or 25% gain

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29
Q

what does PRIME stand for in regards to systematic risk?

A 
Purchasing power risk
Reinvestment rate risk
interest rate risk
market risk
exchange rate risk
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30
Q

risk that is unique to a single security, business, industry, or country

A

unsystematic risk

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31
Q

risk associated with the uncertainty of operating income

A

business risk

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32
Q

the risk that a firm’s financial structure will negatively affect the value of an equity investment

A

financial risk

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33
Q

true or false?
if two firms have the same net income but one uses more debt than the other, the debt firm will have a higher return on equity

A

true

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34
Q

the risk that a borrower will be unable to service its debt obligations

A

default risk

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35
Q

true or false?

default risk is also known as credit risk

A

true

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36
Q

true or false?

obligations of the US government are considered default risk free

A

true

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37
Q

the risk that the political or economic climate of a country will negatively affect an investment

A

political risk

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38
Q

the risk associated with the skills or philosophy of an individual manager of an investment fund or account

A

investment manager risk

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39
Q

the ability to find a ready market where the investor may sell the investment

A

marketability

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40
Q

the ability to sell an investment quickly and at a competitive price, with no loss of principal and little price concession

A

liquidity

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41
Q

real estate is ____ but usually not ____

A

marketable ; liquid

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42
Q

true or false?

treasury bills are not liquid but they are marketable

A

false, they are both liquid and marketable

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43
Q

money market accounts are liquid but not ___

A

marketable

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44
Q

true or false?

cash is the most liquid and marketable asset

A

true

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45
Q

the risk that taxation of investment gains or losses will negatively affect investment return

A

tax risk

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46
Q

the sum of observations divided by the number of observations

A

mean

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47
Q

midpoint of the values after they have been ordered from smallest to largest

A

median

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48
Q

the observation that appears with the greatest frequency

A

mode

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49
Q

if the bell curve is skewed to the right (longer right tail) then this is called ______ skewness

A

positive

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50
Q

which of the three averages (mean, median or mode) is greatest when there is positive skewness?

A

mean

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51
Q

which of the three averages (mean, median, or mode) is greatest when there is negative skewness?

A

mode

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52
Q

if the bell curve is skewed to the left (longer left tail) then this is called ____ skewness

A

negative

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53
Q

measures if a distribution is more or less peaked than a normal distribution

A

Kurtosis

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54
Q

when a distribution is more peaked than a normal distribution

A

leptokurtic

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55
Q

when a distribution is less peaked than a normal distribution

A

playkurtic

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56
Q

when more distributions are cluttered around the mean

A

leptokurtic

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57
Q

true or false?

investors who want to minimize volatility in their portfolios would prefer leptokurtic distributions

A

true

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58
Q

when greater than 50% chance that an observation selected at random will fall on the left side of the mean

A

lognormal probability distribution

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59
Q

lognormal distribution is skewed to the _____

A

right

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60
Q

used to evaluate the risk associated with a given investment and assesses the impact of different variables on an investment’s returns

A

sensitivity analysis

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61
Q

what two calculations do investors perform during sensitivity analysis?

A

NPV and IRR

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62
Q

diversification and unsystematic risk have a ____ relationship

A

inverse (as diversification increases, unsystematic risk decreases

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63
Q

term used to describe how adding an additional stock to a portfolio with only five stock will have a greater impact on the level of diversification than adding an additional stock to a portfolio of 30 stocks

A

law of diminishing returns

64
Q

measures the extent to which two variables move together

A

covariance

65
Q

how to calculate covariance

A

covariance = correlation x standard deviation of A x standard deviation of B

66
Q

calculate the correlation of the following assets:
covariance = 0.0096
standard deviation of A = 20%
standard deviation B = 12%

A

correlation = .40

67
Q

measures the extent to which the returns on any two securities are related

A

correlation (R or p)

68
Q

true or false?

correlation has a range of -1 to +1

A

true

69
Q

what does a correlation of -1 mean?

A

securities move in opposite directions

70
Q

what does a correlation +1 mean?

A

securities move in same direction

71
Q

what does a correlation of 0 mean?

A

securities are not related

72
Q

describes the percentage of variability of the dependent variable this is explained by changes in the independent variable

A

coefficient of determination (R squared)

73
Q

how do you calculate the coefficient of determination?

A

just square the correlation

74
Q

if the coefficient of determination = 1 then the portfolio has no _____ risk

A

unsytematic

75
Q

a relative measure of systematic risk

A

beta

76
Q

the beta of the market is equal to ___

A

1

77
Q

if a security has a beta of 1.25 then the security is 25% ____ volatile than the market

A

more

78
Q

securities with a beta greater than 1 are known as a(n) ____ asset where as securities with a beta less than 1 are known as a(n) _____ assets

A

aggressive ; defensive

79
Q

formula for beta

A

covariance between investment and the market / standard deviation of the market squared

or

correlation between investment and market x standard deviation of investment / standard deviation market

80
Q

John’s investment had a return of 7.5% where as the market had a 9% return. The standard deviation of the investment and the market are 12% and 10% respectively. With a correlation of .65 between the investment and the market what is the beta?

A

.78

81
Q

a measure of risk or dispersion of outcomes around the mean or expected return

A

standard deviation

82
Q

approximately ____% of outcomes fall within 1 standard deviation of the mean

A

68%

83
Q

approximately ____% of outcomes fall within 2 standard deviation of the mean

A

95%

84
Q

approximately ___% of outcomes fall within 3 standard deviation of the mean

A

99%

85
Q

measures the number of standard deviations a data value is from the mean

A

z score

86
Q

how to find z score?

A

(data point - mean) / standard deviation

87
Q

if the data value is higher than the mean then the z score will be ____

A

postive

88
Q

what does a z score of 1.46 indicate

A

it means the data is 1.46 standard deviations above the mean

89
Q

if the data value is smaller than the mean then the z score will be___

A

negative

90
Q

true or false?

standard deviation is a measure of total risk, systematic and unsystematic

A

true

91
Q

how to calculate variance

A

standard deviation squared

92
Q

calculate the standard deviation of the following portfolio:

mean return = 12%
security returns:
13.5%
12%
5%
-2%
7%
23%
6%
10%
45%
10%
.5%
14%
A

standard deviation = 12.29%

93
Q

true or false?
if the securities standard deviation is greater than the market standard deviation the the security is more risky than the market

A

true

94
Q

calculate the expected rate of return for the following security:

bull market = 30% probability with return of 50%
slow growth = 45% probability with return of 10%
bear market = 25% probability with return of -15%

A

= (.30 x .50) + (.45 x .10) + (.25 x -.15)

= 15.75%

95
Q

only considers the downside volatility of an investment

A

semivariance

96
Q

money earned by investing a sum of money for a specific period

A

simple interest

97
Q

how to calculate simple interest

A

principal x interest rate x time

98
Q

calculate simple interest on the following:

Johny borrows $1,000 for 2 years at 8%

A

1,000 x .08 x 2 = $160 (this is the interest only)

99
Q

calculate the compound interest on the following:

johny invests $1,000 for 2 years at 8%

A

$1,000 x 1.08 x 1.08 = $1,166.40

or use
pv = -$1,000
n = 2
i = 8

100
Q

how to calculate holding period return

A

(ending value - beginning value +/- cash flows) / beginning value

101
Q

calculate the holding period return on following:

Bob purchases 100 shares of stock at $40
two years late he sells 100 shares at $52
in addition he received a dividends of $5 over the two years

A

42.5%

102
Q

calculate the holding period return on the following:

Jim owns an investment with the following returns over the past 5 year period:
12%
-9%
3%
5%
-7%
A

(1+12%) x (1-9%) x (1+3%) x (1+5%) x (1-7%) - 1

= 2.51%

103
Q

the average compounded return or the IRR

A

geometric mean

104
Q

calculate the geometric mean of the following:

returns:

  1. 2%
  2. 1%
  3. 5%
  4. 3%
  5. 8%
A

square root of the following:

pv = -1
fv= 1.152 x 1.091 x 1.065 x 1.183 x 1.168
n = 5
pmt = 0

13.09%

105
Q

how to calculate the real rate of return

A

1 + nominal rate / 1 + inflation
minus 1
x 100

106
Q

calculate the real rate of return of the following:
nominal return = 10%
infaltion = 4%

A

5.77%

107
Q

if a lender advertises a 1.25% monthly rate what is the APR?

A

1.25% x 12 = 15%

108
Q

provides the annual rate of interest of an investment or debt when compounding occurs more than once per year

A

effective annual rate

109
Q

how to calculate effective annual rate

A

EAR = [1 + (i / n)] ^n - 1

110
Q

calculate the EAR on the following:

Johnny carries a balance on his credit card. The nominal APR is 9.99% compounded daily

A

[1+ (.0999 / 365)] ^365 - 1

10.5%

111
Q

the earnings rate at which the present value of a series of cash flows will equal its cost

A

IRR

112
Q

the geometric annual rate of return measured on the basis of the current year value of the asset

A

time weighted return

113
Q

measures the rate of return without considering an investor’s size or timing of funds

A

time weighted return

114
Q

the compounded annual rate of return (IRR) that discounts a portfolio’s future value and cash flows to a present value

A

dollar weighted return

115
Q

what is the preferred method for analyzing the performance of a portfolio manager?

A

time weighted return

116
Q

how do you calculate the tax-adjusted rate of return?

A

rate of return x (1 - tax rate)

117
Q

represents the return for a set of securities, such as a portfolio, where each return is weighted by the proportion of the security to the entire group or portfolio

A

weighted average return

118
Q

refers to changing the mix of investment classes based on changing market conditions

A

tactical asset allocation

119
Q

true or false?

when using a tactical asset allocation there is a greater chance to experience high transaction costs

A

true

120
Q

true or false?

tactical asset allocation is also known as market timing

A

true

121
Q

an investment strategy investing in both broad market indexes and higher-risk alternatives

A

core and satellite

122
Q

a portfolio that has the highest amount of return for a given level of risk

A

efficient portfolio

123
Q

who is said to have come up with Modern Portfolio Theory

A

Harry Markowitz

124
Q

what does the efficient frontier highlight?

A

the efficient frontier shows the portfolios that provide the highest rate of return for a given risk or the portfolios with the lowest risk for a given rate of return

125
Q

what is the indifference curve?

A

graph used to measure the risk reward trade offs an investor is willing to make

126
Q

the portfolio that lies at the ____ of the indifference curve and the efficient frontier is the optimum portfolio for the investor

A

tangent

127
Q

true or false?

Portfolios above the efficient frontier are attainable

A

false

128
Q

the x axis of the efficient frontier measures ___

A

risk

129
Q

the y axis of the efficient frontier measures ___

A

expected portfolio return

130
Q

who developed the CAPM?

A

William Sharpe

131
Q

how to calculate CAPM?

A

rf + beta (market return - rf) = expected rate of return

132
Q

what does CAPM calculate?

A

expected rate of return

133
Q

appears in the capital asset pricing model to depict the rates of return for efficient portfolios subject to the risk level (standard deviation) for a market portfolio and the risk-free rate of return.

A

capital market line

134
Q

represents some portion of the portfolio is invested in the market portfolio and the remainder is invested in risk free government securities

A

the lending portfolio

135
Q

the lending portfolio is located to the ___ of the market portfolio on the CML

A

left

136
Q

represents in investor putting 100% of investment assets in the market portfolio and has borrowed funds at the risk free rate to invest in the market portfolio

A

borrowing portfolio

137
Q

the borrowing portfolio is located to the _____ of the market portfolio on the CML

A

right

138
Q

how to calculate the CML

A

portfolio expected return = rf + standard deviation of the portfolio x [ return of market - rf / standard deviation of market]

139
Q

true or false?

the CML uses standard deviation as a risk measure

A

true

140
Q

true or false?

the SML uses beta as a measure of risk

A

true

141
Q

how to calculate SML

A

same way as CAPM

142
Q

true or false?

CAPM explains the returns on stock as a result of one factor

A

true

143
Q

attempts to explain the portfolio return in terms of multiple factors

A

arbitrage pricing theory

144
Q

this theory suggests that investors are unable to outperform the market on a consistent basis without accepting additional risk

A

efficient market hypothesis

145
Q

states that the current stock prices reflect all available information for a company and that the prices rapidly adjust to reflect any new information

A

efficient market hypothesis

146
Q

true or false?

the efficient market hypothesis and technical analysis directly contradict each other

A

true

147
Q

holds that the current stock prices have already incorporated all historical data, such as prices, trading volume, and published financial info

A

efficient market hypothesis weak form

148
Q

holds that the current stock prices not only reflect all past historical data but also data from analyzing current financial statements, industry and economic outlooks

A

efficient market hypothesis semi-strong form

149
Q

holds that stock prices reflect all public info and most private (insider) info

A

efficient market hypothesis strong form

150
Q

what type of info is reflected in weak form of EMH?

A

technical analysis

151
Q

what type of info is reflected in semi-strong form of EMH?

A

technical and fundamental analysis

152
Q

what type of info is reflected in strong form of EMH?

A

technical analysis, fundamental analysis, and insider info

153
Q

suggests that higher returns are attainable with portfolios consisting of securities with low P/E ratios

A

P/E effect

154
Q

states that stocks have a tendency to decline in value during the month of December and to move up in January

A

January effect

155
Q

states that with fewer analysts following a stock there could be stocks that are over/under valued

A

small firm effect

156
Q

give an example of using a collar in terms of options

A

writing a call option in order to generate premium to pay for a put option

157
Q

allows an un-diversified portfolio to be exchanged for interest in a diversified portfolio

A

exchange fund (not an ETF)

CFP (9 decks)

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