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CFP Exam - BIF Exam Prep > BU - Investments > Flashcards

BU - Investments Flashcards

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1
Q

2 Parts of the financial markets

A

Money Markets - short term debt instruments

Capital markets - Long-term debt & equity

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2
Q

Examples of financial markets

A

stock market
bond market
commodities market
foreign exchange market

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3
Q

2 parts of Capital Market

A

Primary market

  • new securities are issued and sold to the public
  • IPOs
  • Issuing firm receives the proceeds
  • Regulated by the securities act of 1933

Secondary market

  • previously issued new securities sold among investors
  • issuing firm is no longer directly involved
  • regulated by the securities act of 1934
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4
Q

Efficient Market Theory (EMT)

A

states that the stock market is efficient and therefore all stocks reflect all relevant information and are priced in equilibrium

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5
Q

Examples of secondary markets

A

Organized exchange: new york stock exchange
Over the counter market: NASDAQ

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6
Q

What kind of investors accept the efficient market theory?

A

Passive investors and would like buy index funds

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7
Q

What are the 3 forms of EMT

A

Strong
Semi-strong
Weak

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8
Q

What is random walk?

A

Random walk theory suggests that changes in stock prices have the same distribution and are independent of each other. Therefore, it assumes the past movement or trend of a stock price or market cannot be used to predict its future movement.

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9
Q

What are the 3 attributes to describe and differentiate the 3 forms?

A

Inside information - Semi strong and weak

Fundamental analysis - Weak

technical analysis - none

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10
Q

What anomalies to the EMT cannot be explained away by EMT believers?

A

Low P/E Effect - Low P/E likely generate more returns and outperform
Small Firm Effect - small firms tend to outperform larger companies
Neglected Firm Effect - prior neglected stocks generate more return over time, while prior best performers underperform
January Effect - small companies stock generate more return in the first 2-3 weeks in January
Value Line Phenomenon - Most popular - stocks with below average balance sheets outperform growth stocks due to investor belief in companies’ potential
Weekend Effect - stock prices fall on Monday, closing less than the previous Friday

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11
Q

IDK: If presented with a HPR question involving margin, where do you adjust?

A

Adjust all the entries to reflect the correct cash flow and subtract the margin interest in the numerator

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12
Q

Time-weighted return

A

Global standard for fund performance
Geometric rate of return = [(1+return 1) x (1+return2) x (1+return3)…]^n - 1

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13
Q

Dollar Weighted Return

A

Appropriate for a client with their own particular cash flows
This return is affected by the timing of cash flows

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14
Q

What is the appropriate discount rate applied to NPV calculations?

A

investor’s required rate of return

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15
Q

Net Present Value

A

discount rate is the investors required rate of return
Calculated using uneven cash flow keys
If the result is + or = go for it, will likely get better than expected returns
If the result is - do not go for it, will likely get less than expected returns

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16
Q

Internal Rate of Return

A

Calculated using the TVM keys
Weakness is that is assumes the reinvestment rate is the IRR
Yield to Maturity and Yield to Call are examples of IRR

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17
Q

Which is the superior model: NPV or IRR

A

NPV

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18
Q

Investment Risks

A

Total Risk = Systematic Risk + Unsystematic Risk

  • Total risk is measured by standard deviation
  • Systematic risk is quantified by beta
  • Unsystematic risk is referred to as Firm-specific
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19
Q

Systematic Risks (cement)

A

Systematic risk cannot be eliminated through diversification

Purchasing Power Risk (inflation)
Reinvestment Risk
Interest Rate Risk
Market Risk
Exchange Rate Risk

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20
Q

Unsystematic Risks (unload, risks you can unload)

A

Unsystematic risk can be eliminated through diversification

Business Risk
Financial Risk
Default or Credit Risk
Regulation Risk
Sovereignty Risk

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21
Q

Relationship of Risk & Return

A

Risk is measured by standard deviation
The greater the standard deviation (risk), the greater the variance of expected return
Low standard deviations provider lower returns

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22
Q

Low risk investments

A

Cash or money market securities
Treasury securities
Investment grade bonds

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23
Q

Higher risk investments

A

Common or preferred stock
Junk bonds (high yield bonds)
Options, futures and forwards
Small cap and growth oriented funds

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24
Q

Factors that influence an investor’s capacity for risk

A

Time horizon
liquidity needs
total investable assets

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25
Q

Currency Exchange

A

Devalue is when $1: 1 euro moves to $1.50: 1 euro. I have to use more $ to purchase euro

Revalue is when $1: 1 euro moves to $1: 1.50 euro. I can get more for $1

Replace the exchange value with a product - ex: $1: 1 apple or $1: 2 apples

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26
Q

Hedging

A

To Buy: to buy the power, do you want to control the outcome
To Sell: to sell the power, do you careless

Long: to buy the product
Short: to sell the product

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27
Q

Intrinsic Value Keys

A 
N = X x2
FV = X
PMT= X /2 
I= X /2
PV= ?

If the yield increases, then the price must decrease, and the other way around

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28
Q

YTM Keys

A 
N = X x2
FV = X
PMT= X /2 
PV= (X)
I= ? x2
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29
Q

YTC Keys

A 
N = # of years until called x2
FV = callable price
PMT= X /2 
PV= (current price)
I= ? x2
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30
Q

3 Forms of Yield Curve

A

Upward sloping: positive, normal, where the rates of short-term paper are lower than the rates on longer term paper
Flat: rates of short-term and long term are similar
Downward sloping: negative, inverted, where the rates of short-term are higher than the rates on longer term paper

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31
Q

An inversion in the yield curve indicative of a …

A

Looming recession in the next 6-12 months, has been 100% correct

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32
Q

Business Cycle Phases and points

A

Phases: expansion and contraction

Points: trough and Peak

Expansion: increasing GDP & decreasing unemployment
Contraction: decreasing GDP & increasing unemployment

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33
Q

Recession is ____

A

2 consecutive quarters with negative GDP

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34
Q

Fiscal Policy

A

Controlled by Congress
Tools are taxation and government spending

Increasing government spending are used to promote economic growth and/or recovery
Government will sell Treasury Securities to slow down economic growth

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35
Q

Monetary policy

A

Controlled by the Federal Reserve Bank
Mandates: sustainable long-term growth (GDP 2.5-3.5%), price levels (core inflation 2-2.5%) and full employment (unemployment 4% or less)
Tools: Discount rate, Reserve Requirement and open market activities

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36
Q

If the Fed issues a “tight” policy, what happens

A

Discount Rate will be increased, increasing the cost of borrowing
Reserve requirements will be increased, decreasing the amounts that can be lent
The Fed will sell treasuries, to pull money from the market

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37
Q

If the Fed issues an “easy” policy, what happens

A

Decrease the discount rate - lowers the cost of borrowing
Decrease the reserve requirements - increasing the amounts to be lent
Buy securities from the market - this puts money back into circulation

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38
Q

Monetary tools in order of easy to implement

A

Buy/sell securities
Adjusting the discount rate
Adjusting the reserve requirement

39
Q

Duration

A

Calculates the time to recoup your money on a bond investment (effective maturity)

Weighted average of the PV of the future cash flows of a bond or bond portfolio
The higher the coupon the lower the duration

Matching duration of fixed income to an investor’s time horizon immunizes those assets
Used to estimate changes in bond prices based on hypothetical changes in prevailing rates
Overestimates risks from rising interest rates and underestimates benefits from lowering interest rates

40
Q

Durations Movement

A

The longer the duration and the lower the coupon - more sensitive to changes in rate
The short the duration and the higher the coupon - less sensitive to changes in rate

Duration is a linear estimate that tends to overestimate the impacts
Convexity is more complex and more accurate

41
Q

Distribution Curve

A

68%
95%
99%

42
Q

Skewness & Kurtosis

A

Positively skewed has outliers in the upper or the right tail (stock market)
Negatively skewed has outliers in the lower or the left tail

Kurtosis is how high or low the peak is
mesokurtic = normal distribution
Leptokurtic = slender distribution (Lipo = skinny :)
Platykurtic = broad distribution (play = broadway)

43
Q

Wash Sale

A

Trigged when a taxpayer realizes a loss on the sale of a security and acquires a “substantially identical” security within 61 days
Ramifications: loss on a sold security will be disallowed, the disallowed loss will be added to the basis of the new securities purchased.

44
Q

Substantially Identical

A

Bonds - difficult to violate unless you buy the exact same bond or bond fund
Stocks - Convertible bonds and call options

Convertible bonds can convert to the stock which was sold for a loss
Purchasing a call option that can be exercised into the same stock that was sold

45
Q

Stock Option Contracts: Intrinsic Valu

A 
COME = Call Option MP - EP 
POEM = Put Option EP - MP

PIT = Premium - Intrinsic Value = Time Premium

Intrinsic Value can never be zero

When the intrinsic value is + then the contract is “in the money”, when they are equal it is “at the money”, otherwise it is “out of the money”

46
Q

Stock Options Definitions

A

Buyer is the long or holder

Seller is the short or writer

Buyer of a call contract = has the right to purchase shares
Buyer of a put contract = has the right to sell shares

Seller of a call contract = has the obligation to sell shares
Seller of a put contract = has the obligation to buy shares

Covered Call = long the stock & short the call (hold the stock & selling the stock), used to generate income
Naked Call = unlimited risk, you don’t own the stock & selling it (short the call)

Protective Put - portfolio insurance
Collar: protects put protects against price decrease, the call premium use to offset the cost of the put
Straddle: used to capitalize on volatility regardless of direction
Spread: Benefit from stability

47
Q

Futures: Definitions

A

Spot Price: the current market value of the item in today’s market
Contracts are standardized
Long Position: anyone who owns something
Short Position: anyone who has to buy something

If you are long - you need a short hedge so you sell future contracts
If you are short- you need a long hedge so you buy future contracts

48
Q

Determinant of an Options Contract’s total price

A

Intrinsic Value (market price of stock and exercise price of option contract)

Time Premium (risk free rate of return, time to expiration and standard deviation of stock)

49
Q

Rebalancing Approaches

A

Constant Ratio: adjusts the portfolio back to its target weights

Variable Ratio: stacks the proportions in favor of assets that have performed poorly in recent periods, This plan not only departs from your original plan, but is also a form of market timing.

50
Q

Commissioners at the SEC have the authority to do

A
  • Interpret federal securities laws
  • Amend existing rules
  • Propose new rules to address changing market conditions, and/or
  • Enforce rules and laws.

Federal securities legislation is created by Congress.

51
Q

To be considered an investment adviser under the “Advisers Act,” a three-prong test must be met:

A
  • The individual or firm advises as to the value of securities, or as to the advisability of investing in or selling securities, through publications or writings and, in fact, they hold themselves out to the general public as providing such advice.
  • The individual or firm is engaged in the business of advising others, by providing general or specific advice or issues reports about securities.
  • The individual or firm receives compensation for advisory services.
52
Q

Exams

A

Series 6: Investment Company Product/Variable Contracts

Series 7: General Securities

Series 62: Corporate Securities

Series 63: to sell securities in any of the 41 states that require state-level rep registration

Series 72: Government Securities

53
Q

Required elements of a registration statement

A
  • A description of the company’s properties and business,
  • A description of the security to be offered for sale,
  • Information about the management of the company, and
  • Financial statements certified by independent accountants.

Part I is the prospectus - the legal offering document that must be delivered to everyone who is offered or buys the securities and must include audited financial statements

Part II contains add’l information and exhibits that the company does not have to deliver to investors but must file with the SEC

Form S-1

54
Q

Red Herring

A

The preliminary prospectus that is used by securities professionals to obtain indications of interest as the SEC reviews a registration statement

20-day waiting period

55
Q

AUM Size according to the Dodd-Frank Act of 2010

A

Small adviser is 0-25MM - prohibited to register with SEC, and must register in the state

mid-size adviser is 25-100MM - if in NY or WY must register with SEC, otherwise register in the state

Large adviser is 100MM+ - must register with the SEC when reaches $110M, and not register with the state

56
Q

Eurodollar CDs

A

are large, short-term CDs denominated in U.S. dollars and issued by banks outside the United States.

They are negotiable, meaning that they can be traded.

they are not have federal deposit insurance

Euro dollar deposits are not negotiable

57
Q

TIPS

A

TIPS’ principal is adjusted every six months to reflect the inflation rate.

58
Q

Government marketable securities

A

T-Bills = less than 1 year Current Price = Face Value × [1 - ((Days to Maturity ÷ 360) × Discount Yield)]

T-Notes = 1-10 Years

T-Bonds = 10-30 years

59
Q

Commercial Paper Features:

A
  • Denominations of $100,000 or more
  • Maturities of up to 270 days
  • Large institutional investors
  • Terms are non-negotiable
  • Issuer may prepay the note

is an unsecured (not backed by any assets) short-term promissory note issued by both financial and non-financial companies.

60
Q

Current Yield is calculated by…

A

Annual coupon rate / market price of bond

61
Q

Revenue bonds may be issued for the following reasons:

A
  • financing publicly owned utilities,
  • financing quasi-utilities, like transportation,
  • financing by levying a tax on properties that benefit from the expenditure, for example a new sewer system,
  • Industrial Development Bonds are used to finance the purchase or construction of industrial facilities

Revenue Bonds are backed by revenues from a designated project, authority, or agency or by the proceeds from a specific tax.

62
Q

Muni Bonds

A

General Obligation Bonds: issued by state and local agencies and backed by the full faith and credit of the agency.

Revenue Bonds: backed by the revenue from designated project, authority and agency

63
Q

Market Indices

A

DOW Jones is price weighted

Standard & Poors 500 is value weighted

Russell 2000 is small companies

Wilshire 5000 is a very broad-based index made up of stocks from NYSE, American Stock Exchange and NASDAQ

64
Q

Preferred Stock

A

Rights: to information, to buy/sell, to dividends arrears & priority to dividends

Participating preferred stockholders are entitled to fixed rate of cash dividends

Cumulative preferred stock gives owner the right to accumulate dividend payments skipped

65
Q

Valuations of stock (3)

A

Market

Book

Par

66
Q

Preemptive Right

A

grants existing stockholders the right of first refusal on any new stock and maintain previous fraction of outstanding shares; prevents dilution of control

67
Q

Warrants

A

Issued by the firm and allow the holder the ability to purchase additional shares

They give the holder the option to purchase shares at an exercise price. The exercise price is set initially to be substantially higher than the prevailing market price. The value of the warrant will fluctuate along with the underlying stock and can be sold in a secondary market.

68
Q

Rights (Stock)

A

also known as subscription warrants

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.

Rights exercise prices are set below the current market prices

69
Q

major hedge fund categories

A

Arbitrage/Relative Value

Quantitative Long/Short

Macro funds

70
Q

Income is free from taxation for REITs if

A

90% of their income is distributed to shareholders

And at least 75% of a REIT’s assets and income must be derived from real estate equity or mortgages.

71
Q

Arbitrage/Relative Value Funds

A
  • Investment Strategy: Seek out basic mispriced securities.
  • Use of Leverage: A high degree of leverage is used to capitalize on otherwise small pricing differences.
  • Risk Control: Necessary to eliminate broad market risk in order to capitalize on relative mispricing.
72
Q

Closed-end Fund

A

market prices are published daily in the financial media

a fund’s net asset values are published weekly and are based on the closing market price for the previous Friday.

A closed-end fund’s shares are considered to be trading at discount when their market price per share is less than their NAV.

The fund’s shares are considered to be trading at a premium when the shares’ market price is greater than the NAV.

73
Q

No-Load funds and Load funds

A

No-load funds, charge lower transaction costs and generally provide fewer services, are beneficial for investors who have some investment knowledge and an understanding of how mutual funds work.

Do not charge commissions

Load funds are beneficial for investors who are seeking advice or guidance from a broker or adviser and do not mind paying a sales charge.

Charge commission

74
Q

A taxpayer who wants to litigate either in a _____________ or in the _________must first pay the deficiency.

A
  • U.S. District Court*
  • U.S. Court of Federal Claims*
75
Q

Trial Courts

A

US Tax Court

US Court of Federal Claims

US District Courts

76
Q

correlation coefficient is greater than zero…

correlation coefficient is zero…

correlation coefficient is less than zero…

A

indicates the securities in the portfolio are moving in tandem

movement of one security in comparison to the other in the portfolio is not predictable

movement of one security as against the other is exactly opposite, indicating the most diversified situation.

77
Q

Black-Scholes-Merton formula shows

A

that the fair value of an option is determined by the following five factors:

stock price

exercise price

risk-free rate

life of the option

the volatility of the common stock

78
Q

BAPM & CAPM

A

BAPM is based on the interaction between information traders and noise traders and also considers value expressive measures

CAPM only considers information traders, and uses utilitarian factors in determining supply and demand for a stock

79
Q

Securities Act of 1933

A

AKA “Truth in Securities Law” or “The Paper Act”

Two basic objectives:

  1. Requiring that investors receive financial and other significant information concerning securities being offered for public sale; and
  2. Prohibiting deceit, misrepresentations, and other fraud in the sale of securities.

The ‘33 Act applies to the primary market, where securities go through an initial public offering (IPO) process.

80
Q

Securities Act of 1934

A

Congress created SEC to regulate the secondary market - Register, regulate and oversee:

Brokerage Firms: firms that charge a fee/commission for executing orders submitted by another firm

Transfer Agents: person who maintains the records of registered securities

Clearing agencies: facilitate the validation, delivery and settlement of securities transactions

Self Regulatory Organizations (SROs): FINRA is an SRO and is accountable to the SEC for the various stock exchanges: NYSE, American Stock Exchange.

Empowers the SEC with disciplinary powers and to require parodic reporting by companies with public securities

The Sarbanes-Oxley Act of 2002 recast and expanded the powers of the SEC, giving the SEC even more authority to regulate a larger group of professionals, including lawyers.

81
Q

SEC

A

Created to promote stability and protect investors

Comprises of 5 presidentially appointed Commissioners, 4 divisions and 18 offices; Has 11 regional and district offices

Meet to interpret federal securities laws, amend existing rules, propose new rules to address changing market conditions and/or enforce rules and laws.

82
Q

Investment Company Act of 1940 (Advisors Act)

A

regulates investment advisors (ABCs)

_A_dvice is given on investments and in the _B_usiness of offering advice and _C_ompensation is received for the advice

regulates the organization of companies, including mutual funds, that engage in primarily in investing, reinvesting and trading in securities, and whose own securities are offered to the public

In place to minimize conflicts of interest

Requires these companies to disclose their financial condition and investment policies to investors when stock is initially sold and regular basis

This act does not permit the SEC to directly supervise the investment decisions or activities of these companies or judge the merits of their investments

Does not include banks, lawyers, accountant, teacher, engineer, bona fide newspaper

The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) passed in 2010, made important amendments to the registration rules outlined in the Investment Advisers Act of 1940.

83
Q

FINRA

A

under SEC oversight, protects investors and market integrity and administers exams and licenses

must become securities licensed to buy/sell securities on behalf of clients

RIAs under the Advisors Act of 1940 are held to fiduciary standard, FINRA licenses are held to a suitability standard

1938 Maloney Act Amendments to the Securities Exchange Act of 1934

84
Q

Orders

A

Market Orders - instructed to buy/sell immediately, broker is obligated to act in “best efforts”

Limit Order - investor sets a price to sell above or buy below, may or may not be executed

Stop-Limit -activates a market order at a certain price and then limits the transaction from going beyond an unwanted price

Fill-or-kill - get cancelled if the broker is unable to fully execute them immediately

85
Q

initial margin requirement

A

the minimum percentage of the purchase price that must come from the investor’s own funds

86
Q

hypothecation agreement

A

grants the brokerage firm the right to pledge the investor’s securities as collateral for bank loans, provided that securities are purchased using a margin account. Most brokerage firms also expect investors to allow them to lend their securities to others who wish to sell them short.

87
Q

Strangle

A

Purchase of one option and sale of another with same expiration dates but different strike prices

Long Strangles are debit transactions

Short Strangles are credit transactions because premiums are received

88
Q

Straddle

A

Put and Call are bought with the same expiration date and exercise price

Short straddles with profit from small price movements around the exercise price

89
Q

Spreads

A

Purchase of one option and sale of another similar but different option

90
Q

Calculate today’s value of a TBill

A

Face Value × [1 - ((Days to Maturity ÷ 360) X Yield)] = Current Price

$1,000 × [1 – ((120 ÷ 360) × 0.0275)] = $990.83

91
Q

contingent deferred sales charge (CDSC)

A

may be assessed to an investor that sells the fund prior to an agreed-upon holding period

92
Q

As long as ____ of REIT income is distributed to shareholders, that income is free from taxation to the REIT.

A

90%

At least 75% of a REIT’s assets and income must be derived from real estate equity or mortgages.

93
Q

CML v SML measurements

A

CML standard deviation

SML uses CAPM, Beta

CFP Exam - BIF Exam Prep (17 decks)

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