CFP - 3 Investments Flashcards
What are the possible maturities for T-bills?
4, 13, 26, 52 weeks
How often are T-bills auctioned?
Weekly except 52s are every 4 weeks
T-bill increments and minimum purchase
$100, $100
Are t-bill subject to OID rules?
No
How are T-bills taxed?
Interest income in the year of maturity equal to the maturity price minus the purchase price
How are T-bills sold before maturity taxed?
Short-term cap gain or loss
Who issues cash management bills?
US Treasury
Are cash management bills auctioned?
No
Do cash management bills have variable or fixed terms?
Variable
How long is the usual maturity of a cash management bill?
a few days
What do companies use commercial paper to finance?
Accounts receivable and inventories
What are commercial paper denominations?
$100,000 or more
What is commercial paper a substitution for?
Short term bank financing
What is the range for commercial paper maturities?
1 to 270 days
What is CP usually backed by?
Lines of credit from banks
Who usually issues CP?
Large, financially strong corporations
Who usually buys CP?
Money market funds
How is CP taxed?
Interest is ordinary income in the year earned
What usually has a higher yield?
CP
T-bills
CDs
CP
What is the min for negotiable CDs?
$100,000
Who buys negotiable CDs?
Large institutional investors
Are CDs highly liquid?
Yes
Who buys non-negotiable CDs?
Individuals
Which type of CD has deductible early withdrawal penalties?
Non-negotiable
What type of interest rates do money market deposit accounts offer?
Variable, short-term interest rates
Are MMDA’s FDIC insured?
Yes
How many withdrawals can you make from an MMDA per month?
Usually no more than 6
What are repos used for?
Used by securities dealers to finance large inventories of marketable securities
What is a repo?
An agreement to purchase an underlying security back at a specific price on a specific date
A dealer uses a repo to finance a $5mm position. The repo term is 1 day and the repo rate is 4%. What is the interest due and how does this work?
Interest due = 5mm x 0.04 x (1/360) = $555.55
Dealer would sell repo for $5,000,000 then buy it back for $5,000,555.55 the next day.
How does a reverse repo work?
Dealer buys a security then sells it back at a higher price.
Reverse repos are AKA
Repurchase agreements
Repurchase agreements are AKA
Reverse repos
What are banker’s acceptances?
Securities acting as a line of credit issued from a bank
Are banker’s acceptances negotiable?
Yes
What are banker’s acceptances used for?
Smaller companies to fund short-term debt needs
What is a Eurodollar?
US dollar denominated deposits in foreign banks
Eurodollar maturities are less than…
6 months
Are Eurodollar CDs more liquid than domestic?
No
What is the duration of a zero-coupon bond?
The time to maturity
How are zeros taxed?
Interest accrued during a given year is taxed in the year earned even though the interest in not received until maturity
Where are registered bonds registered?
With the issuer
Where are bearer bonds registered?
They aren’t. The holder receives payments
Where are book-entry bonds registered?
With a depositor (DTCC for example)
What is a sinking fund?
Funded by the bond issuer to accumulate sufficient funds to pay off the debt upon maturity
Who holds the sinking fund?
Trustee
When do T notes and bonds pay interest?
Semi
What is the best investment to use as collateral for a loan?
Treasury note or bond
What is the longest maturity T bond?
30 years
What are the T note maturities?
2, 3, 5, 7, 10 years
What are T note mins?
$100
What are T bond mins?
$100
Is interest on T notes and bonds subject to state and local tax?
No
Are capital gains on T note/bond sales subject to state and local tax?
Yes
What are the terms for TIPS?
5, 10, and 30
What is the min/increment for TIPS?
$100
How does CPI affect TIPS?
Adjusts the principal value of the bond
Are TIPS interest rates based on the CPI?
No, just the principal is. The interest will accrue on the new inflation adjusted principal
How often do TIPS pay?
Semiannual
What is the maturity face for TIPS?
The greater of the inflation adjusted principal or the original principal
How is interest on TIPS taxed?
State and local exempt. Federally taxed as interest income in the year earned. Principal increase is taxed in the year earned and increases basis.
What are Treasury STRIPS?
Separate Trading of Registered Interest and Principal of Securities
How do STRIPS work?
The principal payment and each interest payment is separated into individual zero-coupon securities by a financial institution then sold
How are STRIPS taxed?
Like zeros
Series EE bonds issued after _____ earn a fixed interest rate
5/1/2005
What are series EE face values?
$25 to $10,000
How long must EE bonds be held?
At least 1 year
What is the penalty for EE bonds redeemed early and what is the cutoff?
5 year cutoff, 3 month interest penalty
EE bonds issued after _____ are excluded from gross income if used for higher education, if they are registered in the _______’s name, and the bond purchaser is ______ or older.
1989, parent, 24
Series HH bonds were discontinued on
9/1/2004
Series I bonds are inflation linked based on ____-
CPI-U - urban consumers CPI
How are series I bonds taxed?
Same as EE
Which US government agency bonds are backed directly by the US gov?
GNMA
What is a unique risk to MBS?
Prepayment risk
Private activity bonds must use more than ____% of the proceeds for ______
10%, private business use
Qualified private activity bonds are tax exempt if _____% or more of the net proceeds are used for IRS qualified purposes
95%
How are serial bonds usually called?
Oldest maturities first, as they have higher interest rates
Formula for tax equivalent yield =
TEY = r / (1 - t)
r is the nominal rate of return
t is the tax rate
Collateral trust bonds are backed by…
stocks and bonds of other companies held in trust
What are debentures?
Bonds not backed by collateral
What does conversion ratio mean? (convertible bonds)
The number of shares of issuer’s stock that will be acquired at exchange
What is the conversion ratio formula?
Par value of convertible security / conversion price
Is the conversion of a senior security into common stock taxable?
No
Is systematic risk diversifiable?
No
How do you decrease unsystematic risk in a portfolio?
Diversification
What are the 5 systematic risks? (PRIME)
Purchasing Power Reinvestment Interest Rate Market Exchange Rate
Unsystematic risk can be significantly reduced with portfolios containing as few as _____ stocks
10
A positively skewed distribution is ____ tailed
Right
A positively skewed distribution has a high _____ and a low _____
Mean, mode
A negatively skewed distribution is _____ tailed
Left
A negatively skewed distribution has a high _____ and a low _____
Mode, mean
What does Kurtosis measure?
Whether a distribution is more or less peaked than a normal distribution
Leptokurtic has a _____ peak than a normal distribution
Higher
Platykurtic has a _____ peak than a normal distribution
Lower
Which type of kurtic distribution is better for investors who want to minimize volatility?
Leptokurtic
Lognormal probability distributions are skewed _____
Right
A lognormal probability distribution has a greater than 50% chance that an observation will fall to the _____ of the mean
Left
What is the formula for covariance?
Correlation coefficient of XY times St Dev of X times St Dev of Y
What is the formula for the coefficient of determination?
R squared, correlation coefficient squared
What is the formula for Beta?
Correlation coefficient of the market and the stock times the st dev of the stock divided by the st dev of the market
What is the short formula for covariance?
Standard devation squared
____% of outcomes fall within 1 st dev of the mean
____% of outcomes fall within 2 st devs of the mean
____% of outcomes fall within 3 st devs of the mean
68
95
99
What is the formula for z-score?
(Value - Mean)/Standard Deviation
Why is holding period return inferior?
Doesn’t consider the amount of time and ignores the time value of money
What is the formula for holding period return (%)?
(( 1 + r1) x (1 + r2) x … (1 + rn) ) -1
What is the arithmetic mean?
Average
What is the geometric mean forumla?
nth root of
1 + r1 times 1 + r2 …. all the way to rn
minus 1
What is the difference between APR and EAR?
APR is just the interest charged during a time period. EAR takes compounding into account
If APR is 9.99% compounded daily, what is the EAR?
( 1 + (0.0999/365) ) ^365 -1 = 10.50%
What is the difference between time weighted return and dollar weighted return?
Time weighted is the return over a certain period, no respect to cash flows (ie mutual fund returns reported)
Dollar weighted is the investor’s actual performance
Connie bought 1 share of XYZ for $50. One year later she received a dividend of $4 and bought a second share for $65. At the end of the second year, she sold the stock for $75 per share. There was no dividend in the second year.
What was the time-weighted return of the XYZ stock?
CF0 -50
CF1 4 (does not take into account the second purchase)
CF2 75
IRR = 26.54%
Connie bought 1 share of XYZ for $50. One year later she received a dividend of $4 and bought a second share for $65. At the end of the second year, she sold the stock for $75 per share. There was no dividend in the second year.
What was her dollar-weighted return?
CF0 -50
CF1 4-65 = -61
CF2 150
IRR = 22.63%
What does the Markowitz Efficient frontier use as a measure of risk?
Beta
What does the Capital Market Line use as a measure of risk?
Standard deviation
Systematic or unsystematic?
Business risk
Un
Systematic or unsystematic?
Financial risk
Un
Systematic or unsystematic?
Default risk
Un
Systematic or unsystematic?
Political risk
Un
Systematic or unsystematic?
Reinvestment rate risk
Sys
Systematic or unsystematic?
Exchange rate risk
Sys
Calculate the standard deviation of the following returns:
13.5 12 5 -2 7 23 6 10 45 10 0.5 14
Put in each one then hit the E+ button. At the end, hit Shift Sx, Sy
=12.2938
Are portfolios below the efficient frontier attainable?
Yes, but they are not preferred as they are inefficient
Are portfolios above the efficient frontier attainable?
No
What two points connect the Capital Market Line?
Risk free rate and portfolio “M” on the Markowitz Efficient Frontier
How can portfolios on the Capital Market Line be above the efficient frontier?
Left of M is a lending portfolio, right of M is a borrowing portfolio. Using leverage allows you to have a portfolio above the efficient frontier
What is the formula for market risk premium?
market rate of return - risk free rate of return
What is the formula for stock risk premium?
market risk premium (rm - rf) times Beta
What is the equation for SML?
Security Market Line = same as CAPM
Mike has a portfolio. It returned 16% last year. The market returned 12%. The risk-free rate was 7% and Mike’s portfolio had a Beta of 1.25. Did his portfolio do well on a risk adjusted basis?
E(r) = 7 + (12 - 7)(1.25) = 13.25%
13.25% was expected and his returned 16% so it did great
What are the 3 factor breakdowns for Arbitrage Pricing Theory?
- Some factors affect all securities: inflation, interest rates, population growth
- Some factors affect specific sectors
- Some factors affect a single company
What is the Arbitrage Pricing Theory (APT) formula?
ri = a0 + b1F1 + b2F2 … + e
ri = expected return a0 = risk free return bn = sensitivity to factor n Fn = factor that affects the security (i.e. GDP) e = error term (should drop out if all relevant factors are captured)
Howie uses multiple regression to determine the sensitivity of a certain stock to various factors.
Inflation: 1.1 Factor Beta, 5% factor risk premium
Unemployment: 0.8, 7%
Industrial Production: 0.5, 6%
If the rate on 90 day T-bills is 2%, what is the expected return of his stock?
= 0.02 + (1.10.05) + (0.80.07) + (0.5*0.06) = 0.1610
16.10%
Which form of EMH?
Holds that current stock prices have already incorporated all historical market data, such as prices, trading volume, and published financial information?
Weak
Which form of EMH?
Technical analysis is already priced in.
Weak
Which form of EMH?
Fundamental analysis and inside information may produce above-market returns.
Weak
Which form of EMH?
The current stock price reflects all past historical price data and data from analyzing financials, industry, and current economic outlook.
Semi-strong
Which form of EMH?
Insider information is the only way to outperform.
Semi-strong
Which form of EMH?
Using inside information is unlikely to produce consistent out performance.
Strong
Which form of EMH?
Fundamental, technical, and insider info is already reflected in price.
Strong
What is the January effect?
Stocks have a tendency to decline during December and go up during January
What is a collar?
Selling an option and buying an opposite option.
Ex. Writing a covered call (establishes a ceiling) and using the premium to pay for a put (establishes a floor)
Private placements are limited to ______ unaccredited investors.
35
What makes an accredited investor?
Income of more than $200k (or $300k with a spouse) in each of the last two years
OR
Net worth over $1 million
What are the 4 types of markets?
First (Exchange)
Second (OTC)
Third (Overlap of Exchange and OTC)
Fourth (Large volume institutions, within 3rd)
Limit order purchase a security at or (above/below) a certain price or sell at or (above/below) a certain price.
purchase below
sell above
What is a stop order?
An order to create a market order if the price reaches a specific level
What is a stop limit order?
An order to create a limit order if the price of a security reaches a specific level.
What is a bond’s current yield?
Annual interest payment / current market price
Jeff has a bond with a coupon rate of 4.25% trading at $965. What is the current yield?
42.50 / 965 = 4.40%
A 3 year bond has a coupon of 8% paid semi. If the yield for a comparable bond increases to a 10% rate, what will this bond trade at?
FV = 1000 PMT = 40 (8% * 1000 / 2) I/Y = 5 (10% / 2) n = 6 (3 * 2)
PV = $949.24
What is the YTM of the following bond?
Price = $750
3 Years to maturity
6% annually paid coupon
PV = -750 PMT = 60 n = 3 FV = 1000
I/Y = 17.385%
What is the YTC of the following bond?
Price = $1000
Callable @ $1050 in 5 years
6% coupon (semi)
PV = -1000 FV = 1050 n = 10 PMT = 30
I/Y = 3.4276 * 2 =6.8553%
What does the unbiased expectations theory state?
Long-term rates consist of many short-term rates and long-term rates will be the geometric mean of short term rates
What does the liquidity preference theory state?
Long term bonds are more price sensitive and investors pay a premium (lower yield) for short term bonds. Argues that the yield curve should always slope upward.
The market segmentation theory breaks borrowers up into short, intermediate, and long. Who borrows in each camp?
Short = commercial banks lend, consumer finance firms borrow
Int = Savings and loans lend, manufacturers borrow for working capital
Long = Life insurance companies lend, expansion of plant/equip/property are the borrowers
In the duration equation, what are the variables?
Y
C
D
T
Y = YTM C = Coupon D = Duration T = Term to maturity
What is an alternate way to calculate duration?
NPV / current market price of the bond.
Each cash flow equals the cash flow for that year (including principal) times the number of that year
What is convexity?
The degree to which duration changes as a result of changes in the YTM. (same relationship to factors as duration)
What reflects an investor’s willingness to take risks?
Indifference curves
An investor selects an appropriate portfolio by choosing the portfolio:
represented by the highest point attainable on the indifference curve, the point of tangency between the indifference curve and efficient frontier
What is the sales comparison approach to real estate valuation?
Finding several properties in a market that have been sold with similar characteristics
What is the cost approach to real estate valuation?
Estimates the value of a property by determining how much it would cost to replace the property and then make adjustments for depreciation or deterioration
What is the income valuation approach to real estate valuation?
Bases the value of the property on the income that can be generated from it
What is the direct capitalization formula for valuing real estate?
V = net operating income / discount rate
What is NOI?
Net operating income, net income before depreciation and mortgage debt service
How do you calculate the implied capitalization rate?
Annual NOI / Cost of property
What is M1 money supply?
Sum of demand deposits, coins, traveler’s checks, and currency
What is M2 money supply?
M1 plus savings accounts, time deposits under $100k, and balances in retail MM funds
Current ratio
Current assets / current liabilities
Quick ratio (acid test)
(Current assets - inventory) / current liabilities
Inventory turnover ratio
COGS / average inventory
Accounts receivable turnover
Sales / average accounts receivable
Fixed asset turnover
annual sales / fixed assets
Operating profit margin
EBIT / sales
Net profit margin
net income / sales
ROA
net income / total assets
ROE
net income / equity
Debt ratio
total debt / total assets
Debt equity ratio
total debt / total equity
Times interest earned ratio
EBIT / annual interest expense
the number of times a company can service its debt
Dividend payout ratio
dividends / net income
PEG ratio
Price / earnings / growth
PEG < 1 is a possible value company
What is the information ratio and what does it measure?
Alpha / Standard Deviation
Measures the consistency with which a manager beats a benchmark
Coefficient of variation (CV) equals…
standard deviation / expected return
What happens when a shorted stock pays a dividend?
The short seller is required to make payment in lieu of dividends to the investor who’s stock was borrowed
Formula for margin call =
debit balance / (1 - maintenance margin)
What is the formula for debit balance?
Price per share times initial margin (50%)
What is a substitution bond swap?
Swapping bonds with identical characteristics but different prices as an arbitrage opportunity
What is an intermarket bond swap?
swapping one type of bond with another (i.e. government bond for corporate bond)
What is a rate anticipation swap?
Swapping for more or less duration based on beliefs in change of interest rate
What is the formula for current yield?
Coupon payment $ amount divided by price of bond
