CFP Investments Flashcards
Eurodollar CDs
Large short-term CDs denominated in U.S. dollars and issued by banks outside the United States. Negotiable/Tradable. Do not have FDIC unlike CDs issued by US Banks.
Eurodollar Deposits
U.S. dollar-denominated time deposits in banks outside the United States. Nonnegotiable/Non-tradable.
Bankers’ Acceptance (BA)
Were created to finance goods in transit but now they are used to finance foreign trade. Buyer of goods issues written promise to the seller to pay within 180 days or less. A bank accepts this promise, obligates itself to pay, and obtains in return a claim on the goods. The written promise becomes a liability of both the bank and the buyer.
Repurchase Agreement (Repo)
Investor A sells Investor B a money market instrument and agree to repurchase it for a slightly higher agreed-upon price at a later date.
Commercial Paper
A short-term promissory note issued by both financial and non-financial companies.
- Denominations of $100,000 or more
- Maturities of up to 270 days
- Large institutional investors
- Terms are non-negotiable
- Issuer may prepay the note
U.S. Treasuries (3 Types & Maturities)
- T-Bills: <1 year
- T-Notes: 1 to 10 years
- T-Bonds: 10 to 30 years
Series EE Bonds
Increase in value every month, and interest is compounded semiannually. No secondary market, must be redeemed and cannot be used as gifts or as collateral. Not subject to state and local taxes.
Series I Bonds
Sold in denominations ranging from $50 to $10,000. Treasury sets the interest every May and November for the next six-month period. The interest rate is based on a fixed rate plus an additional amount, which is determined by the CPI. This is a major distinction with HH bonds, which have no adjustment for inflation. The maturity is 20 years from the date of issue, with an option to extend interest payments for an additional 10 years. Interest is exempt from state and local taxation, and may also be exempt from federal taxation as long as the interest is used to pay qualified higher education expenses.
Treasury Bills (T-Bills)
Money market instruments issued on a discount basis, with maturities of up to 52 weeks and in denominations of $100 or more. Interest earned is treated as interest income.
Risk Free Rate
The interest rate of the T-Bill.
Federal Home Loan Banks
Makes loans to thrift institutions, primarily to savings and loan associations.
Federal National Mortgage Association
Fannie Mae: Purchases and sells real estate mortgages by the Federal Housing Administration, Veterans Administration, and conventional mortgages.
Federal Home Loan Mortgage
Freddie Mac: Purchases and sells conventional mortgages.
Student Loan Marketing Association
Sallie Mae: Purchases federally guaranteed student loans.
Farm Credit Bank
Lends to farmers, farm associations, and cooperatives.
Farm Credit Financial Assistance
Supports the Farm Credit Bank System.
Financing Corporation
Recapitalizes the Federal Savings and Loan Insurance Corporation.
Funding Corporation
Assists recovery of the thrift industry by assisting bankrupt savings and loans.
Stripped Mortgage-Backed Securities
Interest-only (IO) and principal-only (PO) securities that offer investors a significantly different price/yield relationship as compared to traditional mortgage pass-through securities.
Collateralized Mortgage Obligations (CMOs)
A means to allocate a mortgage pool’s principal and interest payments among investors under their preferences for prepayment risk.
Mortgage pass-through securities (GNMA, FNMA, FHLMC)
Pools of mortgages in which investors purchase certificates to receive monthly payments that represent both a pro-rata return of principal and interest on the underlying mortgages.
Tax Equivalent Yield (TEY)
= Tax-free rate ÷ (1- Marginal tax bracket)
Municipal Bond Insurers
- AMBAC (American Municipal Bond Assurance Corporation)
- FGIC (Financial Guarantee Insurance Company)
GO Muni Bonds
Backed by the full faith and power of the municipality, namely the full extent of its taxing power.
What is the difference between American-style and European-style option contracts?
Holder can exercise the contract anytime between the purchase date and the expiration date vs. holder can only exercise the contract immediately before expiration. The first kind is more typical in the US.
Why do some people prefer investing in tangible assets?
These assets can provide low to negative correlation to other financial assets. These investors look toward precious metals and gems, and some have found their most profitable investments right in activities they most enjoy doing: building their hobbies and adding to their collectibles.
What are “business risks”?
Uniquely associated with the company or entity issuing the security. Change is processes may increase short-term expenses but improve a company’s efficiency in production in the long-term. A company being bought out can be beneficial (company is broken up and sold in pieces). Charges for any illegal activities or business practices can be detrimental for the company’s stock.
What is the risk quantified by standard deviation?
- Variability
- Non-Diversified Portfolio
- Total Risk
What is the risk quantified by beta?
- Volatility
- Diversified Portfolio
What is the formula to determine the Total Return?
Calculate the holding period return: HPR = (P1 + D − P0) / P0
What is the formula to determine the after-tax return?
Net the tax effect: After Tax Return = Total Return (1 − tax bracket)
What is the formula to determine the Real Return?
Net the effects in inflation: real rate = (1 + Nominal Return / 1 + Inflation) − 1
Fred had $20,000 in his portfolio at the beginning of the year. He added $5,000 to the portfolio in the middle of the year. The account value before he added the $5,000 was $19,178 and at the year-end, it was $25,998. What was the annual time-weighted return for Fred’s portfolio?
The return for first half year = ($19,178 - $20,000)/$20,000 = -.0411.
The return for second half year = ($25,998 – $19,178 – $5,000) /($19,178 + $5,000) = .075275.
The time-weighted return = [(1 – .0411)(1 + .075275) – 1] = .03108 or 3.108%.
What is the most commonly quoted yield (rate of return) for bond investors?
Yield to maturity (YTM), which is defined as the discount rate that equates the present value of all the bond’s future cash flows with its current market price (purchase price). The YTM is the compounded rate of return of a bond.
What is net present value (NPV)?
It is the present value of future cash flows minus the purchase price of an investment.
What is DDM?
The dividend discount model (DDM) is a quantitative method used for predicting the price of a company’s stock based on the theory that its present-day price is worth the sum of all of its future dividend payments when discounted back to its present value.
What are the three variables that determine a bond’s duration?
- Coupon Rate
- Market Interest Rate
- Number of compounding periods until maturity.
What role does the price of a bond play in determining a bond’s duration?
Price is not a determinant in calculating duration. Price is a function of the market rate of interest.
Most bond investors obtain three types of cash flows:
- periodic coupon interest payments
- reinvestment of those coupon payments
- repayment of principal when the bond matures.
While some bonds have a call premium, it is not a typical cash flow for most bonds.
The true price of the bond will always be _______ the modified duration estimate.
The true price of the bond will always be HIGHER than the modified duration estimate. This is due to the convex shape of the price/yield function.
What is a bond’s intrinsic value? What is a bond’s NPV?
On calculator, input n + i + PMT + FV and solve for PV. Then, PV minus Market Price of bond = NPV. Positive NPV = good deal. Negative NPV = bad deal.
The internal rate of return is sometimes referred to as:
Implied Return
What are the assumptions behind the CAPM, which are also behind the normative approach to investing?
- Investors evaluate portfolios by looking at the expected returns and standard deviations over a one-period time horizon.
- Investors are never satiated.
- Investors are risk-averse.
- Individual assets are infinitely divisible.
- There is a risk-free rate.
- Taxes and transaction costs are irrelevant.
- All investors have the same one-period horizon.
- The risk-free rate is the same for all investors.
- Information is freely and instantly available to all investors.
- Investors have homogeneous expectations.
What is the Capital Market Line (CML)?
The _______ can be described as the most desirable asset allocation line and as such it represents the linear efficient set in the world of CAPM. All investors will hold a portfolio lying on the _______. It is the efficient frontier when borrowing and lending at the risk-free rate are permitted.
What is the Separation Theorem?
The optimal investment decision to buy the market portfolio is separate and independent from the financing decision about whether to borrow or lend to finance the investment in the market portfolio. The optimal combination of risky assets for an investor can be determined without the knowledge of the investor’s preferences toward risk and return.
In the equilibrium world of the CAPM, a security that is not part of the market portfolio is what 3 things:
✓ Not owned by investors
✓ Has an equilibrium price of zero
✓ Has a market value of zero
What is the Arbitrage Pricing Theory (APT)?
Like CAPM, _________ is an equilibrium model that describes why different securities have different expected returns, asserting that securities have different expected returns because they have different betas. Portfolios are assumed to have:
✓ Self-Financing: Does not require additional funds from investors.
✓ Riskless: There is no sensitivity to any factor; there is zero variance and covariance with other portfolios; and there is negligible nonfactor risk.
✓ Positive Return: The riskless arbitrage will result in a positive return.
What law is the APT based on?
Based on the law of one price, which states that if a security’s price is different in different markets, then a riskless profit exists for investors to buy the security from the market with the lower price and sell it in the market with the higher price. Also, investors will take advantage of arbitrage opportunities thus eliminating them.
What is the up-tick rule?
Dictates that a short sale must be made on an up-tick or on a zero-tick. Eliminated by the SEC effective July 6, 2007. As a result of the financial crisis of 2008 and 2009, there have been many revisions to the uptick rule.
Dividend distributions in excess of one’s basis in a stock are classified as ____________.
Distributions to shareholders are taxable only to the extent they are made from either the corporation’s current earnings and profits or accumulated earnings and profits. Distributions over current and accumulated earnings and profits are treated as a non-taxable recovery of capital. Such distributions reduce the shareholder’s basis in the stock. Distributions above the basis are classified as capital gains.
