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CFP Study > CFP Review F.I.I. (Part I) > Flashcards

CFP Review F.I.I. (Part I) Flashcards

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1
Q

Practice Standards for Financial Planning Process

A

Understand the client’s circumstances and financial circumstances
Identify and select goals
Analyze current trajectory and potential alternative courses of action
Develop recommendations
Present recommendations
Implement recommendations
Monitor and Update

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2
Q

aleatory contract

A

an agreement where one party pays, the other only has to perform their end at a random chance ( pay premiums, IF something happens, insurance pays )

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3
Q

indemnity principle

A

” to make whole again “

  • insured cannot profit, can only be compensated to the extent of the loss
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4
Q

12b-1 fees…

A

Sales Related Compensation

cover the costs of distribution – marketing and selling mutual fund shares

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5
Q

Liquidity ratios measure the ability to meet…

A

short-term obligations

  1. current ratio (current assets / current liabilities)
  2. Emergency Fund 3-6 months
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6
Q

Debt ratios indicate how well a client manages…

A

debt

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7
Q

The pie chart approach provides..

A

a visual representation of how the client spends his money

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8
Q

The cash flow approach…

A

income statement approach to recommendations

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9
Q

The financial statement approach helps…

A

where the client is today and uses ratio analysis to determine the client’s weaknesses and strengths

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10
Q

The metrics approach utilizes…

A

quantitative benchmarks to determine where a client should be

(ex. by 30 have 1x your annual salary in retirement savings)

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11
Q

Types (degrees) of CFP Fitness violations..

A

Permanently barred - all felonies that occurred within the last 5 years, revoked financial professional license
Barred until hearing with DEC - two or more bankruptcies, certain violent felonies 5 or more years ago, certain non violent felonies within the last 5 years, Suspension of financial license, revocation of non financial professional license
Other adverse conduct - complaints, civil proceedings, non violent felonies more than 5 years ago, misdemeanors, terminations/investigations

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12
Q

CFP Fitness Standards

A

are for current candidates and former CFP Professionals seeking reinstatement (bars can be temporary depending on the crimes)

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13
Q

Fiduciary Duty (3 Parts)

A

Duty of Loyalty - put client interests above firm & CFP professional, disclose material conflicts of interest, “best interest of client”
Duty of Care - prudence, diligence, care about the client’s goals & circumstances
Duty to Follow Client Instructions - “reasonable and lawful” w/ terms of Engagement

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14
Q

Standards of Conduct

A

A. Duties Owed to Clients (LOTS)
B. Financial Planning & Application of the Practice Standards for the Financial Planning Process
C. Practice Standards for the Financial Planning Process
D. Duties Owed to Subordinates and Firms

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15
Q

Financial Planning Definition

A

a collaborative process that helps maximize a client’s ability to meet life goals through financial advice that incorporates relevant and realistic elements of the client’s personal and financial circumstances

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16
Q

Qualitative (subjective) Information

A

values, goals, risk tolerance, earnings potential, attitudes, expectations, health, life expectancy, family circumstances, needs, priorities, current course of action

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17
Q

Quantitative (objective) Information

A

age, number of dependents, other professional advisors, income, expenses, cash flow, savings, assets, liabilities, available resources, liquidity, taxes, employee benefits, government benefits, insurance coverage, estate plans, education and retirement accounts and benefits, capacity for risk

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18
Q

Risk tolerance vs. risk capacity

A

risk tolerance = a bubble of how much risk you can handle (a level of comfort), risk capacity = how much of that you are willing to expand the bubble

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19
Q

debenture

A

unsecured debt by a corporation

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20
Q

Equipment Trust Certificate

A

used to purchase equipment that is then used as collateral

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21
Q

Bond Ratings

A

Investment -> Junk
(AAA) (BBB/Baa) (C’s)

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22
Q

Three Schools of Counseling

A

humanistic, developmental, cognitive-behavioral

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23
Q

Developmental School of Counseling

A

human development occurs in stages (predictable sequence) - more directive than humanistic, but not as directive as CB

In financial planning, the “baby steps” approach is an example of a developmental approach

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24
Q

Humanistic School of Counseling

A

humanity is generally good and has the capability of self-direction and growth under the right set of circumstances

In financial planning, the advisor serves as more of a guide than an expert

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25
Q

Cognitive-Behavioral School of Counseling

A

highly directive approach!

humans are beings that are subject to the same learning principles established in animal research (operant conditioning, reinforcement)

the financial advisor in this paradigm is more likely to use goals and feedback as ‘carrots’

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26
Q

active listening

A

give feedback (“go on” “yes” “right”) to encourage the speaker to continue speaking

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27
Q

reflective listening

A

seek first to understand, then to be understood

I understand that … you mentioned that …. is that correct?

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28
Q

Traditional Finance

A

“Modern Portfolio Theory”

  • Investors are rational
  • Returns are determined by risk (beta)
  • Markets are efficient
  • The Mean-Variance Portfolio Theory governs (CAPM)
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29
Q

heuristic

A

mental shortcut, rule of thumb - can lead to biases

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30
Q

affect heuristic

A

judge by its cover (beautiful or ugly - immediate effect)

“oh that’s a great stock”
“oh that stock sucks”

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31
Q

availability heuristic

A

I know what I know, I will not do research to find out why I should or should not (based on info that is available to me already)

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32
Q

similarity heuristic

A

tendency or aversion to act on things that are “similar”

i.e. I always have done this at this time

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33
Q

anchoring bias

A

makes us too quick to make decisions based off of the first piece of information that we receive.

Seeing a “price cut” or a “stock drop” can lead to a quick “buy - it’s on sale” mentality

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34
Q

confirmation bias

A

people tend to filter information and focus on the pieces that support their own opinions

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35
Q

recency bias (experiential bias, availability bias)

A

too much care is given to recent observations or stimuli versus long-term historical trends (can affect insurance and retirement spending)

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36
Q

gambler’s fallacy

A

100 coin flips - the chance is always the same.

in gambling - losing consistently does not make you “due” for a win

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37
Q

herding

A

mimic the actions of the larger group, socially to “fit in”

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38
Q

hindsight bias

A

“if the past is so obvious, the future is predictable”

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39
Q

overconfidence bias

A

the opposite of herding. Mostly occurs when the investor only listens to themselves. Often results in over-trading

-overconfidence leads to overstating risk tolerance!

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40
Q

overreaction

A

stock drops, sell all
stock raises, buy all

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41
Q

Regret avoidance (disposition effect)

A

refuse to act in hopes of minimizing any regret over their actions or inactions

-continue to mark stocks at purchase price instead of market price

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42
Q

Belief perseverance

A

people are unlikely to change their views given new information.

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43
Q

mental accounting

A

our tendency to mentally sort our funds into separate “accounts,” which affects the way we think about our spending.

(ex. that money is for down payment, not for daycare costs)

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44
Q

Loss aversion

A

people more strongly prefer to avoid losses than to seek gains

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45
Q

substitute product

A

used in substitute; affects demand

ex. plastic bags vs. paper bags - if the price of plastic bags drops, the demand for paper bags will go down unless they also drop prices

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46
Q

complement product

A

bought alongside another product; affects demand

ex. tennis rackets & tennis balls - if the price goes down on tennis rackets (or demand goes up), the demand for tennis balls will go up

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47
Q

elasticity

A

how much the demand will change with price being affected

ex. If cars go 50% off, sales may go up 500% (highly elastic), if gasoline drops 50% and sales only go up 1%, this is highly inelastic

airline tickets are highly elastic, if they go half off, demand may increase 500%

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48
Q

Monetary Policy

A

The Federal Reserve can:

Make banks hold more reserve, increase the rate that banks are charged for borrowing money from the Fed, or perform open market operations

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49
Q

Fiscal Policy

A

Congress can:

Increase or decrease spending (stimulus), raise or lower taxes

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50
Q

Goals of Both Fiscal & Monetary Policy

A
  1. Maintain Full Employment
  2. Maintain Prices
  3. Maintain Long Term Economic Growth
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51
Q

Open Market Operations

A

Follow the money flow, is the Fed giving money to the market, or taking? (Sell vs Buy, where is the money going?)

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52
Q

Leading Economic Indicators

A

Initial Unemployment Claims Filed
Housing Starts
Money Supply (M2)
Manufacturing Orders
Hours Worked (manufacturing)
Stock Prices (500 best stocks)
Consumer Sentiment

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53
Q

Lagging Economic Indicators

A

CPI
Duration of Unemployment
Prime Rate Average
Inventory to Sales ratio (how much is being sold)

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54
Q

GDP

A

Gross Domestic Product - measures the production within geographic borders, regardless of nationality

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55
Q

GNP

A

Gross National Product - measures the production of nation, regardless of geographic borders

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56
Q

Business Cycle vs. Market Cycle

A

The Market Cycle precedes (indicates) the Business Cycle.

Both share the following:
Trough, Expansion, Peak, Contraction

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57
Q

Inflation

A

the decrease in purchasing power, the increase in prices that people are paying

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58
Q

Interest Rates

A

Affect the price of borrowing money; increases in interest rates will decrease the likelihood people can afford borrowing money

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59
Q

Sectors of Market

A

Consumer Cyclical “durable” (luxuries)
Consumer Non-Cyclical “non durable” (staples, necessities)
Healthcare
Energy (raw materials for energy use - oil)
Utilities (delivery to consumers)
Technology
Capital Goods (equipment to manufacture goods)
Transportation
Financial
Basic Industry - non energy raw materials
Precious Metals

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60
Q

treasury yield curve

A

shows the rates at various maturity dates (can be an indicator of economic expectation)

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61
Q

Securities Act of 1933

A

regulation of IPOs, securities to the primary market

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62
Q

Securities Exchange Act of 1934

A

created the SEC;

regulates securities on the secondary market (public stock exchanges)

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63
Q

Investment Advisors Act of 1940

A

requires certain entities of individuals to register (SEC or state) and disclose information

regulates what an investment advisor is by 3 prong test:
- compensation
- “in the business” of financial advice
- advice or analysis regarding securities

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64
Q

Securities Investor Protection Corporation (SIPC)

A

1970

Works to insure up to 500k in securities, of which 250k can be cash in the event a broker/dealer becomes insolvent

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65
Q

Federal Deposit Insurance Corporation (FDIC)

A

1933

Ensures 250k
- Checking, savings, CDs, money market deposit accounts
“per depositor, per institution, per legal acct. ownership”

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66
Q

Chapter 7 Bankruptcy

A
  • wage earners that liquidate in order to pay debts
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67
Q

Chapter 13 Bankruptcy

A
  • wage earners that pay over time in order to meet debt obligation (36-60 months)
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68
Q

Chapter 11 Bankruptcy

A
  • business shuffle
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69
Q

Dodd Frank Act

A

2010

Reg BI “Best Interest” - Fiduciary standard of care now applies to B/D

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70
Q

FINRA

A

Series Exams to sell products

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71
Q

How to register as an investment adviser?

A

Form ADV with SEC

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72
Q

Brochure Rule

A

ADV 2A & 2B - disclosures, credentials

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73
Q

Reg FD

A

“Full Disclosure” & “Fair Disclosure”

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74
Q

representativeness bias

A

running all new info through a perceptual lens of the past

(tech stocks crashing, this is the Dot Com bubble all over again!)

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75
Q

chance of loss or injury

A

risk

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76
Q

anything that may cause loss

A

peril

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77
Q

anything that increases the chance or likelihood of loss

A

hazard

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78
Q

something that physically increases the chance of a loss

A

physical hazard

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79
Q

If a motorist slides on a slick road and collides with a motorist, what is the hazard? What is the peril?

A

Peril - collision
Hazard - slick road

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80
Q

Dishonesty or character defects that increase the likelihood of a loss

A

Moral hazard

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81
Q

Bank risks lack of insurance hoping for a government bailout

A

Moral Hazard

(ex. cutting corners (cheating, dishonest) because the government can bail you out)

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82
Q

Carelessness or indifference to a loss based on the existence of insurance

A

Morale Hazard

(ex. leaving car unlocked because of insurance “So What?”)

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83
Q

Tactical Asset Allocation

A

an active management portfolio strategy that shifts the percentage of assets held in various categories to take advantage of market pricing anomalies or strong market sectors

i.e. energy sector during the Russian invasion of Ukraine, consumer staples sector during high inflation

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84
Q

Strategic asset allocation

A

a portfolio strategy whereby the investor sets target allocations for various asset classes based on factors such as the investor’s risk tolerance, time horizon, and investment objectives and rebalances the portfolio periodically

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85
Q

Market timing

A

moving investment money in or out of a financial market—or switching funds between asset classes— based on predictive methods

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86
Q

Core & Satellite allocation

A

The core of the portfolio consists of passive investments. Additional positions, known as satellites, are added to the portfolio in the form of actively managed investments.

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87
Q

bond duration

A

measurement of a bond’s interest rate risk that considers a bond’s maturity, yield, coupon and call feature

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88
Q

derivatives

A

financial contract whose value is dependent on the underlying asset

(futures, options [puts, calls, warrants], swaps, forwards)

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89
Q

futures contract

A

farmers use these a lot to sell their harvest before it is ready
production uses futures to lock in stable prices

hedgers, speculators use

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90
Q

options contract

A

offer the holder the option, but not the obligation, to buy or sell the underlying asset or security at a specific “strike” price on or before the option’s expiration date

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91
Q

put

A

buying a put is buying the option to sell your stock at a certain price (can’t lose money - insurance)
selling a put is selling the option to someone to acquire their stock at a certain price (if you are more risk tolerant than they are, longer time horizon, think long-term it’ll be better)

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92
Q

call

A

buying a call is buying the option to buy a stock at a certain price (earnest money for house buying process)
selling a call is selling the option to someone to ‘wait and see’ if they want to buy that stock for the strike price (if it goes up)

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93
Q

forward vs future contract

A

forward contracts are not settled daily, they are settled at the end of the contract

futures are more for speculators and are traded on exchanges

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94
Q

Types of Pooled Investments

A
  • mutual funds
  • hedge funds
  • ETFs
  • closed ended fund (number of shares is set)
  • REITs
  • UITs (expire and split the assets)
  • Pension Funds
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95
Q

How to incorporate closing costs into mortgage payment?

A

On a 500k house with 20% down, 3% closing costs rolled in:

500,000 * 0.80 * 1.03

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96
Q

TVM bonds (semi annual)…

A

n x 2
i / 2

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97
Q

Are mortgage payments BEG or END?

A

END

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98
Q

Customer Complaints
Misdemeanor Convictions
Employer Investigations/Terminations

A

may result in delay/denial of certification

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99
Q

Items that must be provided in writing during FINANCIAL PLANNING

A

-disclaimer of compensation methods
- privacy policy
-Services and Products
-How client pays
-public discipline and bankruptcy
- referral compensation agreements
-terms of engagement and responsibilities of implementation / monitoring

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100
Q

If a client disagrees with your assumptions for inflation and rates of return…

A

limit the scope of the engagement

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101
Q

UIADPIM

A

Understand the Client’s Personal & Financial Circumstances
Identify and Select Goals
Analyze the current course of action and explore alternative courses of action
Develop
Present
Implement
Monitor

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102
Q

housing ratios

A

28% = PITI / monthly gross income
36% = PITI + Recurring Debt Payments / gross monthly income

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103
Q

Life Insurance needs

A

10-16 times gross pay

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104
Q

Disability needs

A

60-70% gross pay

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105
Q

Long-term care needs

A

36-60 months (inflation protected)

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106
Q

Personal Liability Umbrella Policy needs

A

$1-3Mil

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107
Q

Emergency Fund needs

A

formula = current assets / monthly fixed expenses
3 months - both spouses work, or one spouse works and there is another income source
6 months - one spouse works or the work situation isn’t as stable

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108
Q

three panel retirement approach

A

16 x pre-retirement income
10-12% savings rate
8-10% return
Risk/St Dev 8-14%

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109
Q

property coverage

A

should be able to replace at FMV

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110
Q

good debt vs bad debt

A

lifetime of the asset vs. the payment plan

7 year note on a 10 year old car is not good

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111
Q

education savings benchmarks

A

savings for 18 yr

public/state school - 3k/ yr
semi-private - 6k / yr
competitive private - 9k/yr

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112
Q

retirement rule of thumb

A

16x annual pre-retirement $ needs

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113
Q

savings rate

A

10-12%

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114
Q

benchmark for risk / return

A

8-10 % return over long-term horizon
8-14% std deviation of a diversified portfolio

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115
Q

legacy planning benchmark

A
  • will
  • durable power of attorney for healthcare
  • advanced medical directive
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116
Q

financial enmeshment

A

“using your child as your therapist or advisor” when they are not equipped emotionally or cognitively to serve in that capacity

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117
Q

undue influence or control

A

“you tell everyone what to do with the money and you don’t even make a cent”

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118
Q

self determination theory

A

intrinsic motivation requires three needs:
- competence, autonomy, relatedness

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119
Q

qualitative information

A

health, life expectancy, family circumstances, values, attitudes, expectations, earnings potential, risk tolerance, goals, needs , priorities, current course of action

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120
Q

when interest rates increase…

A

stocks and bonds decrease in value
purchasing power decreases (homes are less affordable just on interest rate changes, interest rates are ‘the cost of money’)

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121
Q

unemployment rate & wage rate

A

the more people employed, the more fighting over workers by businesses (wages go up)
the less people employed, the less fighting over workers by businesses (wages can stagnate or go down)

122
Q

supply curve

A

related to efficiency, new firms entering, technological improvements:

MORE supply at a CHEAPER price if market gets more efficient, technology improves production

LESS supply at a more EXPENSIVE price if market has increased costs of production, supply can’t keep up

123
Q

recession vs depression

A

recession - 6 months or 2 straight qtrs
depression - 18 months or 6 straight qtrs

124
Q

deflation vs disinflation

A

disinflation is the SLOWDOWN of inflation rate (6% to 3%)
deflation is the increase in value of the money (negative inflation rate)

125
Q

Producer Price Index (PPI)

A

measures price changes in the wholesale and manufacturing sectors

126
Q

reserve requirement (Fed)…

A

higher- tighter supply
lower- loosen supply

127
Q

excess rate reserve (Fed)…

A

higher - tighter supply of money
lower- loosen supply of money

128
Q

open market operations (Fed)…

A

sell securities = tighten supply (Fed gets cash)
buy securities = loosen supply (Fed sends out cash)

129
Q

discount rate (Fed)…

A

higher= tighter
lower = loosen

130
Q

normal yield curve

A

expansionary policy.. longer term securities have higher yields than shorter term

131
Q

inverted yield curve

A

contractionary policy… longer term securities have lower yields than shorter term

132
Q

What assets are protected from Ch. 7 bankruptcy?

A

Contributory IRAs (up to 1.3m), homestead, life insurance, qualified plans, converted IRAs if marked as rollover (no commingle)

inherited IRAs are NOT protected from creditors unless named to a trust

133
Q

Debts that cannot be discharged during Ch. 7 bankruptcy

A

Student / Gov’t Loans
3 years back taxes
Alimony / Child Support
Monies owed to criminal fines, fraud (negligence is discharged)

134
Q

Unemployment timeline..

A

26 weeks regular benefit, 13 extra weeks during “high unemployment” times; total and maximum of 39 weeks

135
Q

T/F

Age is the most important element in financial planning

A

TRUE

136
Q

Balance sheet…

A

snapshot of current financial standing
does not explain “how” assets got there - depreciation, appreciation, inheritance
movements on balance sheet are tricky - purchases are net -0-

137
Q

current assets

A

money market, cash, savings, CD < 12 mo. , debts you are owed

138
Q

consumer debt expenses should not exceed…

A

20% of NET income

139
Q

reverse mortgage

A

bank pays the homeowner while homeowner retains right to live in home

at death, bank receives the home

requires age 62 or older (can generate income for older homeowners)

140
Q

adjustable rate mortgage (ARM)

A

2/6 means that interest rates cannot increase more than 2% per year or 6% total over the life of the loan

  • someone has 4% currently, they risk a 10% interest rate in 3 years if that were to happen
141
Q

if anticipated sale of assets is upcoming…

A

balance sheet should reflect taxes owed as a ‘reserve liability account’

142
Q

NEED based financial aid programs (Dept of Ed)

A

Federal Pell Grant (depends on EFC)
Subsidized Stafford (Direct) Loan - no interest accrual while in school

Campus-based
Federal Work Study
Federal Supplemental Education Opportunity Grant (FSEOG)

143
Q

Student Loans paid by student

A
  • primary type of aid provided (undergrad and grad)
  • 6 hr or more
  • payment is generally due after a 6 month grace period
  • Sub vs Unsub (interest accrual timing, basis of need)
  • NOT for parent repayment
  • Grad PLUS
144
Q

Student Loans paid by parent

A
  • PLUS
  • 6 hr or more
  • not eligible for Income-Based-Repayment
145
Q

repayment types

A

graduated - starts smaller, 10 years
extended - 25 years, forgiven at end
-IBR evaluates discretionary income (20 yr forgiveness)

146
Q

prepaid tuition…

A
  • can limit financial aid
  • locks in tuition at today’s cost
  • does not include room & board
  • student may not have interest in available programs
  • can be refunded, but only principal
147
Q

529 Plans

A

-can limit financial aid
- 5x gift exclusion lump sum (85k) or 170k for gift splitting couple
- no AGI phase out
- owner controls assets
- beneficiary can be changed at any time
- 10% penalty and gross income on NQ withdrawals
– waived for disability, scholarship, death
- used for qual ed expenses or 10k for private school
- 10k can be used for student loans

148
Q

529 ABLE

A
  • balance must remain under 100k for Federal SSI
  • one acct per beneficiary
  • beneficiaries must be entitled to SSI, SS disability or have disability cert with IRS
149
Q

Coverdell ESA (phase out)

A
  • not only COLLEGE savings, can be used K-12. This is a use > 529
  • can pay for tutoring
  • 2k max
150
Q

Roth IRA as Education Savings Vehicle

A
  • no 10% penalty, but the earnings are NOT tax free anymore (ordinary income)
  • 5 year holding period remains
  • contribution limit, requires earned income
151
Q

Series EE Savings Bond

A
  • purchased in parent’s name
    -no local or state taxation
  • 10k per year max
  • non marketable, non transferable
  • safest investment vehicle (dependent on risk tolerance)
152
Q

UGMA / UTMA

A
  • asset of child when determining financial aid
  • kiddie tax (and other tax implications) so beware of interest payments and rental properties as gifts
  • child can use assets for something other than education

UT can include real estate, UG cannot

153
Q

Education Funding (additional tax advantages)

A
  • $2500 student loan interest ABOVE THE LINE adjustment
  • Lifetime Learning Credit 20% of up to 10k in qualified ed expenses per year (max credit per family is 2k but unlimited # of years)
  • American Opportunity Credit ( four years post-secondary only)
    –per student max is 2500
    –100% of first 2k, 25% of next 2k up to $2500

BOTH HAVE (phase out)

154
Q

Employer Education Assistance

A
  • employer may reimburse for education expenses up to $5,250
155
Q

Can you claim both Lifetime and American Opportunity credit for the same student ?

A

NO

156
Q

objective risk

A

measurable, quantifiable

measures the variation of an actual loss from an expected loss (data)

“Law of Large Numbers”

157
Q

subjective risk

A

based on individual’s perception of risk

158
Q

pure risk

A

loss or no loss

159
Q

speculative risk

A

loss, no loss, GAIN

160
Q

peril

A

the actual cause of a loss

161
Q

hazard

A

conditions that increase the likelihood of loss occurring

162
Q

moral hazard

A

intentional acts to cause accident or increase its severity (character flaw)

163
Q

morale hazard

A

indifference due to insurance coverage

164
Q

physical hazard

A

tangible condition that increases the likelihood of a peril occurring

(coastal house = hurricane likelihood)

165
Q

adverse selection

A

people are more likely to seek out insurance if they have higher-than-average risk
(there needs to be a balance in the pool for it to work - underwriters need to manage adverse selection)

166
Q

things that must happen for a risk to be insurable…

A
  • loss cannot be Catastrophic to the insurer
  • losses cannot make the insurer financially insolvent
  • large Homogenous pool
  • losses must be Accidental (not intentional)
  • losses must be measurable and Determinable (provable value)

CHAD - not Catastrophic, Homogenous, Accidental, Determinable

167
Q

A legal contract requires COALL..

A

Competent parties, Offer and Acceptance, Legal consideration, Lawful purpose

void vs. voidable

168
Q

SUBrogation clause

A

insured cannot get paid twice for the same claim.

the insurer will SUBSTITUTE the insured and take any 3rd party payments while settling claim

169
Q

insurable interest principle

A

insurable interest - hardship resulting from loss
property & liability - must have insurable interest at inception and at time of loss
life insurance - must have insurable interest only at time of inception

170
Q

adhesion principle

A

“take it or leave it” - ambiguities are in favor of insured

171
Q

unilateral principle of contract

A

only one side is promising - the insurer

  • NOT the insured!!
172
Q

estoppel

A

clause that states that insured will not be denied assertion of a right to which they are otherwise entitled (“but you said…”)

173
Q

types of authority

A

express - written agency agreement
implied - public perception & written agency agreement
apparent - public perception ONLY

174
Q

replacement cost vs. actual cash value

A

car

replacement cost - like-kind current cost of replacement
actual cash value - replacement cost minus depreciation (not great for insured)

175
Q

coinsurance formula (only if coverage is less than coinsurance requirement)

A

([Face value of policy / (coinsurance * replacement cost)] * loss) - deductible

ex. 300k replacement cost house, 200k insurance face value, 80% coinsurance, 40k loss, $500 deductible =

[200k / (.8 *300k)] * 40k - 500
= $32,833

  • DO NOT forget the final step (multiply by loss, subtract deductible)
176
Q

Needs Approach to Life Insurance Estimates

A

$ that will be used for:
- final expenses, lump-sum cash needs (debt, education), income needs (readjustment and future), dependency and spousal needs (blackout period for Soc Sec)

177
Q

Human Life Value Approach

A

Salary of the decedent minus their own personal consumption. Include estimates of salary growth and earnings growth (real return must be used), use estimate for their remaining work expectancy

178
Q

CRAP-O (dividend options for participating policies)

A

Cash
Reduced Premium
Accumulate at interest
Paid-up additions (purchase additional DB)
One year term (purchase one year of term insurance)

179
Q

settlement options (payouts)

A

lump sum
interest only (capital retention)
annuity payments (income retention)
- fixed amount, life income, fixed period, life income with period certain

180
Q

nonforfeiture options (termination)

A

Cash Surrender Value (minus fees for surrender)
Reduced-paid up insurance (get a paid-up policy with a smaller death benefit, no premiums)
Extended Term Insurance - paid up term policy in exchange for cash value (same DB)
Accelerated Death Benefit - 24 months or less to live, non taxable, used for anything

181
Q

annuity options (contribution & distribution)

A

contribution:
- lump sum
- periodic installment premium
distribution:
-immediate
-deferred (Flex Pay vs Single Pay (life insurance can be used for SPDA))

182
Q

annuity options (investment options)

A

fixed annuity - accumulates at fixed rate over a period of time (more security)
– equity-indexed annuity is a type of fixed annuity linked to index
variable annuity - may be invested (more risk), no guarantees, keeps pace with inflation

183
Q

life insurance death benefit taxation..

A

tax free!

184
Q

borrowing against cash surrender value…

A

not taxable unless the policy has been front-loaded (MEC)
- if loan is outstanding at death, the DB will be reduced by the amount

185
Q

Accelerated DB

A

in the event of terminal illness, an accelerated death benefit may be elected. Just know that the DB will be reduced by the accelerated DB payments

186
Q

surrendering the cash surrender value taxation..

A

ordinary income on the GAINS

187
Q

taxation of annuities

A

exclusion ratio = premiums paid (basis) / total expected payments
500000/1,000,000 = 50% taxable
any payments beyond life expectancy are 100% taxable as ordinary income

188
Q

HMO vs PPO

A

HMO - in network ONLY
PPO - up to the patient’s preference

189
Q

HSA can be used for…

A

long term care premiums
dental / orthodontics / vision care
COBRA premiums
health care coverage while drawing unemployment
Medicare and other health care coverage if over 65

190
Q

COBRA (continuation of health insurance)

A

20 employees
60 days to make your COBRA election
Can have coverage for:
18 months if reduced or terminated
36 months for death, divorce, Medicare, loss of dependency status
29 months if disabled (SS)

Employee pays 102% of the full premium if COBRA’d

191
Q

Medicaid (Long Term Care)

A

-5 year (60 month) look back at gifts
-spend down assets
-Long Term Care is covered by Medicaid only once the two above situations are addressed

192
Q

Basic Coverage Perils

A
  • Fire
  • Smoke
  • Lightning
  • Wind
    *Volcano
  • Hail
    *Theft
    *Vandalism
    *Aircraft
    *Explosion
  • Riots
  • Vehicles
193
Q

Broad Coverage (6 additional)

A

-Falling Objects
-Ice, Snow, Sleet Weight (roof)
-Accidental overflow / discharge of Water
-Sudden & accidental cracking, burning, bulging of appliances
-Freezing of plumbing, heating, air conditioning, fire sprinklers or appliances
-Sudden and accidental damage from artificial electric currents

194
Q

General Exclusions from Homeowner’s

A

Flood
Earthquake
War
Nuclear
Neglect
Intentional Acts
TERMITES

195
Q

Endorsements on Insurance Policies

A

“additions” purchased separately:
- sink hole
- flood (National Flood Insurance Program)
- Earthquake
- sewage backup
- refrigerated property coverage

196
Q

Property Insurance Coverages

A

SECTION I:
A: Dwelling
B: Other Structures ()
C: Personal Property
D: Loss of Use

SECTION II:
E: Personal Liability
F: Medical Payments to Others

197
Q

Coverage A: Dwelling (Coinsurance)

A
  • 80% of replacement cost is the target
  • If less than 80%, take what you have divided by the 80% replacement cost to multiply by the damage (don’t forget to subtract the deductible at end)
198
Q

Coverage B: Other Structures

A
  • Detached
  • 10% of Coverage A limit is typical (replacement cost)
  • If used for business, must get a separate business coverage!
199
Q

Coverage C: Personal Property

A
  • Tangible
  • 50% of Coverage A = limit
  • Actual Cash Value :( not replacement cost - but you can purchase that endorsement
  • certain items are limited in coverage ( firearms, money, jewelry)
200
Q

Coverage D: Loss of Use

A
  • additional living expenses incurred when unable to occupy the dwelling due to damages caused by a covered peril
  • 30% of Coverage A except for HO-6 & 8 (condo and modified coverage form)
201
Q

Coverage E: Personal Liability

A
  • covers claims that result from bodily injury and property damage to others, when the insured or members of the insured’s family are responsible
  • 100k per occurrence minimum (legal defense and settlement costs also)
202
Q

Coverage F: Medical Payments to Others

A
  • covers all necessary medical expenses without regard to liability for others arising out of the insured’s activities, premises or animals
  • within 3 years of accident
    1k-5k typical, some go up to 10k
203
Q

HO Policy Forms

A

HO-2: Broad Form - 18 named perils
HO-3: Special Form - open perils except personal property (named perils)
HO-4: Renters Form - C,D,E No (dwelling coverage)
HO-5: Comprehensive Form - open perils on dwelling and personal property
HO-6: Condo Form- ‘within the walls’, broad perils coverage, lower personal property coverage and modified loss of use 50%
HO-8: Modified Coverage Form- repair cost vs. replacement cost (expensive materials)

204
Q

Personal Auto Policy (PAP)

A

A- Liability (Bodily Injury and Property Damage)
B- Medical Payments
C- Uninsured Motorist
D- Coverage to Insured’s Auto (Comprehensive and Collision)

205
Q

HO-4

A

Renters

206
Q

HO-2

A

Broad Perils (18 named)

207
Q

HO-3

A

Open Perils, but not for personal property

208
Q

HO-5

A

Comprehensive, open perils on dwelling and personal property

209
Q

HO-6

A

Condo

210
Q

HO-8

A

Modified Form

211
Q

Medicare Parts

A

A - Hospital Insurance
B- Health Care (not dental, eyes or hearing aids)
C- Medicare Advantage (includes other missing coverages like dental vision and hearing)
D- DRUGS

212
Q

NOT covered in Medicare Part B

A

Dental (dentures), Vision, Hearing (hearing aids)
Cosmetic Surgery

213
Q

Activities of Daily Living (ADLs)

A

Bathing & washing
Eating
Toileting
Mobility
Transferring
Dressing

214
Q

market order

A

buy/sell at next available price (quickest)

215
Q

limit order

A

buy/sell at determined price (takes more time)

216
Q

stop order

A

at this price, turn into market order

217
Q

stop limit order

A

extra layer of protection for seller to not sell below the limit price after stop price has been reached

218
Q

best efforts & firm commitment

A
  • make best efforts to sell as much of the offering as possible
  • firm commitment = buy entire issuance of stock
219
Q

prospectus

A

outlines risks, management, business operations, fees and expenses
* trial run with red herring before SEC approval

220
Q

10K & 10Q

A

10K - annual & audited
10Q - quarterly earnings report not audited, but still filed with SEC

221
Q

Annual report goes to…

A

all shareholders

222
Q

margin call

A

(loan) / (1 - maintenance margin)

223
Q

Morning5tar

A

grades/ranks mutual funds and bonds (1-5, 5 being best)

224
Q

Value L1ne

A

ranks stocks (1-5, 1 being best)

225
Q

when should you purchase a stock in order to receive a dividend?

A

two days before the record date

226
Q

qualified dividends taxation

A

CAPITAL GAINS > ordinary income!

227
Q

Insider Trading & Securities Fraud Enforcement Act (1988)

A

insider - anyone with info not available to public
- cannot trade with that knowledge

228
Q

Investment Company Act (1940)

A

created 3 types of investment companies & allowed SEC to regulate:
* open, close and unit investment trusts

229
Q

money market securities

A

-t-bills (< a year)
-commercial paper (corporations loan between each other, 270 day maturity or less, no registration with SEC)
-Bankers acceptance - 9 months or less

230
Q

What does an Investment Policy Statement define?

A
  • Risk & Return
  • Time-line & liquidity (always related)
  • Taxes
  • Legal (if a trust or special account)
  • Unique circumstances

RR TL, TL, U (Risk/return, Timeline/liquidity, taxes & legal, unique)

231
Q

price vs value weighted indicies

A

DOW = price weighted
S&P, NASDAQ, RUSSELL, EAFE, Wilshire = value weighted (market cap considered)

232
Q

traditional finance

A
  1. investors are rational
  2. markets are efficient
  3. mean-variance portfolio theory governs
  4. returns are determined by risk alone
233
Q

behavioral finance

A
  1. investors are human and irrational
234
Q

Prospect Theory

A

Would you rather have:
-given $25
-given $50 then lose $25

people want to avoid losses

235
Q

familiarity bias

A

People tend to overestimate/underestimate the risk of investments with which they are unfamiliar / familiar

236
Q

cognitive dissonance

A

misinterpret information to only pay attention to the information that supports an existing opinion

237
Q

socialization

A

the process of acquiring values, beliefs and behaviors that are acceptable/expected by society

238
Q

multicultural psychology

A

aspects of identity influence a person’s worldview

239
Q

social consciousness

A

awareness / sense of responsibility for problems or injustices that exist within society

240
Q

beta

A

measures systematic (PRIME) risk of a security relative to the market
best used as a measure of volatility of a diversified portfolio

241
Q

standard deviation (probability)

A

68% - 1 std dev
95% - 2 std dev
99% - 3 std dev

total risk of undiversified portfolio

242
Q

leptokurtic +

A

high peak, fat tails

243
Q

platykurtic -

A

low peak, thin tails

244
Q

Monte Carlo Simulation

A

tests the probability over MANY simulations of portfolio success/failure (assumptions include withdrawal rate, etc)

245
Q

measures movement of one security relative to that of another

A

correlation & covariance

246
Q

Risk is reduced (diversification begins) any time the correlation is …

A

Less than 1

247
Q

correlation coefficient (r)

A

covariance = r * sd1 * sd2

r^2 is the coefficient of determination

248
Q

coefficient of determination r^2

A

how much return is due to the market

i.e. corr coeff of .8 has a coefficient of determination of .64 (.8^2) which means 64% of the returns are due to the market

since we cannot diversify away systematic (market) risk, we want the coefficient of determination to be higher (.70)

249
Q

Systematic Risks

A

Purchasing Power Risk - dollar cannot purchase tomorrow what it can purchase today
Reinvestment Risk - mostly bonds (if called or interest rates drop)
Interest Rate Risk - bonds (when not holding - if looking to sell, lower rates are worth less)
Market Risk
Exchange Rate Risk

250
Q

Unsystematic Risks

A

Accounting Risk (books are being cooked)
Business Risk (unique to the sector or trade)
Country Risk (diamond mining in Tunisia)
Default Risk (how likely they will not pay debt)
Executive Risk (Elon Musk)
Financial Risk (company has a lot of debt)
Government/Regulation Risk (tariffs, restrictions on industry may hurt some businesses)

251
Q

market premium

A

(rm - rf)

252
Q

risk premium

A

(rm-rf)B – incorporates BETA as a measure of risk

253
Q

Information Ratio, Jensen’s Alpha, Sharpe & Treynor Ratios

A

IR - can be compared with other IRs to determine which performed against the market
Jensen’s Alpha - tracks manager’s performance vs market (SML) + is better, - is worse

Treynor - return per unit of risk, uses beta, r^2 must be higher than 0.70
Sharpe - return per unit of risk, uses std deviation

Neither Sharpe nor Treynor track performance vs. market (no performance indicators), only risk

254
Q

NPV is deterministic…

A

IF + or 0 –> make the investment
IF - then do not make the investment

255
Q

IRR (aka Dollar Weighted Return)

A

should be calculated with uneven cash flows and you are asked to calculate the compounded rate of return (this is NPV 0)

256
Q

Arbitrage Pricing Theory (APT)

A
  • asserts that pricing imbalances cannot exist for long
  • attempts to take advantage of the pricing imbalances
  • multi-factor model that attempts to explain return based on those factors
  • beta and std deviation are not inputs into APT
257
Q

P/E

A

How much an investor is going to pay for a dollar of earnings

258
Q

PEG Ratio

A

P/E ratio to 3-5 year growth

259
Q

Dividend Payout Ratio

A

[Common Stock Dividend / Earning Per Share (EPS)]

260
Q

Return on Equity

A

Earnings Per Share / Stockholders Equity Per Share

** measures overall profitability of a company

261
Q

Fundamental Analysis

A

Ratio analysis, financial statement analysis to determine value or misplaced value. Also considers economic data that may influence pricing

262
Q

Technical Analysis

A

largely determined by supply and demand
- charts of trading volume and price movements
- moving averages used
- Dow Theory, Market Breadth

263
Q

Efficient Market Hypothesis (EMH)

A
  • Supports passive trading (buy & hold index)
  • Investors cannot consistently achieve above-average market returns
  • Stock prices will follow “random walk”
264
Q

Forms of Efficient Market Hypothesis (EMH)

A

Strong Form: Asserts that stock prices fully reflect all information, public and private. Not even access to inside info can be expected to result in superior investment performance over time. Neither fundamental analysis nor technical analysis can produce superior results over time on a risk-adjusted basis.

Semi-Strong Form: Asserts that all publicly known information is reflected in stock prices. Neither technical analysis nor fundamental analysis can produce superior results over time on a risk-adjusted basis. Only an investor with access to inside information may consistently achieve superior results (but such access is illegal)

Weak Form: Suggests that historical price data is already reflected in current stock prices and is of no value in predicting future price changes.
**Technical analysis will not produce superior results. Fundamental Analysis may produce superior results.

265
Q

Required Rate of Return is derived from…

A

Capital Asset Pricing Model (CAPM)

266
Q

Treasury Securities that are NOT marketable (no secondary market)

A

Series EE
Series I
**Series HH (have not been offered since 2004)

267
Q

Marketable Treasury Securities

A

Bills <1yr
Notes 2-10 yr
Bonds > 10 yr

268
Q

Agency Bonds (GNMA, SLMA, etc)

A

All except GNMA are not backed by the full faith and credit of the US Govt

269
Q

What are the Risks of Corporate and Municipal Bonds?

A

Default: A creditor may seize the collateral and sell it to recoup the principal
Reinvestment: As payments are received from an investment, interest rates may fall. When the funds are reinvested the investor receives a lower yield.
Interest Rate: Rising interest rates may cause bond prices to fall
Purchasing Power: Inflation may lower the value of bond interest payments and principal repayment, thereby forcing bond prices to fall.

Study Hint: Remember: D.R.I.P.

270
Q

Municipal Bond Types

A
  • not taxable at Fed, State or Local Level
  • General Obligation Bond (backed by guarantee of muni authority)
  • Revenue Bond (toll road)
  • Private Activity Bond

insured by AMBAC & MBIA

271
Q

Muni Bond Tax Equivalent Yield

A

Take into consideration:
- Federal Marginal Rate
- State Income Tax Rate
- Whether or not the client itemizes

= (yield) / [1 - (fed + [state (1-fed)])]

272
Q

Yield to Maturity

A

solve for i

  • assume semi annual and par value of 1000
273
Q

Yield to Call

A

solve for i, but use the call price instead of par value

** ALWAYS check the time period to CALL, not the length of the bond

274
Q

Bond prices and Interest Rates

A

Bond prices drop with increased interest rates, and they rise with a drop in interest rates

275
Q

Bond Yield Ladder

A

for Discount (Call Mat Curr Now)
Call
Maturity
Current
–Nominal–
Current
Maturity
Call
for Premium (No Current Mat Call)

276
Q

Yield Curve Theories

A

Market Segmentation - Supply & Demand (normal)
Liquidity Preference - longer maturities are compensated with higher returns for risk (normal)
Expectations Theory - inflation expectations invert the curve (inflation will cool off in the long run, invert the curve)
Unbiased Expectations Theory- term rate structure follows geometric average

277
Q

bond duration

A
  • bigger duration = more sensitive to interest rate changes
  • duration is the time at which investors are immunized from interest and reinvestment risks
  • Modified Duration is a bond’s price sensitivity to changes in interest rates
  • A bond portfolio should have equal duration to the investor’s time horizon
278
Q

portfolio immunization

A

duration matches time horizon

279
Q

convexity

A

The degree which duration changes as the yield-to-maturity (YTM) changes.

Largest for low coupon bonds, long-maturity bonds and low-YTM bonds allows investor to improve the duration approximation for bond price changes.

280
Q

bond strategies

A

bullet - for balloon payments, set the target date, they don’t pay much coupon
ladder - like dollar cost averaging for stocks
barbell - hedge the short vs long term, only reshuffle one side at a time
tax swap - loss for gain

281
Q

Rules for using Duration to Manage Bond Portfolios

A

If interest rates are expected to rise, shorten duration (Interest rates up, shorten Duration)

Remember: UPS: UP for “up” and S for “shorten”)

If interest rates are expected to fall, lengthen duration. Buy low coupon bonds with long maturities.

Interest rates fall → lengthen duration.

Remember: FALLEN - FAL for “fall” and LEN for “Lengthen.”

282
Q

What is the NOI calculation for Improved Land/Real Estate?

A

Improved land is normally income producing.

Income properties include residential rental, commercial and industrial properties. The intrinsic value of a real estate property can be computed using a Net Operating Income (NOI) calculation.

Gross Rental Receipts plus Non-rental Income (parking, laundry, etc.) equals Potential Gross Income (PGI) minus Vacancy and collection losses minus Operating Expenses (excludes interest and depreciation) = Net Operating Income (NOI)

283
Q

Investment Company Types

A

Open-Ended - mutual funds, unlimited shares that trade at NAV (Net Asset Value)
Closed-Ended- limited number of shares
Unit Investment Trust- passive, self-liquidating (end on certain date) and split

284
Q

alternative investments

A

real estate, hedge funds, precious metals, cryptocurrency, collectibles

  • regulation, liquidity, marketability, valuation, theft, taxation all to be considered
285
Q

intrinsic value of calls and puts

A

call option -

Intrinsic value = stock price - strike price (CallStoStri = StoStriC)

put option-

Intrinsic value = strike price - stock price (PutStriSto = StriStoP)

** intrinsic value cannot be less than zero

286
Q

Compare: Warrants vs. Call Options

A

Warrants are issued by corporations, whereas Calls are issued by individuals.

Warrants typically have maturities of several years.

Warrant terms are not standardized. Call options are standardized.

287
Q

What are the Hedging Positions of Futures Contracts?

A

Long Commodity Position: If a farmer is long a commodity (for example, corn) he needs a short hedge and will sell a futures contract.

Short Commodity Position: If Kellogg’s is short a commodity (for example, corn), they need a long hedge and will buy a futures contract.

288
Q

Define: Hedging Strategies - Straddles, Collar, Protective Put

A

Straddle: Buying a Put and Buying a Call - The buyer does NOT own the stock.

Collar: Selling a Call (out-of-the-money) at one strike price and buying a Put at a lower strike price; investor OWNS the stock.

Protective Put: Buying a stock (or already owning it) and a Put for the stock serving as insurance against the decline in the underlying stock. (Hint: A good answer for the exam)

289
Q

Black Scholes Model

A

Price of CALL option considers:
- current price of underlying asset
- time until expiration (longer = more expensive)
- risk-free rate of return
- volatility of underlying asset (std dev)

290
Q

Put/Call Parity

A

Attempts to value a PUT option based on the value of a corresponding CALL option

291
Q

Binomial Pricing Model

A

price can move two ways, forms a tree

292
Q

taxation of options

A

IF contract lapses or expires, premiums paid/gained are SHORT TERM losses or gains

IF the contract is exercised, the premium is added to the basis of the underlying asset. If held for more than 12 months, long term gain or loss, if less, short term

293
Q

Split dollar life insurance …

A

is an arrangement where an employee and employer generally share the premium cost and cash value for death benefit of a life insurance policy covering the life of the employee.

294
Q

The lower the coupon…

A

the more volatile the bond (interest rate risk)

295
Q

The longer the maturity date…

A

the more volatile the bond (purchasing power risk, reinvestment rate risk, interest rate risk)

296
Q

cash dividend effect on call option prices

A

cash dividends drive value of stock down, which also lowers the call option prices

297
Q

To immunize a bond portfolio over a specific investment horizon, an investor would ..

A

Match the average weighted duration of the bond portfolio to the investment horizon.

298
Q

pricing methods of Indexes

A

Value Line - Geometric Average
DOW - simple price weighted
S&P, Wilshire, NASDAQ, Russell - value weighted

299
Q

Riding the yield curve is…

A

a trading strategy that involves buying a long-term bond and selling it before it matures so as to profit from the declining yield that occurs over the life of a bond

300
Q

When evaluating the return of two investment managers, the performance measurement approach generally used is the

A

Time-weighted return

CFP Study (4 decks)

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