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Series 65 > Chapter 8 - Part 2 > Flashcards

Chapter 8 - Part 2 Flashcards

1
Q

Investors looking to generate additional income to help meet monthly expenses can invest in which type of securities?

A 
Corporate bonds
Municipal bonds
Government bonds
Preferred stocks
Money market funds
Bond funds
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2
Q

Investors seeking capital appreciation over time and want their money to grow in value and who are not seeking current income can invest in which type of securities?

A

Common stock

Common fund stock

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3
Q

Investment objective is more concerned with keeping the money they have saved

A

Money market funds
Government bonds
Municipal bonds
High-grade corporate bonds

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4
Q

Investors seeking tax advantages

A

Municipal bonds

Municipal bond funds

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5
Q

Investors who need immediate access to their money need to own liquid investments that will not fluctuate wildly in value

A 
Money market fund
stocks/bonds/mutual funds
Annuities
CMOs
Direct participation programs
Real estate
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6
Q

This investor is willing to take on a high degree of risk in order to earn high rate of return

A

Penny stocks
Small cap stocks
Some growth stocks
Junk bonds

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7
Q

what is CAPM?

A

Capital asset pricing model (CAPM)
Operates under the assumption that investors are risk averse

Investors who take on risk must be compensated for that risk through a higher expected rate of return

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8
Q

Securities with higher beta must offer investors what?

A

a higher expected return

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9
Q

CAPM states that securities with higher risk will have what?

A

lower market prices than securities with less risk

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10
Q

what is CML?

A

capital market line aka “CML”
to evaluate and measure the expected returns of a diversified portfolio relative to the expected returns of the market and the expected risk-free return
Also measures the standard deviation of the portfolio relative to the standard deviation of the market
NOT based on alpha or beta

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11
Q

what is SML?

A

A further derivative measure is used to measure the expected return of a single security based on its beta relative to the expectations of the market and risk-free rate of return
Is partially computed based on the beta of the single security in question

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12
Q

what is Capital risk?

A

Is the risk the investor may lose all or part of the capital they invested

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13
Q

what is Market risk?

A

Aka “systematic risk”

It is the risk that is inherent in any investment in the markets

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14
Q

what is Nonsystematic risk?

A

It is the risk that permits to one company or industry
EXAMPLE
The problems that the tobacco industry faced a few years ago would not have affected a computer company

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15
Q

what is Legislative risk?

A

Is the risk that the government will do something that adversely affects your investment
EXAMPLE
Beer manufacturers probably did not fare too well when the government enacted prohibition

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16
Q

what is Timing risk?

A

Is the risk that an investor will buy and sell at the wrong time

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17
Q

what is Credit risk?

A

Is the risk of default inherent in debt securities

Can lose money if the issuer defaulted and can not pay the interest or principal payments owed to the investor

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18
Q

what is Reinvestment risk?

A

When interest rates decline and higher yielding bonds have been called or have matured, investors will not be able to receive the same return given the same amount of risk
The reinvestment risk and the investor is forced to either accept the lower rate or must take more risk to obtain the same rate

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19
Q

what is Interest rate risk?

A

Is the risk that the price of bonds will fall as interest rates increase

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20
Q

As interest rates increase what happens to bonds?

A

The value of existing bonds fall and may subject the bondholder to a loss if they need to sell the bond

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21
Q

what is Call risk?

A

Is the risk that if interest rates decline, higher yielding bonds and preferred stocks will be called and investors will be forced to reinvest the proceeds at a lower rate of return or at a higher rate of risk to achieve the same return
Call risk only applies to preferred stocks and bonds with a call feature

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22
Q

what is Opportunity risk?

A

Investors who hold long-term bonds until maturity must forgo the opportunities to invest that money in other potentially higher yielding investments

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23
Q

what is Liquidity risk?

A

Is the risk that an investor will NOT be able to liquidate their investment when they need to or that they will not be able to liquidate their investment without adversely affecting the price

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24
Q

Alpha is what?

A

is its projected independent rate of return

The difference between an investment’s expected (benchmark) return and its actual return

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25
Portfolio managers whose portfolios have positive alphas are what?
Are adding value through their asset selection The outperformance measured by alpha indicates the portfolio manager is adding additional return for each unit of risk taken on the portfolio
26
what is Negative alpha?
Is underperformance of a portfolio manager
27
what is Beta?
A stock’s beta is its projected rate of change relative to the market as a whole If the market was up 10% for the year A stock with a beta of 1.5 could reasonably be expected to be up 15%
28
If the question ON THE TEST provides you with a risk-free return, you must do what?
subtract the risk-free return from the market return to determine the risk premium From there, multiply the beta times the risk premium and add back the risk-free rate to predict the precise expected return for the security or portfolio EXAMPLE If using the same example of a stock with a beta of 1.5 and a market return of 10%, you are provided with the risk-free rate of 1% for the 90-day T-bill, your calculation would be as follows: Market return - risk-free rate = risk premium Then, answer x beta 10 - 1 = 9, 9 x 1.5 = 14.5%
29
A stock with a beta higher than 1 means what?
Has a higher level of volatility than the market as a whole | is considered to be more risky that the overall market
30
A stock with a beta less than 1 means what?
Is less volatile than prices in the overall market Is considered to be less risky EXAMPLE Utility stock is an example of a low beta stock
31
A security’s beta measures what?
its non-diversifiable or systematic risk
32
For each incremental unit of risk an investor has to take on, they must be compensated with what?
additional expected returns
33
Sharpe ratio can measure a portfolio’s what?
risk-adjusted return
34
If two portfolios both return 8%, but portfolio A contains dramatically more risk than Portfolio B, then what?
B is much better investment choice
35
The Sharpe ratio will tell an investor what?
how well they are being compensated for the investment risk they are assuming
36
Sharpe ratio formula
(portfolio’s return - risk free return) / portfolio’s standard deviation
37
what is R-squared?
It is the degree to which a portfolio’s performance is designed to mirror the return of a standard benchmark or index
38
A portfolio will have an R-squared reading of 100 if...
If the portfolio has 100% of its assets tied to the index such as an index fund The performance of the portfolio woll mirror the performance of the index
39
The higher the R-squared reading means?
The higher the degree of correlation to the index Will have a more accurate beta coefficient Resulting with the volatility of the portfolio will be more predictable
40
what are the Values range for R-squared?
0-100
41
beta measures what?
systematic risk in the price volatility of a security relative to the market as whole.
42
Standard deviation measures what?
both systematic and unsystematic risk in the volatility of the return of a security versus its expected return
43
what is Modern portfolio theory?
States that the expected rate of return for an investment is the sum of its weighted returns An investment’s weighted return is its possible return multiplied by the likelihood of that return being realized
44
what is Standard deviation?
Is the measurement of the distribution of an investment's varying expected returns
45
The wider the distribution of an investment’s expected returns...
The greater its standard deviation
46
Investments with higher standard deviations contains what?
more risk than investments with lower standard deviations
47
As investment results are plotted over time there is how much chance that its actual return will be within two standard deviations of its expected return? and how much chance that it will be within one standard deviation of its expected returns?
95% chance that its actual return will be within two standard deviations 67% chance that it will be within one standard deviation of its expected returns
48
what is the Monte carlo simulation?
it is a strategy that Portfolio managers will use simulations to examine the possibilities of various portfolio strategies
49
The dollar today is worth more or less than the dollar tomorrow?
more
50
Investors can determine the future value of a sum invested if they know what?
the interest rate, time horizon and compounding schedule
51
The future value of a sum invested today can be determined by using this FORMULA
``` FV = PV (1 + R)^T FV = future value PV = present value R = interest rate T = number of compounding periods for which the money will be invested ```
52
The future value of the investment will increase as the number of compounding periods increases or decreases?
increases
53
An investor can also determine the present value of a future payment by using the following FORMULA
``` PV = FV/(1 + R)^T FV = future value PV = present value R = interest rate T = number of compounding periods for which the money will be invested ```
54
what is iteration?
Investors also use the present value and future value to determine an investment’s internal rate of return through this process
55
Internal rate of return (IRR) takes into consideration what?
the time value of money and all of the future cash flows generated by as investment
56
what is the annualized effective compound rate of return?
Internal rate of return (IRR)
57
When evaluating an investment in a debt security the IRR is equal to what?
the bond’s yield to maturity
58
An investor would NOT use the IRR calculation to evaluate an investment in an equity security because why?
dividends may be stopped or reduced and equity securities have no maturity date
59
IRR is a discount rate that results in the future value and the present value being what?
equal
60
The higher the IRR means what to the investor?
The more attractive the investment
61
Portfolio managers and business operators can use the IRR calculation to measure what?
an investment’s or project’s IRR against their desired rate of return to determine if the investment meets their desired rate of return to determine if the investment meets their requirements
62
Any contribution or withdraw by the investor will have an impact on the overall account so the investor should evaluate the performance by using what kind of method?
the dollar-weighted return
63
what method can be used to determine the IRR of the portfolio by taking into consideration the cash flows in and out of the account?
the dollar-weighted return method
64
If the investor will not be making additional contributions or making withdrawals the investor may use what kind of method to determine the IRR of the portfolio?
the time-weighted return method
65
what is the measure of the Total return?
All dividend or interest cash flow must be taken into consideration
66
If the investment has increased in value...
The sum of the cash flow is added to any capital appreciation The additional cash flow will cause the total return to be higher
67
If the security has fallen in value...
The total of the cash flow may partially or totally offset the loss of value of the security in question
68
The total return from any cash flow plus or minus any capital appreciation or depreciation realized during the time the investment was held equals what kind of return?
the holding period return
69
Once the holding period return has been calculated it can then be used to determine the what?
annualized rate of return
70
Annualized return will allow investors to compare what?
the investment’s return against the performance of relevant benchmarks
71
If a security was held for less than 1 year for an Annualized return its results would have to be what?
multiplied to determine an annualized rate of return
72
If the holding period for an Annualized return was more than 1 year the results would have to be what?
divided to determine the annualized rate of return
73
SIA common stock appreciated 8% over an 18 month period and paid a 2% cash dividend over the 18 months What is the total return? holding period return? annualized return?
The total return in this case would be 10%, found by adding the 2% in cash flow to the 8% appreciation The holding period return would be 10% over the 18 months during which the investment was held The annualized return would be 6.66% found by dividing the 10% return by 1.5 as 18 months equals 1.5 years 10 / 1.5 = 6.66
74
what is Modern portfolio theory?
As money management developed over the last century, analysts began to shift their focus from the returns available from individual investments to the returns available from an entire portfolio aka “modern portfolio theory” It is based on the concept that investor are risk averse
75
Modern portfolio theory divides asset classes into 3 main categories?
Stocks Bonds Cash and cash equivalents
76
what is the efficient frontier?
Portfolio managers can construct portfolios based on various allocations over the 3 main asset classes whose return will be the greatest given each unit of risk
77
for the Modern portfolio theory, any portfolio whose returns are expected to be less than optimal is said to be operating how?
behind the efficient frontier
78
Optimal portfolio performance will be achieved by constructing a portfolio how?
whose securities prices move independently of one another or whose prices move inversely to one another
79
what does Strategic allocation mean?
Means allocating a client’s assets over various asset classes to achieve a given investment objective
80
Asset rebalancing can be divided into which 2 categories?
Systematic rebalancing | Active rebalancing
81
Systematic rebalancing is designed to do what?
to keep the original asset allocation model in place EXAMPLE If a client’s portfolio is designed to be 70%/25%/5% in stocks, bonds and cash respectively, as the percentages shift, the portfolio manager would rebalance the assets to maintain the original percentages
82
when is Systematic rebalancing performed?
Can be done at regular intervals such as quarterly or whenever the asset allocation shifts by a certain percentage, such as by 5% or more
83
Active rebalancing assumes that a portfolio manager can do what?
can effectively shift the asset allocation to take advantage of the shifts in the performance of the various asset classes EXAMPLE If an investor has the same original portfolio allocation (70%/25%/5%) and the portfolio manager thought that the bond market would outperform all other investments, they may use tactical rebalancing to rebalance as 40%/55%/5%
84
investors may elect to employ what kind of strategy and let the allocations go where they may which would reduce transaction costs and tax consequences?
a buy-and-hold
85
On the EXAM you may be required to predict portfolio income by estimating the amount of time it will take to exhaust the principal in an investment account using which factors? and how will you do it?
given a certain interest rate and a fixed withdrawal Since we do not have a calculator in the exam, the number of years must be approximated by calculating the interest on the declining balance and working the numbers out over time
86
for perpetual income accounts, if the investor knows the desired income level to be provided and the interest rate the account will generate, what may be calculated?
the lump sum needed to fund the account
87
To determine the lump sum needed (FORMULA)
Annual income benefit / annual interest rate EXAMPLE If an investor wanted to generate a monthly income of $2000 in perpetuity the annual income benefit would be $24000. If the investor was placing the money in an account with a fixed rate of 6%, then the investor would have to place $4000,000 in the account $24,000 / .06 = $400,000
88
what is the Rule of 72?
Will tell an investor how many years it will take for the principal of the account to double in value
89
Rule of 72 assumes that the interest or earnings of the account are what?
compounded
90
Rule of 72 formula?
72 / interest rate that will be earned EXAMPLE An investor who has $10,000 invested at an annual rate of 8% would like to know when the value of the account will reach $20,000. The answer is found by: 72 / 8 = 9 years
91
The rule of 72 can also be used to calculate what?
the rate of return on an investment given an initial value and a current value over time EXAMPLE If an investor placed $10,000 into an account 12 years ago and the value of that account has grown to $40,000, then the value has doubled twice. The compound rate of return can be found by: 72 / the time it took for the account to double twice Since the account doubled twice in 12 years, it therefore doubled once in 6 years 72 / 6 = 12%

Series 65 (7 decks)

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