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Series 65 > Chapter 8 - Part 2 > Flashcards

Chapter 8 - Part 2 Flashcards

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Series 65 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
Q

Portfolio managers whose portfolios have positive alphas are what?

A

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

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26
Q

what is Negative alpha?

A

Is underperformance of a portfolio manager

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27
Q

what is Beta?

A

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%

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28
Q

If the question ON THE TEST provides you with a risk-free return, you must do what?

A

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%

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29
Q

A stock with a beta higher than 1 means what?

A

Has a higher level of volatility than the market as a whole

is considered to be more risky that the overall market

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30
Q

A stock with a beta less than 1 means what?

A

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

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31
Q

A security’s beta measures what?

A

its non-diversifiable or systematic risk

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32
Q

For each incremental unit of risk an investor has to take on, they must be compensated with what?

A

additional expected returns

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33
Q

Sharpe ratio can measure a portfolio’s what?

A

risk-adjusted return

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34
Q

If two portfolios both return 8%, but portfolio A contains dramatically more risk than Portfolio B, then what?

A

B is much better investment choice

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35
Q

The Sharpe ratio will tell an investor what?

A

how well they are being compensated for the investment risk they are assuming

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36
Q

Sharpe ratio formula

A

(portfolio’s return - risk free return) / portfolio’s standard deviation

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37
Q

what is R-squared?

A

It is the degree to which a portfolio’s performance is designed to mirror the return of a standard benchmark or index

38
Q

A portfolio will have an R-squared reading of 100 if…

A

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
Q

The higher the R-squared reading means?

A

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
Q

what are the Values range for R-squared?

A

0-100

41
Q

beta measures what?

A

systematic risk in the price volatility of a security relative to the market as whole.

42
Q

Standard deviation measures what?

A

both systematic and unsystematic risk in the volatility of the return of a security versus its expected return

43
Q

what is Modern portfolio theory?

A

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
Q

what is Standard deviation?

A

Is the measurement of the distribution of an investment’s varying expected returns

45
Q

The wider the distribution of an investment’s expected returns…

A

The greater its standard deviation

46
Q

Investments with higher standard deviations contains what?

A

more risk than investments with lower standard deviations

47
Q

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?

A

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
Q

what is the Monte carlo simulation?

A

it is a strategy that Portfolio managers will use simulations to examine the possibilities of various portfolio strategies

49
Q

The dollar today is worth more or less than the dollar tomorrow?

A

more

50
Q

Investors can determine the future value of a sum invested if they know what?

A

the interest rate, time horizon and compounding schedule

51
Q

The future value of a sum invested today can be determined by using this FORMULA

A 
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
Q

The future value of the investment will increase as the number of compounding periods increases or decreases?

A

increases

53
Q

An investor can also determine the present value of a future payment by using the following FORMULA

A 
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
Q

what is iteration?

A

Investors also use the present value and future value to determine an investment’s internal rate of return through this process

55
Q

Internal rate of return (IRR) takes into consideration what?

A

the time value of money and all of the future cash flows generated by as investment

56
Q

what is the annualized effective compound rate of return?

A

Internal rate of return (IRR)

57
Q

When evaluating an investment in a debt security the IRR is equal to what?

A

the bond’s yield to maturity

58
Q

An investor would NOT use the IRR calculation to evaluate an investment in an equity security because why?

A

dividends may be stopped or reduced and equity securities have no maturity date

59
Q

IRR is a discount rate that results in the future value and the present value being what?

A

equal

60
Q

The higher the IRR means what to the investor?

A

The more attractive the investment

61
Q

Portfolio managers and business operators can use the IRR calculation to measure what?

A

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
Q

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?

A

the dollar-weighted return

63
Q

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?

A

the dollar-weighted return method

64
Q

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?

A

the time-weighted return method

65
Q

what is the measure of the Total return?

A

All dividend or interest cash flow must be taken into consideration

66
Q

If the investment has increased in value…

A

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
Q

If the security has fallen in value…

A

The total of the cash flow may partially or totally offset the loss of value of the security in question

68
Q

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?

A

the holding period return

69
Q

Once the holding period return has been calculated it can then be used to determine the what?

A

annualized rate of return

70
Q

Annualized return will allow investors to compare what?

A

the investment’s return against the performance of relevant benchmarks

71
Q

If a security was held for less than 1 year for an Annualized return its results would have to be what?

A

multiplied to determine an annualized rate of return

72
Q

If the holding period for an Annualized return was more than 1 year the results would have to be what?

A

divided to determine the annualized rate of return

73
Q

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?

A

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
Q

what is Modern portfolio theory?

A

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
Q

Modern portfolio theory divides asset classes into 3 main categories?

A

Stocks
Bonds
Cash and cash equivalents

76
Q

what is the efficient frontier?

A

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
Q

for the Modern portfolio theory, any portfolio whose returns are expected to be less than optimal is said to be operating how?

A

behind the efficient frontier

78
Q

Optimal portfolio performance will be achieved by constructing a portfolio how?

A

whose securities prices move independently of one another or whose prices move inversely to one another

79
Q

what does Strategic allocation mean?

A

Means allocating a client’s assets over various asset classes to achieve a given investment objective

80
Q

Asset rebalancing can be divided into which 2 categories?

A

Systematic rebalancing

Active rebalancing

81
Q

Systematic rebalancing is designed to do what?

A

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
Q

when is Systematic rebalancing performed?

A

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
Q

Active rebalancing assumes that a portfolio manager can do what?

A

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
Q

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

a buy-and-hold

85
Q

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?

A

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
Q

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?

A

the lump sum needed to fund the account

87
Q

To determine the lump sum needed (FORMULA)

A

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
Q

what is the Rule of 72?

A

Will tell an investor how many years it will take for the principal of the account to double in value

89
Q

Rule of 72 assumes that the interest or earnings of the account are what?

A

compounded

90
Q

Rule of 72 formula?

A

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
Q

The rule of 72 can also be used to calculate what?

A

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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