Chapters 1-5 Flashcards
Real Return
Inflation Adjusted return, adjusting stated (nominal) return gives investor more real assessment of actual return.
Expected Return
Average of distribution of possible returns. Take the probability of each possible return outcome and multiply it by the return outcome and adding both together. Can be used to forecast the future value of a portfolio and acts as a guide to measure actual returns. Built into the CAPM – Capital Asset Pricing Model and calculates the expected return.
Risk Adjusted Return
Assesses if the amount of risk is comparable with the risk taken.
Current Yield
Divide annual interest payment by current market price
Return on Investment
Measure of performance adding all the dividends, interest, return of principal, and capital gains together then divide by the number of years held then divide by original investment amount. (Div, int, cap gain, return of prin / years held / original inv $)
Holding Period Return
Return for the period of time the investment was actually held. Particularly for investments held short term.
Annualized return
(Average Return) Geometric rate of return over any given period into an annual basis. Provides the average annual return per year over that holding period.
Risk Free Rate of Return
Current Rate for 90 day treasury bills typically used for calculations for risk adjusted returns or Sharpe Ratio. (Average return earned in excess of the risk free rate per unit or volatility or total risk)
Total Return
Rate of Return from all sources, including appreciation or depreciation, interest and dividends
Risk Premium
A Higher return expected for taking on greater risk with investing in a growth stock vs. a blue chip or more established company.
Benchmark Portfolio’s
Way to evaluate portfolio returns by comparing them to benchmark index such as the S&P 500, Russell 2000 or EUR AUS and FarEast Index (EAFE)
Yield to Maturity
Rate of return based on actual purchase price of bond, takes any prem or discount into account and uses actual time to maturity for the number of compounding periods. If the bond was purchased at par the YTM would equal stated coupon rate.
Real Interest Rate
Receives this rate after inflation is taken into account. Nominal Int rate = the real interest rate PLUS an inflation premium.
Family Limited Partnership
Used to minimize estate and gift taxes, but must have a legit business purpose (managing real estate, family business, etc.)
C Corp
Pays corporate income tax, and the owners pay personal income taxes on profits received as dividends (double taxation)
S Corp
Suitable for small companies (less than 75 shareholders) that want legal protection of a corporation but flow through of taxation partnerships. *Key word: FLOWssss-through
Limited Liability
Provides owners with protection from debts, but is taxed as a sole proprietorship.
Preservation of Capital
Investor would be concered with safety, invest in Treasury Bills or Money Market Funds.
Current Income
Needs income for living expenses. Invest in high dividend stocks like utilities.
Growth and Income
Invest in a mix of Bonds and Stocks.
Growth
Most concerned with retirement growth. Invest in a diversified stock or mutual fund portfolio. Sector funds.
Speculation
High risk investments with potential of VERY large returns. Rarely an overall portfolio goal but may have a dedicated portion of the portfolio to this goal. Aggressive growth funds and small cap issues would be appropriate.
Cost Basis
Start with original price including transaction costs, add the dollar value of dividends invested that were reinvested. Cost Basis = Original Price + Transaction costs + Dividends. *Stepped UP Cost Basis is applied with inherited stock and is the cost on the date of death.
Corporate Income Taxes
Dividend Exclusion of 70% that applies to Corps that own less than 20% of another company. If the company owns MORE than 20% then the exclusion is 80%. No tax break on Bonds, so companies do not buy them.
Trust Income Taxes
Rev Trusts taxed at grantor’s personal income tax rate-max of 39.6%. Trust is IRREV on Grantor’s death, Grantor has the right to change or terminate trust anytime and can serve as TTEE. IRREV Trusts are taxed at special trust income rates (need a TIN) and will be created during the grantor’s lifetime or contained in a will and become active upon death.
Estate Taxes
Surviving Spouses are not subject to deceased Spouses Estate Tax. Estates valued at LESS than 5.34MM are free from taxes.
Gift Tax
Up to 14k/year to an unlimited number of people. Married couple is 28k/year per beneficiary.
Defined Benefit Plan
Benefits based on a formula of years of service and salary, and an age factor is used as well. Employer makes all contributions, all investment decisions, and bears all the risk.
Qualified Plan
A retirement plan that qualifies for special tax treatment. The investment policy statement is a written document that outlines the plans investment objectives and guidelines
Non- Qualified Plan
The employer cannot deduct their employer contributions.
Defined Contribution Plan
Allocate money to participant’s base on a percentage of each employee’s earnings. Employees can choose their own investment mix and plans may be structured as a Profit sharing plan, 401k, Money Purchase Pension Plan or 403b. *403B is ONLY available to employees of schools, hospitals, and non-profits.
457 Plan
Non-Qualified deferred comp plan established by state and local governments, and tax exempt governments and employers. Eligible employees can salary deferral cont, and earnings grow on tax deferred basis.
Call Risk
interest rates fall, bonds more likely to be called in and reissued at a lower coupon rate.
Reinvestment Risk
Reinvestment of principal after a bond is called or dividends from a high coupon bond being invested in a lower coupon rate.
Credit Risk
bond Issue may not be able to pay expected interest rate pmts or principal.
Interest Rate Risk
If interest rates rise bond prices fall; not concern if holding the bond to maturity.
Purchasing Power Risk
Inflation risk, refers to the possibility as inflation increases the purchasing power of the bond will decrease.
Liquidity Risk
Bond Marketability, certain issues may be less marketable than others
Event Risk
Leveraged buyouts, restructurings, mergers and acquisitions and bankruptcies can have a negative effect on bond prices.
Currency Risk
AKA Exchange risk, only applies to foreign bonds.
Systematic risk
Market risk that the entire market will decline, cannot diversify away.
Beta
Measures stock volatility based on general market movements. Typically, the market as a whole is assigned a beta of 1.0. So, a stock or a portfolio with a beta higher than 1.0 is predicted to have a higher risk and, potentially, a higher return than the market. Conversely, if a stock (or fund) had a beta of .85, this would indicate that if the market increased by 10%, this stock (or fund) would likely return only 8.5%. However, if the market dropped 10%, this stock would likely drop only 8.5%.
Alpha
Measure of stock price volatility based on the specific stock.
Sharpe Ratio
(Total Return – Risk free rate of return) Lower ratio = lower return; higher ratio = higher return.
