EXAM #2 – Definitions (CHAPTERS 4, 5, 8, 9, & 11) Flashcards
1
Q
Financial Statement Analysis
A
the process of calculating financial ratios and comparing the actual ratios to industry established benchmarks.
2
Q
Balance Sheet
A
a statement of financial position that represents the accounting for items the client owns (assets) and items that are owed (liabilities). The balance sheet provides a snapshot of a client’s assets, liabilities and net worth as of a stated date.
3
Q
Assets
A
a balance sheet category that represents anything of economic value that can ultimately be converted to cash.
4
Q
Personal Use Assets
A
a balance sheet category that includes those assets that help to maintain the client’s lifestyle.
5
Q
Investment Assets
A
a balance sheet category that includes appreciating assets or those assets being held to accomplish one or more financial goals.
6
Q
Cash and Cash Equivalents
A
a balance sheet category that represents assets they are highly liquid, which means they either are cash or can be converted to cash within the next 12 months with little to no price concession from the principal amount invested.
7
Q
Liabilities
A
a balance sheet category that represents client financial obligations that are owed to creditors.
8
Q
Short-term Liabilities
A
represent those obligations that are current in nature or due within the next 12 months.
9
Q
Long-term Liabilities
A
financial obligations owed that are due beyond the next 12 months. Long-term liabilities are usually the result of major financial purchases and resulting obligations that are being paid off over multiple years (house, vacation, boat, student loan, etc).
10
Q
Net Worth
A
a balance sheet category that represents the amount of total equity (assets - liabilities = net worth) a client has accumulated.
11
Q
Savings Contributions
A
an income statement category. Examples of savings contributions include 401(k) plans 403B plans, IRAs, education, savings, and any other type of savings account.
12
Q
Income
A
for tax purposes, is broadly defined, and means the gross amount of money in the fair market value of property services or other accreation to wealth received, but it does not include borrowed money or a return of invested dollars.
13
Q
Monte Carlo Analysis
A
a mathematical simulation to determine the probability of success of a given plan. Monte Carlo analysis is useful for financial players to help measure the probability of assumptions being true or false.
14
Q
Sensitivity Analysis
A
a tool used to understand the range of outcomes for each variable in a retirement plan. It rotates each variable toward the undesirable student side of the risk to determine the impact of a small change in that variable on an overall plan.
15
Q
Fair Market Value
A
the price a willing buyer and willing seller would agree to when both have reasonable knowledge of the fact of the transaction and neither is under any compulsion to buy or sell.
16
Q
Returned on investments (ROI) Ratio
A
a critical performance ratio as it measures the compounded rate of return on a client’s investments.
17
Q
Return on Assets Ratio
A
this ratio measures total asset returns. This ratio must be used cautiously when the client is adding assets that leveraged with debt.
18
Q
Savings Rate
A
a rate calculated by taking gross savings in dollars (including employee, elective referrals into 401(k) 403B and 457 plans plus any employer match) and any other savings divided by gross pay.
19
Q
Debt-to-total-assets Ratio
A
indicates what percentage of assets is being provided by creditors. The lower this ratio, the better as it indicates that the assets owned to have a low amount of debt owed.
20
Q
Housing Ratio 1
A
this way shall established by the bank industry reflects the proportion of gross pay on an annual or monthly basis that is devoted to housing (principal, interest, taxes, and insurance). It does not include utilities, lawn, care, maintenance, etc. The benchmark for HR one is less than or equal to 28%.
21
Q
Housing Ratio 2
A
also referred to as HR 1+ all other debt. This ratio was established by the banking industry to determine if the total amount of that is appropriate for a given level of income. If housing ratio 2 is met, the borrower will likely qualify for a conventional loan. The benchmark for HR2 should be less than equal to 36% of gross pay on a monthly or annual basis.
22
Q
Current Ratio
A
measures how many times the client can satisfy their short-term liabilities with current assets (cash or cash equivalents).
23
Q
Emergency Fund Ratio
A
measures how many months of non-discretionary expenses the client has in the form of cash and cash, equivalent or current assets.
24
Q
Liquidity Ratio
A
these ratios measure the ability to meet short-term obligations.
25
Debt Ratios
measure how well the client is managing the overall debt structure.
26
Ratios for Financial Security Goals
these ratios assess the progress of the client is making towards achieving long-term financial security goals.
27
Performance Ratios
these ratios determine the adequacy of returns on investments.
28
Horizontal Analysis
list each financial statement item as a percentage of a base and creates a trend over time.
29
Ratio Analysis
the process of calculating key financial ratios for a client comparing those metrics to industry benchmarks, and then making an evaluation regarding any deficiencies.
30
Vertical Analysis
list each line item on the income statement as a percentage of total income and present each line item on the balance sheet as a percentage of total assets. The restated percentage is known as a common size income statement or balance sheet.
31
Annuity Method
determines how much a client needs to fund a retirement based on the assumption that the person will die exactly at the assumed life expectancy with a retirement account balance of zero.
32
Capital Needs Analysis
the process of calculating the amount of investment capital needed at retirement to maintain a pre-retirement lifestyle and mitigate the impact of inflation during the retirement years.
33
Capital Preservation Model
a capital needs analysis method that assumes that the clients life expectancy the client has exactly the same account balance as they did at the beginning of retirement.
34
Capitalization of Earnings Model
a capital needs analysis method based on producing a perpetual stream of income.
35
Monte Carlo Analysis
a mathematical tool used to calculate the success of an individual retirement portfolio using changing variables.
36
Purchasing Power Preservation Model
a capital needs analysis method I assume that at a client’s life expectancy, the client will have a balance with purchasing power equal to the purchasing power at the beginning of retirement.
37
Pure Annuity Concept
the basic capital needs analysis approach, which is generally prepared on a pre-tax basis.
38
Retirement Funding
the process of calculating the amount of investment capital needed and retirement to maintain the pre-retirement lifestyle and mitigate the impact of inflation during the retirement years.
39
Retirement Life Expectancy (RLE)
the time period beginning at retirement and extending until death; the RLE is the period of retirement that must be funded.
40
Retirement Needs Analysis
process of determining how much money a person needs to accumulate to be financially independent during retirement
41
Remaining Work Life Expectancy (RWLE)
the work period that remains at a given point in time before retirement.
42
Sensitivity Analysis
a tool used to understand the range of outcomes for each variable in a retirement plan. It rotates each variable toward the undesirable side of the risk to determine the impact of a small change in that variable on an overall plan.
43
Suitability
having a reasonable basis to believe that a recommended transaction or investment strategy is appropriate for a client, after considering the client’s age, other investments, financial situation needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, and other relevant issues.
44
U.S. Personal Savings Rate
the average saving amount in the U.S. calculated as personal savings as a percentage of disposable personal income.
45
Wage Replacement Ratio (WRR)
an estimate of the percent of income needed at retirement compared to earnings prior to retirement.
46
Work-Life Expectancy (WLE)
the period of time a person is expected to be in the workforce – generally 30 to 40 years.
47
Aggressive Growth Funds
typically invest in small-cap stocks, where price appreciation is the primary objective.
48
Alpha
the difference between the actual return generated by the fund relative to the expected return gives the level of riskiness of the fund, as measured by beta.
49
Arithmetic or Average Return (AR)
the sum of all returns divided by the number of periods.
50
Asset Allocation
the dividing of a portfolio to various asset classes.
51
Balanced Funds
typically invests in both fixed-income securities and equity securities.
52
Beta
a measure of systematic risk that provides the correlation of the volatility of a portfolio as compared to the market benchmark.
53
Bonds
a debt issuance where the bond issue makes a promise to make periodic coupon payments (interest) and repayment of the par value (principal) at maturity.
54
Business Risk
the inherent risk of doing business in a particular industry.
55
Calls
gives the holder the right to buy the underlying security at a certain price by a certain date.
56
Call Risk
the risk that a bond will be retired early by the issuing company.
57
Capital Asset Pricing Model (CAPM)
informs investors about a reasonable required return for shareholders when investing in individual stocks, but the model is easily applied to mutual funds. The required return is based on risk, free rates of interest, expected market returns, and the level of systematic risk of the fund or portfolio.
58
Capital Market Line (CML)
the macro aspect of the capital asset pricing model (CAPM). It specifies the relationship between risk and return in all possible portfolios.
59
Close-ended Investment Company
any type of investment company that trades on stock market exchanges. Closed-end funds do not journal issue additional shares after their initial following.
60
Coefficient of Determination
a measure of how much return is a result of the correlation to the market or what percentage of a security’s return is a result of the market.
61
Constant Growth Dividend Discount Model
values a company’s stock by discounting the future stream of cash flows or dividends.
62
Corporate Bonds
bonds issued by firms to raise capital to fund ongoing operations, retire debt, fund capital projects, or acquisitions.
63
Correlation Coefficient
measures the movement of one security relative to that of another security.
64
Country Risk
the risk of of political and economic stability or insta polity of a country that a company faces when doing business in a particular country.
65
Covariance
the measure of two securities when combined and their interactive risk (relative risk).
66
Debt
the lending of funds in return for periodic interest payments and the repayment of the principal debt obligation.
67
Default Risk
the risk that a company may not be able to make interest or principal payments under a debt obligation.
68
Efficient Frontier
compares various portfolios based on their risk-return relationship. An efficient portfolio provides the highest amount of return for any given level of risk.
69
Equity
represents ownership in a business or property.
70
Equity Mutual Fund
typically invests in equity securities.
71
Exchange Rate Risk
the risk that international investments and domestic companies that import or export goods are subject to changes in relationship to the price of a dollar, relative to foreign countries.
72
Exchange Traded Funds (ETFs)
a form of an investment company that invests in securities that are included in a particular index.
73
Executive Risk
the risk of moral character of the executives running the company. The extent to which executives break laws, regulations, or ethical standards that may negatively impact a company.
74
Effective Annual Rate
an investment's annual rate of return when compounding occurs more than once per year.
75
Expected Return
the rate of return expected for an asset or investment portfolio.
76
Financial Risk
the amount of leverage companies use in its capital structure. Leverage is a measure of the amount of debt the company uses to capitalize the business.
77
Fixed Income or Bond Funds
typically invest in bonds of various maturities.
78
Futures Contracts
a commitment to deliver an amount of a certain item as a specified date at an agreed-upon price.
79
General Obligation Bonds
bonds backed by the tax authority that issued the bonds. The bonds are repaid through taxes and are collected by the municipality.
80
Geometric Return (GR)
a time-weighted compounded rate of return.
81
Global Funds
not only invest in foreign securities and markets, but also in US domestic securities.
82
Government or Regulation Risk
the potential risk that a country may pass a law or regulation that negatively impacts a particular in industry.
83
Growth and Income Funds
invest in both equities and fixed-income securities. However, a much larger percentage of the fund is allocated to equities.
84
Growth Mutual Funds
typically invest in large and make up stocks, where price appreciation is the primary objective.
85
Holding Period Return (HPR)
represents the total return for an investment portfolio over the period of time the portfolio was held by an investor.
86
Income Funds
typically invest in corporate and government bonds.
87
Index Funds
purchases a basket of stocks to match or replicate the performance of a particular market index.
88
Information Ratio (IR)
Measures the access return above a benchmark, such as the S&P 500, per unit of risk.
89
Internal Rate of Return (IRR)
a compounded annual rate of return. IRR allows for the comparison of projects or investments with different costs and cash flow. The rate that equates the PV of a series of cash flow to an initial investment.
90
Interest Rate Risk
the risk that changes in interest rates will inversely impact both equities (stocks) in fixed income securities (bonds).
91
International Funds
invest in securities and firms that are outside of the US domestic market.
92
Investment Companies
financial service companies that sell shares to the public and use the proceeds to buy portfolios of securities. Mutual funds are one type of investment company where investors buy shares in a fund and own a pro-rata portion of the investment portfolio, time leads them to a share of capital gains, interest, and dividend income.
93
Investment Planning Process
comprised of steps of financial planner and client followed to build an investment portfolio designed to accomplish the clients investment goals.
94
Investment Policy Statement
a written document that specifically identifies an investor’s investment goals and the strategies and parameters that will be employed to reach the goals.
95
Jensen’s Alpha
an absolute risk-adjusted performance measurement.
96
Market Risk
the risk that in the short term, the daily fluctuations of the market tend to bring all securities in the same direction.
97
Modern Portfolio Theory
a set of principles, ideas, and theoretical models developed to help investors make efficient informed portfolio decisions.
98
Money Market Mutual Funds
Invest in short-term government securities, certificates of deposit, commercial paper, and bankers acceptances.
99
Municipal Bonds
bonds issued to fund projects and spending for state or local governments. The three primary types of meeting pons or general obligations bonds, revenue bonds, and private activity bonds.
100
Normal Distribution
describes how returns are dispersed around the average return.
101
Open-end Investment Company
also referred to as a mutual fund, is an investment company where investors purchase their shares from sell them back to the mutual fund itself.
102
Options
include both calls and puts.
103
Private Activity Bonds
bonds issued to finance a joint project between the private sector and a municipality. Private activity bonds are often issued to fund the building of professional sports stadiums.
104
Price Earnings (PE) Approach
valuing equity securities is an earnings-based valuation model that places a premium on the amount investors are willing to pay for each dollar earnings.
105
Purchasing Power Risk
the risk of inflation will cause prices to increase in a dollar today will not be able to purchase the same amount of goods and services tomorrow.
106
Puts
Gives the holder the right to sell the underlying security at a certain price by a certain date.
107
Real Estate Investment Trusts (REITs)
any type of mutual fund that pulls investor contributions to purchase real estate or make construction or mortgage loans.
108
Reinvestment Rate Risk
the rest and the investor will not be able to reinvest income receipt from current investments at the same rate for return as the current investment return.
109
Revenue Bonds
Bonds issued to raise capital to fund a particular revenue-generating project. The revenue generated by the project will be used to repay the bond issuance.
110
Risk-adjusted Performance Measures
Sharpe, Treynor, or Jensen's Alpha, which can be used to measure the performance of any type of investment including stocks, bonds, and mutual funds.
111
Risk Tolerance Questionnaire
evaluates a client’s willingness to take risk by addressing risk issues.
112
Sector Fund
restricts investments to a particular segment of the market. For example, technology, healthcare, telecommunications, financial, and pharmaceutical.
113
Security Market Line (SML)
the relationship between risk and return is defined by the CAPM (when geographically plotted).
114
Semivariance
measures the possibility of returns below the average. Therefore, semivariance is a measure of downside risk.
115
Sharpe Ratio
a relative risk-adjusted performance indicator, meaning the ratio by itself does not provide any insight. A sharpe ratio for one fund needs to be compared to the sharpe ratio for another fund to take on meeting.
116
Small, mid, and large-cap funds
may have an objective regarding the size of a firm’s market capitalization.
117
Socially Responsible Funds
restrict their investments to firms are a good corporate assistance, and do not operate an industry such as alcohol, gambling, or tobacco.
118
Standard Deviation
measures the toll risk of an investment
119
Treynor Ratio
a relative risk-adjusted performance indicator. A Treynor ratio for one fund requires comparison to the Treynor ratio for another fund.
120
Unity Investment Trusts (UIT)
an investment company that passively manages a portfolio of either bonds or stocks, known as a bond or equity UIT.
121
Unsystematic Risk
represents the risk that can be diversified away by combining multiple stocks from multiple industries into one portfolio.
122
U.S. Government Bonds
bonds issued by the US government to finance the national debt to fund deficit spending. The three primary types of bonds issued by the US government are treasury bills, treasury notes, and treasury bonds.
123
Value Funds
typically invest in securities that are deemed to be out of favor or extremely undervalued. They generally have a lower PE ratio than growth funds.
124
Warrants
a long-term option that gives the holder of the right to buy a certain number of shares of stock in a particular company by a certain date
125
Weighted Average Return (WAR)
based on the dollar amount or percentage of a portfolio invested in each asset. Investment with a larger allocation or rating will contribute more to the overall return of the portfolio.
126
Zero-coupon Bonds
Bonds sold at a deep discount to par value and do not pay periodic interest payments. Instead, the bonds increase in value each year so that at maturity, the bonds are worth more than their par value.
127
Zero Growth Dividend Model
values a security based on the stock’s capitalized amount of the annual dividends.
128
American Opportunity Tax Credit (AOTC)
the AOC provides a tax credit of up to $2500 per student for the first four years of qualified education expenses for post-secondary education.
129
College Savings Plan
a plan that allows for college savings on a tax-deferred basis with attendance at any eligible education institution. Distributions from a college savings plan are federal and state income tax-free, as long as they are used to pay for qualified education expenses.
130
Coverdell Education Savings Account (ESA)
a tax-deferred trust or custodial account established to pay for qualified higher education or qualified elementary/secondary school expenses.
131
Education Funding Needs Analysis
determination of the lump sum or annual savings required to pay for college.
132
Employer-provided Education Assistance Program
a program established by an employer to reimburse employees for education expenses. The education expenses may or may not be directly related to the employee's current job duties; it depends on the employer’s policy.
133
Free Application for Federal Student Aid (FAFSA)
a form used to determine a student's eligibility for all types of financial aid, including grants, work-study, and loans. The FAFSA is used to determine the expected family contribution amount (EFC, before 2023; student aid index (SAI) beginning in 2023).
134
Federal Pell Grant
need-based financial aid for students who have not earned an undergraduate degree or a professional degree. A Pell Grant does not have to be repaid. Pell Grants are awarded based on financial need.
135
Federal Perkins Loan
Federal Perkins Loan – a program for undergraduate and graduate students with exceptional financial need. The Perkins loan is a low-interest rate loan (5%) that was offered through universities’ financial aid offices. The university serves as the lender and the federal government provides the funds. No new Perkins loans are available after September 30, 2017.
136
Federal Supplemental Education Opportunity Grant (FSEOG)
a grant awarded to students with exceptional financial need. Pell Grant recipients with the lowest EFC are considered first for an FSEOG.
137
Federal Work-Study (FWS)
jobs on campus or off campus for undergraduate or graduate students to help students pay for their education expenses. To be eligible, students must have financial need.
138
Fellowships
paid to students for work, such as teaching while studying for a master's degree or conducting research while working towards a doctorate of philosophy degree. Fellowships can last anywhere from a few weeks to a few years, depending on the depth and level of work involved.
139
Graduate PLUS Loans
loans for students seeking graduate and professional degrees. A graduate PLUS loan is based on the student’s credit history and is not based on financial need.
140
Grants
money provided to students for post-secondary education that does not require repayment.
141
Lifetime Learning Credit
provide a tax credit of up to $2000 per family for an unlimited number of years of qualified education expenses. Qualifying education expenses must be related to a post-secondary degree program or to acquire or improve job skills.
142
PLUS Loans
loans for parents to borrow to help pay for a dependent’s undergraduate education expenses. PLUS loans are not based on financial need but require that the parent does not have any adverse credit history.
143
Prepaid Tuition Plans
a plan that will allow a parent to purchase college credits today and use those credits when the child attends college.
144
Qualified Tuition Plans
a plan that allows families to save for education expenses on a tax-deferred basis. Section 529 of the IRC authorizes states and educational institutions to adopt qualified tuition plans. The two types of qualified tuition plans are prepaid tuition and college savings plans.
145
Scholarships
a grant or financial assistance made available to students to assist with the payment of education-related expenses. Scholarships are available for academic or athletic achievement. Scholarships can be provided to undergraduate or graduate students.
146
Teacher Education Assistance for College and Higher Education (TEACH) Grant
a grant that provides up to $4000 per year for students to intend to teach in a public or private elementary, middle, or high school that serves a community of low-income families.
147
Stafford Loans
Stafford Loans – student loans administered by the US Department of Education.
148
Uniform Gift to Minors Act (UGMA)
allows minors to own cash or securities. The UGMA/UMA accounts are governed by state law that requires the custodian of the account, usually a parent or guardian, to manage the account for the benefit of the minor child.
149
Uniform Transfer to Minors Act (UTMA)
allows minors to own cash, securities, and real estate. The UGMA/UTA account accounts are governed by state law that requires the custodian of the account, usually a parent or grandparent, to manage the account for the benefit of the minor child.
150
U.S. Government Series EE and Series 1 Bonds
bonds that can be redeemed to pay qualified education expenses and the interest earned on the bonds is excluded from taxable income. For purposes of excluding interest, income, using US government, savings, bonds, qualified education, expenses, include tuition, and fees, but do not include room and board.
151
Personal risk management
a systematic process for identifying, evaluating, and managing pure risk exposures faced by an individual.
152
Pure risk
a risk for which there is a possibility of loss, but no possibility of gain. The possibility of a home being damaged or destroyed by a fire is an example of a pure risk. Most pure risks are insurable.
153
Personal risks
a risk that may cause the loss of income (untimely death, disability, health issues) or alternatively, cause an increase in the cost of living (disability, health issues).
154
Loss frequency
the expected number of losses that will occur within a given period of time.
155
Loss Severity
the potential size or financial damage of a loss.
156
Risk Avoidance
avoiding inactivity, so that a financial loss cannot be incurred.
157
Risk Reduction
implementing activities that will result in the reduction of the frequency and/or severity of losses.
158
Risk Retention
the state of being exposed to a risk and personally retaining the potential for loss.
159
Risk Transfer
transferring or shifting the risk of loss through means such as insurance or a warranty.
160
Perils
the approximate or actual cause of a loss such as fire liability or accidental death.
161
Moral Hazard
a character, flaw or level of dishonesty in individual possesses that causes or increases the chance for a loss.
162
Physical Hazard
a tangible condition or circumstance that increases the probability of a peril occurring and or the severity of damages that result from a peril.
163
Human Life Value Method (HLV)
a method that uses projected future earnings after taxes and individual consumption to determine the family share of earnings (FSE) as the basis for measuring life insurance needs.
164
Life Insurance
at its most basic is income replacement insurance via the death benefits paid upon the death of the insured.
165
Financial Needs Method
a method that evaluates the income replacement and lump sum needs of survivors in the event of an income producers’ untimely death.
166
Capitalization of Earnings Method
a method that preserves the capital and initially uses a numerator of gross income and denominator of restless rate of return to determine life insurance needs. It could be further adjusted to account for taxes, personal consumption and inflation.
167
Disability Insurance
insurance that provides replacement income to the insured while the insured is unable to work because of sickness (illness) or injury (accident).
168
Homeowners Insurance Coverage
a package policy, covering dwelling, dwelling extensions (garage), personal property, loss of use, medical payments for others, and liability.
169
Personal Automobile Policy (PAP)
a package policy that protects against loss due to damage to be owned automobile, damage to the property of others, and bodily injury to be insured, family, members, and others.
170
Personal Liability Umbrella Policy (PLUP)
a policy usually sold in millions of dollars of coverage ($1M, $3M, $5M) and provides access to liability coverage and legal defense, for liability claims that may arise, and that exceed the limit limits of the underlying homeowners and automobile policies.
