Exam 3 Flashcards
1
Q
Profits on stock investments are subject to ____ when held in a “regular” investment account
A
Income taxes
2
Q
Stocks held in _____ accounts like 401(k) plans or IRAs, and college saving accounts like 529 plans, are not taxed while ______.
A
Retirement accounts
Inside the accounts
3
Q
In regular investment accounts, investors pay taxes on each of the two components of their return, ___ and ____
A
Dividends
Realized capital gains or losses
4
Q
Common and preferred stock dividends are taxed at:
0% for individuals in the ___ and __ bracket
15% for individuals in the ___, ___, ___, or ___ bracket
20% for individuals in the ___ bracket
A
0% for 10% and 12% bracket
15% for 22%, 24%, 32%, and 35% bracket
20% for 37% bracket
5
Q
There is also a ___ surcharge tax for incomes over ____ for singles and ____ for married couples
A
3.8% surcharge
$200,000 for singles
$250,000 for married couples
6
Q
Individuals must hold the stock for at least ___ days in the 121-day period beginning ___ days before the ex-dividend date, to get the favorable dividend tax rate
A
61 days
60 days
7
Q
Dividends from Real Estate Investment Trusts (REITs) do not qualify for the favorable dividend tax rates, but there is a __% exclusion of REIT dividends from tax, so effectively REIT dividends get taxed at only ___% of the individuals ordinary tax rate
A
20% exclusion
80%
8
Q
Dividends on stocks are taxable by __ and ___ governments that have income taxes
A
State and local governments
9
Q
A capital gain is realized when you sell stock for ___ than you originally ___ for it
A
More
Originally paid
10
Q
The amount you originally pay for a stock is referred to as the ____
A
Cost basis
11
Q
The cost basis of a stock includes the ______ incurred to buy the stock. Similarly, when selling a stock, ___^ reduce the gain subject to tax
A
Brokerage commission
12
Q
Capital gains are taxed only when ___
A
Realized
13
Q
If appreciated stock or mutual fund shares are passed on to heirs upon death, _____ is owed on the gain realized by the deceased
A
NO capital gains tax
14
Q
If Aunt Millie bought a share of Coca-Cola stock for $1 in 1965 and that share is worth $60 on the day that she dies, the $__ profit avoids _____ altogether. The cost basis for the heir receiving the Coca-Cola share is $___. This feature of the tax code is called the “____” at death
A
$59 profit
Capital gains tax
Cost basis is $60
“Step-up in basis”
15
Q
Donation of _____ shares of stock directly to charity that have been held for more than ____, the current market value of the stock can’t be taken as an itemized _____, and capital gains tax is ____.
A
Appreciated
One year
Tax deduction
Avoided
16
Q
Suppose you have 100 shares of stock that you bought four years ago for $5/share, and now the price is $20/share. By giving the 100 shares to charity, the charity gets full use of the $___ worth of stock, you get a $____ tax deduction, and avoid paying tax on the $____ capital gain.
A
$2000
$2000
$1500 capital gain
17
Q
Capital gains are classified as short-term if the asset is held for __ months or less and long-term if held for more than ___ months
A
Short-term assets held for 12 months or less
Long-term assets held for more than 12 months
18
Q
The tax rate on short-term capital gains is the ordinary ______.
The tax rate on long-term gains is the same _____ rate as ______.
A
Ordinary income tax rate
Special lower rate as dividends on common stocks
19
Q
Capital ___ are first deduced against any capital ____, with ___ losses offsetting ___ gains, and ____ losses first offsetting ___ gains.
A
Losses
Gains
Short-term
Short-term
Long-term
Long-term
20
Q
If total capital losses ____ capital gains, then they can be deducted against _____, like wages and salaries, up to $____. If the losses exceed gains by more than $___^ in a single year, the excess can be “___” without limit to future years to offset future capital gains or ordinary income
A
Exceed
Ordinary income
Up to $3000
$3000
“Carried forward”
21
Q
Capital gains or losses on short sales are always considered ____, regardless of the holding period
A
Short-term
22
Q
Two years ago you bought one share of a stock for $30 and now the stock price is $80. You earn a very good living, and have a 35% tax rate on ordinary income. Ignoring commissions, the capital gains tax you owe if you immediately sell the stock is ____
A
$80 - $30 = $50
Capital gains tax rate for assets held more than 12 months is 15%.
$50(.15) = $7.50
$7.50
23
Q
If possible, hold winners for long periods, more than ____ at a minimum, deferring ___ on gains.
A
One year
Taxes
24
Q
Suppose you bought 100 shares of FDX stock for $50/share on July 1, 2017, and the stock is trading for $70/share on July 1, 2018. You are in the 12% tax bracket. If you sell it on July 1, 2018, the holding period is 12 months, so it is a ___ gain. The tax owed is $___. If you wait until July 2, 2018 to sell, and the stock is still trading for $70, the tax owed on the ___ gain is $___.
A
Short-term gain
.12(100)($70-$50)= $240
Long-term gain
(.00)(100)($70-$50)= $0
25
Suppose you purchase a stock for $60 that does not pay dividends, and earns capital gains of 10% per year for 10 years. If you sell the stock after ten years and pay your taxes, and ignore brokerage costs, how much money do you end up with if you are in the 28% tax bracket?
Price of stock after 10 years:
FV = 60(1.1)^10 = $155.62
Since the stock is held more than 12 months, the long-term capital gains tax rate of 15% applies:
Tax= .15($155.62-$60)= $14.34
After taxes you end up with $155.62 - $14.34 = $141.28 after 10 years
$141.28
26
Suppose you invest your $60 in stocks but sell them within 12 months, and then buy other stocks. You repeat this cycle over 10 years. On average, you earn the same 10% per year before tax. If you are in the 28% tax bracket, and ignore brokerage costs, how much money do you end up with?
After-tax return= 10%(1-.28) = 7.2%
If you sell your stocks within 12 months, you pay taxes at 28% each year.
FV= 60(1.072)^10 = $120.25 after-tax after 10 years.
$120.25
$141.28 - $120.25 = $21.03 less than the buy and hold investor
27
Suppose you invest your $60 in stocks but sell them within 12 months, and then buy other stocks. You repeat this cycle over 20 years. On average, you earn the same 10% per year before tax. If you are in the 35% tax bracket, and ignore brokerage costs, how much money do you end up with?
Buy and hold investor vs. Active trader
Buy and hold:
FV = $60(1.1)^20 = $403.65
Tax = .15($403.65 - $60) = $51.55
After-tax, you have $352.10 after 20 years.
Active trader:
After-tax return = 10%(1-.35) = 6.5%
Sell within 12 months, pay 35% each year
FV = 60(1.065)^20 = $211.42 after-tax after 20 years
$352.10 - $211.42 = $140.68 less than the buy and hold investor
28
Sell losers quickly to realize _____: which on stocks can offset ____ on other stocks in a portfolio, or can offset taxes on ____ if there are no ____^ to offset
Capital losses
Realized gains
Ordinary income
Realized gains
29
Suppose you bought 50 shares of Disney for $45 and the price is $30 six months later. If you sell, you realize a short-term loss of $___, saving $___ if you are in the 28% bracket. Assuming a modest 6% annual return, you can earn $___ on the tax savings in the first year
$15 per share loss
.28(50)($15) = $210
Saving $210
6% annual return:
.06($210) = $12.60 on tax savings
30
If you have already realized (or anticipate realizing) both short-term and long-term capital gains in a given year, it is best to sell any _____ losers in your portfolio before they become ____.
Short-term losers
Before they become long-term losers
31
By taking a short-term loss rather than a long-term loss, you can offset short-term gains rather than long-term gains, and thus reduce your total ____.
Tax bill
32
If you sell a stock at a loss, and buy the same stock within a period beginning ___ days before and ending ___ days after the sale, you cannot take a ___ for __ purposes
30 days
30 days
Capital loss for tax purposes
33
Nothing stops you from selling a loser and then buying a ___ stock. If auto stocks are depressed, but you think they will recover, you can sell GM at a loss for ___ purposes, and buy Ford.
Similar
Tax
34
For many people, _____ will be their largest and most important financial investment
Stock mutual funds
35
Mutual fund rating services, like Morningstar and Lipper, classify stock funds into several different categories, based on the _____ objectives and policies. While these classifications are not precise, they give some guidance about ___ and ___.
Fund's stated investment
Risk and potential return
36
These funds buy stocks with high capital gain potential and relatively high risk
Growth
37
___ funds buy ___ stocks, stocks with relatively low P/E and P/B ratios. These stocks often pay higher _____ than growth stocks
Value
Value
Dividend yields
38
These funds buy stocks with roughly the same risk and expected return as the average or typical stock
Blend
39
Large-cap funds buy ___ company stocks, and so forth. Morningstar classifies funds into a 3-by-3 grid, with ___, ___, and ___ on one axis, and ___, ___, and ___ on the other
Large company stocks
Growth, blend, and value on one axis
Large, mid, and small cap on the other
40
Index funds attempt to match the returns of a _____ of stocks
Diversified index portfolio
41
Small stock index
Russell 2000
42
Comprehensive index of virtually all actively-traded stocks in the U.S.
CRSP U.S. Total Market Index
43
Indexing strategy:
You try to do ___ the overall market
As well as
44
Specialize in one sector of the market, such as health care, oil, computers, etc.
Sector funds
45
___ funds invest in the U.S. and abroad, while ___ funds focus only outside the United States
Global
International
46
Fees on international mutual funds are almost always ___ than on domestic funds. This is because trading is usually _____ on foreign stock exchanges than in the United States, and research is more ___ and ___
Higher
More costly
Difficult and costly
47
Younger individuals in particular should consider investing some of their portfolio into ___ stock funds. Emerging markets have considerable ____, though relatively high ___, including ___ and ___ risk
International
Growth potential
Risk
Political and Exchange rate risk
48
A number of stock (and hybrid) mutual funds invest based on social criteria, generally avoiding corporations making tobacco, alcohol, nuclear power, and other products considered undesirable
Socially Responsibly Funds
49
Investment strategy:
Make sure your own ____ is consistent with the fund's stated ____
Risk tolerance
Investment strategy
50
Historical returns:
Look for a fund that earns returns ___ the ___ for its style over the past __ to __ years
Above the average
5-10 years
51
Expenses and loads:
As a rule, choose a ___ fund with ___ expenses
No-load
Below-average
52
Age of fund and tenure of manager:
For an actively-managed fund with a good track record, make sure the manager that earned the high returns is ___. If a new manager is in charge, there is no reason to believe past _____ will persist
Still there
Superior performance
53
Size of fund:
Large stock trades tend to have a significant "____"
Market impact
54
Diversification:
If you hold only one or two stock mutual funds in your overall portfolio, make sure the funds are _____, both in terms of the ____ and ____
Well-diversified
Number of stocks held and industry concentration
55
Tax Efficiency refers to the fund's effectiveness in limiting the ____ of fund shareholders for any given ____ total return
Tax liabilities
Before-tax
56
These funds try to hold appreciated stocks for more than 12 months to get the lower capital gains tax rate, and to hold on for as long as possible thereafter to defer capital gains taxes for shareholders. They also sell losing stocks quickly to realize tax losses
Tax-managed funds
57
Turnover:
High turnover usually produces high ______ and high _____ for fund shareholders
Capital gain realizations
| Tax liability
58
Frequent trading can also ___ returns in a more subtle way, through paying the ____ to buy and sell, and also the "___" of trading
Bid-ask spread
"Market impact"
59
The higher the turnover of a mutual fund, the higher will be the capital gains taxes paid by investors. True or false?
True
60
All else equal, is it better to buy shares in a mutual fund with substantial unrealized short-term capital gains, or a fund with substantial realized short-term capital gains?
Short-term unrealized gain
61
Historically, the typical actively-managed stock fund has _____ broadly-based stock indexes like the S&P 500. A majority of actively-managed funds ___ to beat the index in a typical year
Underperformed
Fail
62
"Survivorship bias" can make overall mutual fund performance look ___ than it ___. Poorly-performing funds are often merged into other ___ or ___
Better than it really is
Funds or liquidated
63
Index mutual funds can effectively own an entire _____ or even the entire ____ for maximum diversification
Market segment
| Stock market
64
Index funds trade infrequently, so incur ____ costs. There is no _____ required, so management and advisory fees are low
Low transaction costs
Investment research
65
Since index funds have ___ turnover, they are more ____ than most other funds
Low
Tax-efficient
66
Index funds have ___ risk of falling below average in its category: Index funds will ______ the index by a ___ fraction because of their operating expenses, but will never ___ badly
Little
Underperform
Small
Underperform
67
In most years, index funds earn a __ return than the average actively-managed fund
Higher
68
Choose stocks with no ___, low ___ and ___, a well-defined _____, and a good ____ record, preferably over ___ years or more
No loads
Low expenses and turnover
Investment strategy
Long-term record
10 years or more
69
Net cash flows into stock funds are ____ correlated with the total return on stocks over the past ___ months
Positively
12
70
In general, after stocks fall, investors ____, and after stocks rise, investors put ____. It makes more sense to employ a contrarian strategy, buying a bit ___ after dips and selling a bit after ____
Bail out
More money in
More
After rises
71
Closed-funds do not continuously ___ their shares for ____
Offer
Sale
72
Closed-fund shares generally are not ____
Redeemable
73
Closed-fund shares trade on a ____
Stock exchange
74
Closed-fund shares are almost always ____ managed
Actively
75
Lousy managers can survive much longer in a ___ fund than in an ___ because investors can't withdrawer their money
Closed-end
Open-end
76
An investment that the fund reasonably expects cannot be sold in current market conditions in seven calendar days without significantly changing the market value of the investment
"Illiquid" security
77
While mutual funds cannot invest more than ___% of assets in "illiquid" securities, ____ funds do not have a limit
15%
Closed-end funds
78
Investment companies that have characteristics of both index mutual funds and closed-end funds
Exchange-traded funds (ETFs)
79
A typical ETF is like an ____ fund that trades on a ____ and are not ____ by individual investors
Index mutual fund
Stock exchange
Redeemable
80
Most stock and bond ETFs are ____ index funds, rather than ___ managed like closed-end funds
Passive
Actively
81
Seek to achieve a daily return that is multiple of the daily return of a securities index
Leveraged ETFs
82
Attempt to achieve a daily return that is an inverse multiple of the daily return of a securities index
Inverse ETFs
83
Leveraged ETFs are high-risk bets on a(n) ___ in the index, and inverse ETFs are high-risk bets on a(n) ___ in the index
Increase
Decrease
84
Cheap way for individuals to hold precious metals
Commodity ETFs
85
ETF premium or discount to NAV is generally quite ___
Small
86
Investors can buy and sell ETFs at ____ during the trading day
Any time
87
Individual investors need a ____ account, and must pay ____ and a ____ for every transaction in an ETF
Brokerage account
Brokerage commissions and bis-ask spread
88
ETFs rarely realize capital ______ on ETF shares. This is a ___ thing for investors, as they control their own ____, and are not at the mercy of the behavior of other investors as with mutual funds
Gain distributions
Good
Capital gains realizations
89
ETFs do not sell shares directly to the ____. They do issue new shares to qualified institutional investors, known as ______.
General public
Authorized Participants (APs)
90
New ETF shares are created in large blocks that are known as "____"
Creation units
91
APs generally obtain creation units with a basket of ____ that closely mirrors the ETF's _____, called an "____" purchase
Securities
Portfolio
"In-kind" purchase
92
APs who want to get rid of their ETF shares have two options:
- Sell individual shares to other investors on the secondary market
- Redeem creation units from the ETF sponsor
93
APs will want to redeem ETF shares through _____ if the price of ETF shares in the market is ____ the value of the basket of securities that mirrors the ETF's portfolio
"In-kind redemption"
Below
94
What keeps premiums and discounts very small for investors?
The ability of APs to purchase creation units with baskets of securities and redeem creation units for baskets of securities
In-kind purchases and redemption
95
HPR formula:
[Ending Price + Cash Dividend or Coupon]/Beginning Price - 1
HPR = Capital gains yield + Dividend or Coupon Yield
96
The annual percentage return, including dividends/coupons reinvested within the year, averaged over a sample period of T years
Arithmetic mean
| Look at formula in course pack
97
The cumulative total accumulation from an initial $1 investment after T years, all dividends/coupons reinvested, expressed as a constant per year percentage return
Geometric mean
| Look at formula in course pack
98
Arithmetic and Geometric mean example:
2014: 30%
2015: 0%
2016: -20%
2017: 10%
2018: 0%
Find the Arithmetic and Geometric mean
Arithmetic mean =
(30%+0%-20%+10%+0%)/5 = 4%
Geometric mean =
(1. 3)(1)(.8)(1.1)(1) = 1.144
(1. 144)^(1/5) - 1 = 2.727%
99
The arithmetic mean is always _____ or equal to the geometric mean
Greater than
100
When should you use arithmetic mean and when should you use geometric mean?
Use arithmetic to find the average return over a short period like one year and use geometric when you want to find the average return over a long period
101
Expected value of squared deviation from mean
Formula?
Variance
E[(r-E(r))^2]
102
Square root of variance
Standard deviation
103
Rate of return that can be earned with certainty, rf
Usually the rate on a short-term T-bill, like a 3-month T-bill
Risk-free rate
104
Rate of return in excess of risk-free rate = r-rf
Excess return
105
Expected excess return = E(r)-rf
Risk premium
106
Sharpe (Reward-to-Volatility) ratio:
S = (E(r)-rf)o
o= standard deviation
107
Represents the tradeoff between the expected excess return on a risky asset portfolio, and the risk (standard deviation) of that portfolio
Sharpe Ratio
| Named after William Sharpe
108
We assume that investors prefer more to less, but are _____ and want to ____ the Sharpe ratio for their overall portfolio of risky investments
Risk averse
Maximize
109
Historically, ____ have earned higher average returns than ____ who have earned higher average returns than ____ with a higher standard deviation of return
U.S. stocks > T-bonds > T-bills
110
Logically, when t-bill rates are low and stock market volatility is low, it is reasonable to expect future ______ to be correspondingly low
Stock returns
111
Denote wb and ws as the ____ or investment _____ in bonds and stocks respectively
Weight or investment proportions
112
The return on the portfolio (rp) is the weighted average of the return on its components
rp = ___ + ___
__ + __ = 1
ws(rs) + wb(rb)
wb + ws = 1
(Look at pages 113-114)
113
Expectation of the product of deviations from individual means
Covariance
114
The set of all available portfolio risk-return combinations, found by setting the weights on the two assets to all possible combinations
Investment opportunity set
115
Market risk is measured by
Beta
116
The part of the graph with a positive slope
Efficient frontier
117
Risk including growth in GDP, unemployment, interest rates, inflation, and foreign exchange rates
Market or systematic risk
118
Companies that sell products where purchase can be postponed generally have a greater exposure to ____ than companies that sell products with steadier demand
Market risk
119
Risk including management skill or lack thereof, changing consumer tastes, technology advancement that favor one industry or firm over another
Unique or firm-specific or idiosyncratic risk
120
Firm-Specific risk can be reduced by _____
Diversification across stocks
121
The plot of expected return-standard deviation combinations available by varying allocation between a risky asset or portfolio and a risk-free asset
Capital Allocation Line (CAL)
122
Separation theorem says risk-averse investors should tilt their portfolios toward the _____ and away from the ______ of risky assets
Risk-free asset
Optimal portfolio
123
The plot of risk-return combinations available by varying allocation between the market portfolio of risky assets and a risk-free asset
Capital Market Line (CML)
124
Applications of the CAPM (3):
- Active investment management, security selection
- Capital budgeting
- Investment performance evaluation
125
Assumptions of the CAPM (3):
- All investors can borrow and lend freely at rf
- All investors have identical beliefs
- All investors are risk averse and single period mean-standard deviation optimizers
126
The risk premium on any asset is equal to the asset's ___ multiplied times the ____ on the market portfolio
Beta x Risk premium
127
Suppose the risk-free rate is 3%, the expected return on the market is 10%, and Walmart stock has a beta of 0.4. What is the expected return on Walmart stock from the CAPM?
E(r) = 3% + 0.4(10% - 3%) = 5.8%
128
The covariation of a security's return with the overall market determines its..
Expected return
129
The beta of the market portfolio is one, so stocks with betas greater than one have expected returns _____ than the expected return on the market portfolio
Greater
130
A stock with a high return variance can have a _____, if its correlation with the market is very low
Low expected return
131
A risky security can have an expected return equal to the _____, if its return is uncorrelated with the market return
Risk-free rate
132
A risky security can have an expected return ____ the risk-free rate, if its return has a negative correlation with the market return
Below
133
The graph of the CAPM expected return on an individual security or portfolio against the beta of the security or portfolio
Security market line
134
The intercept of the security market line is the ____
Risk-free rate
135
In the CAPM, if a stock has a beta of zero, its expected return equals ____
The risk-free rate
136
The slope of the security market line is the ____ on the market divided by the ___ of the market
Risk premium
Beta
137
Equals the actual return on a stock or portfolio, compared with the predicted return on that stock or portfolio from the CAPM
Alpha
138
Historically, there is a ____ association between average returns on stocks and their beta, but the association is weak
Positive
139
Low beta stocks tend to earn returns ____ than predicted by the CAPM, while high beta stocks tend to earn returns ____ than predicted by the CAPM
Higher
Lower
140
Present value, using discount rate r, of its series of expected future cash flows
Intrinsic Value of a stock
141
Constant growth DDM formula requires that r is strictly _____ than g
Greater
142
If the per-share value V0 is ____ than the market price per share, the stock is a buy. If the per-share value is ____ than the market price per share, the stock should be avoided
Greater
Less
143
Define ROE
Net income/Beginning Common Equity
144
Dividend payout ratio =
Dividends/Earnings
145
The forecaster value or price after T years, (Pt), growth is constant
Terminal value
146
Free Cash Flow Valuation =
Cash Dividends + Share Repurchases - Share Issues
= Net Income - Increase in Common Stockholder's Equity
147
Using too high a market risk premium - estimates of value will likely be ___ market price, using too low a market risk premium - estimates of value will likely be ___ market price
Below
Above
148
Profit Margin on sales =
EBIT/Sales
149
Total asset turnover =
Sales/Average assets
