Final Exam Review

Question 1

What are the requisites for an insurable risk?

Answer 1

1. It has large numbers of homogeneous exposures.
2. The insured losses must be accidental
3. The insured losses must be measurable and determinable
4. The loss must not be financially catastrophic to the insurer.
5. The loss probability must be determinable.
6. The premium for risk coverage must be reasonable and affordable.

Question 2

What is indemnity?

Answer 2

The principle of indemnity assets that an insurer will only compensate the insured to the extent that the insured has suffered an actual financial loss.

Question 3

What is a peril?

Answer 3

The immediate cause and reason for a loss occurring. Include accidental death, disability and property losses.

Question 4

What are the three types of hazards

Answer 4

Moral- Potential for loss caused by the insured’s moral character
Morale- Indifference to a risk due to the fat that the risk is insured.
Physical- Physical condition that increases the likelihood of a loss occurring

Question 5

Pure vs speculative risk

Answer 5

A pure risk is the change of a loss or no loss occurring. There is no chance to experience gain. Speculative risks include the chance for profit.

Question 6

What is adverse selection?

Answer 6

The tendency of those that most need insurance to seek it out.

Question 7

Preferred Stock

Answer 7

Has features of securities and bonds. Debt features: stated par value, stated dividend rate as a percentage per year. Equity features: price may generally move with the price of common stock. Differences: dividends do not fluctuate like common stock dividends, no maturity date like a bond. Tax advantage: corporations receive a 70, 80, or 100 tax deduction of P/S dividends. The same deduction applies to common stock. Cummulative vs. Noncumulative. Stock value= dividend/ required rate of return.

Question 8

Property Valuation formula

Answer 8

Net Operating Income/Capitalization Rate

Question 9

What are the characteristics of a closed investment company?

Answer 9

Fixed capitalization. Shares trade on an organized exchange. May trade at a premium or a discount to NAV

Question 10

What are the characteristics of an open investment company?

Answer 10

Unlimited capitalization. Shares are bought and redeemed directly from fund family. Shares trade at NAV. Must distribute all caps gains and 90 percent of interest.

Question 11

What are the characteristics of a unit investment trust?

Answer 11

Can be equity or fixed income. Typically fixed income trust. Self liquidating. Passive management. Units, not shares.

Question 12

What are some common types of mutual funds?

Answer 12

Index funds: very low costs, track performance of various market indexes, passively managed and tax efficient. Growth funds: Invests in equities with have P/E. Primary objective is to generate capital appreciation. Growth and income fund: invests in equities and income producing assets. Primary objective is to generate capital appreciation and current income. Balanced fund; invests in more bonds than equity fund. Global fund: invests in international and US securities. International fund: invests in only international securities.

Question 13

What are some characteristics of Exchange Traded Funds

Answer 13

Portfolios of stock that represent and index. Tax efficient. Traded on an exchange similar to stocks. Don’t have to buy and sell blindly. Low cost of ownership.

Question 14

REIT

Answer 14

Stands for Real Estate Investment Trust. Attractive because of low correlation to the stock market. Similar to closed end mutual fund. Must distribute 90 percent of income to shareholders.

Question 15

What are three types of REITs

Answer 15

Equity-Actually owns apartment buildings. Most common type. Invests in real-estate and capital appreciation. Income is generated through rental and appreciation. Mortgage- Invests mostly in mortgage and construction loans. Make a spread between lending and borrowing rate. Hybrid- Combo between equity and mortgage REITs.

Question 16

American Depository Receipts

Answer 16

ADR represent foreign stock held in domestic bank’s foreign branch. Entitle shareholders to capital gains dividends. ADR’s trade on US exchanges are denominated in US dollars and trade in US dollars. Dividends are paid in US dollars. Do not eliminate exchange rate risk.

Question 17

Options

Answer 17

Options are derivative securities. The value of an options depends on the value of an underlying asset. Contractual agreement between two parities the seller or writer and a buyer. All exchanges are handled through option clearing houses.

Question 18

Call option-

Answer 18

is the right to buy a specified number of
shares at a specified price (strike or exercise price) within a specified period of time (American options) or at a specified future date (European options).

Question 19

Put Option

Answer 19

A put option is the right to sell a specified number of
shares at a specified price (strike or exercise price) within a specified period of time (American options) or at a specified future date (European options).

Question 20

What are the three reason’s people invest in options?

Answer 20

1. Hedging. 2. Speculation. 3. Income

Question 21

How do you calculate the intrinsic value of a call option?

Answer 21

Stock Price-Strike Price

Question 22

How do you calculate the intrinsic value of a put option?

Answer 22

Strike Price-Stock Price

Question 23

How do you calculate the time premium of a call or put option?

Answer 23

Premium-Intrinsic value

Question 24

Portfolio Insurance

Answer 24

Portfolio insurance is using put options
on an index to “lock-in” portfolio gains. Typically the investor will have a well diversified portfolio and is concerned about a down turn in markets. Purchasing put options on the S&P 500 will protect a well diversified portfolio from a down-turn in the markets.

Question 25

Black/Scholes Model

Answer 25

Model used to determine the value of a call option. Consider's the following variables: 
Current price of the underlying asset
Time until expiration
The risk-free rate of return
Volatility of the underlying asset
Strike (exercise) price

Question 26

Put/Call Parity

Answer 26

Attempts to value a PUT option based on the value of a call option

Question 27

Binomial Pricing Model

Answer 27

Attempts to value an option based on the assumption that a stock can only move in one of two directions

Question 28

Futures Contracts

Answer 28

Commodity- Copper, wheat, pork bellies, oil. Financial- currency, interest rates, stock indexes.

Question 29

What are the differences between futures and options contracts?

Answer 29

Options contracts give the owner the right to do something. Future contracts obligate the owner to take or deliver an underlying asset. Establishes the delivery price based on the selling price of the
futures contract.