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CFP Exam > Fundamentals of Investments > Flashcards

Fundamentals of Investments Flashcards

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1
Q

best efforts underwriting

A

the underwriter agrees to sell as much of the offering as possible

the risk of the issue not selling resides with the firm because any shares not sold to the public are returned to the company

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2
Q

firm commitment underwriting

A

the underwriter agrees to buy the entire issuance of the stock from the company

the risk that an issuance may not sell resides with the underwriter

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3
Q

prospectus document

A

outlines the risk, management team, business operations, fees, and expenses

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4
Q

red herring document

A

preliminary prospectus issued before the SEC approval and is used to determine investors’ interest in the security

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5
Q

10K document

A

an annual report of financial statements filed with the SEC

audited

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6
Q

10Q document

A

a quarterly report that is filed with the SEC

not audited

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7
Q

annual report document

A

contains a message from the Chairman of the Board on the progress in the past year and outlook for the coming year

sent directly to shareholders

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8
Q

liquidity

A

how quickly something can be turned into cash, with little to no price concession

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9
Q

marketability

A

exists when there is a ready-made market for something

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10
Q

market order

A

timing and speed of execution are more important than price

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11
Q

when is a market order most appropriate?

A

for stocks that are not thinly traded

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12
Q

limit order

A

the price at which the trade is executed is more important than the timing

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13
Q

when is a limit order most appropriate?

A

for stocks that are extremely volatile and are not frequently traded

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14
Q

stop order

A

the price hits a certain level and turns to a market order

once the stop price is reached, the stock is sold at that price or possibly less because it has become a market order

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15
Q

what is the risk with a stop order?

A

the risk is that the investor may receive significantly less than anticipated if the market is moving too quickly

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16
Q

stop-loss limit order

A

the investor sets 2 prices:
1. the stop-loss price (once the price is reached, the order turns to a limit order)

  1. limit price (an investor will not sell below the second price)
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17
Q

what is the risk with a stop-loss limit order?

A

the risk is that if the market moves quickly, the order may not fill and the investor will be left with the stock at a significantly lower price

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18
Q

short-selling

A

selling first at a higher price, in the hopes of purchasing the stock back at a lower price

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19
Q

when is short-selling appropriate?

A

when the investor anticipates the price of an asset to decrease in value

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20
Q

initial margin

A

reflects the amount of equity an investor must contribute to enter a margin transaction

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21
Q

maintenance margin

A

the minimum amount of equity required before a margin call

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22
Q

margin position (definition)

A

the current equity position of the investor

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23
Q

margin position (formula)

A

margin position = equity / FMV

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24
Q

equity (formula)

A

equity = stock price - loan

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25
Q

margin call (formula)

A

margin call = loan / (1 - maintenance margin)

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26
Q

what happens when there is a margin call?

A

the investor must contribute equity to restore their equity position

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27
Q

Value Line

A

ranks stocks on a scale of 1 to 5 for timeliness and safety

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28
Q

what is the best and worst ranking for Value Line?

A 
best = 1 (signal to buy)
worst = 5 (signal to sell)
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29
Q

Morningstar

A

ranks mutual funds, stocks, and bonds using 1 to 5 starts

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30
Q

what is the best and worst ranking for Morningstar?

A 
best = 5 stars
worst = 1 star
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31
Q

ex-dividend date

A

the date the stock trades without the dividend

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32
Q

when is the ex-dividend date in relation to the date of record?

A

the ex-dividend date is one business day before the date of record

33
Q

date of record

A

the date on which you must be a registered shareholder in order to receive the dividend

34
Q

when is a cash dividend taxed?

A

upon receipt

35
Q

when is a stock dividend taxed?

A

when the stock is sold

36
Q

what is a stock split?

A

increases shares outstanding and reduces stock price

37
Q

Securities Act of 1933

A

regulates the issuance of new securities (primary market)

requires new issues are accompanied with a prospectus before being purchased

38
Q

Securities Act of 1934

A

regulates the secondary market and trading of securities

created the SEC

39
Q

Investment Company Act of 1940

A

authorized the SEC to regulate investment companies

40
Q

Investment Advisors Act of 1940

A

required investment advisors to register with the SEC or the state

41
Q

Securities Investors Protection Act of 1970

A

established the SIPC to protect investors from losses resulting from brokerage firm failures

42
Q

Insider Trading and Securities Fraud Enforcement Act of 1988

A

defines an insider as anyone with information that is not available to the public

insiders cannot trade on that information

43
Q

Treasury Bills

A
  • issued in varying maturities up to 52 weeks

- denominations in $100

44
Q

Commercial Paper

A
  • short-term loans between corporations
  • maturities of 270 days or less
  • does not have to register with SEC
  • denominations of $100,000
45
Q

Bankers Acceptance

A
  • facilitates imports/exports
  • maturities of 9 months or less
  • can be held until maturity or traded
46
Q

Eurodollars

A

deposits in foreign banks that are denominated in US dollars

47
Q

what is an Investment Policy Statement?

A

establishes a client’s objectives and limitations on investment manager

used to measure investment manager’s performance

48
Q

what are the objectives and constraints detailed on the Investment Policy Statement?

A

objectives:

  • return requirements
  • risk tolerance

constraints:

  • time horizon
  • liquidity
  • taxes
  • laws and regulations
  • unique circumstances
49
Q

Dow Jones Industrial Average

A

simple price-weighted average

does NOT incorporate market capitalization

50
Q

S&P 500

A

value-weighted index

incorporates market capitalization of individual stocks

51
Q

Russell 2000

A

value-weighted index of the smallest market cap stocks in the Russell 3000

52
Q

Wilshire 5000

A

the broadest index that measures the performance of over 3000 stocks

value-weighted index

53
Q

EAFE

A

value-weighted index that tracks stocks in Europe, Australia, Asia, and the Far East

54
Q

what are the 4 basic premises of Traditional Finance?

A
  1. investors are rational
  2. markets are efficient
  3. the mean-variance portfolio theory governs
  4. returns are determined by risk
55
Q

what does it mean to say that investors are rational?

A

investor decisions are logical, centered on a clearly defined goal, free from the unsteady influences of emotion or irrationality, and take into account all available information

56
Q

what does it mean to say that markets are efficient?

A

at any given time, a stock’s share price in the market incorporates and reflects all relevant information about that stock

57
Q

what is the mean-variance portfolio theory?

A

mean-variance investors choose portfolios by viewing and evaluating mean returns and variance for their entire portfolio

58
Q

what are the 4 basic premises of Behavioral Finance?

A
  1. investors are normal
  2. markets are not efficient
  3. the behavioral portfolio theory governs
  4. risk alone does not determine returns
59
Q

what does it mean to say that investors are normal?

A

normal investors have normal wants and desires, but may commit cognitive errors (through biases or otherwise)

normal investors may be misled by emotions

60
Q

what is the behavioral portfolio theory?

A

investors segregate their money into various mental accounting layers

investors compartmentalize certain goals to be accomplished in different categories based on risk rather than viewing their entire portfolio as a whole

61
Q

affect heuristic

A

deals with judging something, whether it is good or bad

62
Q

anchoring

A

attaching one’s thoughts to a reference point even though there may be no logical relevance or is not pertinent to the issue in question

63
Q

availability heuristic

A

when a decision maker relies upon knowledge that is readily available in his or her memory

64
Q

bounded rationality

A

when individuals make decisions, their rationality is limited by the available information, the tractability of the decision problem, the cognitive limitations of their minds, and the time available to make the decision

decision-makers in this view act as “satisficers”

65
Q

confirmation bias

A

people tend to filter information and focus on information supporting their opinions

66
Q

cognitive dissonance

A

the tendency to misinterpret information that is contrary to an existing opinion or only pay attention to information that supports an existing opinion

67
Q

disposition effect

A

aka regret avoidance

investors create mental accounts when they purchase stocks and continue to mark their value to purchase prices even after market prices have changed

68
Q

familiarity bias

A

investors tend to overestimate/underestimate the risk of investments with which they are unfamiliar/familiar

69
Q

gambler’s fallacy

A

investors often have incorrect understanding of probabilities which can lead to faulty predictions

70
Q

herding

A

people tend to follow the masses or the “herd”

71
Q

hindsight bias

A

hindsight is looking back after the fact is known and assuming they can predict the future as readily as they can explain the past

72
Q

illusion of control bias

A

the tendency for people to overestimate their ability to control events

73
Q

overconfidence bias

A

concerns an investor that listens mostly to his or herself

overconfident investors mostly rely on their skills and capabilities to do their own homework or make their own decisions

74
Q

overreaction

A

a common emotion towards the receipt of news or information

75
Q

prospect theory

A

people value gains and losses differently

76
Q

recency

A

giving too much weight to recent observations or stimuli

77
Q

similarity heuristic

A

used when a decision or judgement is made when an apparently similar situation occurs even though the situations may have very different outcomes

78
Q

naive diversification

A

the process of investing in every option available to the investor

AKA 1/n diversification

CFP Exam (24 decks)

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