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CFA Level III > Individ and Institutional Investors > Flashcards

Individ and Institutional Investors Flashcards

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CFA flashcards
1
Q

Human Capital

A

discounted PV of expected future labor income; decreases over time

discount rate pos correlated to riskiness of cash flows

inc HC volatility = dec PV HC = dec demand for life insurance

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2
Q

Financial Capital

A

sum of all other assets; increases over time

defined benefit plan

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3
Q

Net Wealth

A

financial capital + human capital - liabilities

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4
Q

Financial Stages of Life

A
  1. education
  2. early career
  3. career development
  4. peak accumulation
  5. preretirement
  6. early retirement
  7. late retirement
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5
Q

Risks for Individuals

A
  1. earnings risk - disability insurance
  2. premature death risk
  3. longevity risk - annuities
  4. property risk
  5. liability risk
  6. health risk
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6
Q

Types of Life Insurance

A
  1. Temporary: set time frame, cheaper
  2. Permanent: lasts for life
  • Whole Life: fixed annual premium payment
  • Universal Life: variable payments
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7
Q

Gross Premium

A

net premium + load

  • net premium: PV benefit payments
  • load: operating exp + cost to write plan
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8
Q

Net Payment Cost Index

A

NPCI

assumes dealth at the end of the eval period, cash value is not considered

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9
Q

Net Surrender Cost Index

A

NSCI

assumes policy is terminated at end of period and cash value is received

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10
Q

Why Choose an Annuity

A
  1. expect to live longer
  2. lifetime income
  3. leave an estate
  4. less risky
  5. don’t have other guarenteed income sources (pension)
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11
Q

Asset Allocation of Total Wealth

A

higher risk HC (similar to equity), diversify with bond-like FC

lower risk HC (similar to FI), diversify with equity-like FC

  • HC similar to FI = higher need for life insurance
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12
Q

Risk Management

A
  1. risk aoidance
  2. risk reduction
  3. risk transfer (buying insurance)
  4. risk retention (self-insure)
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13
Q

Systematic Risk

A

Cannot be diversified away; beta

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14
Q

Company [Property] Specific Risk

A

Nonsystematic risk; can be diversified away

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15
Q

Objectives When Managing Concentrated Positions

A
  • Reduce risk
  • Generate liquidity
  • Optimize tax efficiency
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16
Q

Considerations When Managing a Concentrated Position

A
  • Restrictions on sale
  • Desire for control
  • Wealth creation
  • Other uses for asset
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17
Q

Institutional and Capital Market Constraints

A
  • Margin lending rules
  • Securities laws and regulations
  • Contractual restrictions
  • Capital market limitations
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18
Q

Goal-Based Investing

A

primary capital

  • personal risk bucket
  • market risk bucket

surplus capital

  • aspirational risk bucket
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19
Q

Estate Tax Freeze

A

split company and retain voting preferred stock and gift non-voting common stock; growth increases value of common stock, freeze taxes on future gain (shift taxes)

retain control, decrease taxes

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20
Q

Limited Partnership

A

serve as general partner and gift limited partnership; retain control, lower limited partnership taxes because lacking control and liquidity

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21
Q

Monetization of Stock

A
  • Forward sale: sell stock for delayed delivery
  • Forward conversion w/ options: collar (long put, short call)
  • Total return equity swap: pay equity return, get another asset’s return
  • Short sale against the box: borrow shares, short stock (best for public firms)
22
Q

Modified Hedging

A

dec downside risk, retain upside on underlying - avoid being treated as sale for tax purposes

  • Protective put: long stock, long put
  • No-cost/ zero-prem collar: long put, short call (diff strike prices, same premium)
  • Prepaid variable forward: $/ share upfront, variation in future shares paid b/c change in stock price
23
Q

Cross Hedge

A
  • short another highly correlated stock
  • short a highly correlated index
  • long puts
24
Q

Liquidating Private Business Options

A
  • strategic buyout
  • financial buyer/ sponsor
  • recapitalization
  • sell to management/ key employees
  • divest non-core business assets
  • sell/ gift to family
  • personal line of credit secured by firm
  • IPO
  • employee stock ownership plan (ESOP)
25
Q

Accumulated Benefit Obligation

A

ABO

total PV of pension liabilities to date, assuming no further accumulation of benefits

26
Q

Projected Benefit Obligation

A

PBO

ABO + PV of additional liability from future employee compensation increases

used to calc funded status

27
Q

Total Future Libability

A

PBO + PV of expected inc in benefits due to employees based on future service

28
Q

Defined Benefit Plan

A

DB

company agrees to make payments to employees after retirement base on criteria; employer bears investment risk

29
Q

Defined Contribution Plan

A

DC

company agrees to make contributions of a certain amount as they are earned by an employee; employee bears risk, portable

  • participant directed: employee chooses investments
  • sponsor directed: firm chooses investments
30
Q

DB Plan Risk Considerations

A
  1. manage standard deviation of surplus or assets
  2. achieve 100% funded status
31
Q

DB Plans Return Objectives

A
  1. generate return to meet liabilities
  2. minimum return = actuarial discount rate
  3. absolute return objective
32
Q

DB Plan Risk Objectives

A

use asset/ liability management (ALM)

  1. funded status
  2. financial status and profitability
  3. correlation between profitability and plan assets
  4. plan fatures (impact on liquidity needs)
  5. workforce characteristics (age)
33
Q

Cash Balance Plan

A

DB plan

defines benefit in terms of an account balance; firm must pay promised benefit payments

balance belongs to employee, portable, pay credit based on individ characteristics, interest credit based on benchmark

34
Q

Foundation

A

grant making entity funded by gift

35
Q

Endowment

A

long-term funds owned by a non-profit institution

36
Q

Smoothing Rate

A

average out distributions or factor in inflation; less volatile

37
Q

Simple Spending Rule

A

spendingt = S*( MVt-1 )

38
Q

Rolling 3-yr Average Spending Rule

A

spendingt = ( spending rate ) * ( 3 year avg MV )

39
Q

Geometric Spending Rule

A

spendingt = ( R )*( spendingt-1 ) + ( 1 - R )*( S )*( MVt-1 )

R = smoothing rate to reduce volatility

40
Q

Foundation and Endowment Objectives and Constraints

A
  • return: maintain value (compounded return)
  • risk: more risk, no defined liability reqs
  • tax: exempt, outside income taxed
  • time: legally perpetual
  • liquidity: minimum spending rate
  • legal/ unique: depends
41
Q

Life Insurance Return Objectives

A
  • credit rate: required rate of return to pay off policy
  • net interest spread: more money - charge lower premiums, invest more aggressively
  • portfolio segmented by line of business
  • total return: difficult b/c highly regulated
  • WANNA MAKE A PROFIT AND BE COMPETITIVE
42
Q

Life Insurance Risk Tolerance

A
  • ALM: durationliabilities = durationassets to minimize volatility
    • valuation risk
    • reinvestment risk
  • heavily regulated: reserves, capital requirements
  • cash flow volatility
  • credit risk
43
Q

Life Insurance Liquidity Constraints

A
  • aggregate liquidity needs
  • asset marketability risk: issues selling assets to liquidate portfolio
  • disintermediation risk: policyholders can borrow against plan at predetermined fixed interest rate; inc interest rate, policyholders will invest directly
44
Q

Life Insurance Constraints

(excluding liquidity)

A
  • time: long term, duration of liability
  • tax: frim tax, policyholder usually not taxed
  • legal: heavily regulated > eligible inv, valuation methods
  • unique: depends on product offerings, firm size, level of surplus
45
Q

Non-Life Insurance Objectives

A
  • risk: uncertain payouts, shorter duration, geographical correlation
  • return: depends on pricing, profitability, surplus size, taxes > total return approach
46
Q

Underwriting Cycle

A

usually tied to business cycle

low profits (t = 0) > inv in taxable bonds (higher yield) > dec duration > raise premiums > begin profiting (t > 0) > inv in tax exempt bonds > inc duration > lower premiums > low profits (t = 0)

47
Q

Non-Life Insurance Constraints

A
  • time: shorter than life insurance, long tail (long time to actual payout)
  • liquidity: higher, less predictable
  • legal: regulatory constraints
  • unique: depends
48
Q

Bank Constraints

A
  • time: short, duration of liabilities
  • liquidity: generally short an liquid, dependent on deposits and regulations
  • taxes: taxable
  • legal: regulations to prevent mismatch of asset-liability duration
  • unique: depends
49
Q

Bank Objectives

A
  • risk: usually below average, based on ALM framework (DA vs DL)
  • return: postive interest rate spread, meet liquidity needs
    • capital risk position = capital needed to support risk weighted assets (investment activities)
50
Q

Investment Companies, Commodity Pools, Hedge Funds

A

intermediaries that pool and invest money based on stated objective of portfolio, returns are passed to investors

CFA Level III (12 decks)

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