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CFA Level III > Individ and Institutional Investors > Flashcards

Individ and Institutional Investors 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
Accumulated Benefit Obligation
ABO total PV of pension liabilities to date, assuming no further accumulation of benefits
26
Projected Benefit Obligation
PBO ABO + PV of additional liability from future employee compensation increases used to calc funded status
27
Total Future Libability
PBO + PV of expected inc in benefits due to employees based on future service
28
Defined Benefit Plan
DB company agrees to make payments to employees after retirement base on criteria; employer bears investment risk
29
Defined Contribution Plan
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
DB Plan Risk Considerations
1. manage standard deviation of surplus or assets 2. achieve 100% funded status
31
DB Plans Return Objectives
1. generate return to meet liabilities 2. minimum return = actuarial discount rate 3. absolute return objective
32
DB Plan Risk Objectives
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
Cash Balance Plan
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
Foundation
grant making entity funded by gift
35
Endowment
long-term funds owned by a non-profit institution
36
Smoothing Rate
average out distributions or factor in inflation; less volatile
37
Simple Spending Rule
spendingt = S\*( MVt-1 )
38
Rolling 3-yr Average Spending Rule
spendingt = ( spending rate ) \* ( 3 year avg MV )
39
Geometric Spending Rule
spendingt = ( R )\*( spendingt-1 ) + ( 1 - R )\*( S )\*( MVt-1 ) R = smoothing rate to reduce volatility
40
Foundation and Endowment Objectives and Constraints
* 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
Life Insurance Return Objectives
* 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
Life Insurance Risk Tolerance
* ALM: durationliabilities = durationassets to minimize volatility * valuation risk * reinvestment risk * heavily regulated: reserves, capital requirements * cash flow volatility * credit risk
43
Life Insurance Liquidity Constraints
* 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
Life Insurance Constraints | (excluding liquidity)
* 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
Non-Life Insurance Objectives
* risk: uncertain payouts, shorter duration, geographical correlation * return: depends on pricing, profitability, surplus size, taxes \> total return approach
46
Underwriting Cycle
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
Non-Life Insurance Constraints
* time: shorter than life insurance, long tail (long time to actual payout) * liquidity: higher, less predictable * legal: regulatory constraints * unique: depends
48
Bank Constraints
* 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
Bank Objectives
* 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
Investment Companies, Commodity Pools, Hedge Funds
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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