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INVESTMENT- CFP > Investment > Flashcards

Investment Flashcards

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CFP® flashcards
1
Q

What is Unsystematic Risk?

A

Known as Diversifiable Risk, may also be referred to a Non-systematic Risk.

  • Business Risk: Refers to the nature of the firm’s operations (i.e., possibility of loss due to new technology)
  • Financial Risk: Refers to how the firm finances its assets (i.e., the possibility of loss due to heavy debt financing)
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2
Q

What is Systematic Risk?

A

Also known as Non-Diversifiable Risk.

  • This part of risk is inescapable because no matter how well an investor diversifies, the risk of the overall market cannot be avoided.
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3
Q

What are the Types of Systematic Risk?

A
  • Purchasing Power Risk: Loss of purchasing power through inflation.
  • Reinvestment Risk: Risk that proceeds available for reinvestment must be reinvested at a lower interest rate than the instrument that generated the proceeds.
  • Interest Rate Risk: The risk that a change in interest rates will cause the market value of the fixed income security to fall.
  • Market Risk: Risk of the overall market
  • Exchange Rate Risk: Risk associated with changed in the value of the currency.

Study Hint: Remember P.R.I.M.E.

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4
Q

FDIC Insured Amounts (per bank/per type of account)

A
  • Individual: $250k
  • Joint (per owner): $250K
  • Trust (per beneficiary): $250k
  • IRA/Keogh: $250k
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5
Q

The Yield Ladder

A

REMEMBER YMCA- DISCOUNT ON TOP

Discounted Bonds (Yields Higher than coupon)

Yield to Call

Yield to Maturity

Current Yield

Nominal Yield (Annual Coupon Rate)

Current Yield

Yield to Maturity

Yield to Call Premium Bonds (yields lower than coupon)

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6
Q

What are the provisions of EE Bonds?

A
  • Non-marketable, Non-transferrable, can’t be used for collateral
  • Sold at Face Value
  • Interest Rate based on 10 yr Treasury Note Yields
  • Fixed Interest Rate that is in effect at the time of purchase
  • Subject to federal taxation when redeemed, unless used as education bonds
  • Not subject to state or local taxes
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7
Q

What are the provisions of I bonds?

A
  • Non-marketable, non-transferrable, can’t be used for collateral
  • Sold at Face Value
  • Interest Rate is composed of two parts:
    • A Fixed Base Rate (remains the same for the life of the bond)
    • An Inflation Adjustment (adjusted every 6 months)
  • Subject to federal taxation when redeemed (unless used as education bonds)
  • Not subject to state or local taxation
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8
Q

What are the Types of Municipal Securities?

A
  • General Obligation Bonds (GO Bonds): Backed by the full faith, credit and taxing power of the issuer. GO Bonds are generally considered the safest types of municipal credit.
  • Revenue Bonds: Backed by a specific sources of revenue to which the full faith and credit of the issuer is NOT pledged. Because revenue bonds are backed by a single source of funds (like toll roads, hospitals, power plants, etc.), they have a greater credit risk than GO Bonds. As such, they trade at higher yields.
  • Insured Municipal Bonds: The insurers pay timely interest and principal when the issuer is in default. Municipal bond insurers are AMBAC and MBIA.
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9
Q

What do Indenture Agreements Cover?

A
  • Form of Bond
  • Amount of Issue
  • Property Pledged
  • Protective covenant, including any provision for a sinking fund
  • Working Capital and Current Ratio
  • Redemption Rights
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10
Q

What are the Risks of Corporate and Municipal Bonds?

A
  • Default: A creditor may seize the collateral and sell it to recoup the principal
  • Reinvestment: As payments are received from an investment, interest rates may fall. When the funds are reinvested the investor receives a lower yield.
  • Interest Rate: Rising interest rates may cause bond prices to fall
  • Purchasing Power: Inflation may lower the value of bond interest payments and principal repayment, thereby forcing bond prices to fall.

Study Hint: Remember: D.R.I.P.

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11
Q

What are the Risks of Government Bonds?

A

RIP only! No default or credit risk.

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12
Q

What are the market values to define

Market Capitalizations of Companies?

A
  • Large: > $10 billion
  • Mid: $2-10 billion
  • Small: < $2 billion
  • Micro: < $300 million
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13
Q

American Depository Receipt (ADR)

A
  • Prices of ADRs quoted in US dollars
  • Dividends paid in US dollars
  • Dividends declared in foreign currency
  • Attain diversification and risk reduction due to lower correlation of foreign securities with US securities.
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14
Q

What is the NOI calculation for Improved Land/Real Estate?

A

Improved land is normally income producing.

Income properties include residential rental, commercial and industrial properties. The intrinsic value of a real estate property can be computed using a Net Operating Income (NOI) calculation.

Gross Rental Receipts

+ Non-rental Income (laundry, etc.)

= Potential Gross Income (PGI)

- Vacancy and collection losses

= Effective Gross Income

- Operating Expenses (excludes interest and depreciation)

= Net Operating Income (NOI)

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15
Q

What are General Definitions for Options?

A
  • Intrinsic Value is the minimum price the option will command as an option. It is the difference betwen the market price and exercise price of the stock.
  • Exercise Price is the price at which the stock can be purchased or sold on exercise of the option.
  • Premium is the market price of an option. As the option approaches its expiration date the market price of the option (Premium) approaches its Intrinsic Value Time. Premium is the amount the market prices of an option exceeds its intrinsic value.

Study Hint: IV + TV = Premium

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16
Q

What is the Taxability of Call Options?

A

At the Time of Purchase: Non-deductible Capital Expenditure

To the Writer Due to Lapse: Premium received is a short-term gain

To the Writer Due to Exercise: Premium received is added to sale price (can be long term gain if underlying security was held more than 12 months, otherwise short term). Covered Call.

To the Holder: If the option is NOT exercised, then the option is considered sold (it expires) and it is a short-term loss. The option period is 9 months or less.

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17
Q

Define: Hedging Strategies - Straddles, Collar, Protective Put

A

Straddle: Buying a Put and Buying a Call - The buyer does NOT own the stock.

Collar: Selling a Call (out-of-the-money) at one strike price and buying a Put at a lower strike price; investor OWNS the stock.

Protective Put: Buying a stock (or already owning it) and a Put for the stock serving as insurance against the decline in the underlying stock. (Hint: A good answer for the exam)

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18
Q

Compare: Warrants vs. Call Options

A
  • Warrants are issued by corporations, whereas Calls are issued by individuals.
  • Warrants typically have maturities of several years.
  • Warrant terms are not standardized. Call options are standardized.
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19
Q

What are the Hedging Positions of Futures Contracts?

A

Long Commodity Position: If a farmer is long a commodity (for example, corn) he needs a short hedge and will sell a futures contract.

Short Commodity Position: If Kellogs is short a commodity (for example, corn), they need a long hedge and will buy a futures contract.

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20
Q

Compare: Reg D Accredited vs. Non-Accredited Investors

A

Accredited (Unlimited):

  • Net worth of $1 million or,
  • Individual with income of $200,000 or,
  • Couple with income of $300,000

Non-Accredited

  • Issue sold to a maximum of 35 investors
  • Must use a purchaser representative if not “sophisticated”
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21
Q

Coefficient of Determination R2

A

The square of the correlation coefficient measuring the proportion of the variation in one variable explained by the movement of the other variable.

How is R2 used on the exam?

It describes the percentage of a fund’s movement that are explained by the movements in the S&P 500.

Index funds/diversified funds based on the S&P 500 will have R2 of very close to 100%, while sector funds (not diversified) will have very low R2 (typically 5% - 25%).

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22
Q

Risk Level Quantification

Compare: Standard Deviation vs. Beta

A

Standard Deviation: Measures variability of returns used in a non-diversified portfolio and is a measure of total risk.

Beta: An index of volatility used in a diversified portolio and is a measure of systematic risk.

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23
Q

Geometric Return vs. Internal Rate of Return (IRR)

A

Geometric Return or Time-Weighted Return: Evaluates the performance of a portfolio manager.

Add 1 to the returns expressed as a decimal

Multiple the returns = FV

-1 is always PV

N = number of years

solve for i

IRR or Dollar Weighted Return: Compares absolute dollar amounts.

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24
Q

“Real” vs. Nominal Rate of Returns

A

Real: The inflation adjusted interest rate

Nominal: Actual returns not adjusted for inflation.

The “Real” rate is defined as the Nominal Rate of return adjusted for inflation.

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25
Q

Holding Period Return (HPR)

A

The total return (income plus price appreciation and dividends less margin interest) over the entire period divided by the out of pocket cost of the investment.

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26
Q

Taxable Equivalent Yield (TEY)

A

To make the returns on municipal bonds comparable to those of taxable bonds, the TEY can be calculated.

  • TEY = Tax Exempt Yield / (1-Marginal Tax Rate)

OR

  • Tax Exempt Yield = TEY x (1-Marginal Tax Rate)

To find EXEMPT you Multiply

to find E

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27
Q

Duration (Principles to Remember)

A

Years to Maturity: Remember duration and maturity are positively related

Annual Coupon: Remember duration is inversely related to coupon rate

YTM: The current yield on comparative bonds (duration is inversely related)

Remember, Coupon and Yield are Interest Rates - Inversely Related.

Exam- Match goal to duration

A Zero Coupon bond has same duration as maturity!

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28
Q

Zero Coupon Bonds

A
  • Duration equal to Maturity
  • No coupon interest, yet produces “phantom” income
  • No reinvestment rate risk
  • Sold at deep discounts to PAR
  • Fluctuate more than coupon bond with the same maturities
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29
Q

Rules for using Duration to Manage Bond Portfolios

A

If interest rates are expected to rise, shorten duration (Interest rates up, shorten Duration)

Remember: UPS: UP for “up” and S for “shorten”)

If interest rates are expected to fall, lengthen duration. Buy low coupon bonds with long maturities.

Interest rates fall → lengthen duration.

Remember: FALLEN - FAL for “fall” and LEN for “Lengthen.”

30
Q

Conclusions to Fluctuations in Bond Prices

A
  • The smaller the coupon, the greater the Relative Price Fluctuation
  • The longer the term to maturity, the greater the Price Fluctuation
  • The lower the market interest rate, the greater the Relative Price Fluctuation

SMALL coupon

LONG maturity

LOW market interst rate

= greater price fluctuation

31
Q

Convexity

A
  • The degree which duration changes as the yield-to-maturity (YTM) changes.
  • Largest for low coupon bonds, long-maturity bonds and low-YTM bonds allows investor to improve the duration approximation for bond price changes.
32
Q

What is Return on Equity (ROE)?

A

ROE = Earnings Available for Common (EPS) / Common Equity (net worth or book value)

EPS divided by Book Value or Net Worth

33
Q

How to Calculate Dividend Payout Ratio

A

Dividend Payout Ratio = Common Dividends Paid / by Earnings Available for Common (EPS)

34
Q

What are three types of Efficient Market Hypothesis (EMH)?

A

Strong Form: Asserts that stock prices fully reflect all information, public and private. Not even access to inside info can be expected to result in superior investment performance over time. Neither fundamental analysis nor technical analysis can produce superior results over time on a risk-adjusted basis.

Semi-Strong Form: Asserts that all publicly known information is reflected in stock prices. Neither technical analysis nor fundamental analysis can produce superior results over time on a risk-adjusted basis. Only an investor with access to inside information may consistently achieve superior results (but such access is illegal)

Weak Form: Suggests that historical price data is already reflected in current stock prices and is of no value in predicting future price changes.

Technical analysis will not produce superior results. Fundamental Analysis may produce superior results.

35
Q

Types of Indexes / Benchmarks

A

Dow Jones: 30 industrial stocks, price weighted

S&P 500 (large caps): Broader measure of NYSE activity, value weighted

Russell 2000 (small caps): Smallest 2000 stocks of the Russell 3000 index, value weighted

Wilshire 5000: Broadest measure of the activity and movement of the overall stock market, value weighted.

Value Line: ±1700 stocks, equally weighted

NASDAQ: Broadest measure of OTC trading, value weighted

Europe, Australia and Far East (EAFE): Equity performance of the major foreign markets, value weighted.

Barclays Aggregate Bond: More than 5000 US Government, corporate and mortgage backed and asset backed bonds.

36
Q

Tax Basis of a Mutual Fund

A

First-in, First-out method treats shares acquired first as being sold first.

Specific ID requires the seller to identify the shares of the fund that are sold. Specific ID allows the investor to create gain, neutralize gain or create a loss (most flexible).

Average Cost allows the investor to divide the total cost of all shares held by the number of shares sold.

37
Q

Steps to Risk-Adjusted Measures of Performance (Sharpe)

A
  • Step 1: Look for a low R2 (less than 60), or a non-diversified portfolio.
  • Step 2: Look for the highest Sharpe number.
38
Q

Steps to Risk Adjusted Measures of Performance

Jensen (Alpha) / Treynor

A
  • Step 1: Look for high R2 (60+) or a diversified portfolio.
  • Step 2: Look for the highest positive Alpha. If no Alpha is given, then look for the highest Treynor.
39
Q

What is a Margin (Maintenance) Call?

A

The formula for calculating when an investor will receive a margin call is:

  • (1 - Initial Margin % ÷ 1 - Maintenance Margin %) x Purchase Price of stock

Shortcut: 2/3 of the purchase price if the minimum maintenance is 25%. If it’s 30%, take 2/3 and then choose the next highest number.

40
Q

Examples of Passive Investment Strategies

A
  • Buy & Hold (EMH)
  • Dollar Cost Averaging
  • Index Investing
  • Strategic Asset Allocation (revised every few years)
41
Q

Examples of Active Investment Strategies

A
  • Market Timing
  • Tactical Asset Allocation
  • Technical Analysis
42
Q

Arbitrage Pricing Theory (APT) Keys

A
  • Unexpected Inflation
  • Unexpected changes in industrial production
  • Unanticipated shifts in risk premium
  • Unanticipated changes in structure of yields.
43
Q

T-Bills

A
  • 3,6,12 Months
  • SAFEST
  • BENCHMARK FOR RISK FREE RETURN
  • no coupon- interest is the discount!
  • sold at discount yield basis
44
Q

Notes

A
  • 1-10 year maturities
  • RIP
  • no D for Default
  • Semi annual interest
    *
45
Q

Treasury Bonds

A

10-30

46
Q

Federal bonds pay-

A

FEDERAL TAX!

47
Q

GNMA’s

A
  • direct guarantee of the U.S. Govt’
  • NOT issued by the Treasury
  • FED, STATE AND LOCAL TAXES!
  • each payment received represents both interest AND a return of principal
48
Q

CMO Z- Tranche

A
  • Longest Duration= Highest Interest Rate Risk
  • Last One = Highest Yield
  • only receives interest and pricipal after all others liquidated.
49
Q

Bond Ratings

What are Bad Bonds?

A

BB and Below

* Bad Bonds*

50
Q

Bond Conversion Formula

A
51
Q

Preferred Stock

A

Corporation buy due to 50% dividend exclusion

Excess funds

Pays a fixed dividend rate

infinite duration- does not mature

Riskier than Bonds due to duration

can be Cumulative or Noncumulative

52
Q

Mutual Funds

A

Redeemable NOT tradeable

Open Ended

53
Q

GICs

A

similar to CD’s

issued by insurance companies

terms 2-5 years

guaranteed interest rate

value does not fluctuate

value DOES depend on financial strength of issuer

popular for defined benefit plans

54
Q

Capitalization Rate

A

NOI / Cap Rate

Exam Question may ask for Cap Rate but only give info for NOI-

2 step question!

55
Q

Devaluation Vs. Revaluation

A

Devaluation = lowering of the value of a currency realative to those of other nations

Revaluing = increase in currency’s value

Convert $10,000 x 90 Yen = 900,000 Yen

Increase Stock goes up 50% x 1.50 = $1,350,000 Yen

Divide by exchange rate / 100 = $13,500 US dollars

$13,500/$10,000 = 35% retun NOT 50%

example of Devaluation of YEN

Revaluation of US Dollar

56
Q

Liquidity vs. Marketability

A

Liquidity- Can NOT loose $

Marketability- Can be sold QUICKLY

** Liquid AND Marketable = 3 month T-Bill

57
Q

Normal Vs. Lognormal distributions

A

% = Normal

$ = Lognormal

58
Q

Calculating
Standard Deviation

A
59
Q

Standard Deviation Shortcut

A

P less than 1 = divide by 2 and go down 1

P = 1 simply divide by 2

60
Q

Change in Bond Prices FORMULA

A

NEGATIVE DURATION ( CHANGE IN INTEREST RATES/ 1+ YIELD TO MATURITY)

ON FORMULA SHEET- REMEMBER THE -D

WILL HAVE TO CONVERT THE ANSWER TO A % AND THEN X BY BOND PRICE.

61
Q

Constant Growth Model

A

Dividend (1+ Growth Rate of Dividend) / Required Rate of Return - Growth Rate

*On Formula Sheet *

62
Q

Dividend Discount Model

Shortcuts!

Dividend (1+ growth rate) / Required rate- growth rate

A

1st growth rate LOWER than SECOND

Calculate using ONLY the SECOND growth rate

Then choose the next LOWEST answer choice

1st growth rate HIGHER than SECOND

Calculate using ONLY the SECOND growth rate

Then choose the next HIGHEST answer choice

63
Q

Security Market Line

*Formula on Sheet*

A
64
Q

Ex Dividend Date for Common Stock

A

PED

Purchase Date

Ex- Dividend Date

Date of Record - 1st business day after Ex-Date

65
Q

Put bonds

A

The right to sell In return for the put privilege buyer sacrifices yield. Convertible bonds also sacrifice yield.

66
Q

Preferred stock

A

C corps buys Riskier than bonds Duration = infinite

67
Q

Risks of GICS

A

Inflation And reinvestment rate risk

68
Q

Determine which stock is riskier?

A

Standard deviation/ mean

69
Q

Systemic Risk

A

PRIME Not diversfiable Beta (markets are volatile) High R2= portfolio diversified = alpha /traynor

70
Q

Unsystematic Risk

A

Standard deviation - total risk BF - business/financial risk diversifiable Low r2 Sharpe

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