Investment Flashcards
Duration Basics
- bond duration is the weighted average maturity for all cash flows
- duration is the moment the investor is immunized from interest rate risk and reinvestment rate risk
-Modified duration is bonds price sensitivity to interest rates - bond portfolio should have bond duration equal to investors time horizon
What is the relationship between bond duration and bond term? And coupon rate/YTM and duration
As duration increases, term increases. direct relationship
Inverse relationship
Equation for net Operating INcome
Gross Rentals + non rental income - Vacancy and collection losses - cash expenses + interest expenses
What are the 2 forms of underwriting and description
- Best efforts - underwriter agrees to sell as much as the offering as possible.
Any shares not sold are returned to the firm.
Firm Commitment- underwriter purchases all offerings and sells. Any shares not sold are not returned to the firm.
Name the key documents for investment planning and description
- Prospectus - outlines risk, management team, fees. MUST be issued prior to selling any shares.
- Red Herring - Prelim prospectus issued before SEC approval to determine investor interests.
- 10K and 10Q - 10k is auidited financial report with SEC. 10Q is quarterly financial statement filed with SEC.
- Annual Report - sent directly to shareholders with message from chairman about future outlook.
What is a market order
timing and speed more important than price. for stocks not thinly traded
What is a limit order
Price traded is more important than timing. for stock not frequently traded and volatile.
What is a stop order
Price hits a certain level then becomes a market order.
What is a stop limit or stop loss limit order
2 prices are set:
-stop loss price - then switched to limit order
-limit price set and will not sell lower.
* may be left with stock at extremely low price.
What is an initial margin
reflects the amount of equity an investor must contribute to the stock . *%50 unless otherwise stated.
What is a maintenance margin
the min amount of equity required before a margin call.
Margin position
equity / FMV
equity= stock price - loan
- NOT ON EXAM
Margin Call Eq
LOAN / (1 - Maintance margin)
Describe the different research reports
- Value Line - Ranks STOCKS 1-5 for timeliness and safety (1 - highest to buy)
- Morning Star - Ranks MUTUAL FUNDS. 1-5 stars
Describe the ex dividend date and date of record and when someone can buy the stock
- Ex-dividend: the day the stock trades without a dividend.
- 1 day before the date or record. If you sell before or on ex dividend date you receive the dividend. you cannot receive dividend if you BUY on or after the date. - Date of Record- date to be a registered shareholder to receive the dividend. To receive dividend, must buy 2 days before date of record.
How are cash dividends taxed?
qualified dividends receive capital gains treatment.
cash dividend taxed upon reciept.
How are stock dividends taxed?
Not taxed until sold
Define the following Securities Regulations:
1. Securities Act of 1933
2. Securities Act of 1934
- regulates issues of new securities on primary market and before they are sold
- regulates issue of securities on secondary market and created the SEC to enforce compliance
Define the following Securities Regulations:
3. Investment Company Act of 1940
4. Investment Advisors Act of 1940
5. Securities Investors Protection Act of 1970
- Authorize SEC to regulate investment companies (open, closed, unit investment trust)
- Require investment advisors to register with SEC
- created SPIC to protect investors from losses resulting in brokerage firm failures
Describe the different Money Market Securities.
- Commercial Paper - short term loans between corps. maturity 270 days or less. Denominations of 100k.
- Treasury Bills- up to 52 week maturities. 100$ up to 5M.
- Bankers Acceptance - facilitates imports and exports. 9 months or less maturity.
- Eurodollars - deposits in foreign banks in US dollars.
What is an investment policy statement and its parts?
- establish client and investment manager goals and restrictions. Measures investment manager performance.
RRTTLLU
- Risk, return, taxes, timeline, Liquidity, legal, unique circumstances
Describe the market averages and how they are weighted
- Dow Jones- price weighted
- S&P 500- value weighted
- Russell 2000- smallest value weighted
- Wilshire 3000- broadest measure of 3k stocks. value weighted
- EAFE - value weighted
What are the assumptions of behavioral finance
- Investors are NORMAL
- Markets are NOT efficient
3.Behavioral Portfolio theory governs - risk alone does not determine results
Describe Affect Heuristic
deals with judging something. do they like or dislike the company non financial issues
Describe Anchoring
anchoring to a reference point that has no relevance
describe Availability Heuristic
decision maker depends on knowledge that is readily available in their memory. may pay attention to recent events instead the longer trends.
Describe Bounded Rationality
Seek satisfactory solution instead of the optimal one. “Satisfiers”
Describe confirmation bias
People filter information and focus on information supporting their opinions
Describe Cognitive dissonance
tendency to misinterpret information that is contrary to existing opinion or only listen to information supporting an existing opinion
Describe disposition effect
known as regret avoidance or faulty framing. make a mental account of price to sell or buy and follow even when the market changes
Describe familiarity bias
tend to overestimate or underestimate risks of investments that are familiar/unfamiliar
Describe gamblers fallacy
believe stock will continue on upward trend and not selling
Describe Herding
follow the masses
Describe Hindsight
Looking back after the fact is known and predicting the future trend
Describe Illusion of control
overestimate ability to control events
Descrive overconfidence
focus on own skills to do their own research and make own decisions
What is the CAPM model and the equation.
calculates relationship of risk and return using beta.
* also known as security market line.
Rf + (Rm-rf) B
What is the information ratio and equation
- relative risk adjusted performance
- measures excess return and consistency by investment manager
IR = Rp - Rb/ SD
What is the Treynor Index and the equation and measurement
- risk adjusted performance manager needs to be compared to other tremor ratio.
- Uses Beta.
Rp-Rf/B
What is the Sharpe Ratio with equation and measurement
-measure of portfolio performance and compared to another
- SD
Rp-Rf/SD
What is the holding period return equation?
* NOT ON EXAM
Selling Price - Purchase price (+-) cash flows/ purchase price or equity invested
Items added to holding period return (define where it goes):
1. Dividends received
2. Margin Interest Paid
3. Taxes paid
4. Purchased securities on margin
- Add to numerator
- Subtract from numerator
- (only for after tax gain or loss) subtracted from numerator
- Subtract interest paid in numerator. Subtract total cost from the proceeds. Denominator - include your equity in trade
What is the equation for Effective Annual Rate and what does it measure?
effective value on interest rate with compounding more than once per year.
EAR = 1 + (i/n)^n - 1
How do you calculate the weighted average portfolio
FMV/ Total value of portfolio X RETURN(OR BETA)
Then add all sums
Describe the Arbitrage Pricing Theory
- pricing imbalances cannot exist for period of time otherwise investors will exploit
- multifactor model to explain result based on factors
- sensitivity to inflation, risk premium, expected return
- BETA and SD not used
Explain the Dividend discount model and how to calculate next year dividend?
*FORMULA ON EXAM
values a company stock based on future cash flows. Know as Gordon Growth and Intrinsic Value
Next year
D0 (1 + G)
What is the dividend Payout Ratio? and details
* NOT ON EXAM
Common Stock Dividend / EPS
- the higher, the more mature the company
- The higher, may indicate dividend may be reduced
What is return on Equity equation? And details
* NOT ON EXAM
EPS/ Stockholder equity per share
- measure overall profitability of company. All direct relationship between ROE, Dividend and earnings
Define Fundamental Analysis
conducting ratio analysis to determine future financial performance and future price stock, and how the economy will effect it.
- believe stock price performance is based on the firm financial performance
_ some securities are misplaced and we can find those.
_ investors can determine future stock behavior
Describe technical analysis
Depend on supply and demand to drive price.
What is the Efficient Market Hypothesis 3 forms and what they see advantage through
Weak Form: historical data cannot predict returns so passive approach and fundamental analysis for returns and inside information
Semi Strong: Public information and historical data cannot reflects price and inside information provides returns
Strong: ALL information cannot predict price and that it is all random
What are the market anomalies
- January effect - better months because of tax in November and December
- Small firm affect - can outperform large cap. Easier to earn
- Value Line Effect: stocks that receive higher ranking (1) outperform lower ranking
- P/E Effect: low outperform High
What are maturities and denominations for each market security:
- Treasury Bills
- US Treasury Notes
- US Treasury Bonds
- less than 1 year, $100
- 2-10 yrs
- greater than 10 year maturity at $100
How do you calculate coupon rate?
Coupon payment/PAR
How do you calculate current yield?
Coupon payment/ Price of bond
Describe the YTM
Compounded rate if investor buys and holds until maturity.Assumes can reinvest coupon payments at the YTM rate.
Describe Yield to Call
compounded rate if investor buys and holds until bond retires by issuer.
Describe the ladder at a premium and discount from highest to lowest?
Premium - CR - CY -YTM - YTC
Discount - YTC - YTM - CY - CR
Describe the following Yield Curve Theories:
Liquidity Preference, Market Segmentation, Expectations Theory
- Investor will invest in lower yields due to preferring liquidity. Long term yields should be higher than short term.
- Yield curve depends on supply and demand. If supply is higher than demand then it will result in lower rates.
- Reflects investor inflation expectations. when inflation is expected to be lower then long term rates are lower than short term rates.
Define the following tax strategies:
Tax Swap, Barbells, Laddered bonds, Bullets
- Selling a bond that has a gain and one that has a loss to offset. Or selling a bond with a losss to purchase a new bond.
- owning both short term and long term bonds. when interest rates move only one side needs to be sold and restructured.
- purchasing bonds with varying maturities. help reduce interest rate risk.
- very little payments during the period but then lump sum at specified time. Zero coupon, treasury and corporate bonds are good examples. Used when investor has balloon liability in the future.
What is a preferred stock?
Has both debt and equity features
Debt - stated par value
equity - price may moves like a common stock
- no maturity date
-dividend does not fluctuate - tax advantage for corporations to receive 50-65% deduction of dividends based on ownership
What is a convertible bond and equation?
*NOT ON EXAM
value in terms of a stock that can be converted. Even if a stock doesn’t perform well it has a floor.
= PAR/CV x Price of common stock
What is property valuation and the equation for net operating income?
- to determine how much an investor will pay for real estate.
NOI
Gross Rental Receipts
+ Non Rental Income
= Potential Gross Income
- Vacancy and Collection losses
= Effective Gross Income
- total Expenses
= Net income
+ Interest and Depreciation Expense
What are the three types of investment companies and describe each one.
Open Ended, Closed Ended and Unit Investment Trust
- Open - Unlimited # of shares, if continue to receive contributions to fund family then keeps issuing. Shares trade at Net Asset Value
Asset - liabilities / Shares Outstanding
- Fixed initial capitalization because certain amount are sold to public then traded on organized exchange. Can sell at discount
- Can be equity or fixed income. No investment manager just trustee. Self liquidating and passively managed.
Describe the following type of mutual funds:
Aggressive Growth, Growth, Growth and Income, Value Fund, Balanced Fund, Bond Fund, Money Market Fund.
- Invest in small caps and offer greatest potential for capitalization
- Invest in equities with High P/E, little to no dividends with rapid growth
- Invests in equity and income producing assets for rapid growth and capital growth
- Invests in undervalued funds with low P/E with high yields and positive outlook
- Invests in more bonds than equity. looking for a balanced return.
- liquid bonds investments that are conservative and cost effective
- Highly liquid, appropriate for emergency funds and invest in mutual funds with 90day less matures.
What is a a Real Estate Investment Trust?
Hedge against inflation and have low correlation with index. Must distribute 90% to stockholders to maintain tax exempt.
3 types:
1. Equity, mortgage and hybrid
Describe the buy and sell ideas for call and put options
What is the intrinsic value for a call and put option
Call: stock price - strike price
Put: strike price - stock price
CANNOT BE LESS THAN 0
Describe the following option strategies:
Covered Call
Married Put
Selling call option owned by the investor to generate income but still own the stock
Buying a put option on a stock or index owned by the investor (“portfolio insurance”)
Describe the following Pricing Models:
Black Scholes
Put/Call Parity
Binomial Pricing Model
- Determine the value of a call option considering the current price, time till expiration, risk free rate, volatility of underlying asset
- values the put from corresponding call
- value an option based on assumption that stock can move only 2 directions
Describe the difference between an option contract and a futures contract
Option give the RIGHT to do something; futures OBLIGATES holder to take delivery
