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CFP > Investment > Flashcards

Investment Flashcards

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CFP® flashcards
1
Q

Unsystematic Risk

A

Known as diversifiable risk, may alslo 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

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

Types of systematic risk

A

PRIME

  • Purchasing Power Risk - 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 changes in the value of the currency
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4
Q

FDIC Insured Amount

(per bank/per type of account)

A

Individual: 250k

Joint: 250K

Trust (per bene): 250k

IRA/Keogh: 250k

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5
Q

The Yield Ladder

A

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
  • Yields lower than coupon
  • Premium Bonds

Premium Bonds

(yields lower than coupon)

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6
Q

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

I bonds

A
  • Non-marketable, non-transferrable, can’t be used for collateral
  • Sold at face value
  • Interest rate is composed of two parts
    1. A fixed base rate (remains the same for the life of the bond
    2. 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

Types of Municipal Securities

A
  • General Obligation Bonds: backed by the full faith, credit and taxing power of the issuer. GO bonds ae generally considered the safest types of munis.
  • Revenue Bonds: backed by a specific sources of revenue to which the full faith and redit of the issuer is NOT pledged. Because revenue bonds are backed by a single source of funds (like toll roads, hospitals, power plants, etc.)
  • Insured municipal bonds: The insurers pay timely interest and principal when the issuer is in default. Muni insurers are AMBAC and MBIA.
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9
Q

Indenture Agreement Covers

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

Corporate and Municipal Bond Risks (DRIP)

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.
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11
Q

Government Bond Risks

A

RIP only! No default or credit risk.

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12
Q

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

Real Estate

(land - improved)

(NOI)

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
  • Operating Expenses (excludes interest and depreciation)

= Net Operating Income (NOI)

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15
Q

Options (General Definitions)

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 (strike 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.
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16
Q

Call Options - taxabilty

A

At the time of purchase: non-deductile capital expenditure

  1. To the writer due to lapse: premium paid is a short-term gain
  2. To the writer due to exercise: premium paid is added to sale price (can be long term gain if underlying security was held more than 12 months, otherwise short term). Covered Call.
  3. 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

Hedging Strategies

(straddles and combinations collar, protective puts)

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. (good answer for the exam.)

18
Q

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.
19
Q

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.
20
Q

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”
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&P500. Index funds/diversified funds based on the S&P500 will have R2 if very close to 100%, while sector funds (not diversified) will have very low R2 (typically 5% - 25%).

22
Q

Risk Level Quantification

(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.
23
Q

Geometric Return

vs.

Internal Rate of Return (IRR)

A

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

IRR or Dollar Weighted Return - compares absolute dollar amounts.

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.

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.

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

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

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.

28
Q

Zero Coupon Bonds

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

Using Duration to Manage Bond Portfolios

A
  • If interest rates are expected to rise, shorten duration. (interest rates up, shorten duration - 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 - 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
31
Q

Convexity

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

Return on Equity (ROE)

A

ROE = Earnings Available for Common (EPS)

Common Equity (net worth or book value)

33
Q

Dividend Payout Ratio

A

Dividend Payout Ratio =

Common Dividends Paid

Earnings Available for Common (EPS)

34
Q

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 info 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

(how are stocks weighted: DJIA, SP500, R2000, W5000, VL, NAS, EAFE)

A
  • DJIA: 30 industrial stocks, price weighted
  • S&P 500: broader measure of NYSE activity, float weighted
  • Russell 2000: Smallest 2000 stocks of the Russell 3000 index, cap weighted
  • Wilshire 5000: Broadest measure, value weighted.
  • Value Line: ~1700 stocks, equally weighted
  • NASDAQ: Broadest measure of OTC trading, cap weighted
  • EAFE: Major foreign markets, value weighted.
  • Lehman Bros Agg Bond: More than 5000 US Govt, corporate and mortgage backed and asset backed bonds.
36
Q

Tax Basis of a Mutual Fund

A
  • FIFO treats shares acquired first as being sold first
  • Specific ID requires the seller to identify the shares of the fund that are sold. Allows the investor to creat 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 sheld.
37
Q

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

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 higest Treynor.

39
Q

Margin (Maintenance) Call

A

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

1 - Initial Margin %

————————- x Purchase Price of stock

1 - Maintenance Margin %

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

Passive Investment Strategies

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

Active Investment Strategies

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

Arbitrage Pricing Theory

(APT) Keys

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

CFP (7 decks)

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