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CFP EXAM FLASHCARDS > Investment > Flashcards

Investment Flashcards

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1
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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2
Q

What is Return on Equity (ROE)?

A

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

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3
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.

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4
Q

Correlation Coefficient

A
  1. Perfectly positively correlated securities: pij = +1.0, securities move exactly together. No reduction of risk. Maximum risk
  2. pij=0-1.0 The risk of the portfolio is less than the risk of the individual securities
  3. Perfectly negatively correlated securities: pij=-1.0, securities move exactly opposite. In theory, risk is completely eliminated

pij = COVij/SDixSDj

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5
Q

Examples of Active Investment Strategies

A
  • Market Timing
  • Tactical Asset Allocation
  • Technical Analysis
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6
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.
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7
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 plus Non-rental Income (laundry, etc.) equals Potential Gross Income (PGI) minus Vacancy and collection losses minus Operating Expenses (excludes interest and depreciation) = Net Operating Income (NOI)

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8
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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9
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.

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10
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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11
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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12
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 Premium Bonds (yields lower than coupon)

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13
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
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14
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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15
Q

Geometric mean

A

time-weighted return

measures investment performance as a % of capital at “work”

shortcut to calculate: 1 + returns then multiple all returns to get Xij FV, 1 +/- PV, #N, solve for i

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16
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.

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17
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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18
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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19
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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20
Q

Standard Deviation

Vs

Beta

A

Standard Deviation: variability of returns around the average/means of those returns. Used in a nondiversified portfolio and is a measure of total risk

Beta: volatility of a securities returns relative to a market index. Used in a diversified portfolio and is a measure of systematic risk

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21
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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22
Q

What are the Risks of Government Bonds?

A

RIP only! No default or credit risk.

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23
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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24
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.

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25
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
26
Q

Duration (Principles to Remember)

A

Duration is used to compare interest rate risk between bonds with different maturities and coupons. It can be used to immunize a bond from loss of principal due to interest rate changes.

Years to Maturity: Remember time is (on top) poisitively related to duration

Annual Coupon (interest rate): _i_nversely related to duration

YTM: The current yield (interest rate) on comparative bonds is _i_nversly related to duration

27
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.

28
Q

What are the Types of Systematic Risk?

A
  • Purchasing Power Risk: Loss of purchacing 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.

29
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.
30
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.

31
Q

How to Calculate Dividend Payout Ratio

A

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

32
Q

optimal risk-adjusted return

A

securities realized return / beta coefficient

33
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
34
Q

Arbitrage Pricing Theory (APT) Keys

A

the security’s movement and return are NOT explained by a relationship between risk and return. Security returns are the result of arbitrage as investors seek to take advantage of perceived differences in prices.

  • Unexpected Inflation
  • Unexpected changes in industrial production
  • Unanticipated shifts in risk premium
  • Unanticipated changes in structure of yields.
35
Q

Examples of Passive Investment Strategies

A
  • Buy & Hold (EMH)
  • Dollar Cost Averaging
  • Index Investing
  • Strategic Asset Allocation (revised every few years)
36
Q

What is 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)
37
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”
38
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
39
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.

40
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.

41
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.

42
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.”

43
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

44
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
45
Q

Capital market line (CML)

A
  • expresses the macro aspect of the CAPM
  • specifies the relationship betwen risk (standard deviation/total risk) and the return of a portfolio
  • a slope tangent to the Markowitz efficient frontier. To expect a higher return, the invester must assume more risk.
46
Q

Security market line (SML)

A
  • expresses the micro level of CAPM
  • the relationship between risk (beta/systematic) and the return for an individual stock
  • diversification doesn’t matter
47
Q

Liquidity

vs.

Marketability

A

Liquidity: assets that are converted into cash without much loss of principle. (short-term CDs, laddered CDs, or life insurance cash value. NOT CEFs, MFs ETFs, and brokered CDs)

Marketability: speed and ease with which a security may be bought or sold.(REITs, CEFs, ETFs, stocks, and brokered CDs. NOT savings/checking/MM accounts and MFs)

48
Q

Coefficient of Variation

A
  • CV = SD / average or mean
  • measures relative variability to compare investments
  • the higher CV the riskier the stock
49
Q

Yield to Maturity

A
  • Reinvestment risk = YTM aka “effective yield”
  • EEs and STRIPs have NO reinvestment risk, because they bear no interest to reinvest
50
Q

Yankeebonds

vs

Eurodollars

vs

ADRs

A
  • Yankeebonds: foreign issued bond issued in US by foreign banks. Issued in USD.
  • Eurodollars: US companies issued to foreign companies
  • ADRs: receipts for shares of foreign-based corporations held in US. ADR holders are entitled to dividends and cap gains. Dividends are paid in USD but declared in foreign currency.
51
Q

Guaranteed Investment Contract (GIC)

A
  • Similar to CDs issued by commercial banks
  • issuer assumes all market, credit, & interest rate risk
  • dependent on financial strength of issuer (default risk)
  • term: 2-5 yrs at guaranteed interest rate
  • popular with DB plans
52
Q

Real Estate Investment Trust (REIT)

A
  • Similar to CEF but invest in Real Estate
  • Investors achieve diversification & marketability
  • Mortgage REITs are highly leveraged, inflation BAD
  • Asset location: good in IRA/tax-deferred accounts
53
Q

REIT tax rules

A
  1. at least 75% of income must come from Real Esate
  2. If 90% of investment income is distributed, only undistributed is taxed
  3. distitrbuions are ordinary dividends. May qualify for QBI deduction of 20%
54
Q

Unit Investment Trusts (UITs)

A
  • Passive investment. Assets are not traded but frozen
  • No new securities are purchased, securities are rarely sold
  • self liquidating, as funds are received, get distributed to unit holders
  • Sponsor redeems unit @ NAV
55
Q

Conversion Value Formula

A

CV = (Par / Conversion Price) x Stock Price

56
Q

Mortgage Bonds

A
  1. GNMA: Buys FHA, VA, and FHA mortgages and pools then together. Offers “pass through” certificate. direct guarantee of US gov’t. not issued by Treasury, therefore subject to state, local, and fed taxes.
  2. FNMA, FHLMC: for profit mortgages. not guaranteed by US gov’t.
  3. CMOs: Offered in tranches (A-Z), payments received are viewed as “cash-flow” and tranched accordingly.
57
Q

Dividend Payment Process

A
  1. Declaration date: company declares dividend
  2. ex-dividend date: shareholders owning stock before this date will receive dividend (one day before record date)
  3. record date: date the company reviews records to see who gets dividend
  4. payment date: when dividend is paid to shareholders
58
Q

Treasury Securities

A
  1. OIDs: issued at discount from par value. Each year a portion of the discount is “earned” and taxable (phantom)
  2. Bills/Notes/Bonds: marketable securities, there is no state or loval income tax on interest. Bills are quoted in terms of discount to yield.
  3. STRIPS: zero-coupon, direct obligation of fed. discount is treated as taxable income, earned annually (phantom)
  4. TIPS: Face value is adjusted semiannually to keep pace with inflation. taxed annually on the interest payment (phantom) plus appreciation in face value.
59
Q

Mutual Funds

A
  • aka Open-end investment companies
  • shareholders cash-in by redeeming their shares back to the company
  • shares are non-negotiable, reedemable securities
  • NOT MARKETABLE
  • series 6 required (NOT series 7), non-individual investment
60
Q

Closed-end investment companies (CEFs)

A
  • one-time stock issuance, no new shares are issued
  • shares are then traded on an exchange
  • Series 7 required
61
Q

Black-Scholes option valuation model

A
  • considers 5 variables, used to value option of a non-dividend-paying stock (think “call up”​
  1. ​exercise price
  2. time remaining until expiration
  3. interest rate
  4. volatility of stock
  5. price of stock
  • all variables of direct up relationship for call except exercise price
62
Q

Short Selling

A
  • investor thinks the price will decline and doesn’t own it
  • to cover, short seller instructs broker to repurchase (cover) security.
  • must be made in margin account
  • net proceeds + required margin are held by broker
  • no time limit
  • dividens declared must be covered by short seller

CFP EXAM FLASHCARDS (7 decks)

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