Investment Basics and Strategies Flashcards
The return on investments after applicable income taxes are subtracted. An investment with a before-tax return of 8% would have an after-tax return of 6.08% for an individual in the 24% bracket. This is calculated by multiplying .08 by 1 minus the tax bracket of .24: [.08 (1 – .24)].
After-tax return
A mutual fund that invests primarily in the stocks of companies that plow all or most of their earnings back into the company, producing little current income but growth in the value of the company and the stock.
Aggressive growth fund
A mutual fund that invests in different types of assets to create a diversified portfolio of investments, including such items as foreign and U.S. stocks and bonds, real estate, precious metals, and currencies. The point of these funds is to minimize volatility in the overall portfolio while attaining favorable returns.
Asset allocation fund
Pertains to investments. It is a strategy of diversification aimed at reducing variability of return from a portfolio of investments. The point of asset allocation is to invest in different types of assets that move in different ways from others in the portfolio
Asset allocation strategy
A mutual fund that combines different types of assets, such as stocks and bonds, within one fund. Types of these funds include balanced funds, lifestyle funds, and lifecycle funds.
Asset combination fund.
A mutual fund that invests in stocks, preferred stocks, and bonds. Investment objectives are security of principal, reasonable current income, and reasonable long-term capital appreciation.
Balanced mutual fund
A measure of the volatility of an asset relative to the volatility of an index. Beta measures only systematic risk
Beta
Stock that is issued by major, well-established companies. ______ stocks have long records of earnings growth and dividend payments in both good and poor economic conditions.
Blue-chip stock.
A debt of the issuer that is a legal obligation to pay principal and interest when due.
Bond
A mutual fund that invests in bonds. Funds of this type may invest in short-term, intermediate-term, or long-term maturity bonds. They may also specialize in bonds of a specific type of issuer; for example, they may invest only in corporate bonds, only in municipal bonds, or only in Treasury securities.
Bond mutual fund
Investment risk that addresses the uncertainty of investment returns resulting from the nature of a business or the industry in which it operates. Examples include the uncertainty relating to future earnings, competition, and management of the business
Business risk
If a bond is callable, the issuer has the right to redeem the bond before maturity at a predetermined amount.
Callable bond.
An excess of the sale price of a capital asset—such as a stock, a bond, a personal automobile, or a home—over its basis (generally its purchase price).
Capital gain.
An excess of the basis in a capital asset over its sale price. Some capital losses are tax deductible, but personal losses are typically not deductible (such as a loss on the sale of a personal automobile).
Capital loss
A company that invests in diversified portfolios of investments on behalf of investors, but which has fixed capitalization. The company issues a fixed number of shares, and by purchasing shares of the company, an investor presumably will share in the gains or losses experienced by the underlying portfolio of investments. When the portfolio performs well, the investor’s shares in the company generally will increase in value; when the portfolio does poorly, the shares generally will decrease in value. The investor must buy or sell shares in the market; they are not purchasable or redeemable by the investment company. As a result, changes in the value of the portfolio are not the only determinant of changes in the price of the shares; share price is also determined by market conditions and investor sentiment.
Closed-end investment company
Short-term promissory notes issued by major, well established corporations. Commercial paper is issued in large denominations.
Commercial Paper
Pertains to investment strategies. It is the opposite of diversification; it involves investing in a single security, industry, or type of security.
Concentration.
Pertains to bonds and preferred stock. The corporate issuer may include a provision enabling bond or preferred stockholders to exchange their securities for a certain number of common stock shares at a specified price.
Conversion privilege
An asset allocation approach that divides a portfolio into two components: (1) a core for 70% to 80% of the portfolio that typically contains indexed mutual funds or broad-based exchange-traded funds, and (2) a satellite for the remainder of the portfolio to increase returns and/or provide additional diversification to the portfolio.
Core/satellite asset allocation
A debt instrument issued by a business. Typical features include semiannual interest payments based on a stated coupon rate and payment of the face amount upon maturity.
Corporate bond
The annual interest rate paid by a bond issuer
Credit Risk
Also called exchange rate risk, it is the risk of diminishing both principal and return on a foreign investment because of unforeseen changes in the relative values of U.S. and foreign currencies. It is considered a type of nondiversifiable (i.e., systematic) risk.
Currency risk
When a firm cannot meet its obligations, it is in danger of defaulting. Default risk tends to be highest among businesses without enough profitable sales, especially when they also have excessive debt.
Default risk
A bond selling below its par value
Discount bond
An investment strategy that involves investing in many different securities to reduce risk; the opposite of concentration
Diversification
An investment strategy that involves purchasing the same dollar amount of a security at regular intervals. When the security’s price is low, more shares will be purchased. When it is high, fewer shares will be purchased.
Dollar cost averaging
A measure of the sensitivity of a bond’s price to a 1% change in interest rates.
Duration
Earnings per share is the company’s net income (profit) for the year divided by the number of shares outstanding
Earnings per share
Equity represents ownership. As applied to stock, equity is stock ownership in a corporation. As it applies to real estate, it is the difference between the amount of any mortgage on the property and its market price
Equity
A mutual fund that invests primarily in equity securities of companies that pay above-average dividends.
Equity income mutual fund
The possibility that a security will be affected by an unanticipated and damaging event.
Event risk
A basket of securities, usually stocks, that track indexes (both U.S. and international) or specific sectors of the stock or bond market (although some ETFs are tied to the price of commodities like gold, silver, or oil). They trade throughout each business day just like stocks and generally are low-cost and tax-efficient
Exchange-traded funds (ETFs)
Are unsecured debt securities usually issued by large commercial or investment banks. As with any debt issue, ETNs have a fixed maturity, with maturities of 30 years not being unusual. Like ETFs, they often track an index or benchmark, or a commodity, such as gold.
Exchange-traded notes (ETNs
A fund’s annual expenses divided by its average net assets. Passive index funds and ETFs have lower expense ratios than actively managed funds.
Expense ratio
A public corporation that issues mortgage-backed securities collateralized by a pool of mortgages made by lenders.
Fannie Mae
Use of borrowed funds to enhance gain on an investment. It also increases the potential variability of return (investment risk)
Financial leverage
The amount of debt a firm has (shown on its balance sheet). A firm that is highly leveraged (large amounts of debt) has greater financial risk than a firm with little or no debt.
Financial Risk
An investment that promises a stated amount of income, either in the form of periodic payments (such as interest) or a stated ending payout (such as with deep discount bonds). Because payouts are fixed, these securities tend to be subject to interest rate risk and purchasing power risk
Fixed-income security
A security sold by the Freddie Mac (formerly the Federal Home Loan Mortgage Corporation or FHLMC), collateralized by pools of conventional residential mortgages. Freddie Mac guarantees the payment of principal and interest on these securities.
Freddie Mac
An in-depth examination of many variables, unique to the issuer of the security and its industry and the overall economic factors, that impact the intrinsic value of a security.
Fundamental analysis.
A bond issued by a municipality for which interest payments are secured by the general taxing power of the municipality
General obligation municipal bond (GO)
security collateralized by a pool of primarily VA and FHA mortgages that are packaged according to interest and maturity by mortgage bankers, commercial banks, and other financial institutions
Ginnie Mae
Also called a world mutual fund, it is a fund that invests in both U.S. and foreign securities.
Global Mutual Fund
The stock of a company whose sales and earnings are expanding faster than those of most stocks and faster than the general economy. The company usually is aggressive, emphasizes research or innovation, and retains earnings for future expansion rather than paying them out to shareholders.
Growth Stock
Limited partnerships with managers as the general
partners and investors as limited partners (no more than a total of 99). Hedge funds are lightly regulated, generally available only to wealthy individuals, and
have little transparency. They can use a variety of investment strategies so they can be conservative or very aggressive. Their fee is usually 1% or 2% of assets
plus 20% of profits
Hedge Funds
A fund that attempts to own securities that mimic an
established index, such as the S&P 500, Dow Jones Industrial Average, or Wilshire 5000. Using stock indexes has been common, but now use of bond
indexing is also increasing.
Index Mutual Fund
A general increase in the level of prices within the economy.
Inflation
U.S. government securities that increase in value with
changes in inflation. See Treasury Inflation-Protected Securities.
Inflation-indexed bond.
A type of nondiversifiable (systematic) investment risk. This is the risk that a bond’s price will fall if interest rates rise.
Interest rate risk.
A fund that invests only in foreign securities
International mutual fund.
The probability that actual investment returns will vary from expected returns.
Investment risk.
The appropriateness of an investment for a specific investor, which is determined by considering the investor’s risk tolerance, time frame, sophistication, individual circumstances and preferences, and financial resources.
Investor suitability.
The ability to convert an investment to cash quickly, without loss of principal.
Liquidity
Related to the uncertainty of converting an investment to cash within a short period of time at, or near, the original principal invested. This is a type of unsystematic risk.
Liquidity risk.
Pertains to mutual funds. A load is a sales charge sometimes incurred by the investor for executing a mutual fund transaction.
Load
The variability of return caused by investors’ reactions to tangible and intangible events. It is considered a type of nondiversifiable (systematic) risk.
Market risk.
The degree to which there is an active market in which an investment may be traded. For example, stocks that are actively traded on an exchange have higher levels of marketability than real estate (under most conditions).
Marketability.
The date when principal must be repaid to a bondholder.
Maturity date.
An approach to strategic asset allocation that
strives for the highest return for a given level of risk or the lowest risk for a given level of return.
Modern portfolio theory (MPT).
Available through savings and loan associations
and banks. Earnings rates are determined by the institution, and they tend to be lower than rates for money market funds. Money market deposit accounts are FDIC insured, up to $250,000 per ownership category. Check writing privileges are typically available, although they may be restricted.
Money market deposit account.
A mutual fund consisting of short-term money
market instruments, such as Treasury bills, negotiable certificates of deposit, and commercial paper. Some specialize in tax-free securities. Such funds are highly liquid and offer a high degree of safety of principal. Check writing privileges are typically available, although they may require checks to be of a minimum amount such as $250.
Money market mutual fund.
Debt instruments secured by a pool of mortgages.
Mortgage-backed securities (MBS).
A bond issued by a municipality, usually to finance a new project such as a library, hospital, or airport. The advantage is that interest received by investors generally is free from federal taxation, and
sometimes it is free of state and local income taxes as well. The two main types of municipal bonds are general obligations (GOs) and revenue bonds.
Municipal bond.
A nonprofit insurer that has no capital stock. It is
generally owned by policyholders.
Mutual insurance company.
Pertaining to mutual fund pricing, it is the fund’s net
assets divided by the number of shares outstanding.
Net asset value per share.
Pertains to mutual funds. A no-load fund does not have a “load” or “sales charge” assessed.
No-load.
An investment company that pools the money of
many investors, hires an investment adviser to manage the pool, and invests to achieve one or more financial objectives. Commonly referred to as a mutual
fund. It is a fund that continues to offer shares to the public (i.e., “open-end”). Shares are purchased and redeemed through the fund, with purchase prices based
on net asset value of the shares and any sales charge assessed.
Open-end investment company.
Bonds: The value that will be paid to investors when the bond is redeemed at maturity. Preferred Stocks: The stated value of the stock and the price at which the stock was initially sold. Common Stocks: The dollar amount assigned to the stock upon issue.
Par value.
An equity investment in which dividends are fixed at the stock’s issue. However, a corporation can pass on dividends (not pay them) without becoming insolvent. Preferred stockholders have a higher claim on the
corporation than common stockholders, but a lesser claim than bondholders
Preferred stock.
A bond selling above par value.
Premium Bond
The official booklet that describes a security and offers the sale of its shares. Its purpose is to provide full and fair disclosure of relevant investment information.
Prospectus
systematic risk, it is the impact of inflation or deflation upon the value of an investment’s returns. For example, when an individual purchases a bond, he or she may reasonably expect to receive the face amount of the bond at maturity, which is usually $1,000. Given the impact of inflation, however, the purchasing power of $1,000 will have been significantly reduced over time. Fixed-income investments tend to be highly subject to ________.
Purchasing power risk.
Similar to a closed-end investment company, but organized to invest in real estate. It provides centralized
management, limited liability, continuity of interest, and transferability of ownership. They generally avoid corporate tax by distributing at least 90% of its taxable income to shareholders. These distributions are then taxed as ordinary income.
Real estate investment trust (REIT).
Also known as reinvestment risk, the risk that interest
rates have decreased at the time payments from an investment are received so that reinvestment of those payments is at a lower rate than that previously earned.
Reinvestment rate risk.
A bond used to finance municipal projects in which
principal and interest are payable solely from revenues produced by the project.
Revenue municipal bond.
The possibility of loss or the possibility that the actual result will vary from the expected result.
Risk
An investment principle that increased levels of risk must be assumed if the investor hopes to earn higher return. Likewise, lower risk assumption generally leads to lower returns
Risk-return trade-off.
The level of risk that an individual is willing to assume in
investing, based upon his or her emotional temperament, investment experience,
and financial constraints.
Risk tolerance.
Bonds issued by the U.S. government through its
TreasuryDirect.gov website that earn a fixed rate of interest semiannually (EE bonds) or earn a fixed rate plus a rate tied to inflation (I bonds).
Savings Bond
Fund investing in the stocks of one industry or specializing in a theme, such as leisure.
Sector mutual fund.
A registered savings bond that is a U.S. government obligation. These bonds are issued at face value and earned a fixed rate over its lifetime. They make no current interest payments.
Series EE bond.
A registered savings bond that is issued at face value, the principal of which increases with inflation.
Series I bond.
Pertains to bonds. Bond indentures sometimes contain a
sinking fund provision, which is a plan for the early retirement of some bonds in the issue at fixed intervals. This is generally considered beneficial to bondholders
since the corporation’s full obligation to repay does not come at a single time.
Sinking fund provision.
A measure of risk that indicates the degree to which an
investment’s returns deviate from its average return over a period of time. The greater the _________ of an investment, the greater the risk. It measures total risk (both systematic and unsystematic risk).
Standard Deviation
An informational brochure on a mutual fund, which is available upon request. The statement contains information that is classified as useful but nonessential by the Securities and Exchange Commission
and therefore typically is not included in the prospectus.
Statement of additional information.
A fund in which the underlying investments are stocks.
Stock mutual fund.
An approach to asset allocation that focuses on long-range objectives to set a portfolio’s asset mix.
Strategic asset allocation.
An abbreviated mutual fund prospectus that contains some of the most important information about a fund, such as investment objective, investment strategies, risks, performance, fees and expenses, and fund
management.
Summary prospectus.
The variability of return that is caused by factors affecting all comparable investments; also referred to as nondiversifiable risk.
Systematic risk.
A method of an analyzing securities or market movement based on supply and demand factors reflected in volume and/or price behavior.
Technical analysis.
The sum of an investment’s current income (dividends or interest) gains or losses.
Total return.
A short-term obligation of the U.S. government that is issued at a discount and redeemed at face value upon maturity. Income, which is received upon maturity, is not taxed at a state or local level.
Treasury bill.
A long-term obligation of the U.S. government that is issued at or near par. Interest is paid semiannually and is not taxed at a state or local level.
Treasury bond.
A U.S. government obligation issued at or near par, with maturities of 5, 10, and 30 years whose principal
increases with inflation. Interest is paid at a fixed rate of principal semiannually and is not taxed at a state or local level.
Treasury inflation-protected securities (TIPS).
An intermediate-term obligation of the U.S. government that is issued at or near par. Interest is paid semiannually and is not taxed at a state or local level.
Treasury note.
Pools of securities sponsored by brokerage houses and
sold to investors in units. The portfolio is generally selected and then fixed, unlike a mutual fund, which is either actively managed or mirroring a benchmark.
Unit investment trust.
The variability of return that is caused by factors that are
unique to a given company, industry, or property. It is risk that can be reduced through diversification.
Unsystematic risk.
A return earned from an investment, typically expressed as a percentage. There are several methods of measuring yield, such as nominal yield, current
yield, and yield to maturity.
Yield
A measure of yield that factors in both interest income and any change between the price at the purchase date and the call price at the earliest date the bond can be called.
Yield to call
A measure of yield that considers both current income
generated and any change in a bond’s value between the purchase price and the maturity value. It assumes reinvestment of income streams received at the same
rate of return.
Yield to maturity.
An original issue discount bond that matures at par value, the difference being interest earned. While interest is earned over the life of the bond, there are no cash interest payments made. However, the investor is taxed upon accrued interest annually. The bond increases in value as interest is earned, and therefore interest is received when the bond is sold or matures.
Zero Coupon Bond
