Investment Mgt Flashcards
Options - Buyers rights
A Contract that gives buyers rights and seller obligations.
Buyer can choose to buy or sell 100 shares of underlying securities up and until the Expiration Date at the Strike Price.
For this right, buyer pays a premium/price
Options - Seller’s obligations
Seller is obligated to sell or buy 100 shares of the underlying security when called upon up and until the expiration date at the strike price.
For this obligation, the seller receives a premium/price
Yield Curve
Normally, The lender expects to charge higher interest rate for long-term loans; The longer the term of the loan, the higher the interest rate
Inverted curve indicates recession
Bond Price and Interest Rates/Yields
Inversely related = As Yields (market rate/value) go up, bond prices go down and vice versa.
Think of seesaw
Premium = Bond price higher than $1000
Discount = bond price lower than $1000
Nominal Yield (Bond)
Nominal Yield = Coupon Rate
Current Yield (Bond)
Annual Coupon Payments / Current market price of the bond
Duration
Weighted average of the present values of the future cash flows of a bond or bond portfolio
amount of time (in years) it takes for a bond investor to get their money back (aka effective maturity)
Higher Coupon & Shorter Maturity = Low Duration (get your money back sooner)
Lower Coupon & longer maturity = high duration (get your money back later)
Par Value of Bond
$1000
Yield to Worst
Investment decisions should be on Yield to Worst
YTW is lesser of YTM and YTC
(not always, but typically)
When Bond is selling at premium ( > $1000), the YTW = YTC
When Bond is selling at discount ( < $1000), the YTW = YTM
Interest rate coloration to bond duration
bond duration is longer in high interest rate environment
bond duration is shorter in low interest rate environment
For zero coupon bond, the duration = maturity term
Duration match to time horizon vs. maturity horize
Match the duration of fixed income portfolio to an investor’s time horizon (NOT maturity)
Options - Characteristics
Contract between buyer and seller to either buy or sell lots of shares.
Options contracts can be used to hedge existing stock positions or to speculate on stock without having a long position in the stock.
All contracts will stipulate an exercise price and an expiration date.
All contracts cover 100 shares of the underlying stock.
Options - In the Money
Call contract is in the money when Market Price is greater than (raises above) Strike/Exercise Price.
Put contract is in the money when Market Price is less than (falls below) Strike/Exercise Price.
Options - Out of the Money
Call contract is out of money when Market Price is less than Strike/Exercise Price
Put contract is out of money when Market Price is greater than Strike/Exercise Price
When is a put options contract in the money
Market Price is less than (falls below) Strike/Exercise Price.
when is call contract in the money
Market Price is greater than (raises above) Strike/Exercise Price.
When is put contract out of the money
Market Price is greater than Strike/Exercise Price
when is call contract out of the money
Market Price is less than Strike/Exercise Price
Intrinsic Value for Call Options (COME) Call Option
= Market Value - Exercise Price
Intrinsic Value for Put Options (POEM) Put Option
= Exercise Price - Market Value
Options - At the Money
When Market Price = Strike Price
Options intrinsic value amount
Lowest can be 0
(CANNOT be negative)
Options - Call
contract to buy options (Call to Buy)
Options - Put
contract to sell options (Put to sell)
Covered call writing
Long/own the underlying stocks ans want to generate income while expecting the share price to increase. Sell/short a call contract
Used to generate income for the portfolio.
Only considered covered if you own enough shares to cover all contracts sold.
Naked call writing
Does not long/own the underlying stock AND sells/shorts the call contract (at an exercise price)
Since you don’t have the stock and have to buy them to fullfill the call contract, the stock price can be unknown and more than the exercise prices (I.e. Seller/Writer bears UNLIMITED risk.)
Options - Cost Basis
Options Cost basis = cost of purchasing the stocks of the underlying security + when the options contract gets exercised, the last premium gets added to cost basis
Protective Put
Own/Long the stock and buy/long the put contract
used for portfolio insurance/protection.
Collar (Zero-cost collar)
Long the stock - long the put - short the call
The put is used to protect against a stock price decrease, and the call premium is used to offset the cost of the put.
Spread
Involves purchasing and selling the same type of contract.
Benefit from stability (i.e., minimum moves in the underlying stock’s price).
Straddle
Inverse of Collar (play both sides of the field)
Long a put and a call on the same underlying stock with the same expiration date and strike price.
Used to capitalize on volatility regardless of the direction.
Market Risk Premium (MRP)
AKA equity risk premium (ERP)
Rm - Rf
CAPM
Ri = Rf + ((Rm - Rf) x Beta)
Ri = Rf + (Market Risk Premium x Beta)
CAPM = Ri = Rf + Stock Risk Premium
Stock Risk Premium
(Rm−Rf) βi
= Market Risk Premium x Beta
Taxation of TIPS Bond Ladder
TIPS held in taxable account create “phantom income” on increases to par value. Traditionally Semi-annual interest payments on TIPS are subject to federal income tax
Taxation of Bonds
Phantom income applies to the spread between the purchase price and par value of zero-coupon bonds
Taxation of Money Market Funds
MM Mutual fund reinvested dividends are considered income, subject to taxation
I-Bonds and Taxation of I-Bonds
I-Bonds offer investors the opportunity to pay taxes annually, upon sale or defer taxation until maturity.
What are the minimum margin equity standards?
Min fed stock initial margin requirements = 50%
Mid fed maintenance margin requirements = 25%
Total Premium of Options
IV + Time Premium
IV cannot be less than 0
COME
IV of Call Options = MP - EP
POEM
IV of Put Options = EP - MP
At what price will I receive a margin call?
Use the Margin Call Price Formula to calculate the margin call price. When the stock price falls below the margin call price amount, you will received a margin call
(1 - initial margin %) /
(1 - maintenance margin %)
x Initial Purchase Purchase Price
Spot Price (Futures)
Spot price is what the current market value of the item is in today’s market
Long Position
Anyone who owns something is said to be “long”
(e.g., a farmer growing corn is long corn).
Short Position
Anyone who has to buy something is said to be “short”
(e.g. a construction company that needs to build is short lumber).
Short Hedge
anyone who is long (owns something) needs a short hedge.
Selling a futures contract establishes a short hedge.
Long Hedge
Long Hedge: anyone who is short (needs to buy) needs a long hedge.
Buying a futures contract established a long hedge.
Forward Contract
Are NOT standardized and carry counter party risk
What futures position should you take if you think price in the future will be higher than today ?
Take a long position
What futures position should you take if you think price in the future will be higher than today ?
Take a short position
Most effective options strategies when you expect a big rise in the stock price
Protective call OR Covered Put
Protective call = Buy the call contract/right to buy the stock for the stock for which you expect the stock prices to go up (ie. EP will be lower than MP = Buy low)
Covered Put = Sell a put contract / agree to buy stock
NPV
used to evaluate the cash flows associated with CAPITAL PROJECTS AND EXPENDITURES
NPV is superior
NPV >= 0 (positive) - go for it (actual return > Er)
NPV < 0; avoid it (actual return < Er)
If the NPV and the IRR suggest two different investment projects, select the project with a higher positive NPV.
Wash Sale
occurs when a taxpayer realizes a LOSS on the sale of a security and acquires a “substantially identical” security within a 61-day period.
T -30 < T0 > T+30
if a wash sale is triggered, a client’s tax return will be affected.
Wash Sale - Substantially Identical
Bonds: Investor purchases back the same exact bond or bond fund
Convertible bond – can convert to stock which is the same stock that was sold for a loss.
Purchase of a call option that can be exercised into the same stock that was sold for a loss.
(Selling a call no problem; fixed income secs are also no problem typically)
Wash sale ramifications
Loss on sold security will be disallowed.
The disallowed loss will be added to the basis of the new securities purchased.
Eventually you will be allowed to use the loss when the new (replacement) securities are sold (via the higher cost basis).
Current Ratio - Improvement or NOT
Current Assets / Current Liabilities
current ratio increasing = good (going higher/up because liabilities/denominator is decreasing compare to Assets/numerator)
Debt Ratio - Improvement or NOT
Total Debt / Total Assets
Debt ratio is decreasing = good (going down/low, It’s improving (because total assets are growing compare to total debts or debts are decreasing compare to assets)
Accredited Investors - Financial Criteria
Net worth over $1M, excluding primary residence (individually or with spouse or partner) OR
Income over $200K (individually) or $300K (with spouse or partner) in each of the prior two years, and reasonably expects the same for the current year.
Accredited Investors - Prof. Criteria
Pros with Series 7, 65, or 82 license
Director, Executives, General partners of the company selling the securities
Any “family client” of a “family office” that qualifies as an accredited investor,
“knowledgeable employee” of the fund
Leading indicators
tend to rise and fall in advance of the economy
Avg weekly hours of production workers (manufacturing)
Initial claims for unemployment insurance
Manufacturers’ new orders
% of companies reporting slower deliveries
New orders of non-defense capital goods
New private housing starts
Yield curve
S&P 500
Money supply (M2) growth rate
Index of consumer expectation
Coincident indicators
tend to change at the same time as the economy
Employees on non-agricultural payrolls
Personal income less transfer payments
Industrial production
Manufacturing and trade sales
Lagging indicators
tend to follow or lag economic performance
Avg duration of unemployment
Ratio of trade inventories to sales
Change in index of labor cost per unit of output
Average prime rate
Commercial and industrial loans outstanding
Ratio of consumer installment credit outstanding to personal income
Change in CPI
Benchmarks
LGR US Stocks = S&P 500
LGR US Stocks & Bonds = Vanguard balanced
SML US Stocks = Russell 2000
US Bonds = Barclays Cap
All Pub US Companies = Wilshire 5000
Cash = 3-month T-Bill
Commodities = Deutsche Bank Liquid Commodity
Pub REITS = Down Jones US Select REIT
Stocks in Dev. non-US = EAFE
Stocks in Emg. non-US = MCSI ME
Real Estate Investment Trusts (REITs)
are closed-end investment companies that:
invest in real estate instead of financial assets and,
serve as a conduit for earnings on investments in real estate or loans secured by real estate.
REIT Earnings
REITs pass earnings on to their shareholders.
As long as 90% of REIT taxable income is distributed to shareholders annually, that income is free from taxation for the REIT.
At least 75% of a REIT’s assets and income must be derived from real estate equity or mortgages.
Mortgage REITs
Real Estate Mortgage Investment Conduits (REMICs)
allow investors to receive a stream of income from the mortgage payments.
Equity REITs
offer investors the potential growth of their investments through realized capital gains, as well as the pass-through from rental income.
