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CFP Exam March 2023 > Investment Planning > Flashcards

Investment Planning Flashcards

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1
Q

When to buy a call

A

Buy a call when the market is going up

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2
Q

When to buy a put

A

Buy a put when the market is going down

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3
Q

Buyer of an option is called

A

holder or long

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4
Q

Seller of an option is called

A

writer or short

S for short and seller

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5
Q

Stock option contracts cover how many shares

A

100

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6
Q

Call means

A

the right to BUY shares

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7
Q

Put means

A

the right to SELL shares (put my shares on someone else)

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8
Q

Call favorable difference

A

COME
MP > EP
Market price - Exercise price
*in the money

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9
Q

Put favorable difference

A

POEM
EP > MP
Exercise price - Market price
*in the money

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10
Q

Out of the Money

A

no favorable difference between EP or MP

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11
Q

At the Money

A

Market price = Exercise price

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12
Q

Options Clearing Corporation (OCC)

A

guarantees the performance of both parties & eliminates counterparty risk

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13
Q

Intrinsic Value can never be

A

Market price & Exercise price

*can NEVER be less than $0

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14
Q

How to determine the time premium?

A

If the intrinsic value is $0, the cost of the premium is the time premium

ie: call option with a premium of $4.25
EP of $150
MP of $148.85
Intrinsic value= $148.85-$150=$0

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15
Q

What is the most risky option strategy?

A

Naked call writing because it bears unlimited risk

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16
Q

What does selling a naked put mean?

A

Selling a put on a company without necessarily having the money you need to buy that company

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17
Q

What does selling a naked call option mean?

A

It means you are forced to sell stock that you do not even own!

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18
Q

What does naked mean in options trading?

A

It means you do not have the money to buy the stock in your account right now and you do not own the stock

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19
Q

A straddle is…

A

2 options contracts at the same time

Buying a straddle gives you the ability to exercise the contracts while the other contract is used to offset the price

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20
Q

A straddle is ideal when…

A

You expect a lot of volatility (but you don’t know if the stock is going to go up or down, you just know it is going to move!)

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21
Q

What is a futures contract?

A

Agreement to buy/sell a specific amount of a commodity, currency, or financial instrument at a future date

standardized like an option contract but in volume

ie: barrels of oil

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22
Q

If the price of the commodity will be higher in the future you would

A

Go LONG the futures contract, BUY a futures contract

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23
Q

If the price of the commodity will be lower in the future you would

A

Go SHORT the futures contract, SELL a futures contract

Lower and short are small & short!

Short for sell!

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24
Q

Does a future contract have counterparty risk?

A

No, the clearing house acts as an intermediary and guarantees performance of both parties

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25
Q

What does being long mean?

A

own the asset

ie: farmer growing corn in the field

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26
Q

What does being short mean?

A

need to buy something in the future

ie: a construction company to needs to buy lumber for a project

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27
Q

To protect a long hedge, you need to…

A

implement a short hedge, SELL a futures contract

DO THE EXACT OPPOSITE

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28
Q

To protect a short hedge, you need to…

A

implement a long hedge, BUY a futures contract

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29
Q

Money markets concentrates on

A

short-term debt instruments (less than a year)

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30
Q

Capital markets trade in

A

long-term debt and equity instruments

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31
Q

What are examples of financial markets?

A

-stock market
-bond market
-commodities market
-foreign exchange market

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32
Q

Capital markets are broken into 2 categories…

A
  1. primary market-where issuers come to the market for the 1st time (IPO)
  2. secondary market
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33
Q

What is the primary market?

A

Where new securities are issued and sold to the public for the 1st time

Securities are registered with the SEC and sold to clients through the IPO process

In primary markets its the issuers who receive the funds!

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34
Q

What are the primary markets and issues regulated by?

A

Securities Act of 1933

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35
Q

What is the secondary market?

A

Where previously issued securities trade among investors

Key differentiator is that the issuing company is NOT directly involved

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36
Q

Secondary markets and issues are regulated by?

A

Securities Act of 1934

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37
Q

Secondary markets take two forms:

A
  1. organized exchange (NYSE)
  2. over the counter (OTC) market (NASDAQ)
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38
Q

What Act created the SEC?

A

Securities Act of 1934

*Remember that 1933 (primary) comes before 1934 (secondary)

*The 2nd of the 2 major post-great depression pieces of legislation created the SEC

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39
Q

What is a market order?

A

An order that is going to be executed immediately

ie: a buy order that will be purchased at the very best next available price

*most common/popular

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40
Q

What is a limit order?

A

Trade that will sit and wait until the price you stipulate

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41
Q

What is the Investment Advisors Act of 1940?

A

Act that requires firms or practitioners who are compensated for advising others about securities in investments must register with the SEC and conform with regulations that are designed to protect investors

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42
Q

What is the Reg BI rule?

A

Advisors can no longer just make recommendations that are suitable, the recommendation actually needs to be in the clients best interest

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43
Q

Holding period return formula

A

(ending value-initial value) + income generated / initial value

*HPR simplified = Profit / Cost

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44
Q

Holding period return is NOT…

A

indexed for time!

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45
Q

What return is affected by the timing of cash flows?

A

Dollar weighted return!

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46
Q

What return is NOT affected by the timing of cash flows?

A

TWRR is NOT affected by timing of cash flows!

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47
Q

Time weighted return is the same as

A

geometric return

based solely on appreciation/depreciation of portfolio from period to period

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48
Q

Dollar weighted return uses

A

Cash flow calculation and find IRR

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49
Q

Total Risk formula

A

systematic risk + unsystematic risk = total risk

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50
Q

Total risk is measured by

A

standard deviation

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51
Q

What risk CANNOT be eliminated through diversification?

A

Systematic risk

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52
Q

What risk can be eliminated through diversifying the portfolio?

A

Unsystematic risk

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53
Q

Unsystematic risk is AKA

A

Firm specific risk

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54
Q

Wash sale ramifications

A
  1. loss on sold security will be disallowed
  2. disallowed loss will be added to the basis of the new securities purchased
  3. you will be allowed to use the loss when the new (replacement) securities are sold (via the higher cost basis)
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55
Q

Yousef buys 100 shares of X stock for $1,000. He sells these shares for $750 and within 30 days from the sale buys 100 shares of the same stock for $800. Because Yousef bought substantially identical stock he cannot deduct the $250 loss on the sale. What is his new basis in the stock?

A

$1,050

$250 + $800 = $1,050

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56
Q

3 situations to determine if interest must be imputed

A
  1. Gift loans: provided out of love, affection, or generosity
  2. Corporate shareholder loans: from a corporation to its shareholder
  3. Compensation related loans: from employer to employee
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57
Q

5 exceptions when imputed interest does NOT apply

A
  1. loans between individuals totaling $10,000 or less (except when borrowed funds are used to purchase income-producing property)
  2. Corporate loans and compensation loans totaling less $10,000 or less
  3. Debt subject to original issue discount (OID) provisions
  4. Sales of property for $3,000 or less
  5. When all payments are due within 6 months
58
Q

What are the minimum federal stock initial margin requirements?

A

50%

59
Q

What are the minimum federal maintenance margin requirements?

A

25%

60
Q

Gross Profit Margin Ratio

A

gross profit / sales

net income / total sales

61
Q

Operating profit margin ratio

A

operating income / revenue

62
Q

Return on assets (ROA) ratio

A

Earnings after tax / total assets

63
Q

Return on equity (ROE)

A

earnings after tax / equity

64
Q

Price per earnings ratio (P/E Ratio)

A

Price / earnings

Individual share price / earnings per share

Market value price per share / company’s earnings per share

65
Q

What is an alternate way to solve for price per earnings ratio?

A

Can use values for the whole company by:

total market cap value / net income

66
Q

The CAPM formula is used to determine…

A

The required rate of return!

67
Q

A straddle is ideal when…

A

You expect a lot of volatility (but you don’t know if the stock is going to go up or down, you just know it is going to move!)

68
Q

Everything else being equal the shorter the maturity of a bond and the ______________ the coupon rate, the lesser the sensitivity of the bond’s price to interest rate changes

A

HIGHER

69
Q

The higher the coupon of a bond…

A

the LOWER the duration will be compared to maturity

70
Q

Zero coupon bonds have durations that…

A

equal maturity

71
Q

Beta is a measure of…

A

non-diversifiable risk

72
Q

Which form belief asserts that access to insider information would provide an advantage to the investor?

A

Semi-strong form

73
Q

A protective put is established to protect a…

A

Long position in the stock by buying a put

74
Q

If a client has a high concentration of stock and is willing to sell it over a certain price you what option strategy could you use…

A

Collar!

You could buy a put contract (on the floor price) and sell a call contract (for the price they are willing to sell at)

75
Q

If alpha is positive…

A

then it indicates that the manager outperformed the market

76
Q

What is naive diversification?

A

No thought to asset allocation according to their risk tolerance, time horizon, or liquidity needs

77
Q

What describes the distribution curve for US stocks?

A

US stock markets are generally positively skewed meaning investors can expect frequent small losses and a few large gains

78
Q

What measure of risk does the capital market line measure?

A

Capital Market Line (CML) measures the standard deviation of returns (total risk)

79
Q

What are the systematic risks?

A

PRIME

Purchasing power risk
Reinvestment risk
Interest rate risk
Market risk
Exchange rate risk

80
Q

What are the 5 unsystematic risks?

A

Business risk
Financial risk
Default risk
Regulation risk
Sovereignty risk

81
Q

Options Chart

A

Call: Bull/Bear
Put: Bear/Bull

82
Q

What is a positively skewed distribution curve?

A

Means there are many outliers in the RIGHT tail!

*Note the curve is more on the left, but the right tail is the part that is skewed to the right!

83
Q

What is a negatively skewed distribution curve?

A

Means there are many outliers in the left tail

*Note the curve is more on the right, but the left tail is the part that is skewed to the left!

84
Q

The extent to which a distribution is not symmetrical

A

Skewness

85
Q

Statistical measure that describes when a distribution is more or less peaked than a normal distribution

A

Kurtosis

86
Q

Normal distributions are known as…

A

Mesokurtic

87
Q

Distribution cuvre that is more peaked (slender)

A

Leptokurtic

88
Q

Distribution curve that is less peaked (broad)

A

Platykurtic

*Platy = fatty

89
Q

Small cap stock returns have a high variability and therefore less predictable, what is the best way to describe the distribution of these returns?

A

Platykurtic - when returns are highly variable you would expect to a flat, platykurtic distribution

90
Q

Efficient market hypothesis states…

A

stock market is efficient and all stocks reflect relevant information and are priced in equilibrium

91
Q

Investors who accept EMT are what type of investors…

A

Passive investors

92
Q

What type of analysis evaluates investments by analyzing statistical trends gathered from price movement and volume?

A

Technical analysis

93
Q

What type of analysis relies on financial information reported by the company whose stock is being analyzed, ratios and metrics are created using the data which indicate how a company is performing compared to similar companies?

A

Fundamental analysis

*Fundamental analysis is used is weak form of EMT

94
Q

What are anomalies to the EMT?

A

-low P/E effect
-small firm effect
-neglected firm effect
-January effect
-value link phenomenon

95
Q

If you believe in fundamental analysis and access to insider information what form of EMT do you believe in…

A

weak form

96
Q

If you just believe in insider information you believe in…

A

semi-strong form

97
Q

Gifted property takes on the basis and holding period of…

A

the person that gifted it to you!

The basis and holding period is carried over, there is NO step up in basis!

98
Q

When is gift tax adjustment added to the donee’s basis?

A
  1. when the donor actually paid gift taxes

AND

  1. when the FMV is > than the donor’s basis
99
Q

What is the gift tax adjustment formula?

A

Step 1: Current value - cost basis / Current value - annual exclusion

Step 2: take answer from step 1 x amt of gift tax paid

Step 3: add amt from step 2 to the original basis, which equals the new cost basis

100
Q

What is the time premium impacted by?

A
  1. standard deviation of the underlying stock
  2. amount of time to expiration
  3. risk free rate of return (rate on t-bills)
101
Q

What 2 assets would trigger substantially identical requirement for a wash sale?

A
  1. convertible bond-can convert to stock which is the same stock that was sold for a loss
  2. purchase of a call option- that can be exercised into the same stock that was sold for a loss
102
Q

What is the capital appreciation formula used for?

A

Before tax appreciation

103
Q

What is the capital appreciation formula?

A

Sale price (end value) - purchase price (initial value) / purchase price (initial value)

104
Q

What is the annual yield formula?

A

annual income / purchase price (end value)

105
Q

A portfolio that plots above the security market line (SML) indicates…

A

that the portfolio manager produced superior returns given the risk taken

106
Q

What is the bond yield and pricing formula?

A

bond see saw

$ on left & % on right

NY

CY

YTM

YTC

107
Q

What return is affected by the timing of cash flows?

A

Dollar weighted return!

108
Q

What is a linear estimate of sensitivity to changes in rates?

A

Duration is a linear extimate

109
Q

The distribution curve for 3 month T bill is described as…

A

Leptokurtic - very consistent and predictable, the curve would be more peaked

110
Q

Technical analysis is…

A

dismissed by all 3 forms of EMT

111
Q

What is the formula for income yield?

A

dividends / initial price (purchase price)

112
Q

YTM, YTC, and YTW are examples of…

A

IRR calculations

113
Q

When illustrating investment returns over a period of time greater than 1 year what measure of return should be used?

A

Time weighted return!

114
Q

CAPM is used to quantify…

A

-SML
-expected return
-required return

115
Q

If an investor is anticipating a large drop in interest rates what strategy should they employ with their bond portfolio?

A

Increase the duration & reduce the yield

*increase the portfolio’s sensitivity to change

116
Q

What is the risk statistic associated with the efficient frontier?

A

Standard deviation

117
Q

Members of an LLC that meet the federal income tax definition of a partnership are…

A

subject to SE tax and can deduct health insurance premiums

LLC is liable for payroll and excise taxes

118
Q

What is the price at which a well-informed seller will sell to a well-informed buyer when neither is compelled to buy or sell?

A

Fair market value

119
Q

What would be considered invested assets on the statement of financial position?

A

-common stocks
-mutual funds
-life insurance cash value
-deferred annuities

120
Q

All goods in the long run are considered to be…

A

elastic

121
Q

What is the law of demand?

A

The law of demand states that as price increases the quantity demanded will decrease

or

if price decreases the quantity demanded will increase

122
Q

What is covered call writing?

A

SELLING A CALL

Buy the stock, sell the call

*works best when the stock price stays in a certain trading range

123
Q

What is covered call writing used for?

A

Selling the call is a way to generate income for the portfolio

124
Q

What is a protective put used for?

A

Portfolio insurance

Used to protect your account from going down in volume and value

Buy a put to offset the decrease in value of your stock

125
Q

What is a collar?

A

buying a put to protect stock from going down

selling a call to generate income (to offset the cost of the expensive put)

*when we use a collar we are protecting our position and reducing the cost we have to pay to protect the position, but we are also LIMITING OUR GAINS

126
Q

What a straddle?

A

buying a call and buying a put because you know the stock is volatile!

127
Q

What is a spread?

A

buying and selling the same contract at different vaules

128
Q

When do you use a spread?

A

When there is stability!

You want to the stock price to stay between a certain price range

129
Q

Selling a call or a put…

A

generates income

because selling allows you to collect the premium (aka income)

130
Q

With the capital market line (CML) can you be above the line?

A

No, it is impossible to be above the CML because it’s not possible to get more than the optimal amount of return give a unit of risk

131
Q

What formula do you use when solving for expected return and required rate of return?

A

CAPM

132
Q

What formula do you use when you are solving for adjusted rate of return?

A

Sharpe, Treynor, or Jensen

133
Q

What is the weakest measure of return?

A

Holding period return, because it is not indexed for time

134
Q

What is the holding period return formula if you have margin?

A

ending value - 50% of initial value - other 50% of initial value - % initial (margin)

XYZ stock
bought for $50
sold for $100
*used margin
5% margin interest
divided by the amount we put in

$100-$25-$25-$1.25=$48.75 / $25 = 1.95 (195%)

.05x25=$1.25

135
Q

When the Federal Reserve buys securities…

A

it puts $ in the economy

expansionary tactic

136
Q

When the Federal Reserve sells securities…

A

it removes $ out of the economy

contractionary tactic

*selling t bills takes money out of the economy!

137
Q

What is the market risk premium for CAPM?

A

Rm-Rf

*sometimes CFP will do the math for you!
**double check to make sure you don’t need to subtract out the risk free rate, they might have given you what you need, which is the market risk premium

138
Q

What is the stock risk premium for CAPM?

A

(Rm-Rf)(B)

This whole chunk is the stock risk premium!

*they might give you this info so you do not need to calculate the entire CAPM formula

139
Q

What is the formula for a margin call?

A

1-initial margin % (usually 50%) / 1-maintenance margin % (usually between 25%-30%) x price of the stock

*if stock falls below this price then there will be a margin call

140
Q

What is portfolio immunization?

A

Immunization is a risk mitigation strategy that matches asset and liability duration so portfolio values are protected against interest rate changes

Immunization can be accomplished by cash flow matching, duration matching, convexity matching, and trading forwards, futures, and options on bonds

141
Q

What are TIPS?

A

Inflation protected security which has 2 components of returns:

  1. semi-annual interest payment
  2. quarterly adjustment to face value
    *interest rate is applied to adj. FV to determine interest pay out

THE PRINCIPAL (FV) CAN GO UP OR DOWN WITH INFLATION, the TIPS will not go below the original FV

CFP Exam March 2023 (7 decks)

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