Investment Planning Flashcards
What is the formula for Modified Duration?
D/ (1+(y/n)
What is the relationship between durational and coupons sensitivity to changes in rate?
Higher coupon and shorter duration, lower sensitivity to changes
Lower coupon and longer duration, higher sensitivity to changes
What is the linear estimate that tends to overestimate the impacts on prices?
Duration
what is a more accurate indicator in changes in Bond price than duration?
Convexity
What is the calculation formula for a change in bond price based on hypothetical rates?
-D ((Change in Yield/ (1+Yield))
What is the formula for duration of a bond
1+ Y/ Y
Long hand - [(1+Y) + T( C-Y)]/[1+y)^t - 1) + y
What plots the rates of fixed income securities?
The yield curve
What 3 forms can the yield curve take?
- upward sloping (positive/normal) ST<LT rates
- Flat ST similar to LT rates
- Downward sloping (negative/inverse) ST> LT rates
What does an inversion in the yield curve indicate?
looming recession
What 2 things is the yield curve a function of and how does the short and long end react?
The business cycle and Fed policy
Short end - sensitive to Fed policy
Long end - market rate, predicts economic conditions
What is the present value of a bond given current market conditions and characteristics?
Intrinsic value
What 4 things are a function of valuation of a bond?
1.Coupon payments
2. Market value of interest for comparable bonds
3. Amount of time remaining to maturity
4. Maturity value ( par value - always 1k unless stated)
What is the order of yields for premium and discount bonds?
Teeter totter
Premium YTC - YTM - CY - Coupon(nominal)
Discount Coupon(nominal) - CY - YTM - YTC
What is the stated or coupon yield of a bond?
the nominal yield
What is the annual income paid by a bond dividend by the current market price?
The current yield
What is used to estimate sensitivity of a bond to changes in rates?
Duration
What is yield to worst?
The lesser of YTM or YTC
The appropriate yield to make an investment decision on
What calculates, on a TVM basis, the time to recoup your money on a bond investment?
Duration
What is the weighted average of the present value of future cash flows of a bond?
Duration
For normal income producing and zero-coupon bonds, what is the duration relationship to maturity?
Normal income - Duration will always be less than maturity
Zero-coupon bonds - will always be the same
What does a higher coupon mean for duration?
Shorter duration
How does duration estimate changes in bond prices?
1% change in interest rate would result in duration as a % change in bonds price
What does duration tend to do for risk in rising and lowering interest rate environments?`
Rising - overestimates risk
Lowering - underestimates benefits
What does matching duration of a fixed income portfolio to an investors time horizon do?
Immunizes the assets
Reduces purchasing power and reinvestment rate risk
How do you find R^2 if correlation coefficient is given?
Square it ( multiply by itself)
What measures how closely the performance at an asset can be attributed to performance of benchmark?
R^2
What type of distribution curve is more peaked than normal?
Leptokurtic
What type of efficient frontier curve do risk averse investors have?
Steep
What are points below the efficient frontier curve deemed?
Inefficient
What are the 2 main financial markets?
- Money Markets
- Capital Markets
What is a statistical measure that describes when a distribution is more or less peaked than normal?
Kurtosis
What is the Sharpe ratio formula? (provided on the CFP formula sheet for test)
(Rp - Rf) / SD
What is the formula for the Jensen’s Performance Index (Alpha)? ( provided on the CFP formula sheet for test)
Rp - [Rf+ (Rm-Rf)B
What is the formula for the CAPM and the 2 components within it? (provided on exam sheet)
Rf + (Rm-Rf)B
Market risk premium= Rm-rf
Stock premium = (rm-rf)B
What ratio measures the risk-adjusted performance of a portfolio in terms of Standard Deviation?
The Sharpe ratio
When is it appropriate to use the Sharpe ratio?
When R^2<.7
What is a Sharpe ratio useful for?
To compare against other investment Sharpe ratios
What does a higher Sharpe ratio mean?
A higher risk-adjusted rate of return
What measures the risk adjusted performance of a portfolio manager using beta?
The Treynor ratio
When is it appropriate to use the Treynor ratio?
R^2 > .7
What does a higher Treynor ratio mean?
Higher risk-adjusted rate of return
What is the Treynor ratio formula? [ Provided on CFP formula sheet]
(Rp-Rf)/Bp
uses beta instead of Standard deviation as in the Sharpe ratio
What is used to quantify expected return given a market return and a Beta to the Market? Also quantifies investors required rate of return
Capital Asset Pricing Model (CAPM)
What is CAPM used to plot?
Security market line (SML)
How do you determine Alpha given CAPM?
Subtract CAPM from the actual return
What is the excess return of an investment relative to a benchmark?
Alpha
What is used to measure/evaluate the benefit of a portfolio mangaer?
Alpha (Jensen’s performance index)
When is Alpha valid?
R^2 > .7
Is Alpha an absolute or relative value?
Absolute
What is the difference between absolute and relative value?
absolute measures intrinsic value without comparing to others, relative compares.
What are the 3 plot points of alpha on the security market line?
Above 0 - good (better than expected)
On 0- Good (expected)
Below 0 - Bad (less than expected)
What 3 attributes are used to differentiate the different forms of Efficient market theory?
- Insider information
- Technical analysis
- Fundamental analysis
What are the three forms of efficient market theory?
- Strong
- Semi-strong
- Weak
What theory states that the stock market is efficient and all stocks reflect all relevant information and are priced in equilibrium?
Efficient market theory
What are points above the efficient frontier curve deemed?
Impossible
Which of the 3 forms of Efficient market theory have access to technical analysis?
None
In a normal distribution curve what are the 3 different probability levels for standard deviation?
68%
95%
99%
Remember the curve is symmetrical
What is used in probability analysis of expected returns around an average return?
Normal distribution curve
What 3 factors influence an investors capacity for risk?
- Time horizon
- Liquidity needs
- Total investable assets
What is systematic risk quantified by?
Beta
What is the measurement for total risk?
Standard Deviation
What is the equation for total risk?
Systematic plus Unsystematic risk
What are the 5 unsystematic risks?
- Business
- Financial
- Default/credit risk
- Regulation
- Sovereignty
What are the 5 systematic risks?
PRIME
1. Purchasing power
2. Reinvestment
3. Interest rate
4. Market
5. Exchange rate
What are the 2 types of investment risk?
- Systematic (non-diversifiable)
- Unsystematic ( diversifiable)
When should use beta vs SD with regards to R^2?
Beta when R^2 < .7
Standard deviation when R^2 >.7
What kind of distribution curve is less peaked than normal?
Platykurtic
What is the term for movements of stock being utterly unpredicatable?
Random walk
What type of strategy does weak and semi-strong Efficient market theory use?
Active
What type of investment strategy does a strong form Efficient market theory use?
Passive
What risk is used in efficient frontiers?
Standard deviation
What type of efficient frontier curves do risk tolerant investors have?
Flat
What chart determines the optimal amount of return given a unit of risk taken?
Efficient frontier
What are the 5 anomalies that Efficient market theory can’t Explain?
- Low P/e Effect
- Small firm effect
- Neglected firm effect
- January effect
- Value line phenomenon
Which of the 3 forms of Efficient market theory have access to fundamental analysis?
Weak form
Which of the 3 forms of Efficient market theory have access to inside information?
Semi-strong and weak
What type of Kurtosis does a normal distribution have?
Mesokurtic
What are the 2 types of skewness in distribution curves?
Right tailed - positive
Left tailed - negative
What is the extent to which a distribution is not symmetrical?
Skewness
What are the 2 forms of secondary capital markets?
Exchange and OTC
What law created the SEC?
The securities act of 1934
What laws overlooks the primary and secondary capital markets?
Primary - The securities act of 1933
Secondary -The securities act of 1934
What are the 2 types of capital markets?
Primary - New securities
secondary - trade among investors
What are the 3 types of order entrys?
- Market
- Limit
- Stop
Is the holding period return indexed for time?
No
What are the two components of the holding period return?
Capital appreciation - (Pe-Pb)/Pb
Income yield - D/Pb
How do you calculate holding period return?
(Pe-Pb+D)/Pb
What measure of return is used with specific clients that does not account of when investments are made?
Dollar weighted return (IRR)
Describe a buy/sell limit and buy/sell stop
Buy limit - below price
Sell limit - above price
Sell stop - below price
Buy stop - above price
What is the calculation for TWRR?
Geometric mean
[(1+x)(1+x)^(1/n)] -1
What measure of return is the global standard for fund performance, used to evaluate portfolio mangers, and based solely on appreciate/depreciation from period to period?
Time Weighted return
(geometric mean)
(I on calculator, use beginning value as PV, ending value as FV) and number of periods solving for as N)
What is the tax equivalent yield formula?
Tax free yield / (1-t)
What is the tax free equivalent yield?
Taxable yield x (1-T)
What do you want to match duration to?
Expected time horizon
Price is right rules, closest duration to the time frame without going over
What doe a flat yield curve mean?
transitory - curve in process of inverting
What happens when people get nervous about the economy and pour money into long term bonds as a safe haven?
Interest rates decrease, yield curve inverts
Unless specifically described as an annual bond, what time frame do all bonds pay at?
Semi - annual (including zero coupon bonds)
What is the difference between nominal and current yield?
Nominal - printed on paper (coupon)
Current - what you actually earn on the bond
What is used in situations where a dividend-paying security has a temporary expected growth rate that stabilizes to constant growth?
- Multistage dividend discount model
What are the 3 steps in the multistage dividend discount model?
Step 1. Calculate end of year dividend for the beginning time frame. Ex. D1= (D0 x (1+g) D2=(D1 x(1+G) D3=(D2 x (1+g)
Step 2. Calculate stock value based on constant growth
V= D1/ (r-g)
D1 will be the end of period from step 1
Step 3. Find NPV
Use CF in calculator
CF 0 will be 0. Then the D1, D2, and D3+ V (whatever the last period is)
What is the process of pledging securities in your brokerage account for a loan from your brokerage firm?
Margin
What are the 2 minimum equity standards set by the federal reserve for margin?
- Initial margin = 50%
- Maintenance margin = 25%
What is the formula for a margin call? (not on the formula sheet, need to memorize)
(1-IM/1-mm) x Purchase Price of stock (+ commission)
What is the equation for sustainable growth rate where retention rate and ROE are given?
ROE x Retention rate
What is margin also referred to
Leveraging a position
What is used to speculate on and hedge individual stock positions?
Stock options
For stock options, what is the buyer and seller also known as?
Buyer - holder-Long
Seller - writer-short
What right does the buyer have with call and put options?
Call - right to buy
Put - right to sell
What obligation does the seller have for call and put options?
call - obligated to sell
put - obligated to buy
How many shares does an options contract cover?
100 shares
What does the options clearing corporation guarantee and what does it eliminate?
performance of both parties and eliminates counterparty risk
When is a call and put in the money?
Call - MP>EP
PUT MP<EP
What 2 items (and 5 sub items) determine an options prices?
- intrinsic value
market price of stock
exercise price of contract - Time value
risk free rate of return
time to expiration
variability of stock
greater any 3 are, greater Time premium
Can intrinsic value of an option be less than 0?
no
What is the intrinsic value for call and put opitons?
COME - Call Option = MV-EP
POEM - Put Option = EP-MV
What stock option strategy long the underlying stock and short the call?
Covered call
Used to generate income
What Stock option strategy does not own the stock but shorts the call?
Naked call writing
What stock option strategy long the stock and long the put?
Protective put - stock insurance
What stock option short stock and long call?
protective call
protects short positions in stock
What stock option strategy short the stock and short a put?
Covered put - uses stock put to cover short position
What stock option strategy longs the stock, long the put, and shorts a call?
Collar (zero - cost) - put protects decrease, premium offsets cost
What stock option strategy long put and call on same stock for the same date and price?
Straddle - capitalize on volatility
What stock option strategy involves purchases and selling the same type of contract?
Spread - benefits from stability
What is an agreement to buy or sell a specific amount of a commodity, currency, or financial instrument at a price in the future?
Future contract
For futures contracts, what is the current MV of an item it todays market known as?
Spot price
Are futures contracts standardized?
yes
For futures contracts, what are long and short positions?
Long - owns something (farmer/corn)
Short - buys something (construction needs lumber)
What are futures hedging strategies for long and short positions?
Long hedge - if short, buy one
short hedge - if long, sell one
What are the 2 difference between futures and forwards?
Forwards are not standardized and not executed through a clearing house
What is used to evaluate the cash flows associated with capital project and capital expenditures?
Net present value NPV
What are the 3 results NPV can have and what does it tell us?
- Positive - Take on the project Actual return is greater than required
- Zero- Take on the project.
Actual return is equal to required - Negative - do not take on the project
Actual return is less than required
What allows a planner to compare computed rate to required rate of return?
IRR - internal rate of return
What is the Weakness of IRR?
The weakness of IRR is that it assumes reinvestments are made at the IRR
On the calculator what do you use to find NPV and IRR?
NPV = Time value functions and NPV key
IRR = CF functions and IRR key
What are the examples of IRR calculations?
YTM and YTC
Which is better to use when comparing projects of unequal lives, IRR or NPV?
NPV
What occurs when a taxpayer realizes a loss on the sale of security and acquires a substantially identical security within 61 days?
Wash sale
Who can deduct losses a wash sale?
If it occurred during the normal course of business as a dealer in stock or securities
What is the time frame of a wash sale?
30 days before day of trade and 30 days after
61 days total
For a wash sale, what are the considerations for bonds and stocks?
Bonds - hard to violate
Stocks - call option and convertible bonds
same stock or identical
What happens to the disallowed loss on a wash sale?
It is added back to the basis of the new purchase
What benchmark would be appropriate for a portfolio with primarily large US Stocks?
S&P500
What benchmark would be appropriate for a portfolio with primarily small US stocks?
Russell 2000 Index
What benchmark would be appropriate for a portfolio with primarily stocks in developed non-US economies?
MSCI Europe, Autralasia, Far East Index (EAFE)
What benchmark would be appropriate for a portfolio with primarily stocks in emerging non-US economies?
MSCI Emerging markets index (EM)
What benchmark would be appropriate for a portfolio with primarily US bonds?
Barclays capital aggregate Bond Index
What benchmark would be appropriate for a portfolio with primarily publicly trade REITS?
Dow Jones US select REIT index
What benchmark would be appropriate for a portfolio with primarily commodities?
Deutsche Bank liquid commodity index
What benchmark would be appropriate for a portfolio with primarily cash?
3-month treasury bill
What benchmark would be appropriate for a portfolio with primarily large US stocks and US bonds?
Vanguard Balanced index (VBIAX)
What benchmark would be appropriate for a portfolio with primarily all publicly traded U.S. Companies?
Wilshire 5000
What would be the appropriate allocation for a client who wants current income, investment stability, and capital preservation with a timeframe of 3-5 years?
Conservative
What would be the appropriate allocation for a client who wants current income and investment stability, but also some opportunity to row their investments, with a time frame of 5 years?
Moderately conservative
What would be the appropriate allocation for a client who wants current income, solid growth, and relative stability, and who can tolerate low levels of portfolio volatility with a 10 year time frame?
Moderate
What would be the appropriate allocation for a client who is most concerned about growing their investments and who can tolerate moderate levels of portfolio volatility with a time frame at least 10 years?
Moderately aggressive
What would be the appropriate allocation for a client who is most concerned about growing their investments and who can tolerate high levels of portfolio volatility with a time frame of 15 or more years?
Aggresive
What 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?
Real estate investment trust (REITs)
What % of taxable income must be distributed by a REIT to shareholders annually in order to be income tax free for the REIT?
90%
What % of assets and income for a REIT must be derived from real estate equity or mortgages?
75%
What type of REIT receives a stream of income from the mortgage payments?
Mortgage REITs
A.K.A real estate mortgage investment conduits (REMICs)
What type of REIT offers investors the potential growth of their investments through realized capital gains, as well as the pass-through from rental income?
Equity REITS
What asset class has low levels of correlation with other asset classes, is likely to keep pace with inflation, but illiquid?
Real Estate
What asset class has low correlation with equities, is a hedge against inflation, has no natural income, and can be highly volatile?
Commodities
What asset class has no capital loss, highly liquid, typically a low return, and value is eroded by inflation?
Cash
What asset class historically outperform cash and bonds, benefits from economic growth, can have high volatility and can see periods of negative returns?
Equities
What asset class has less volatility than equities, delivers stable income, historically, returns lag equities, and returns are driven by interest rates?
Government and investment grade bonds
What asset class has low correlation with other assets, has a variety of drivers and return characteristics, can be illiquid, and can be complex?
Alternatives
What asset class is a diverse asset class, can provide higher yield and inflation protection, and is riskier than government bonds but less risky that equities?
High yield and emerging market bonds
