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CFP Exam > Investment Planning > Flashcards

Investment Planning Flashcards

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1
Q

What is a corporate Bond or Debenture?

A

A corporate bond is a certificate of debt secured by a physical asset

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2
Q

What is Beta?
What does Beta Measure?

A

a) Beta is a measure of the volatility of a security compared to the market as a whole (usually the S&P 500)
b) Beta measures volatility aka systematic risk
c) When a stocks Beta > 1 it can be interpreted as more volatile

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3
Q

Beta is used in the ….

A

Capital Asset Pricing Model (CAPM), which describes the relationship between systematic risk and expected return for assets

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4
Q

What is the Beta of the S&P 500?

A

Beta = 1.0

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5
Q

How to interpret Beta?

A

a) Beta 1.0 indicates that the price is activity is strongly correlated with the market
b) Beta < 1 indicates the security is less volatile than the market
c) Beta > 1 indicates security price is more volatile than the market

d) A Beta of -1 = opposite or inversely correlated
e) A Beta of +1 =

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6
Q

Who does IIROC regulate

A

Oversees all investment dealers and trading activity on debt and equity marketplaces in Canada
- 200 investment dealers

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7
Q

The MFDA is…

A

Now recognized as an SRO but responsibility for regulation remains with the securities commissions

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8
Q

CIPF - Canadian Investor Protection Fund

A
  • Covered by IIROC, TSX and Montreal Exchange
  • Protects insolvency of SRO member firm
  • $1M per fund
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9
Q

OBSI - Ombudsman for Banking Services and Investments does

A

Independent and impartial dispute resolution services that is offered free of charge to clients of member firms (IIROC, MFDA, IFIC)

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10
Q

Typical money market instruments are:

A

Treasury Bills
Commercial paper
Bankers Acceptances

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11
Q

T-Bills

A

Yield = (Par – Purchase Price) x ( 365 ) x 100
( Purchase Price ) ( Term)

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12
Q

T Bills

A

are issued at a discount and mature at par, usually $100,000 or $1M

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13
Q

a Bonds principal is also known as

A

the Face Value

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14
Q

What is a debenture?

A

Essentially the same as a bone, expect debentures are not secured by any specific assets

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15
Q

What are bonds secured by?

A

a physical asset

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16
Q

What is the rate of interest on a bond also called?

A

The Coupon Rate

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17
Q

At bond maturity what is repaid in full to the bondholder?

A

The principal AKA the Face Value amount

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18
Q

All bonds have 3 things

A
  1. issue date
  2. maturity date
  3. stated face value ( or par value or maturity value)
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19
Q

What is the face value of most Bonds?

A

$1,000

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20
Q

How often do Bonds pay interest?

A

Semi annually unless otherwise stated

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21
Q

The only features on Bonds that change are:

A

The bond’s price and yield
(issue date, maturity and coupon never change)

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22
Q

Bonds interest rates are…

A

inversely related. If interest rates rise (fall) bond prices fall (rise)

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23
Q

Bond’s priced below $1,000 (or par) are…

A

Trading at a discount
- Above par = trading at a premium
- at $1,000 = at par

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24
Q

When do investors buy preferred shares?

A

When they have an objective of earning income
-PS generally do not have voting rights
-PS are less volatile than CS

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25
Q

Common Shares are…

A

“Stocks” or securities representing ownership in a corporation and usually have voting privledges.
-CS have “residual claim” on the assets of the company after all other creditors
- Investors buy common shares with the objective of earning capital gains
-Longer term horizon, potential volatile price changes with CS

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26
Q

What units are always priced at the Net Asset Value (NAV) and are redeemable at any time?

A

Mutual Funds
NAV = (Fund Assets - Fund Expenses) / # of assets issued

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27
Q

How is the offering price and redemption value of an open-ended mutual fund calculated?

A

-Offering Price = NAV / (1 - Load)
-Redemption Value = NAV x (1 - Load)

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28
Q

What are open-ended mutual funds?

A

They are traditional mutual funds with unlimited number of shares and always issued in primary market
- Units always priced at the Net Asset Value (NAV) and are redeemable at any time

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29
Q

What are closed - end mututal funds

A

Traded on secondary exchanges (ie. NYSE or TSX)
- limited number of units
- many trade at premium or discount to NAV due to investor perception

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30
Q

What are Labour - sponsored mutual funds?

A
  • Fund with specific mandate to invest in small and medium sized Canadian companies as well as start ups
  • tax credits offered for LSVCC or LSIF
  • risky investments
  • must be held for 8 years to maintain tax credit, otherwise repayment
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31
Q

Segregated funds are

A

insurance companies version of mutual funds
Seg funds have;
-maturity guarantee
- death “ “
- creditor proofing
-probate protection
-insurance protection/

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32
Q

Which funds have removed the “Phantom Tax”

A

Seg funds

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33
Q

What are the two types of Registered Annuities?

A
  1. Registered Fixed Term-To-Age 90
  2. Life Annuity
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34
Q

What is a prescribed annuity?

A
  • A non-registered annuity and income is treated as equal parts principal and interest
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35
Q

What do derivative’s offer investors?

A

The ability to leverage

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36
Q

Who are the two parties to every derivatives contract?

A
  1. The Buyer AKA “the party going long”
  2. The Seller AKA “the party going short”
    - speculative and risky investment choices
    - using derivatives to reduce risk is called “hedging”
    - cost of purchasing is called the “premium”
    - buyer pays this premium for right to decide to “exercise” or let “expire”
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37
Q

Call options have the right to…

A
  • Long call: party that buys / has the right (not obligation) to buy underlying security
  • Shot call: “ “ to sell
  • Investors would buy call options if they believe security is going up in value
  • they would “exercise their right” if they were “in the money”
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38
Q

Put options have the right to…

A

-Long put option = sell
- short put option = buy
- Investor would buy put option if they believe the security is going down
- In the money = underlying security price lower than exercise price

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39
Q

Taxation of Investments:

A

a) INTEREST income: taxed as regular income in persons top MTR
b) DIVIDEND income: tax subject to special gross up and tax credit rules
c) CAPITAL GAINS income: taxed favorably since only 50% of the gain is taxable

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40
Q

What types of income do stocks yield?

A

Dividends and Capital Gains

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41
Q

What is a bond?

A

A bond is a loan to a government or company that is secured by the gov’s power to pay back or by a specific company asset
-They generate Interest income
-risk is low to high
-range usually 1-30 years
-interest paid at fixed rate (interest generated semi-annually unless otherwise stated)
-Rate will depend on interest rate and credit rating of issuer
-If company dissolves, bondholders have right to remaining assets

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42
Q

What is a debenture?

A

A loan to a company that is NOT secured by specific assets
-generates interest income
-low to high risk
-work the same way as bonds

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43
Q

What are stripped bonds?

A

-interest payment coupons and principal portion of bond separated from each other and sold individually
-generate interest
-low to medium risk
-sold at discount and mature at face value

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44
Q

What is Face Value?

A

-Value of the fixed income security was issued at and is the value you receive when it matures
-EG: a bond that has a face value of $1,000 and an interest rate of 5% would pay you $50 per year

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45
Q

-Buying bonds with high or lower face values example

A

-A bond that has a face value of $1,000 and an interest rate of 5% would pay you $50 per year
-If you buy the bond for $950 your actual rate of return will be higher than 5%, if you buy the bond for higher at $1,050 your actual rate of return will be lower than 5%
-

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46
Q

What are Mortgage Backed Securities ?

A
  • An ownership interest in a pool of mortgages
    -interest and capital gains (losses) generated
    -low to med risk
    -MBS fully guaranteed by CMHC
    -offer fixed rates and returns
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47
Q

How do you make money when you own securities? Aka when you buy stocks “equities”

A
  • you become part owner of the business and you make money is the stock increases in value or if they pay a dividend - neither are guaranteed
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48
Q

What is a common share?

A
  • A share that has voting rights
    -Returns in dividends or capital gains (losses)
  • Risk med - high
    -Commission when you buy/sell
    -investors looking to earn capital gains
49
Q

What is a Preferred Share?

A

-Share that pays a fixed dividend
-investors looking for a fixed income
-Dividends and capital gains
-med-high risk
-usually no voting rights
-sometimes can get special features like the right to sell etc

50
Q

What is a Mutual Fund?

A
  • A fund the continually issues units or shares to investors
    -Pays in distributions of interest, cap gains or dividends
    -costs can include redemption, sales, switch, trailing commissions etc
    -low to very high risk
    -widely available and easy to buy/sell
    -NAV = when you buy or sell units or shares of a fun you receive the current value of the fund, this is called the “net asset value”
    -MF are not guaranteed
51
Q

Closed -end fund

A
  • fund that issues finite number of units
    -can be difficult to sell
52
Q

Exchange Traded Fund

A
  • a fund that holds the same mix of investments as a stock or bond market and trades on stock exchange
    -EFTs typically follow the index
    -Fees typically lower than traditional MF
53
Q

Segregated Fund

A
  • an insurance product that combines investment funds with insurance coverage
    -buy and sell under insurance contracts
    -comes with guarantees if you hold for minimum 10 years typically
    -usually have a death benefit
54
Q

Labour-Sponsored investment fund (LSIF)

A
  • a fund that provides venture capital to new and small businesses and offers tax incentives for investors
    -high risk
    -hold period of 8 years to receive tax credits
55
Q

Futures and Forwards Contracts

A
  • a contract where the seller agrees to deliver to the buyer a specified amount of an asset at specified price and given date
    -traded on commodities such as grain, livestock, bonds etc
  • Futures traded on exchange
    -Forward contracts are traded in over-the-counter markets
    -returns depend mainly on changes in value of underlying assets
    -can be used to speculate or reduce risk
56
Q

Income Trusts (REITS)

A
  • A trust that is designed to distribute cash to investors
    -most common are REITs, oil and gas trusts (royalty trusts) and business income trusts
57
Q

Facts about Cash Surrender Values

A
  • CSV is matrimonial property and will be divided among spouses
  • CSV is made up of both contributions made and contract income received
  • It is common for SEG funds to have brand name mutual funds as underlying asset
58
Q

What are convertible bonds?

A

permit bond holder to exchange bond for common shares. It provides safety of bonds but permitted growth of an equity
-provides a lower coupon rate for issuer

59
Q

What is a sinking fund?

A

-obligates issuer to repurchase a certain amount of outstanding debt over a specific time (usually a year)

60
Q

Why would an issuer issue convertible bonds?

A
  1. Enable the issue to be sold at a lower yield
  2. Possibly raise equity capital on more favorable terms
61
Q

What do Put options do?

A
  • Put options provide the holder the right to SELL SHARES
  • Put have time limits at which they expire
  • Puts are less risky than short selling (short has unlimited loss whereas puts are limited to the premium)
62
Q

What are convertible bonds?

A

-in general they offer investors safety associated with bonds but growth with equities
- forced conversion means issuer forces bondholder to convert bond to common shares, being an advatage for the issuer
-coversion price is average common stock price paid as result of conversion
-conversion only takes place if price of the CS were to increase

63
Q

What is a Private Placement?

A

Underwriting of a large new high quality security to a small number of investors

64
Q

Dividend Payment =

A

= Dividend yield x PAR value

65
Q

Current Yield =

A

Dividend in dollars (dividend payment / martket prices) X 100

66
Q

What are withdrawal funds?

A

Help investors with a lump sum of money but need a withdrawal plan

  1. Ratio - not suitable for meeting fixed commitments like a mortgage
  2. Fixed Dollar - similar but dollar amount specified
  3. Fixed Period - intent to have all capital exhausted when plan ends
  4. Life Expectancy Adjusted -
67
Q

How are interests and yields exactly the same?

A
  • there is very little difference between them, they both represent a rate of return on investment
  • since interest rates are FIXED the only way to increase yields would be to decrease the market price and vice versa
68
Q

Bonds stats

A
  • bonds with lower coupons have MORE volatile prices
  • bonds with long terms to maturity are more volatile
    LOW COUPON LONG TERM = more volatile

For example a bond with an IR or drop in yields from 12%-10% is less volatile than 4%-2%

69
Q

How do you calculate Yield on a Tbill?

A

= face value - purchase price / PP x (365/## of days) x 100

70
Q

Seg Funds held in an RRSP

A
  • the owner of the contract MUST be the person whose life is insured by the contract
  • there is always creditor protection with a seg fund
71
Q

Open End Funds aka Mutual Funds

A

continually issue shares to investors and redeem on demand at current net asset

72
Q

Closed End Funds

A

Have a fixed number of units that trade on the stock exchange

73
Q

REITS

A

have fixed number of units and trade on stock exchange

74
Q

Hedge Funds

A

limited number of units, restrictions and redemption periods

75
Q

Duration is:

A

Measure in years

Duration measures how much bond prices are likely to change when interest rates move

  • lower coupon = higher D
  • higher coupon = lower D
  • lower IR = higher the D
  • higher IR = lower D
76
Q

RRSP contribution is calculated on?

A

EARNED INCOME ONLY!!!
Earned income is:
-Net income from employment
-net income from business, including partnership
-net rental income from real estate
-CPP or QPP disability pensions
-Spousal support payments include in your income

  • things like EI or investment income don’t count towards RRSP room.

LESSOR OF 18% of earned income or max of about $29K

77
Q

What does earning less of the annual YBE (3500) mean?

A

The person has substainally ceased working

78
Q

Things to consider when acquiring an investment:

A
  1. Time Horizon
  2. Liquidity
  3. Growth
  4. Inflation - growth investments are considered best hedge against inflation
  5. Income - usually referred to as fixed income (like most bonds pay, while others pay at maturity such as GIC).
    - Income investments tend to be more stable than growth
    -favored by those close to retirement - provide stability and lost income
  6. Diversification
  7. Risk Tolerance
  8. Capital Preservation - GICs and Accumulation annuities are good for this
  9. Volatility - way of measuring risk
79
Q

What do Yield Curves Represent?

A

Graphical expression of a fixed incomes (bond) yield to maturity
- a leading indicator

3 Types:
1. Normal = healthy and predictable
2. Inverted Yield Curve = unusual events, can indicate a recession (looks like the bottom half of a C)
3. Flat = uncertain investors

80
Q

What is Duration?

A

An indication of how much a bonds prices will fluctuate in relation to a change in interests rates

  • expressed as a number
    -higher the duration number = more volatility
81
Q

What are strip bonds?

A

Aka zero coupon bonds

  • used as portfolio insurance and typically only held in RRSP due to their tax liability
  • coupons are stripped and sold separately from AA bonds
82
Q

Callable Bond

A

Allows issuers to call the bond before maturity say after 8 years instead of 15 to readjust their bond rates if interest rates change greatly, they can call them back and reissue new bonds at diff rates

-the flexibility costs the issuer a higher return for the callable feature

83
Q

Retractable Bond

A

Opposite of callable bond and is less risky so provides a lower return

84
Q

Convertible Bonds

A

Offer the upside of bonds (stability and Income) with the upside of common shares (voting rights and capital appreciation)

  • more volatile than traditional bonds but less risky than typical equity
85
Q

Mortgage Bond

A

Safest of the corporate issued bonds as its the most senior form of debt. Good security = lower return

86
Q

Debentures

A

more risky, no asset to secure it and typically junior issuers

87
Q

Government Bonds

A

The gov of Can is largest issuer of bonds
- very safe as they are protected by the power of taxation

88
Q

Preferred Shares

A

Hybrid between bonds and CS. Lack security of bond
- provide regular and predictable income
-no maturity date
-gross up and tax credit applied
- yields up share prices fall
-

89
Q

Money Market Fund

A

Short term capital raising such as T-Bill (gives company short term capital) - liquid and very secure for investors

90
Q

Treasury Bills

A

issued by gov, safest - risk free return

91
Q

Commericial Paper

A

alternative and more risky option than TBILL

92
Q

Bankers Acceptance

A

MM Instrument

93
Q

Derivatives

A

-Include Futures and forwards (mustard farmer example)

  • Puts and Calls (Put holder is hoping for a drop in price, call holder is hoping for an increase in share price)

Think of calls and puts this way:
If I dont like something I PUT it down
If I like something I CALL it to me

  • Rights and Warrants
  • Swaps
94
Q

WHy are derivatives used?

A
  1. Speculation - investor looking to profit from anticipated large gains or losses
  2. Insurance / Hedging - go long, hope the shares increase in value
  3. Income
  4. Business Risk (think of the mustard farmer)
  5. Trading Strategies
  6. Leverage
95
Q

What is Modern Portfolio Theory?

A

Harry Markowitz developed it, a theory to determine how a share is bought and sold

CAPM - Beta

Beta measures risk level with an investment. Beta 1.5 means its roughly 50% riskier than rest of market, Beta of .7 would be 70% as risky as the market.

LOWER BETA = LESS RISK. Beta of 1 is same as market

Alpha is opposite of Beta - it measures risk of MARKET as a whole

Market moves as whole = Alpha
One equity moves = Beta

96
Q

What is Standard Deviation?

A

It is.a measure of risk in the sense of how far from average a piece of data lies.

EG a commute can vary depending on the day, traffic, weather etc… SD could measure the volatility of the commute, how far from the average it can get.

SD can help us determine the stocks with the greatest return and least risk

The higher the SD the more risk

If an return is 8% and SD = 2, the variation of volatility to the average would be 6-10%

If SD was 8 the range would be 0-16%, much riskier with higher SD… Great swings each way aka higher volatility

97
Q

What equations how measure Standard Deviation?

A

1 Sharp Ratio measures return per unit of standard deviation and typically range between 0-1
- higher SR = higher expected return for unit of extra SD
- doesnt say everything but if two units have same level of risk and one has a higher SR aka more return per unit of risk, then the stock with the higher SR should be chosen

98
Q

What is Sharp Ratio Formula?

A

Sharpe Ration = (Return - Risk-Free Return) / Standard Deviation

SD in formula is presented as a percentage eg. .06 (6%)

Higher sharpe ration = better investment

99
Q

How can funds be diversified?

A
  1. By Asset Class
    -T-Bills
    -Bonds
    -Equity
  2. Geography - invest georgraphically
  3. Sector - 9-10 which include:
    -Healthcare
    -Financials
    -Resources
    -Communications
    -Consumer Discretionary
    -Industrial Goods
    -Utilities
    -Basic Materials
    -Conglomerates
    Helps negate events like 2008 crash
  4. Regulatory Regime
  5. Tax Structure
  6. Investing Style
  7. Time - dollar cost averaging
100
Q

Investing Styles:

A

Growth vs Value

Buy and Hold

Active Vs Passive etcetc

101
Q

CESG Grants - how much and how do they work?

A

The gov’t grants you 20% of your annual contribution to a max of $500/year (to max out in a year you would need to contribute $2,500)

  • middle to low income families can receive an additional 10-20% of the first $500 contributed to RESP
  • CESG amounts accumulate and can be carried forward to the current year

-additional low income grants are only calculated on the first $500!!

Say low income family contributes $2,000
Their grant would be:
2000(.20) + 500 (.10) = $450

102
Q

RESPs cont limits are?

A

Have NO annual max contribution limit, just a lifetime limit of $50K

103
Q

How many years can you “catch up” with RESPs on gov grants?

A

$2500 per year gets you your max grants ($500 + 10-20% on FIRST $500 if low income)

if you missed two years the max catch up would be $5,000 for $1,000 grant in two back to back years - what this means is you can “catch up” for missed years but only in 2 year time frames

  • Lifetime limits with all grants and additional grants is still $7,200
104
Q

RDSP quick facts

A
  • Max matching grant is $3,500 in on year and up to $70,000 in bene’s lifetime

-It can receive grants until Dec 31 of bene’s 49th year

105
Q

What is a CDSG?

A

RDSP government grant for low income families
- no contributions required to receive grant, based on income only
- $1,000 max per year
- lifetime limit is $20,000 and until bene is 49
- based on family income

106
Q

Bonds always compound interest when?

A

Semi annually, including strip bonds

AND bond payments are always END mode

107
Q

What type of risk can be resolved with diversification?

A

Unsystematic Risk aka specific or unique risk!!!! Unsystematic risk relates to individual security holdings

108
Q

What is Systematic Risk?

A

Market Risk as a whole - you cannot diversify away systematic risk. The whole system as a unit has risk.

Aka NON Diversifiable risk

109
Q

What is Unsystematic Risk?

A

Risk related to a specific security holding, it can be lessoned through diversification

110
Q

What is another way of saying “average annual return”?

A

Weighted Average Return

111
Q

How to calculate After Tax Return and After Tax REAL Return?

A

Let’s use an example:
- Marginal tax rate of 44% (always use marginal, sometimes you will be given others and it’s there for trickery eg. average tax rate)
- Item average return rate is 4.5%
- inflation rate is 1.5%

This number will give you an APPROXIMATE.. if you use it, let grader know it’s approximate return:

After Tax Return = 4.5% x (1 - .44 MTR) = 2.52%
After Tax REAL Rate of Return (aka remove inflation) = 2.52 - 1.5 = 1.02% Real Return

112
Q

How to Calc After Tax Return

A

after tax: ROR rate % X (1 - .## MTR) = %

real return = After tax % from Q1 - INFLATION = REAL RETURN

113
Q

Say you have a question where someone needs $45,000 per year in retirement and they have $770,000 saved, they want to know what rate of return their account is required to generate to keep up with 2% inflation… how would you solve this?

A

In TWO steps:
Step 1: Solve for Real Rate of Return Required:
N=34
I = solve = 4.9445
PV= -770,000
PMT = 45,000 (into your pocket)
FV = 0 always 0 unless you need a leave a sum at the end
Mode: given

Ok, so Real Return is 4.9445, what return does he need to keep up with the 2% inflation?

Step 2: SOLVE for Nominal Return!!!

NR = (1 + Real Return) X (1 + Inflation) - 1
= (1 + .049445)(1 + .02) - 1 = 7.04% NOMINAL inflation, this will keep up with inflation

114
Q

What is the MAX RRSP over contribution limit?

A

$2,000

115
Q

RRSP tax deduction value example

A

Your cont room is $40,000 + 17,000 new room allocated - 4,800 to an spl rsp = $52,480 MAX contribution to your RRSP.

What is the value of your RSP deduction?
= 55,480 cont X MTR .44 = $22,566 value of tax deduction

116
Q

Knowing a clients Time frame and risk tolerance are important for?

A

Asset allocation

117
Q

What are some fixed-income asset funds?

A

Fixed - income funds:

-GICs
-Bonds
-Mortgage funds

118
Q

What does a portfolio holdings of 55% equities provide?

A

a hedge against inflation

119
Q
A

CFP Exam (18 decks)

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