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BIF Review > Investment Planning > Flashcards

Investment Planning Flashcards

1
Q

Define margin

A

the process of pledging securities in your brokerage account for a loan from your brokerage firm.

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2
Q

what is used as collateral in a margin account

A

underlying securities

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3
Q

Minimum federal stock initial margin requirement

A

50%

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4
Q

Minimum federal maintenance margin requirements

A

25%

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5
Q

Formula for a margin call

A
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6
Q

Example of Calculating the margin call price when the initial purchase price is $10

A
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7
Q

when is the multi stage dividend discount model used

A

in situations where a dividend-paying security has a temporary expected growth rate that changes to a stabilized rate for constant growth

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8
Q

Dividend growth rate formula

A

D1= (D0 x (1+g))
D2= (D1 x (1+g))
D3= (D2 x (1+g))

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9
Q

Steps to calculating multi stage discount dividend model

A

Step 1: calculate the YE dividends for x amt of years at 1st dividend growth rate. Step 2 calculate the stock valuation years 3 based on the new, constant dividend growth rate. Step 3: solve for NPV

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10
Q

Final dividend amount for dividend discount model

A

The final dividend at the initial growth rate (Step 1) is used in the Constant Growth Dividend Discount Model (Step 2) with the new (constant) growth rate.

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11
Q

equation to calculate a sustainable growth rate

A

b x ROE where b is the retention rate and ROE is return on equity

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12
Q

when do margin calls end up being an inescapable spiral

A

volatile and negative markets

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13
Q

who pays the premium to enter into an options contract

A

the buy of the contract

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14
Q

how many shares do contracts cover of the underlying stock

A

100 shares

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15
Q

what is a call in a favorable position

A

when MP > EP

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16
Q

what is a put in a favorable position

A

when MP < EP

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17
Q

when as the option considered “at the money”

A

when MP = EP

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18
Q

what does the options clearing corporation (OCC) eliminate in an options contract?

A

counterparty risk

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19
Q

what are bullish moves in options contracts?

A

buying/holding call options; sellinging/writing puts

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20
Q

what are bearish moves in options contacts?

A

buy/holds puts; sell/writes calls

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21
Q

what makes time premium higher in an options contract?

A

Risk-free rate of return
Time to expiration
Variability of the underlying stock (as measured by standard deviation)
The greater any or all of the three variables above, the greater the time premium

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22
Q

when can intrinsic value be 0?

A

NEVER

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23
Q

Intrinsic Value for Call Options Formula

A

(COME) Call Option = Market Value - Exercise Price

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24
Q

Intrinsic Value for Put Options Formula

A

(POEM) Put Option = Exercise Price - Market Value

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25
Q

what two components make up the two parts of total premium in a stock option premium?

A

intrinsic value and time premium

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26
Q

When and how does time premium decrease?

A

it decreases as time goes on

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27
Q

Define covered call writing and what it is used for

A

Long the underlying stock - short the call

Only considered covered if you own enough shares to cover all contracts sold.

Sets a cieling on stock
Used to generate income for the portfolio.

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28
Q

Naked call writing

A

Does not own the underlying stock - short the call

Writer bears UNLIMITED risk

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29
Q

Protective put

A

Long the stock - long the put

This is the very essence of portfolio insurance.

puts a floor on stock price to min losses

is costly eventually

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30
Q

what is more expensive in general between puts vs calls?

A

puts

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31
Q

Collar (Zero-cost collar) and when/why it is used

A

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.

32
Q

Stock option strategy: Straddle

A

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.

33
Q

Stock option strategy: spread

A

Involves purchasing and selling the same type of contract.

Benefit from stability (i.e., minimum moves in the underlying stock’s price).

34
Q

With a futures contract, what position would you take if you think the price in the future will be higher than today?

A

a long position

35
Q

With a futures contract, what position would you take if you think the price in the future will be lower than today?

A

a short position

36
Q

Which between futures and forward contracts are standardized?

A

futures contracts are standardized. Forward contracts are not standardized

37
Q

Which between futures and forward contracts carry counterparty risk?

A

forward contracts carry counterparty risk.

38
Q

How are most futures contracts settled?

A

settled out for cash, and not physical delivery of the underlying asset

39
Q

Who is the intermediary to a futures contract?

A

The Clearinghouse

40
Q

If the NPV and the IRR suggest two different investment projects, which should the investor select?

A

a higher positive NPV.

41
Q

What does the IRR calculation assume that is a weakness?

A

the reivestment rate is the IRR. Underestimates when rates fgo higher, overestimates when rates go lower

42
Q

NPV vs. IRR

A

The NPV is considered a superior model to IRR when comparing investment projects of unequal lives.
Investing at the required rate of return is more reasonable than at the IRR.
With changes of more than two inflows or outflows in an investment project there will be only one NPV, however, multiple IRRs.

43
Q

Internal Rate of Return (IRR)

A

allows the financial planner to compare the computed rate to the required rate of return.
The method discounts the future cash flows at an appropriate method used to determine the exact discount rate to equalize cash inflows and cash outflows of a specific investment or project.

Calculated using the TVM keys (N, PV, FV, PMT, and i%).
Yield to maturity (YTM) and yield to call (YTC) are examples of IRR calculations.

44
Q

What does the result of the NPV calculation tell us?

A

If the result is positive, the investor should undertake the investment.
The actual return will be greater than the required return.
If the result is negative, the investor should avoid the investment.
The actual return will be less than the required return.
If the result is zero, the investor should undertake the investment.
The actual return will equal the required rate of return.

45
Q

Net Present Value (NPV)

A

is used to evaluate the cash flows associated with capital projects and capital expenditures.
The method discounts the future cash flows at an appropriate discount rate and allows the present value of the inflows to be compounded to the present value of the outflows.
The discount rate used is the investor’s required rate of return.
Calculated using the uneven cash flow keys (CF0, CFj, and Nj).

46
Q

How to make a decision for NPV

A

postive or zero NPV, accept the project

47
Q

How to make a decision for IRR

A

Accept project where IRR exceeds the required rate of return

48
Q

What is a wash sale

A

occurs when a taxpayer realizes a loss on the sale of a security and acquires a “substantially identical” security within a 61-day period. Time wash sale time period extends from 30 days prior to the trade date to 30 days after the trade date.

49
Q

Substantially Identical recognized wash sales

A

Bonds: Unless the investor purchases back the same exact bond or bond fund, it is difficult to violate the wash sale rule with fixed income.
Stocks: two assets to be aware of that would trigger “substantially identical”:
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.

50
Q

Wash sale ramifications:

A

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).

51
Q

Wash sale example

A

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 loss of $250 on the sale. However, he adds the disallowed loss of $250 to the cost of the new stock, $800, to obtain his basis in the new stock, which is $1,050.

52
Q

What consequences does a wash sale have?

A

significant tax consequences

53
Q

What are the four basic type of financial rations

A

liquidity ratios, activity ratios, ativity ratios, profitability ratios, debt ratios

54
Q

What are liquidity ratios used for

A

Used to determine the ability to meet short-term obligations

55
Q

What are activity ratios used for

A

Used to determine the relative efficiency of financial management.

56
Q

What are profitability ratios used for

A

Used to measure relative profitability.

57
Q

What are debt ratios used for

A

Used to determine the ability to meet long-term obligations.

58
Q

What is the optimal combo for current and debt ratios

A

high current ratio and lower debt ratio

59
Q

current ratio

A

current assets/current liabilities

60
Q

quick ratio

A

current assets-inventories/current liabilites

61
Q

working capital

A

current liabilities/current assets- current liabilities

62
Q

gross profit margin

A

gross profit/sales

63
Q

operating profit margin

A

operating income/revenue

64
Q

reutnr on assets (ROA)

A

EAT/total assets

65
Q

return on equity (ROE)

A

EAT/equity

66
Q

debt to equity

A

total long-term debt/equity

67
Q

debt ratio

A

total debt/total assets

68
Q

when does imputed interest income get looked at

A

Gift loans provided out of love, affection, or generosity.
Corporate shareholder loans from a corporation to its shareholder.
Compensation-related loans from employer to employee.

69
Q

5 exceptions when imputed income does NOT apply

A
  1. Loans between individuals totaling $10,000 or less; except when the borrowed funds are used to purchase income-producing property.
  2. Corporate loans and compensation-related loans totaling $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 six months.
70
Q

what happens when loans exceed $100,000?

A

the imputed interest is charged based on the Applicable Federal Rate (AFR)

71
Q

How is the imputed interest calculated for loans between 10k-100k?

A

the imputed interest is the lesser of:

the AFR, or
the borrower’s net investment income.

72
Q

What happens if the borrower’s net investment income is $1,000 or less?

A

imputed income will NOT apply.

73
Q

key numbers related to imputed interest calculations:

A

$1,000 (NII of this amount or less is not imputed on loans between $10,000 - $100,000)

$10,000 (loans below = not imputed; loans greater than & up to $100,000 = lesser of borrower’s NII or AFR)

$100,000 (loans above use the AFR to calculate imputed interest)

74
Q

Who is interest imputed to between borrower and lender?

A

lender

75
Q
A

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