Investment Planning 17% (29 Questions) Flashcards

Question

Standard Deviation

Answer 1

The dispersion of outcomes around the mean. The greater the SD = the greater the risk 68% w/in 1 SD of mean 95% w/in 2 SD of mean 99% w/in 3 SD of mean

Answer 2

Interest = principle x interest rate x time John borrows $1000 for 2 years @ 8%. What is interest charged. 1000 X .08 X 2 = $160. *John would ultimately pay $1160 back to lender

Answer 3

Interest earned on interest John invest $1000 for 2 years @ 8% PV: 1000 N: 2 I/YR: 8 Solve for FV: $1166.40

Answer 4

Total return of an investment for the given period over which the investment is owned HPR = ending value - beginning value (+ or -) cash flows ÷ beginning value

Answer 5

Sum of observations ÷ total # of observation

Answer 6

Probability x single period rate of return Probability (30%) Single Per. Return (.50) = 15%

Answer 7

[(1 + Rate of Return) ÷ (1 + Inflation Rate) -1] X 100

Answer 8

Yearly cost expressed as a % *If lender advertises 1.25% monthly, the APR = (1.25% X 12 mos)= 15%

Answer 9

TAR= return x( 1- marginal tax bracket) Ex: Allision: 32% tax bracket Corp Bond Coupon: 7% 7% X (1-.32) = 4.76%

Answer 10

Time Weighted: 1. Measure return w/o considering w/d's or deposits 2. Preferred method for portfolio mgr. performance Dollar Weighted: 1. Provides assessment of actual performance including w/d's and deposits. 2. CF method for this problem.

Answer 11

TAR = realized return X (1- marginal tax bracket) Ex: Allison 32% tax bracket Corp Bond coupon 7% TAR = [7% X (1-.32)] TAR = 4.76%

Answer 12

RAR = Actual Rtn ÷ Beta

Answer 13

Client's Tax Situation Horizon Risk Tolerance Economic Forecast

Answer 14

1. Appropriate allocation based on the long-term financial goals of the client. 2. Mirrors mkt index that seeks low cost means of generating long term returns w/ minimal turnover Rebalance 1-2x/yr

Answer 15

1. Active Mgr w/ short term market adjustments, 2. Tries to time market w/ indiv. stock picking Sell overvalued security Buy undervalued security

Answer 16

Core: Passive philosophy to achieve mkt based returns Investing in broad mkt indexes (S/P 500) Satellite: attempt to achieve above mkt returns though high risk alternatives & global exposure (REITS, high yield bonds, emerging mkts)

Answer 17

CY = annual interest payment ÷ current market price Jeff has a bond with an annual coupon rate of 4.25% that is currently trading at $965. What is the bond’s current yield? $42.50 ÷ $965 = 0.0440, or 4.40%

Answer 18

The internal rate of return (IRR) for cash flows associated with the bond, including the purchase price, coupon payments, and maturity value Ex: End Mode 2 p/yr Bond currently at $970 PV: +/- 970 PMT: 30 FV: 1000 N: 15 I/YR: 6.31%

Answer 19

Determines the weighted average number of years until an investment is recovered.

Answer 20

The process of determining the fair or intrinsic value of a security. This value is then compared with the current market value to determine what course of action will be undertaken: buy, sell, or hold (Factors: Econ environment, stock mkt tendencies, int rates & biz cycles) Focuses on company's PERFORMANCE & EARNINGS that company's industry, and its financial statements. Looks at financial P/E ratios Look at a company's financial condition, as revealed by its income statement and balance sheet

Answer 21

Is an attempt to determine the demand side of the supply/demand equation for a particular stock or set of stocks Rely on stock charts PRICE & VOLUME believe that the history of the stock price will tell the whole story of the security and that there is no need to be concerned with corporate factors such as earnings, financial leverage, product mix, and management philosophy NOT USED FOR Efficient Market Hypothesis

Answer 22

indicates what the market is willing to pay per dollar of earnings. P/E = mkt price per share ÷ earnings per share If ABC Stock is currently trading for $50/share and has an earnings per share of $2.50, the P/E ratio would be 50 ÷ 2.5 = 20 High PE = overpriced Low PE = buying opp!

Answer 23

Is a measure of relative valuation that can be used to com-pare companies with different growth rates Companies with a low PEG ratio will have higher rates of return Stocks with PEGs < 1.0 will have higher future rates of return & are good value stocks.

Answer 24

Purchasing securities over times predetermined amounts at regular intervals. Buy less securities when market rises Buy MORE securities when market falls Works best in fluctuating markets.

Answer 25

Aims to have MV of account increase at regular intervals to predetermined amounts. Amounts are either invested or shares are liquidated to bring account MV in line with predetermined target.

Answer 26

Investor buys the same amount of shares every time.

Answer 27

Dividends are automatically reinvested back into the company’s stock Reinvested dividends are treated the same for tax purposes as cash dividends

Answer 28

Bonds with equal dollar amounts but w/ staggered maturities (3 yrs, 2 yrs, 1 yr) Helps reduce portfolio interest rate risk

Answer 29

Portfolio consisting of short term & long term bond maturities Active mgmnt required for this strategy.

Answer 30

Bonds with target maturity date to match the cash needs of an investor. Parents buying bonds for child's expected college start date (Bonds each maturing in 14 yrs.)

Answer 31

Buying a set percentage of assets in each class. Buying an index fund Transaction cost & taxes are minimized

Answer 32

Based on the concept that the markets are efficient in pricing securities and that it is unlikely that an investor will be able to outperform the market on a consistent basis

Answer 33

Based on the concept that above-market returns can be achieved through security selection & market timing. Those who believe that active management can outperform the market do not believe the market is perfectly efficient.

Answer 34

Elayne believes ABC stock is overpriced. She sells short 100 shares of ABC when it is trading at $100 per share. Three months later ABC may be purchased for $85 per share. Elayne repurchases 100 shares of ABC on the open market and replaces the borrowed stock for a profit of $15 per share, or $1,500.

Answer 35

Margin- When an investment is purchased on margin, one-half of the funds are put up by the investor and one-half is borrowed from the broker (assumes a 50% initial margin) a. Initial margin—the percentage of the original purchase that must be provided by the investor (currently 50%) b. Maintenance margin—the level at which an investor will be required to add funds to the margin account. Maintenance margins are usually set at 35% but may differ from broker to broker. c. Debit balance—the loan amount owed to the broker. This amount will include the original amount borrowed plus any accumulated interest. d. Equity—the value of the security less the debit balance. Another term for equity is “margin.” The margin in a stock is the equity, not the debt. Margin call = debit balance ÷ 1 − maintenance margin

Answer 36

Harry pays $20,000 to purchase shares of Solvent Company (trading at $25 per share). If Harry uses a margin account (50% initial margin) to purchase this stock, he can buy 1,600 [(20,000 × 2) ÷ 25] shares. An amount of $20,000 is borrowed from the broker. Harry is concerned about receiving a margin call. At what point will Harry receive a margin call (assume a maintenance margin of 35%)? Margin call = debit balance ÷ 1 − maintenance margin margin call = $25 × 0.50 ÷ 1 − 0.35 = $19.23 Harry will receive a margin call when the price of the stock declines below $19.23. NOTE: Margin call can be determined on a per share basis or on a total market value basis.

Answer 37

A right to BUY a security for a specified price w/in specified timeframe Buy (being long) a call Write (being short) a call

Answer 38

A right to SELL a security for a specified price w/in specified timeframe Buy (being long) a put Write (being short) a put

Answer 39

Buy (being long) a call Write (being short) a call

Answer 40

Bullish: mkt prices ↑ Buy a CALL Write a PUT Bearish: mkt prices ↓ Write a CALL BUY a PUT

Answer 41

ABC Stock currently trading at $45 Call Option at $40 Intrinsic Value of Call Option = $5 *If ABC was trading at $35 intrinsic value = $0 b/c you could buy stock for less than your $40 call option.

Answer 42

ABC stock currently trading at $45 Put Option at $40 Intrinsic Value of Put Option: $0 *If ABC was trading at $35 intrinsic value = $5

Answer 43

Investors are unable to outperform the market on a consistent basis. Current stock prices reflect all available information for a company & that prices adjust to reflect any new information. Any new information must be unexpected, therefore any changes in the stock price resulting from this new info will be random.

Answer 44

Return Probability A: 12% 0.15 B: 11% 0.55 C: 8% 0.30 What is the expected return of the portfolio? E(r) = P1(R1) + P2(R2) + P3(R3)

Answer 45

8% coupon bond, maturing in 5 years, & selling currently for $850. What is current yield? CY = $80 ÷ $850 CY = 0.09412, or 9.41%

Answer 46

Income from coupons reinvested over the investment horizon. By investing in bonds that have a duration equal to the investor's investment time horizon, any bond price/value changes caused by interest rate fluctuations, will be approximately offset by changes in the interest earned on the reinvested coupons.

Answer 47

3. An investor who buys the securities of firms that are not followed by many analysts is trying to benefit from the neglected-firm effect. 4. An investor who befriends the chauffeur of a firm's CEO to solicit information about the firm's plans before making investment decisions believes the markets are strong-form efficient. The P/E effect suggests that portfolios consisting of stocks with low price-to-earnings ratios have higher average returns than do portfolios consisting of stocks with high P/E ratios. Strong-form market efficiency suggests that all public and private information is included in market prices. A person who solicits private information believes that it is possible to profit by making trading decisions based on private information, and does not believe that the markets are efficient in the strong form. Weak-form efficiency suggests that all historical price and volume information is included in stock prices but that gains may be made by analyzing other publicly available information.

Answer 48

I. Mark should buy lumber futures. II. Theresa should sell cotton futures. Mark is SHORT lumber because he needs lumber to produce his products. A hedge position for Mark would be to go long lumber futures, that is, to purchase lumber futures. Theresa is LONG cotton because she owns cotton for manufacturing purposes. A hedge position for Theresa is to go short, that is, to sell cotton futures.

Answer 49

Interest rate risk Reinvestment rate risk

Answer 50

The expected rate of return for ABC stock is 2.55%, calculated as follows: (0.35 × –0.10) + (0.40 × 0.12) + (0.25 × 0.05) = 0.0255, or 2.55%. Therefore, Lucy should not purchase the stock because the expected rate of return is lower than her required rate of return.

Answer 51

The value of stocks will increase, and investors will buy them because the lower required return increases the present value of future stock benefits.

Answer 52

Under the weak form of the EMH, access to fundamental analysis and insider information can achieve superior results. Under the semistrong form of the EMH, only access to insider information can achieve superior results. Under the strong form of the EMH, not even access to insider information can achieve superior results. Anita uses fundamental analysis, which is supported only by the weak form of EMH. Michael does not use fundamental or technical analysis. His strategy is supported by the semistrong and strong forms of the EMH. Sally uses technical analysis, which is rejected by all forms of the EMH.

Answer 53

Answer: 67.50% His HPR using margin was 67.50%, calculated as follows: Ending value = 400 shares × $49.50 per share = $19,800 Beginning value = 400 shares × $36.00 per share = $14,400 Cash outflow = margin interest = 0.075 × 0.50 × $14,400 = $540 Initial investment = 0.50 × $14,400 = $7,200 HPR = ($19,800 − $14,400 − $540) ÷ $7,200 = 67.50%

Answer 54

C) In-the-money A put option is in-the-money when the exercise price > than the market price of the underlying security. A put option is out-of-the-money when the market price is > than the exercise price.

Answer 55

1. This technique involves investing a specific amount into an investment vehicle, regardless of whether the recent trend in the investment has been up or down. 2. If prices decline, the fixed investment amount will purchase a greater quantity of the security. 3. For the long-term investor, the presumption is that prices will eventually rise, so a lower average price translates into greater profits.

Answer 56

6.99% TEY = tax-exempt yield ÷ (1 − marginal tax rate) 4.75% ÷ (1 − 0.32) = 6.99%

Answer 57

The APT determines returns based on multiple factors. These factors might include inflation, growth in GDP, major political upheavals, or changes in interest rates.

Answer 58

The security market line (SML) shows the relationship between the rate of return and systematic risk (beta). Thus, the SML depicts a security's expected return as a function of its systematic risk

Answer 59

Grant's current equity in XYZ: $52 − (50% × $75) = $14.50 Required equity: $52 × 40% = $20.80 Difference: $6.30 × 100 shares = $630

Answer 60

Portfolio A Sp = (0.0865 - 0.0155) ÷ 0.10 = 0.71 Tp = (0.0865 - 0.0155) ÷ 1.36 = 0.05221 Portfolio B Sp = (0.0745 - 0.0155) ÷ 0.12 = 0.4971 Tp = (0.0745 - 0.0155) ÷ 1.52 = 0.03882

Answer 61

64% Because the correlation coefficient is 0.80, the coefficient of determination (R-squared) is 0.64 (.80²) Therefore, 64% of investment returns can be explained by changes in the market (i.e., systematic risk represents 64%).

Answer 62

economies of scale. Benefits of FoF over traditional hedge fund investing include expertise and information advantage, monitoring, immediate exposure, improved diversification, economies of scale and accessibility, liquidity, improved access to managers, lower negotiated fees, education, more favorable regulation (not necessarily less regulation), possible currency hedging, and leverage opportunities. FoFs usually result in less investment transparency and FoF investors must give up control through the FoF form of hedge fund investing.

Answer 63

I. The time value of the call option is $5. IV. The intrinsic value of the call option is $10. The time value of the call option is calculated as follows: time value = market price of call option − intrinsic value of call option. Intrinsic value = $50 − $40 = $10. Time value = $15 − $10 = $5. Because the current market price of the stock is greater than the exercise price, the call option is in-the-money. The writer will receive an option premium of $1,500 (100 shares × $15 call option price).

Answer 64

A) John's maximum gain is $3 John's maximum gain is $3, but his MAX LOSS IS UNLIMITED. Because the call option was written as a naked call option, the seller (John) will have to buy the stock at the prevailing market price if the call option is exercised by the buyer. The buyer would exercise the call option when the stock price exceeds $20. Any price level over $20 begins to reduce the call option buyer's potential loss, and at $23 the seller and buyer break even.

Answer 65

I. The investor must recognize annual interest accumulation as taxable income, even though no money is actually received. II. Duration = YTM III. A zero-coupon bond sells at a deep discount to par value. IV. An increase in market interest rates adversely impacts the market value of the bond.

Answer 66

Depicts the risk-return relationship for efficient portfolios of securities. Securities OVER SML line are "undervalued" Securities UNDER SML line are "overvalued"

Answer 67

An ↑ in the RFR ↑ the value of the European call option. An ↑ in the price of the underlying stock and/or the variability in the price of the underlying stock ↑ the value of the European call option. An ↑ in the time to expiry also ↑ the value of the European call option

Answer 68

I. Preferred stockholders are paid after bondholders but before common stockholders in terms of priority of payment of income and in case of corporate liquidation II. If the issuer of a cumulative preferred stock fails to pay the dividend in any year, the unpaid dividend(s) will have to be paid in the future before common stock dividends can be paid. III. Preferred stock dividends are not legally binding but must be voted on each period by the corporation's board of directors. IV. Preferred stock dividend income continues forever, unless the stock issue is called or otherwise retired

Answer 69

Series I bonds for inflation-protected savings for their child's education. Series HH bonds cannot be purchased and are no longer available for exchange of Series EE bonds. To receive the tax benefits for qualified higher education, Series EE or I bonds must be purchased by a taxpayer who is at least 24 years old and who uses the proceeds to finance qualified education expenses for himself, his spouse, or a dependent. Series I bonds provide inflation protection because they have a fixed base rate and an inflation adjustment. However, they do not provide tax-free earnings for retirement.

Answer 70

The yield to maturity for this bond is 8.71% calculated as follows: End Mode 2 P/Y PV: –(977.36) N: 60 (30 × 2) PMT: 42.50 (85 ÷ 2) FV: 1,000 Solve for I/YR : 8.71%

Answer 71

2.05% ΔP/P = -D x (new yield - old yield) ÷ (1 + old yield) ΔP/P = −4.6 × [(0.0498 − 0.0545) ÷ (1 + 0.0545)] ΔP/P = −4.6 × (−0.0047 ÷ 1.0545) ΔP/P = 0.0205, or 2.05% Change in Price = -D x (new yield - old yield) ÷ (1 + old yield)

Answer 72

I. Duration = to the investor's investment time horizon. II. Immunization allows an investor to earn a specific rate of return, regardless of whether interest rates increase or decrease.