Investment Planning Flashcards
Unsystematic Risk
Known as diversifiable risk, may also be referred to in some reference
books as non-systematic risk.
• Business risk: Refers to the nature of the firm’s operation (ie:
possibility of loss due to new technology)
• Financial risk: Refers to how the firm finances its assets (ie:
possibility of loss due to heavy debt financing)
Systematic Risk
Also known as non-diversifiable risk. This part of the risk is inescapable
because no matter how well an investor diversifies, the risk of the overall
market cannot be avoided.
Types of Systematic Risk
“P R I M E”
Purchasing power risk: loss of purchasing power through inflation
Reinvestment rate risk: risk that proceeds available for reinvestment must be
reinvested at a lower interest rate than the instrument that generated the proceeds
Interest rate risk: risk that a change in interest rates will cause the market value of the
fixed income security to fall
Market risk: risk of the overall market
Exchange rate risk: risk associated with changes in the value of currency
FDIC Insured Amounts
per bank/per type of account
Individual $250 K
Joint $250 K
Trust (per beneficiary) $250 K
IRA/Keogh $250 K
The Yield Ladder
Discounted Bonds
Yields higher than coupon
Y Yield to call
M Yield to Maturity
C Current Yield
A Nominal Yield (Annual Coupon Rate)
Current Yield
Yield to Maturity
Yield to Call
Yields lower than coupon
Premium BondsEE Bonds
• Non-marketable, nontransferable, cannot be used for collateral
• Sold at face value
• Interest rate based on the 10-year Treasury note yields
• Fixed interest rate that is in effect at the time of purchase
• Subject to federal taxation when redeemed (unless used as education
bonds)
• Not subject to state or local taxes
I Bonds
. Non-marketable, nontransferable, cannot be used for collateral
. Sold at face value
. Interest rate is composed of two parts
♦a fixed base rate (remains same for the life of the bond)
*an inflation adjustment (adjusted every six months)
. Subject to federal taxation when redeemed (unless used as education
bonds)
. Not subject to state or local taxes
Types of Municipal Securities
General obligation bonds: backed by the full faith, credit and taxing power of the issuer. GO Bonds are generally considered the safest type of municipal credit.
Revenue bonds: Backed by a specific source of revenue to which the full faith and credit of the issuer is not pledged. Because revenue bonds are backed by a single source of funds (like toll roads, hospitals or nuclear
power plants), they have greater credit risk than GO bonds. As such, they trade at higher yields.
Insurer municipal bonds: The insurers pay timely interest and principal when the issuer is in default. Municipal bond insurers are AMBAC (American Municipal Bond Assurance Corp.) and MBIA (Municipal Bond Insurance Association Corp).
Indenture Agreement Covers
- Form of bond
- Amount of issue
- Property pledged
- Protective conversant, including any provision for a sinking fund
- Working capital and current ratio
- Redemption rights, call, put or conversion provisions
Corporate and Municipal Bonds
DRIP
Default risk: A creditor may seize the collateral and sell it to recoup the
principal
Reinvestment risk: As payments are received from an investment, interest
rates fall. When the funds are reinvested, the investor receives a lower
yield.
Interest rate risk: Rising interest rates may cause bond prices to fall.
Purchasing power risk: Inflation may lower the value of bond interest
payments and principal repayment, thereby forcing prices to fall
Government Bonds
(RIP) no Default or credit risk
Capitalization
market of company
Large: market value exceeds $10 billion
Mid: market value is between $2-10 billion
Small: market value less than $2 billion
Micro: market value less than $300 million
American Depository Receipt
ADR
• Prices ofADRs quoted in US Dollars
• Dividendspaid in US Dollars
• Dividends declared in foreign currency
Attain diversification and risk reduction due to lower correlation of foreign
securities with US securities
Real Estate
(Land - improved)
(NOI)
Improved land is normally income producing. Income properties include
residential rental, commercial and industrial properties. The intrinsic value
of a real estate property can be computed using a net operating income
NOI computation.
Gross rental receipts
+ Nonrental income (laundry, etc.)
Potential gross income (PGI)
-Vacancy and collection losses
-Operating expenses (excludes interest and depreciation)
=Net operating income (NOI)
Options
General Definitions
Intrinsic value is the minimum price the option will command as an option. It is the difference between the market price and the exercise price of the stock.
Exercise price (strike price) is the price at which the stock can be purchased or sold on exercise of the option.
Premium is the market price of an option. As the option approaches its expiration date, the market price of the option (the premium) approaches its intrinsic value
Time premium is the amount the market price of an option exceeds its
intrinsic value
IV +TV = Premium
Call Options - Taxability
At the time of purchase: non-deductible capital expenditure
- To the writer due to lapse: premium paid is short-term gain
- To the writer due to exercise: premium paid is added to sale price (can be long-term gain if the underlying security was held more than 12 months, otherwise is short-term gain). Covered Call
- To the holder: if the option is not exercised, then the option is considered sold (it expires) and it is a short-term loss. The option period is 9 months or less.
