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)
- Finanical risk: Refers to how the firm finances it assets (ie: popssibility of loss due to heave debt financing)
Systematic Risk
Also know 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 od 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 fail
Market risk: risk of the overall market
Exchange risk: rosk associated with changes in the value of currency
FDIC Insured Accounts
(per bank/per type of account)
Individual $250K
Joint $250k
Trust (per beneficiary) $250k
IRA/Keogh $250k
The Yield Ladder
Y M C A
Discounted Bonds
Yields higher than coupon
Yield to call
Yield to Maturity
Current Yield
Nominal Yield (Annual Coupon Rate)
Current Yield
Yield to Maturity
Yield to Call
Yields lower than coupon
Premium Bonds
EE Bonds
- Non-marketable, nontransferable, cannot be used as collateral
- Sold at face value
- Interest rate bassed on the 10-year Treasury note yields
- Fixed interest rate that is in effect at the time of purchase
- Subject to federal taxation when redeeemed (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 the 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 subjet 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 typr of municipla 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 insurer pay timely interest and principal when the issuer is in default. Municipal bond insurers are AMBAC (American Municipla Bond Assurance Corp.) and MBIA (Municipal Bond Insurance Association Corp.)
Indenture Agreement Covers
- Form of bond
- Amount of issue
- Property pledged
- Protective convenant, including any provision for a sinking fund
- Working capital and current ratio
- Redemtion 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 proincipal
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 of ADRs quoted in US Dollars
- Dividends paid 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 compuyted using net operating income NOI computation.
Gross rental receipts
+Nonrental income (laundry, etc.)
Potentail gross income (PGI)
-Vacancy and collection losses
-Operating expenses (exclides interest and depreciation)
=Net operation 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 prioce 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 intrinisic value
Time premium is the amount of market price an option exceeds its intrinisic value.
Call Options - Taxability
At the time of purchase: non-deductible capital expenditure
- To the writer ue to lapse: premium paid is short term gain
- To the writer due to exercise: premium paid is added to the 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 iption 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.
