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CFP > Investment Planning > Flashcards

Investment Planning Flashcards

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0
Q

Revocable Trust

IRAs and other retirement accounts

A

Revocable: allow for additional $250K of coverage per revocable trust beneficiary

Revocable trust regulations require that beneficiaries must be the follow:
*qualifying family members
specifically named in the account records
the intention of the owner must be that the account will belong to the named beneficiaries upon the owner’s death

IRA and other retirement accounts: Retirement accounts are insured separately from any non-retirement funds. IRA, self-directed Keogh funds, 457s, and certain self-directed defined contribution plans are aggregated with a a limit of $250K

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1
Q

Certificate of Deposit CD - Individual vs Joint

A

Individual - 250,000 coverage of cking,saving, and cd in individual name at a bank

Joint - 250,000 per individual aggregate joint

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2
Q

Components of Individual Bond

A

Bond: Bonds are debt security which obligates the issuer to pay interest (usually semiannually) and to repay the principal amount when debt matures.

Par value: bonds are issued with a stated part value (face value usually 1000) and a states rate of interest (coupon rate or nominal rate)

Discount Bond: Bond sells at a discount when par value is in excess of the bond’s purchase price

Premium Bond: Bond sells at a premium when the bond’s purchase price is in excess of par value.

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3
Q

The Yield Ladder

A 
Y - yield to call   Discount 
M - yield to maturity
C - current yield 
A - annual coupon
C - current yield     Premium 
m - yield to maturity
Y - current yield
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4
Q

Accrued interest Definition

A

The interest that has accumulated since the principal investment, or since the previous interest payment if there has been one already. For a financial instrument such as a bond, interest is calculated and paid in set intervals.

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5
Q

Original Issue Discount OID

A

bond is discount from Par Value at the time of issue
may original issue discount bonds are zero coupon bonds
originally sold far below par value and pay no interest until maturity
Discount on bond must be accreted over the bonds life
each year the portion of the discount that has been earned is included as taxable interest income, and bond’s basis is increased
Zero-coupon bond owner must report interest income although the bond pays no interest before maturity
with new OID municipal bond, the discount must be accreted on a straight-line basis over the life of the bond
annual accretion amount is non-taxable municipal interest income. if held to maturity, there is no capital gain or loss

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6
Q

Difference between Treasury Bill, Notes, and Bonds

A

Bills mature in 3-12 months and are quoted in terms of discounted yield ($100 to $1 million). The difference between issue price and maturity is taxed as interest

Notes are intermediate debt maturing in 1-10 years (1000-100,000)

Bonds are long term debt maturing in 10-30 years (1,000 to 1 million)

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7
Q

Treasury Inflation-Protection Securities TIPS

A

The investor is Taxed annually on the interest payment plus the appreciation in face value. The increase in face value is only nominal or “phantom” income that is not collectible until the bond is sold or matures. However, this income is taxable in the year it is accrued. TIPS are not subject to state and local taxes.

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8
Q

EE Bonds

A

nonmarketable, 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

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9
Q

HH Bonds

A

available only by exchanging at least $500 in series EE bonds
pay semiannually by check
non marketable
no longer exchangeable for ee bonds

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10
Q

I Bonds

A

nonmarketable, nontransferable, cannot be used for collateral
sold at face value
interest rate is composed of 2 parts
*fixed base rate (life of bond)
*an inflation adjustment (every 6 mo)
*subject to federal taxation when redeemed (unless used for education bonds)
*Not subject to state or local taxes

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11
Q

Government National Mortgage Association GNMA

A

buy FHA, VA, and farmers home Administration insured mortgages from bands and places them into mortgage pools
issues modified mortgage backed pass through certificates representing individual interest int the pool
Direct-guarantee of the U.S. government
minimum size of an individual GNMA certificate sold to an individual investor is 25K
Risks are not subject to default, interest rate risk, and reinvestment rate risk

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12
Q

Types of Municipal Securities

A

GO
Rev
Insurer municipal bonds: the insurer will pay timely interest payments when issuer is in default (ambac, berkshire)

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13
Q

Corp Bonds

A

considered Longer term

mortgage bonds back by specific real property

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14
Q

Tranches

Definition and Purpose

A

a special type of bond class in sequential pay collateralizaed mortgage obligation is CMO.

to speed up the maturity of the senior tranches by disbursing payment z tranche. Z is the highest risk and longest duration

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15
Q

Corporate and Municipal Bonds (Risk)

A 
DRIP 
Default
Reinvestment risk
Interest rate risk
Purchasing power risk - inflation may lower the value of bond interest payments and principal repayment, thereby forcing prices to fall.
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16
Q

Government Bonds

Risk

A

RIP

no default

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17
Q

Rating Agencies

Standard and Poor vs Moody

A

Investment grade
S&P = AAA, AA, Moody Aaa, Aa
A, BBB A, Baa

Speculative Grade
S&P BB and Below, Moody Ba and below

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18
Q

Callable Bonds

Definition and Cause

A

can be redeemed by the issues prior to its maturity; usually a premium is paid to a bond owner when the bond is called
redeemable bond

Cause: decline in market interest rate
Call Premium: cost to the issue for early redemption

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19
Q

Put Bond

Def and Cause

A

Holder forces the issue to repurchase the security at specified dates before maturity

Cause: firm must redeem the bond a specific date for its principal amount. If interest rates were to rise after bonds were issued, then there would be a drive down in price of the bonds.

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20
Q

Capitalization Cap

Definition

A

refers to the market value of the company

Large - 8 billion +
Mid 2 billion - 8 billion
Small - 301- 2 billion
Micro - less - 300 million

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21
Q

Preferred Stock

definition

A

a hybrid security because it resembles both equity and debt.

who buys? The typical purchases of preferred shares is a corporate treasurer with excess funds on hand. If the treasurer buys bonds, all the interest is taxable. but if the corporation buys preferred, then 70% of the dividends received are excluded from taxation

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22
Q

American Depositary Receipts

ADR

A

A negotiable certificates issues buy a U.S Bank representing a specified number of shares in foreign stock that is in a foreign stock that is traded on the U.S. exchange instead of buying shares of foreign-based companies in overseas markets, Americans can buy shares in the U.S. ADR are quoted and denominated in U.S. Dollars. ADRs help to reduce administration and duty costs that would otherwise be levied on each transaction.

ADRs do not eliminate currency and economic risks for the underlying shars in the another country.

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23
Q

Exchange Traded Funds

ETF

A

Security representing a basket of stocks or bonds
May be an open or closed-end fund
Generally more tax efficient than traditional open-end mutual funds

Def: A security that tracks an index, a commodity, or a basket of assets lake an index fund, but it trades like a stock on an exchange, thus experiencing price changes throughout the day as it is bought and sold

Open end: amy operate in the form of UIT or investment company

SPY

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24
Q

Real Estate

Land-improved NOI

A

Improved land typically is income producing. income properties include residential rental, commercial, and industrial properties. The intrinsic value of a real estate property can be computed using a NOI computation.

Gross rental
\+ non-rental income
-------------------------
Potential gross income (PGI)
- vacancy and collection losses 
-operating expenses (not including interest and depreciation) 
--------------------------------
Net operating income
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25
Q

Real Estate Investment Trust
REIT

vs.

Real estate Limited Partnership RELP

A

REIT = portfolio investment and subject to taxation like a stock, actively traded on securities markets, managed by board of directors with are ultimately accountable to their shareholders

RELP = subject to passive loss rules, generally illiquid, managed by a general partner

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26
Q

Options General Definitions

A

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 approaches its intrinsic value.

Time premium is the amount the market price of an option exceeds its intrinsic value.

27
Q

Call Options - Taxability

A

At the time of purchase: nondeductible 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)

To the holder: if the option is not exercised; The option is considered sold (it expires) and it is a short term loss. The option period is 9 months or less

28
Q

Futures Contracts

A

Long commodity position: if a farmer is long a commodity, he needs a short hedge an will sell a futures contract.

Short commodity position: If Kellogg is short a commodity (corn) Kellogg needs a long hedge and will but a futures contract.

29
Q

Reg D

Accredited vs. Non-accredited Investor

A

Accredited (unlimited)
Net worth of $1,000,000 (not including personal residence)
Individual with an annual income of $200,000
couple with joint income of 300,000
think 1,2,3

Non-accredited
Sold to a max of 35 investors
must use a purchaser representative if not sophisticated

30
Q

Warrants vs Call Options

A

warrants are issued by corporations whereas calls are created by individuals

warrants typically have maturities of several years

warrants terms are not standardized; call options are standardized.

31
Q

Types of Systematic Risk

A 
PRIME - can't diversify the system
Purchase power risk
Reinvestment rate risk
Interest rate risk
Market risk
Exchange rate risk
32
Q

Unsystematic Risk

A

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
  • Financial risk - refers to how the firm finances its assets
33
Q

Systematic Risk

A

This part of the risk is inescapable because no matter how well an investor diversifies, the risk of the overall market cannot be avoided.

Also known as non-diversifiable risk or total risk

34
Q

Devaluation vs. Revaluation

A

Devaluation: lowering of the value of a currency relative to the currencies of other nations; can also result from a rise in value of other currencies relative to the currency of a particular country

Revaluation; generally means an increase in the currency’s value

35
Q

Perfectly Positively correlated vs. Perfectly Negatively Correlatated

A

Positively: securities have a value of +1. The securities move exactly together as there is no reduction of portfolio risk.

Negatively: Securities have a value -1. The securities move exactly opposite as risk is completely eliminated.

36
Q

Coefficient of Determination R2

A

the square of the correlation coefficient measuring the proportion of the variation in one variable explained by the movement of the other variable.

How is R2 used on exam? It describes the % of the funds movement that is explained by the movement in the s&P 500. Index funds/diversifeid funds based on the S&P 500 will have R2 of very close to 100%, while sector funds (not diversified) will ahve very low R2 (5-25%)

37
Q

Coefficient of Variation

A

Define: The standard deviation divided by the average or mean

38
Q

Standard Deviation vs. Beta

A

Standard Deviation: measures variability of returns used in a nondiversified portfolio and is a measure of total risk

Beta: measures volatility of returns in a diversified portfolio and is a measure of systematic risk

39
Q

Risk-Adjusted Return

A

To standardize for risk, one must divide an individual funds realized return by its beta coefficient.

40
Q

Time-Weighted Return Geometric Return vs.

Dollar-Weighted Return Internal Rate of Return

A

Time Weighted: portfolio accounting method that measures investment performance (income and price changes) as a percentage of capital at work thus eliminating the effect of additions and withdrawals

Dollar Weighted: portfolio accounting method that measures changes in total dollar value, treating additions and withdrawals of capital s part of the return along with the income and captial gains and losses

41
Q

Real vs. Nominal Rate Return

A

Real: the inflation adjusted interest rate

Nominal: actual returns not adjusted for inflation

The “real” rate is defined as the nominal rate of return adjusted for inflation

42
Q

Holding Period Return (HPR)

A

The total return (income plus price appreciation and dividends less margin interest) over the entire period divided byt he price of the investment (out of pocket)

43
Q

Internal rate of return (IRR)

A

IRR: discount rate at which the present value of future cash flows equals the cost of the investment.

when the NPV of the cash flow is zero, the discount rate being used is the IRR.

When the IRR is greater than the required return, the investment is acceptable.

44
Q

Yield to Maturity - YTM

A

YTM: promised compounded rate of return an investor will recieve from a bond at the rate equal to the computed YTM.

Take into account both the market price of the bond as well as any capital gains or losses on the bond if held to maturity.

When calculating YTM, always use semiannual compounding(even n a zero coupon bond)

45
Q

Yield to call YTC

A

YTC: presumes that the bond will be redeemed by the issuer at the first call date in the indenture agreement.

Uses the same calculation as YTM except that the principal value at maturity is replaced the call price, and the maturity date is replaced by the first call date.

46
Q

Taxable Equivalent Yield TEY

A

To make the returns on municipal bonds comparable to those of taxable bonds, the TEY can be calculated.
Taxable equivalent yield = tax exempt yield / 1-tax bracket

or

Tax exempt yield = TEY x 1-tax bracket

47
Q

Principles of Duration

A

t = years to maturity (remember duration and maturity are positively related)
c= annual coupon (duration and coupon rate are inversely rated)
y= YTM, the current yield on comparative bonds (duration is inversely related)
remember coupon and yield are interest rates = INversely related.

48
Q

Zero Coupon Bond

A

duration equal to their maturities
no coupon interest yet produces phantom income
no reinvestment rate risk
sold at deep discounts to par
fluctuatemore than coupon bonds with same maturities

49
Q

using duration to manage bond portfolios

A

If interest rates are expected to rise, shorten duration UPS

if interest rates are expected to fall fallen = LEN = lengthen duration

50
Q

Conclusions to Fluctuation in Bond Prices

A

The smaller the coupon, the greater the relative price fluctuation

The longer the term to maturity, the greater the relative price fluctuation.

The lower the market interest rate, the greater the relative price fluctuation

51
Q

Dividend Discount Model

A

If the market lowers the required rat of return for a stock the value of the common stock will rise.
If investors expect that growth in dividends will be higher as a result of favorable development for the firm, the value of the common stock will rise.

The opposite (higher required rate of return or lower dividends) lowers the value of the common stock

52
Q

Return of Equity ROE

Dividend Payout Ratio

A

ROE = earning available for common (EPS) / Common equity (net worth or book value)

Dividend payout ratio = common dividends paid / earning available for common (EPS)

53
Q

Components for CML )

A

the expected return on a fully diversified portfolio
that a diversified portfolio should fall somewhere along the CML
it cannot be used to evaluate the performance of a singe security r a portfolio that lacks full diversification
Rf is the risk free return (100% tbills)

54
Q

Efficient Frontier

A

Efficient frontier provides an investor the highest return for any given level of risk or the lowest risk for any given level of return. Any point on the efficient frontier is efficient.

Inefficient (attainable) all dots (those below the efficient frontier) are feasible but are inefficient. They are not the efficient frontier.

Not feasible (unattainable) portfolios outside (above) the boundary (the efficient frontier) are not feasible because they cannot exist for any period of time under the model.

55
Q

Three types of Efficient Market Hypothesis

EMH

A

Strong form: asserts that stock prices fully reflect all information, public and private. Not even access to inside information can be expected in superior investment performance over time. no fundamental or technical analysis can produce superior results over time

Semi-strong form: no tech, fundamental, insider maybe produce superior results

Weak: no to tech and insider, Fundamental analysis may produce superior results.

56
Q

Active Investment Strategies

A

Fundamental analysis methods
Technical analysis methods
Tactical asset allocation

57
Q

Passive Investment Strategies

A 
buy and hold EMH
dollar cost averaging 
index investing 
strategic asset allocation (revise every few years) 
core-satellite
58
Q

current ratio

A

current ratio = current assets/current liabilities

current assets: cash equivalents marketable securities, accounts receivable, and inventory

Current liabilities: accounts payable, credit card debt and taxes payable. always use credit card debt even if the credit cards are paid off monthly. Only use taxes payable when the material indicates the taxes are due or the material actually says they are payable.

59
Q

Types of Indexes / Benchmarks

A 
dow jones = 30 stocks, price weighted 
s&p = value weighted
russell 2000 = smallest 2000
wilshire 5000 = activity & movement 
Nasdaq = broad measure of OTC trading - value weighted
EAFE - euro, Australia, Far East 
Lehman Brothers Aggregate bond: bond mkt
60
Q

Tax Basis of Mutual Fund

A

first in, first out method treats shares acquired first as being sold first

specific ID allows the investor to create gain, neutralize gain, or create a loss

ave cost method allows investor to divide the total cost of all shares held by the number of shares held

61
Q

Risk Adjusted Measure of performance

Sharpe

A

1st key = Look for R2 ( Less than 60 ) or NON DIVERSIFIED portfolio

2nd key = look for the highest SHARPE number

62
Q

Risk Adjusted Measure of Performance

Jensen (alpha) / Treynor

A

1st Key:
Look for a high R2 (60+) or DIVERSIFIED portfolio

2nd Key:
Look for highest positive alpha, If no alpha given, then look for the highest Treynor number

63
Q

Margin Maintenance Call

A

The formula for calculating when an investor will receive a margin call is the following:
1-initial margin % / 1-maint margin % multiplied by stock price

Short cut = 2/3 of price if minim main is 25%, if minim maint is 30%, take 2/3 and choose next highest number

64
Q

Hedging Strategies

straddles and combinations, collar, protective put)

A

straddle - buying a put and buying a call; the buyer does NOT own the stock
Collar: sell a call (out of the money) at one strike price and buys a put at a lower strike price; investor OWNS the stock

Protective put: buying a stock (or owning it already) and a put for the stock serving as insurance agains the decline in the underlying stock

65
Q

Arbitrage Pricing Theory APT

A

APT: Pricing of securities in different markets cannot differ for any significant lengthy of time.

Explains movement in security prices without making an assumption concerning risk preferences

Security returns are the result of arbitrage as investors seek to taker advantage of perceived differences in prices of risk exposure. Research suggests that 4 are preeminent.

unexpected inflation
unexpected changes in the level of industrial production
unanticipated shifts in risk premium
unanticipated changes in the structures of yields

66
Q

Black-Scholes

Options Valuation Model

A

Variables to value the option of a NON dividend paying stock

  • price of underlying stock
  • exercise price of the option
  • time remaining to the expiration of the option
  • interest rate
  • volatility of the underlying stock

an increase in the exercise price of a call decreases the calls value. However, an increase in the exercise price of a put increases the put’s value.

CFP (13 decks)

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