Investment Planning Flashcards
1
Q
This is the investment banker who agrees to lead the offering process for an IPO
A
originating house/lead underwriter
2
Q
Other securities firms that agree to assist with marketing the IPO
A
syndicates
3
Q
This underwriting agreement provides no guarantees from the investment bankers to the company going public - they will sell as many shares as possible
A
best efforts agreement
4
Q
In this underwriting agreement, investment bankers guarantee the company that the entire issue will be purchased. The investment bankers absorb the loss if they fail to sell the entire issue.
A
First commitment
5
Q
This is the right to increase the size of the offering
A
Green shoes
6
Q
This is a sale of securities to the public by insiders or other affiliated persons
A
Secondary offering
7
Q
Agents of sellers of securities who receive a commission for executing a transaction
A
brokers
8
Q
Principals who buy and sell securities for their own accounts
A
dealers
9
Q
This is the market for new issues
A
primary market
10
Q
This is the market for previously issued securities
A
secondary market
11
Q
The number of shares that are available for trading by investors
A
public float
12
Q
How many shares is in a round lot?
A
100
13
Q
An order to buy or sell at the current price
A
market order
14
Q
An order to buy or sell at a specific price
A
limit order
15
Q
An order that is good just for the day, if not executed, it expires at the end of the day
A
pay order
16
Q
an order that will remain in effect until either it is executed or canceled
A
good-til-canceled order
17
Q
An order to buy or sell if the price of a stock trades at or through a set price
A
Stop order
18
Q
When an investor borrows a stock and sells it on an exchange
A
short position
19
Q
Who sets the initial margin requirement?
A
The Fed
20
Q
What is the current initial margin requirement?
A
50%
21
Q
What is the margin call formula?
A
(1-initial margin %)/(1-maintenance margin %) x purchase price of stock
22
Q
How much does the FDIC insure per bank account?
A
$250,000 per owner
23
Q
These are short term debt issued by the U.S. government
A
Treasury bills
24
Q
These are unsecured short-term promisory notes issued by large corporations with maturities up to 270 days
A
Commercial paper
25
This money market instrument allows lenders and banks to negotiate terms. It involves amounts larger than $100,000.
Negotiable CDs
26
These are short term drafts guaranteed by a bank and used to finance international trade by guaranteeing payment to the exporter of goods
Bankers' acceptances
27
These are dollar denominated time deposits (6 months or less) made at foreign banks or at foreign branches of American banks
Eurodollar CDs
28
How is interest income taxed?
at ordinary income tax rates
29
How are qualified dividends taxed?
At long term capital gains rates
30
How long must a security be held to classify as long term?
More than 1 year
31
What is the maxium tax rate for collectibles?
28%
32
Gains and losses are netted with
Gains and losses of a similar type (ST or LT)
33
If a taxpayer has short term losses and long term gains
The losses are netted with the gain. If there is a net loss, up to $3,000 loss is allowed annually. If there is a net gain, it is taxed at long term rates.
34
If a taxpayer has short term gains and long term losses
The losses are netted with the gains. If there is a gain, it is taxed at the marginal tax rate. If there is a loss, up to $3,000 loss is allowed to be taken annually.
35
If a taxpayer has short term and long term gains
They are taxed separately at their respective rates
36
What is the medicare contribution tax
3.8% of the lesser of net investment income or the excess of the modified AGI over a specified threshold amount
37
When you sell a security at a loss and buy it back within 30 days of the sale, or purchase a security within 30 days prior to the sale, this is known as
wash sale
38
What is the penalty for a wash sale?
The loss is disallowed. It is added to the cost basis of the shares.
39
What are the three goals of the Fed and the U.S. Treasury?
1. Full employment
2. Stable prices (low inflation)
3. Economic growth
40
When prices are falling in absolute terms
deflation
41
During periods of deflation, investments should center on
very-high quality debt instruments
42
What are three tools the Fed has?
1. Setting reserve requirements of banks
2. Setting the federal funds rate and the discount rate
3. Buying and selling U.S. government securities in the open market
43
The rate at which banks borrow money from the Fed
discount rate
44
Rate at which banks can borrow from each other
federal funds rate
45
What actions mark expasionary policy for the Fed?
1. lower reserve requirement
2. lower discount rate
3. purchase government securities
46
What actions mark contractionary policy for the Fed?
1. Increase reserve requirement
2. increase discount rate
3. sell government securities
47
The diversifiable component of total risk
unsystematic risk
48
The risk associated with the nature of the business
business risk (unsystematic)
49
The possibility that a debt security will be called in by its issuer prior to maturity
call risk (unsystematic)
50
The risk that an enterprise's financial condition will deteriorate, resulting in a downgrading of its debt
credit risk (unsystematic)
51
The risk that an enterprise's financial conditions will deteriorate to the point where it will not meet its financial obligations
default risk (unsystematic)
52
The risk associated with the extent to which debt has been used to finance a company's operations
financial risk (unsystematic)
53
The risk that an investment does not have an active market within which to trade the investment
Marketability risk (unsystematic)
54
The degree of uncertainty associated with the time it takes to sell an investment with a minimum of capital loss from the current market price.
Liquidity risk (unsystematic)
55
The risk associated with actions and decisions of the investment manager that could adversely impact one's investment in the fund he or she is managing.
Investment manager risk (unsystematic)
56
The risk associated with the uncertainty of an adverse outcome due to the interpretation of tax laws and regulations
Tax risk (unsystematic)
57
The uncertainty caused by the possibility of adverse political events occurring in a country.
Political risk (unsystematic)
58
The nondiversifiable component of total risk (expressed as beta)
Systematic risk
59
The risk that future inflation will cause the purchasing power of cash flow from an investment to fall
purchasing power risk (systematic)
60
The risk that falling interest rates will cause the cash flow from an investment to fall when the principal or interest payments of that investment are reinvested at lower rates
Reinvestment risk (systematic)
61
The risk that a change in interest rates, especially rising rates, will cause the market value of a fixed-income security to fall
Interest rate risk (systematic)
62
The risk that changes in the overall market prices will cause changes in the market value of a specific security.
Market risk (systematic)
63
The risk that an appreciating home-country currency, compared to a foreign currency, will cause an investment in a foreign security denominated in the foreign currency to be worth less, in dollar terms, than what that investment would have been worth if the currency rates had remained stable
Exchange rate risk (systematic)
64
Risk from shocks that are generated and amplified within the financial system
Endogenous risk
65
The tendency of the returns of two assets over time to move in the same or in different directions
Covariance
66
The statistical measure of the strength of the relationship of the return of two assets
Correlation coefficient
67
The proportion of the total variation in returns of a security that is explained by the variation in returns of another security or of a benchmark index
Coefficient of determination
68
An investment's risk per unit of expected return
Coefficient of variation
69
A measure of systematic risk. It measures a stock's volatility.
Beta
70
This form of risk cannot be diversified away
Systematic
71
A well diversified portfolio can be formed by how many securities?
10 to 15
72
A well diversified portfolio can be achieved by how many mid to small cap stocks?
25 to 30
73
How many different mutual funds in different assets classes can create a diversified portfolio?
4 to 7
74
A distribution that has a hump to the left
positively skewed
75
A distribution that has a hump to the right
negatively skewed
76
Investment returns tend to be _______ skewed.
positively
77
A distribution that has a greater peak.
Leptokurtic
78
A distribution that has a lesser peak.
Platykurtic
79
This form of kurtosis has less variance.
Leptokurtic
80
This form of kurtosis has a wide variance in returns.
Platykurtic
81
Returns fall within one standard deviation of the mean ___% of the time.
68%
82
Returns fall withint two standard deviations of the mean ___% of the time.
95%
83
Returns fall within three standard deviations of the mean ___% of the time.
99%
84
Coefficient of variation equals
standard deviation / arithmetic mean
85
A statistical measure of the relative dispersion of data points around a mean.
Coefficient of variation
86
Is a higher or lower coefficient of variation better?
lower - less risk being taken to achieve the return
87
What is the problem with covariance?
It does not tell us magnitude
88
Correlation coefficient has a range between
-1 and 1
89
R represents the
correlation coefficient
90
A correlation coefficient of 1 means
the two assets have a perfectly positive relationship
91
A correlation coefficient of 0 means
the two assets have no relationship
92
A correlation coefficient of -1 means
the two assets have a perfectly negative relationship
93
Correlations tend to __________ in rising markets and ___________ in falling markets.
decrease, increase
94
A beta of 1.2 means that the assets has ____% of the volatility of the benchmark.
120%
95
In order for beta to be reliable, the stocks must have a coefficient of determination (R squared) of
70% or greater
96
market risk premium
return of the market - risk free rate
97
This provides an absolute measure of risk adjusted return
Jensen's Alpha
98
A graph showing the relationship between systematic risk and the required return for an investment for any given level of risk. Determined by CAPM.
Security Market Line (SML)
99
A graph showing the relationship between the total risk and return for a portfolio of securities in which risky securities are combined with a risk-free asset.
Capital Market Line (CML)
100
A graph that represents various combinations of securities plotted so that a maximum expected return is shown for each incremental risk level
Efficient frontier
101
The portfolio that maximizes an investor's expected return consistent with that investor's given level or risk
Optimal portfolio
102
What are the seven assumptions of Markowitz Portfolio Theory?
1. Investors are risk averse
2. Investors make investment decisions based on expected return and risk only
3. Investors have homogenous expectations
4. One-period time horizon
5. Free access to all relavent information
6. No transaction costs
7. Capital market is perfectly competitive
103
The optimal portfolio is located at the point where the investor's ______________ and the _______________ are tangent.
indifference curve, efficient frontier
104
What is the formula for the capital market line?
expected return of the portfolio = risk free return + standard deviation of the portfolio x ([market return - risk free return]/standard deviation of the market)
105
If interest rates increase the SML will
shift up
106
If inflation is expected, the SML will
shift left
107
If investors are risk averse, the SML
has a steeper slope
108
A multi-factor model that is an alternative to CAPM. Posits that four major factors affect a stock's return.
Arbitrage Pricing Theory
109
What are the four major factors that affect a stock's return under Arbitrage Pricing Theory?
1. Inflation
2. Industrial production (changes in GDP)
3. Risk premiums
4. Yield curves (interest rates)
110
The identification of an asset mix that will provide the optimal balance between expected risk and return for a long investment horizon.
Strategic Asset Allocation
111
Focus on sector and securities. Periodically revising the asset mix, moving funds from one category that appears to be overvalued to one that appears undervalued.
Tactical Asset Allocation
112
Divide a portfolio into a core holding of stocks and bonds and a satellite portion. The satellite portion is used to take advantage of opportunities that add return, diversification, and/or reduce risk.
Core/satellite Asset Allocation
113
Changes the asset mix as the market changes.
Dynamic Asset Allocation
114
The idea that security prices adjust rapidly to the arrival of new information, and current security prices reflect all information about the security.
Efficient Market Hypothesis
115
What are the assumptions of the efficient market hypothesis (6)?
1. Large number of competing participants
2. Information is readily available
3. Transaction costs are small
4. An investor cannot outperform or underperform the market
5. An investor can earn a return that is commensurate with the amount of risk assumed
6. Even if a security is mispriced, one cannot predict the direction of the error in an efficient capital market
116
The idea that successive price changes in a stock are independent.
Random walk
117
Investors should not be able to achieve above-average returns consistently using trading rules based on historical information. Fundamental analysis can help investors spot information errors and potentially find undervalued securities.
Weak form efficient market hypothesis
118
Trading rules based upon information after it becomes publicly available should not result in consistently above-average returns. Fundamental analysis is of no value. The only way to beat the market is inside information.
Semi-strong form of the efficient market hypothesis
119
Stock prices fully reflect all public and private information. No group of investors should be able to consistently achieve above average returns. There is no way to outperform the market.
Strong form of the efficient market hypothesis
120
The anomaly that stock prices are lower in December than in January (especially for small-cap stocks)
January Effect
121
The anomaly that stocks with high dividend rates tend to outperform stocks paying lower dividend rates
Dividend-yield anomaly
122
The anomaly that stock prices tend to peak in value on Friday and decline in value on Monday
Weekend effect
123
The anomaly that low P/E stocks outperform high P/E stocks
Low P/E
124
The anomaly that small-cap stocks outperform large-cap stocks
Size (small firm) effect
125
The anomaly that stocks with high book to market prices outperform stocks with low book to market prices
BV/MV effect
126
The anomaly that it is profitable to buy stocks with few analysts
Neglected firm effect
127
The anomaly that stocks rated 1 in Value Line ourpeform stocks rated 5
Value Line effect
128
The idea that investors hate to take losses and will generally prefer to avoid losses than to achieve gains
Loss aversion
129
Investors may choose to invest or not invest based on a fear of missing out or of losing money
Fear of regret
130
People tend to be over optimistic about the market and believe they are above average
Overconfidence (Optimism Bias)
131
Investors make judgements based on stereotypes. They become overly pessimistic about investments that have performed poorly in the past and overly optimistic about investments that have done well.
Representativeness
132
Investors attempting to determine the potential success of a new investment by comparing it to an already understood category or previously held investment
Based-rate neglect (a form of Representativeness)
133
An investor failing to accurately consider the sample size of the data used to make a judgement
Sample-size neglect (a form of Representativeness)
134
Investors are influenced by the way an idea is presented.
Framing
135
Investors search for and rely on information that supports their decisions.
Confirmation bias (Rationalization)
136
Discomfort experienced when newly acquired information conflicts with preexisting understandings.
Cognitive Dissonance
137
Individuals only register information that appears to affirm an already chosen decision
Self perception (a form of Cognitive Dissonance)
138
Rationalizing actions that enable a person to adhere to the original course
Selective decision making (a form of Cognitive Dissonance)
139
Investors, when looking back, see events that took place in the past as having been more predictable than they seemed before they happened
Hindsight bias
140
The tendency of investors to ascribe their success to talent or foresight, while blaming failures on others or outside influences
Self-Attribution Bias
141
The tendency to hold on to certain beliefs even when faced with new information that should alter those beliefs
Anchoring
142
The problem of putting too much weight on current events or data and not enough weight on past, historic trends
Recency
143
Treating one dollar different from another depending on where it comes from, where it is kept, and how it is spent
Mental Accounting
144
The misunderstanding people have in relating nominal rates or prices with real (inflation-adjusted) rates or prices
Money illusion
145
Giving more importance to data or information that is easy to obtain
Availability bias
146
People faced with a selection of choices tend to choose whatever option ratifies, confirms, or continues the existing situation
Status Quo Bias
147
The tendency to believe that one can control or influence outcomes, when this is not possible
Illusion of Control Bias
148
Individuals value an owned asset more than those that are not owned
Endowment Bias
149
The dividend payout ratio
the percent of earnings per share a company pays out in a dividend
150
The date the board of directors declares that a dividend will be paid and identifies the key dates
declaration date
151
The date the dividend is paid to shareholders
distribution date
152
The date the corporation closes its books and identifies who the shareholders are
Record date
153
How many days before the distribution date must an investor buy a security in order to receive the dividend on the distribution dates
two days
154
One business day before the record date. An investor who executes a trade on this day will not receive the dividend on the next distribution dats.
ex-dividend date (ex-date)
155
A dividend paid in the company's stock rather than cash
stock dividend
156
When management decides to lower the market price of the stock in order to encourage more investors to purchase shares of the company.
Stock split
157
How do you calculate the new stock price after a stock split?
divide original price by ratio of new stock to old
158
Converting a certain number of old shares into one new share.
Reverse split
159
Allow individuals to reinvest their cash dividend distributions into additional shares of the company's stock.
Dividend Reinvestment Plans (DRIPs)
160
A company repurchases some of its outstanding shares of stock
Stock repurchase
161
How is required return for a security calculated?
using CAPM
162
The value of the security that is computed using a discounted cash flow approach to valuation.
intrinsic value
163
An investor will want to buy a stock if the current market price is __________ its intrinsic value.
less than or equal to
164
If a company's P/E ratio is lower than either industry P/E or market P/E or both, it may be
undervalued
165
Stocks with price-to-sales ratio of less than ___ are generally undervalued
1.0
166
Stocks with price-to-sales ratio of greater than ___ may be overvalued
3.0
167
How is price-to-sales ratio computed
(Net sales/number of shares outstanding)/price per share
168
How is the growth-adjusted P/E ratio (PEG) calculated?
P/E ratio/earnings growth rate
169
A PEG ratio of less than ___ may identify an undervalued company
1.0
170
How is price-to-book ratio calculated?
(equity/number of shares outstanding)/book value
171
What is the zero growth model?
V = D zero/r
172
When is the zero growth model used?
with stocks whose dividend is fixed and will never grow
173
How do you calculate the dividend growth rate based on company earnings?
g = ROE x rr
ROE - return on equity
rr - retention rate
174
What are the four purposes of an investment policy statement?
1. Setting objectives
2. Defining the asset allocation policy
3. Establishing management procedures
4. Determining communication procedures
175
What should be included in an IPS?
1. Return requirments
2. Risk tolerance
3. Liquidity
4. Time Horizon
5. Laws and regulations
6. Taxes
176
Which ratios of risk adjusted performance assume a well diversified portfolio?
Treynor and Jensen (use beta which assumes diversification)
177
What is the order for using risk adjusted performance metrics?
```
Beta
Alpha
Treynor
Sharpe
BATS
```
178
Calculation for HPR that is not on the formula sheet
(S+I+P)/P
S-current price or sale price
P - purchase cost
I - income received during the holding period (subtract margin interest paid)
179
This form of weighting reflects the actual return to the client
dollar weighted
180
This form of weighting reflects the actual performance of the manager over a specified period of time
Time weighted
181
If NPV is greater than 0
The investment should be purchased
182
If NPV equals 0
the investment should be purchased
183
If NPV is less than 0
the investment should not be purchased
184
Considers things such as the past records of assets, earnings, sales, products, management, and markets of a company in order to predict a company's future success or failure
Fundamental analysis
185
Analyzes the price movement patterns of a company's securities
Technical analysis
186
How is return on equity ratio calculated?
(earnings after tax - preferred dividends)/(equity - preferred stock)
187
Bonds that are backed by a legal claim to some specific property of the issuer in case of default
Secured (senior) bonds
188
Bonds that are backed by the general credit of the issuer
Unsecured bonds (debentures)
189
A type of bond that may be exchanged for the company's common stock under certain conditions
Convertible bonds
190
Bond that pay interest only if and when it is earned. They can omit interest payments and not be in default.
Income bonds
191
How does maturity affect a bond's volatility?
Usually, the longer the term, the greater the volatility
192
This type of bond has no reinvestment risk
zero-coupon bond
193
This type of bond has greater interest rate risk than similar grade and maturity bonds
zero-coupon bond
194
What bonds are considered investment grade?
Those with a rating of BBB (Baa) or better
195
When will an issuer call a bond?
If interest rates decline enough
196
What are the main risks associated with bond investing?
```
Default risk
Reinvestment risk
Interest rate risk
Purchasing power risk
DRIP
```
197
These are federal debts with maturities over 1 year and up to 10 years?
Treasury notes
198
These are federal debts with maturities over 10 years?
Treasury bonds
199
These are federal debts that offer a rate of return that increases with inflation?
Treasury Inflation-Protected Securities (TIPS)
200
How are TIPS calculated?
The coupon rate stays the same, but it is paid on principal which is adjusted for inflation
201
What is the annual limit on purchases of Savings Bonds per social security number?
$10,000
202
Gurantees mortgages that are issued by the FHA, VA, or the Rural House Service. It is an obligation of the U.S. government.
Ginnie Mae
203
Guarantees the principal and interest on mortgage participation certificates on conventional residential and multifamily properties.
Freddie Mac (FHLMC)
204
Guarantees principal and interest on securities backed by pools of conventional mortgages.
Fannie Mae (FNMA)
205
The risk that interest rates fall and prepayments risk
Prepayment risk
206
Unsecured bonds backed by the full faith and credit of the issuer and its taxing power
General obligation bonds
207
Municipal bonds serviced by specific revenue producing projects
Revenue bonds (private activity bonds)
208
Which municipal bonds have interest that is subject to AMT?
private activity bonds
209
The yield that a fully taxable security must earn in order to provide the same promised return as a tax-exempt security
taxable equivalent yield
210
Corporate bonds that are collateralized by a first mortgage lien on some of or all of a firm's property.
mortgage bond
211
A corporate bond that is secured by financial assets, such as stocks, bonds, or notes.
collateral trust bonds
212
Corporate bonds that are issued by transportation companies and are secured by the equipment that is purchased with the debt issue's proceeds.
equipment trust certificates
213
How are zero coupon bonds taxed?
taxes must be paid on implied interest
214
These bonds correlate more closely with common stocks than other bonds
high-yield bonds
215
Bonds denominated in a currency not native to the country where they are issued
Eurobonds
216
Bonds issued by foreign banks, corporations, or governments, but sold in the U.S. and denominated in U.S. dollars
Yankee bonds
217
Bonds sold outside of the U.S. by overseas companies, but denominated in U.S. dollars and underwritten by a non-U.S. bond syndicate
Eurodollar bonds
218
What risks is preferred stock subject to?
interest rate risk, business risk, default risk
219
This rule allows corporations holding stock of domestic companies to exclude from income 50% of dividend income they receive from other corporations (if they own less than 20% of the investee).
Dividend exclusion rule
220
Are the dividends of preferred stock tax deductible?
No
221
What direction does a positive yield curve slope?
upwards to the right
222
What direction does a negative (inverted) yield curve slope?
downwards to the right
223
When is an inverted yield curve likely to be seen?
When inflation is high and the Fed increases short term interest rates to combat it
224
The idea that current long term interest rates contain an implicit prediction of future short term interest rates.
Unbiased Expectations Theory
225
The idea that long term interest rates should be higher than a combination of short term rates because of the extra risk involved in holding longer maturities.
Liquidity Preference Theory
226
The idea that asset/liability management constraints contribute to the rate structure.
Market Segmentation Theory
227
When an imbalance in supply and demand exists within a given market maturity, lenders and borrowers could be induced to shift to maturities that are less preferred as long as they are compensated for taking on additional risk.
Preferred Habitat Theory
228
How should income investors invest with a flat yield curve?
Only buy long term bonds if they are highly confident that interest rates will fall in near future.
229
How can income investors take advantage of an inverted yield curve?
Buy high yield bonds that also have tremendous price appreciation potential. When interest rates return to normal, long term rates will fall less than short term. Long term bonds will appreciate more in price than short term and higher rates are locked in.
230
How can income investors take advantage of a steeply sloped yield curve?
They may be able to generate a higher coupon rate in return for willingness to invest for 3-4 more years.
231
How can speculators take advantage of a steeply sloped yield curve?
Speculators can get significant capital gains if the steep slope returns to a normal slope.
232
How is current yield on a bond calculated?
annual coupon rate/current price
233
How is yield to maturity on a bond calculated?
sum of the current yield and the appreciation or depreciation the bond will experience between the current date and its maturity date
234
How is Tax Equivalent Yield calculated for bonds free from federal income tax but subject to state income tax?
tax-free yield/(1-marginal tax bracket)
235
How is Tax Equivalent Yield calculated for bonds free from both federal and state income tax?
tax-free equivalent yield/[(1-SMTB)(1-FMTB)]
236
What is the relationship between current yield, yield to maturity, and yield to call for bonds trading at par?
They are equal
237
What is the relationship between current yield, yield to maturity, and yield to call for bonds trading at a premium?
current yield > yield to maturity > yield to call
238
What is the relationship between current yield, yield to maturity, and yield to call for bonds trading at a discount?
current yield < yield to maturity < yield to call
239
This enables us to compare the interest rate risk of bonds with different coupon rates and maturities.
Duration
240
How does duration affect interest rate risk?
The longer a bond investment's duration, the more sensitive the investment is to changes in interest rates.
241
If a bond fund has a duration of 15.3, how will it be affect by a 1% drop in interest rates?
It will increase 15.3%
242
Bonds with higher coupon rates have ______ durations.
lower
243
Duration of a zero coupon bond is equal to
its maturity
244
All other factors equal, an increase in interest rates _________ duration.
decreases
245
All other factors equal, an increase in maturity _________ duration.
increases
246
A bond that declines more in value than duration alone would explain in a rising interest rate environment and will not rise as much as expected in a declining interest rate environment is exhibiting
negative convexity
247
What are examples of bonds with negative convexity?
callable bonds and mortgage backed bonds
248
A bond's unsystematic risk is reflected in its
credit rating
249
When interest rates rise, the spread between high and low quality debt
widens
250
Bonds with lower credit ratings have higher ________ to compensate for the greater risk.
coupon rates
251
These bonds are best for those with low capacity for volatility.
short to intermediate term bonds
252
These bonds are best for those with high capacity for volatility.
long-term bonds, zero-coupon bonds, and high-yield bonds when confident about lower interest rates in the near future
253
When an investor has a specific goal at the end of a known time horizon, he may implement this strategy of matching the duration of the bond or bond portfolio to the time horizon of a cash need. This offsets interest rate risk and reinvestment risk.
Immunization
254
In order to practice immunization in a bond portfolio, individuals must use
zero-coupon bonds
255
Bonds with maturities spread out over the time horizon are used.
Bond ladder
256
The amount to be invested in bonds is divided beween short-term issues and long-term issues.
Bond barbell
257
Maturities are concentrated in intermediate-term maturity relative to shorter or longer maturities.
Bond bullet portfolio
258
Swapping out of a lower-yield bond into a higher-yielding bond.
Pure yield pick-up swap
259
Swapping two bonds that are essentially the same as far as maturity, quality, call features, and coupon when one bond is mispriced.
Substitution swap
260
A bond swap that takes advantage of a perceived mispricing between two sectors of the market.
Intermarket spread swap
261
Swapping bonds based on an investor's opinion on the direction of interest rates.
Rate anticipation swap
262
An investor sells a bond for a capital loss, then purchases a bond with very similar characteristics from another user.
Tax swap
263
Which types of debt instruments are best for stability of income?
1. Treasury bills
2. money market funds
3. AAA rated issues
264
Which types of debt instruments are best for capital gains?
1. zero-coupon bonds
2. high yield bond funds
3. funds with longer duration
265
Which types of debt instruments are best for investor in higher tax brackets?
1. tax-free bonds
266
Which types of debt instruments are best for those concerned about default risk?
1. Treasury securities
267
Which types of debt instruments are best for those who want a current yield higher than Treasury bills, notes, or bonds but still want a high level of security?
US agency bonds
268
Which types of debt instruments are best for those who want a specific amount of money in the future?
zero coupon Treasury bond
269
These are bonds issued locally by a domestic borrower and denominated in the local currency.
domestic bonds
270
These are bonds issued in a local market by a foreign issuer and denominated in the local currency.
international bonds
271
When should aggressive investors choose bonds with a low duration?
When they expect interest rates to rise
272
How is the conversion value (CV) for a convertible bond calculated?
CV = (face value of the bond/conversion price) x current market price of the underlying stock
273
What is the conversion ratio?
the number of share of stock into which a bond can be converted
274
How is the converstion ratio calculated?
face value of the bond/conversion price
275
The amount over the investment value (intrinsic value) that an investor pays for a convertible bond.
Investment premium
276
The difference between the market price of the convertible bond and the conversion value.
Conversion premium
277
An investor will not convert a convertible bond until the _________ exceeds the _________.
conversion value; investment value
278
What is a way to calculate duration that is not on the formula sheet?
(price decrease - price increase)/(2(current price)(0.01))
279
An investment instruments that gets its value from an underlying investment product
derivative
280
The right, but not the obligation, to buy or sell a stock at a specified price within a specified period of time
option
281
The last date on which the option can be exercise.
Expiration date
282
The price at which the stock can the purchased or sold if the option is exercised
Exercise price (strike price)
283
The market price of the option
premium
284
The amount that the option is "in the money"
Intrinsic value
285
The amount by which the market price of the option exceeds its intrinsic value
Time premium (time value)
286
When the underlying stock of a call option is selling above the exercise price, or when the underlying stock of a put option is selling below the exercise price.
In the money
287
When the underlying stock is trading at the exercise price.
At the money
288
When the underlying price of a call option is selling below the exercise price, or when the underlying stock of a put option is selling above the exercise price
Out of the money
289
Long-term options that may not expire for several years.
LEAPS - long-term equity anticipation securities
290
If you anticipate the price of stock will go up you should purchase a _____ option.
Call
291
If you anticipate the price of a stock will go down, you should purchase a _____ option.
Put
292
This occurs when an investors writes a call option for stocks they already own.
covered call
293
In order to hedge your portfolio with options, you must take a position in options that is _______ your portfolio.
opposite
294
What is the intrinsic value of an option that is at or out of the money?
zero
295
For a long call option, the profit potential is _______ and the loss potential is _______.
unlimited; limited
296
For a short call option, the profit potential is _______ and the loss potential is _______.
limited, unlimited
297
For a long put option, the profit potential is _______ and the loss potential is _______.
substantial; limited
298
For a short put option, the profit potential is _______ and the loss potential is _______.
limited; substantial
299
A call written when the investor does not own the underlying stock.
naked call
300
A put written when the investor has no position in the underlying stock.
naked put
301
To make profitable trades when buying or selling a put or a call, the investor must be right about three things
1. The direction of the stock's future price movement
2. The specific price
3. The time period
302
A speculative strategy invests with a limited time frame where the maximum loss is the cost of the option.
Purchase a call or put
303
A conservative strategy that keeps the premium but gives up upside potential.
Covered call writing
304
An extremely risky strategy, in which the loss increase as the stock price rises
Naked call writing
305
A moderately conservative strategy in which put options are written on stocks you wouldn't mind owning.
Naked put writing
306
A more aggressive strategy in which you are short a stock and write a put.
Covered put writing
307
A strategy where you own stocks and want to protect the stock or portfolio from downturn by purchasing a put
Protective put
308
Combining a put and a call on the same stock with the same expiration and exercise price. It is betting on a large price movement, but uncertain of the direction).
Straddle
309
Combining into one transaction two or more options with different strike prices and/or expiration dates (looking for a change in the differential between the contracts)
Spread
310
A company creates an option to buy its stock at a specified price within a specified period of time
warrants
311
A contract that provides for the future exchange of an asset in the future at a specified delivery date for a specified payment amount
Futures
312
The initial margin requirement for a futures contract
Good faith deposit (performance bond)
313
If equity falls below this amount, then the investor must deposit enough funds into the account immediately in order to bring the account back to at least the initial margin requirement amount.
Maintenance margin
314
The current price of an asset in the cash market if you were buying a commodity right now
spot price
315
Price of a contract for future delivery
future price
316
When an investor purchases a contract for future delivery
long position
317
When an investor sells a contract for future delivery
short position
318
A daily settlement process whereby any increase or decrease in account equity is adjusted for daily changes in the price of the underlying asset
marked-to-market
319
Real assets usually have a ______ correlation with financial assets.
low or negative
320
What affect do high interest rates have on gold prices?
they depress them
321
A REIT must invest ____% of total assets in real estate and derive at least ___% of gross income from rents.
75; 75
322
Earnings from a REIT are taxed as
ordinary income
323
This form of REIT owns real estate property
equity REIT
324
This form of REIT invests in mortgages, not properties
Mortgage REIT
325
How does a weak U.S. dollar affect the returns of foreign securities?
It increases them
326
This is the default method for taxing mutual funds
FIFO
327
This type of mutual fund may trade at a premium or a discount to NAV
closed-end fund
328
This type of mutual fund invests overseas and in the U.S.
Global
329
A passive investment with a fixed portfolio
Unit Investment Trust (UIT)
330
A bond will a smaller coupon will have _______ relative price fluctuation.
greater
331
A bond will a smaller coupon will have _______ reinvestment risk.
lower
332
The lower the interest rate, the _______ the relative price fluctuation.
greater
333
The longer the term to maturity, the _______ the relative price fluctuation.
greater
334
How will higher inflation affect bond values?
They will fall
| higher inflation = higher interest rates = lower bond values
335
How will higher coupon rates affect a bond's interest rate risk?
It will be lower
| higher coupon rates = lower duration = lower interest rate risk
336
As interest rates decrease, duration _______
increases
337
If R squared is low, what is the relavent measure to use when comparing securities.
Standard deviation
338
Buying a call and selling a put are both _______ strategies.
bullish
339
Buying a put and selling a call are both _______ strategies.
bearish
340
An investor who expects a large price fluctuation, either up or down, should _______ a call or put, respectively.
buy
341
An investor who expects a small price fluctuation, either up or down, should _______ a put or call, respectively.
sell
342
Buying a put and selling a call
collar
343
These allow for the trading of international securities in domestic countries. Their dividends are declared in local currencies and paid in U.S. dollars.
American Depository Receipts (ADR)
344
What tax benefits to ADR holders receive?
foreign tax credits for income tax paid to a foreign country
345
A disguised dividend such as a below-market shareholder loan.
constructive dividend
346
A payment to shareholders that exceeds the company's retained earnings.
Liquidating dividend
