Investment Planning Flashcards
What is the difference between a 10k/10Q and an annual report?
10K: annual financial report as required by the SEC
10Q: quarterly unaudited financials
Annual Report: Contains a message from the CoB on the progress in the past year and outlook for the coming year.
What is the difference between liquidity and marketablility?
Liquidity: how quickly something can be turned into cash
Marketability: Ready-made market for something
What are the types of orders?
Market: When time is appropriate (when frequently traded)
Limit: When price is appropriate (when not frequently traded)
Stop Order: When price hits a certain price, it becomes a market order
Stop Limit or Stop-Loss: When (1) price target is hit, becomes a limit and then (2) when the limit price is reached, it becomes a Market.
What are the characteristics of Margin?
The initial margin is how much the investor must contribute.
Reg T set the initial margin at 50% and was established by Fed Reserve
Assuming a stock was acquired on margin, when must an investor contribute more cash and how is it determined?
Required Equity - Actual Equity = Amount required to contribute?
Required = Stock Price * Maintenance Margin
Actual = Stock Price - Debt
Assuming a stock was acquired on margin, at what price would the investor be required to contribute additional cash?
This is the Margin Call Formula. It is used to determine when an investor must add to his margin position.
Margin Call = Loan amount per share/(1 - Maint. Margin)
What is the ex-dividend date?
The date the stock trades without a dividend. Must own the stock by this date in order to be registered and entitled to the dividend.
What is the date of record?
The date on which one must be a registered shareholder.
Date of Record minus 2 days in order to be entitled to a dividend.
What must one know in order to understand a client’s risk tolerance?
The Investment Policy Statement establishes RR TTLLU
Return, Risk, Taxes, Time-Line, Liquidity, Legal, Unique circumstances of the client.
For purposes of the margin requirement, what is the formula for a loan?
Loan = Price * (1 - initial margin requirement)
How do the stock split and the stock dividend impact a shareholder without bringing any changes in the value to the company?
The value of the stock split and the value of the stock dividend increase the number of shares but not the total value of those shares
How does the DIJA differ from the other indexes?
DIJA is priced based whereas the others are value based.
When considering standard deviation, what do the numbers 68, 95 and 99 represent?
68%: 1 standard deviation
95%: 2 standard deviations
99%: 3 standard deviations
What do the standard deviations help with?
What is the probability of achieving a result of x%?
100 - total for standard (68% for 1 sd) = difference
Difference/2 = probability
A higher standard deviation will mean the stock is more risky. If asked which stock is more risky, select the one with the highest standard deviation.
What is the coefficient of variation and how is it used?
CV = Standard Deviation / Average Return
Used to measure risk of two or more stocks with different average returns.
What is a Monte Carlo Simulation?
A spreadsheet simulation that gives a probabilistic distribution of events occurring.
What does covariance measure?
Measures two securities combined and their interactive risk.
Measures relative risk.
SD of Asset A * SD of Asset B * Correlation Coefficient
What does correlation measure?
Movement of one security against another.
Covariance/[(SD of A)*(SD of B)]
Diversification can occur at less than 1 and is most diversified at -1
What does beta measure?
The volatility of a single security against the whole market.
The greater the beta, the more risk
Return of stock / Return of market
It is the measure of risk of a diversified portfolio.
What is R-Squared?
It is the square of correlation coefficient.
A higher R-Squared means most of the return is coming from the market thereby meaning less systemic risk.
If greater than 0.7, then a good measure…if less than that, use standard deviation.
What do we look for in R-Squared when measuring a client’s portfolio?
The highest Beta.
What is portfolio risk?
A measure of risk measured through determination of the interactivity of the standard deviation and covariance of security in the portfolio?
Weighted Average Approach: Deviation*Weight for each security then pick the choice that is less than this.
What is Systemic Risk and what are they?
The lowest level of risk one could expect in a fully diversified portfolio. It is inherent in the system:
Not diversifiable
PRIME:
Purchasing Power Reinvestment Rate of Return Interest Rate Risk Market Risk Exchange Rate Risk
What is Unsystemic Risk and what are they?
The risk that exists in a specific firm or investment.
Diversifiable
ABCDEFG
Accounting Risk Business Risk Country Risk Default Risk Executive Risk Financial Risk Government Risk
What is the efficient frontier?
Represents the most efficient portfolios in terms of risk and reward.
High Return Low Risk
Low Risk High Return
What is one way to describe an optimal portfolio for a client?
Where the client’s Indifference Curve is tangent to the Efficient Portfolio.
How is the expected rate of return calculated? What is the CAPM model?
Required Rate of Return =
Risk Free Rate + (Market Risk Premium) * Beta
Market Risk Premium = Return of Market - Risk Free Rate
What is the Security Market Line?
The relationship between risk and return as defined by CAPM and graphically plotted results in the SML.
What is the information ratio? (it is one portfolio performance measure)
A relative risk-adjusted performance measure
(Portfolio’s actual return - Return of the benchmark)/tracking error on active return
What should one keep in mind when considering the Traynor Index and the Sharpe Index? (both used as portfolio measures)
Traynor is for diversified portfolios so uses Beta
Sharpe is for nondiversified portfolios so use Standard Deviation.
If given standard deviation, R squared, Alpha and Sharpe, how best to evaluate?
If R-Squared over 70, then pick the one the with highest alpha (for well diversified portfolios).
If R-Squared under 70, then pick the one with the highest Sharpe
If correlation is .8, which is the best measure?
.8^2 = .64. Because this is less than .7, this is a sign of a undiversified portfolio, we must use Sharpe as it is a measure of standard deviation.
