Brainscape's Knowledge GenomeTM

Browse over 1 million classes created by top students, professors, publishers, and experts.


See full index

Investments > Investments 1 > Flashcards

Investments 1 Flashcards

1
Q

Describe:

  1. A limit order
  2. A stop order
  3. A stop loss order
A
  1. A limit order limits your selling (or buying) once the market hits a certain price.
  2. A stop order becomes a market order once a certain price is reached. This means that the actual price of the trade may be different than the stock price.
  3. A stop-loss order has both features.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

What is the difference between an initial and a maintenance margin?

What is the assumed initial margin on the CFP exam?

A

It’s obvious if you think about it.

50%.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

What is the margin position?

At what price does an investor receive a margin call?

A

The margin position is how much equity the investor currently has.

Margin position = Share price - loan per share.

Margin call price = loan ÷ (1 - maintenance margin)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

Calculate how much an investor must contribute in response to a margin call.

A
  1. Assume he must contribute enough to restore the maintenance margin (MM).
  2. Calculate the req’d equity (stock price x MM).
  3. Calculate the actual equity: stock price - debt. Note: All calculations are per share. Debt = Original price x (1 - initial margin).
  4. Subtract 3 from 2.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

What are Value Line and Morningstar?

A

Stock rating companies.

Value Line ranks mostly stocks, while Morningstar ranks mostly mutual funds.

A rank of 1 for Value Line is high and means buy.

A rank of five for MorningStar is high and means buy.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

Explain ex dividend date and date of record.

A

The ex dividend date is one day before the date of record. To receive the dividend, an investor must purchase the stock prior to the ex dividend date, or two days before the date of record. Conversely, an investor can sell the stock on the ex dividend date and receive the dividend.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

What are stock dividends?

A

Dividends paid in stock. Not taxable to the investor until the stock is sold.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

What is the securities act of 1933? What is the securities act of 1934?

A

1933 - Regulates primary markets. Requires prospectus for new issues.

1934 - Regulates secondary markets. Created the SEC to enforce compliance with security regulations and laws.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

What is the investment company act of 1940?

What is the investment advisors act of 1940?

A
  1. Allowed the SEC to regulate investment companies.

2. Required investment advisors to register with the SEC or their state.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

What is the securities investors protection act of 1970?

What is the insider trading and securities fraud enforcement act of 1988?

A
  1. Established the SPIC to protect investors from losses from investment firms going bankrupt. Applies to domestic and foreign investors.
  2. Defines an insider as someone with information not available to the public. Prohibits such persons from trading on that information.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

What are:

  • commercial paper
  • bankers’ acceptances
  • Eurodollars
A

Commercial paper is ST loans between companies

Bankers’ Acceptances are used to facilitate imports and exports.

Eurodollars are accounts in foreign banks denominated in dollars.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

What are the Russell 2000, and the Wilshire 5000?

A

Russell 2000 is an index of the smallest stocks.

Wilshire 5000 is the broadest stock index.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

What are the 5 tenets of Behavioral Finance?

A
  1. Investors are people—sometimes they commit cognitive errors or are misled by emotion.
  2. Markets are not efficient.
  3. The behavioral portfolio theory governs: investors use “mental accounting” to compartmentalize their portfolio rather than seeing it as a whole.
  4. Risk alone does not determine returns—market cap, investors’ likes or dislikes about the company, social responsibility, stock momentum, etc. also have influence.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

What are the standard deviation %’s?

A

68, 95, 99.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

How do you answer ‘which of the two assets is riskier’?

How do you compute standard deviations?

A

The asset w/ the higher St. Dev. Is riskier.

Press the SD key after each year’s return (being sure to +/- the negative ones), then OS 8

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

What are leptokurtic and Platykurtic?

A

Lepto is tight distribution around the mean.

Platy is low peak.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
17
Q
  1. What is ‘mean variance optimization’?

2. What is a Monte Carlo Simulation?

A
  1. Adding risky securities to a portfolio, but keeping the expected return the same.
  2. A probabilistic distribution of results based on varying model assumptions.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
18
Q

What do Β and StD measure?

What is the B of the market

How do you compute B

A

Β measures volatility compared to that of the market. It measures systematic risk. The Β of the market as a whole is 1. Β may be calculated by dividing one security’s risk premium by the market’s risk premium (ie, if a stock returns 20%, and the market returns 10%, then the B of the stock is 2.).

B is used to measure the risk of a diversified portfolio.

St. Dev. Measures total risk. It is used to measure the risk of a non-diversified portfolio.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
19
Q

Discuss R-Squared, and how it determines what risk measure to use.

A

R-squared is the square of the correlation coefficient. When it is greater than .7, use B to measure risk. When it is less, use St. Dev.

R-squared also tells you what % of a stock’s return is due to the market.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
20
Q

How do you estimate risk in a two asset portfolio?

A
  1. Use the formula with a long square root provided on the sheet.

Or

  1. Compute the weighted average, and take a number lower than the weighted avg. to compensate for correlation.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
21
Q

What are the 5 systemic risks?

Hint: PRIME

A 
Purchasing power
Reinvestment rate
Interest rate
Market
Exchange rate
22
Q

What are the 6 non-systemic risks?

Hint: ABCEDFG

A 
Accounting - Audit firm too closely tied to management (false audit).
Business
Country
Default
Executive
Financial - amt. of leverage
Govt & Regulation
23
Q

Describe the efficient frontier.

A

The EF exists on a graph between return and risk that shows the highest level of return for a given level of risk.

Portfolios beyond the EF are considered unattainable. Ones below it are inefficient.

24
Q

What are the 3 inputs to the modern portfolio theory developed by Markowitz?

A

Risk, return, and covariance (how assets move relative to one another—they don’t need to be negatively correlated, just not perfectly correlated).

25
Q

What is the optimal portfolio (theoretically)?

A

Where a given investor’s indifference curve between risk and return tangents the efficient frontier.

26
Q

What is the Capital Asset Pricing Model?

What is the market risk premium?

A

It calculates the relationship of risk and return for an individual asset using Β to measure risk.

It’s inputs are used to construct the SML.

It’s provided on the formula sheet. (Rm - Rf) in the formula is the market risk premium—the reward for investing in the market rather than in a risk free asset.

27
Q

What is the Capital Market Line?

A

It’s an efficient frontier that includes a risk free rate of return. It measures portfolios, not single investments. It uses St. D. To measure risk. The formula is no longer provided on the CFP list.

The CML graphs return against St. Dev. Returns beyond it are unattainable, ones within it are inefficient. The efficient portfolio is where the EF tangents the CML. Before that, the investor is said to be lending at the risk free rate of return, beyond he’s borrowing.

28
Q

Discuss the SML.

A

The SML plots the results of calculations from the CAPM. It intersects the y-axis at the risk free rate of return.

Like the CAPM, the SML uses Β for risk; the CML uses st. Dev. Portfolios, or stocks, above the SML are undervalued, and should be purchased. Ones below it are overvalued, and should be sold.

29
Q

The Information Ratio

A
  • Relative risk-adjusted performance measure.
  • The denominator is “tracking error” or the Std. Dev. Of the difference between portfolio return and market return.
  • Measures performance of a fund manager relative to an index, thus can be positive or negative.
  • Provided formula.
30
Q

The Sharpe Ratio (5).

A
  • Sharpe is identical to Treynor but uses St. Dev instead of Β.
  • Measures relative, risk adjusted return; the higher the better.
  • Very similar to Treynor for diversified portfolios.
  • Ranks one manager, or one portfolio against another, but not against the market.
  • Use for not-well-diversified funds or portfolios because it includes a broader array of risks (unsystematic ones).
31
Q

The Treynor Ratio (4)

A
  • Is a relative, risk adjusted performance measure; it only makes sense when compared to the Treynor of something else.
  • Measures how much return was achieved per unit of systemic risk. The higher the better. Measures systemic risk, so uses Β.
  • Justifies use of B because it’s a portfolio measure; in a well-diversified portfolio, non-systemic risk is near zero.
  • Does not say if an adviser out-performed the market.
32
Q

When do you choose Sharpe, Treynor, or Alpha?

A

It depends on r-squared, which measures the diversity of the portfolio.

When r-squared ≥ .70, use Treynor and Alpha because the portfolio is well-diversified and B is therefore a viable measure of risk.

When r-squared < .7 use Sharpe to incorporate the unsystemic risks that were not diversified away.

If the exam doesn’t give you r-squared, use Sharpe.

33
Q

How do you calculate holding period return?

What are exam tricks to make holding period return more difficult?

A
  • (Selling price - purchase price +/- any cash flows) ÷ purchase price or equity invested.

Exam tricks:

  • Dividends rec’d or margin interest paid: add or subtract from numerator.
  • Taxes paid, include only if question asks for after tax return.
  • Margin securities—include only your equity in the denominator. Adjust all cash flows in the numerator.
34
Q

What is the effective annual interest rate (EAR)?

What does it calculate

A

EAR = (1+i/n) to the nth power.

Calculates annual interest rate on an investment that compounds more than annually.

You can also do a TVM problem with $100 as the PV.

35
Q

What is the geometric mean?

How do you calculate it on the 10b11+?

A

Geometric mean is the compounded rate of return.

To calculate:

  1. Multiply the fractions of 1 that each return represents (ie, 5% = 1.05, -2% = .98, does 0 = 1?)
  2. OS, y to the x, enter number of periods, OS, 1/X, =
  3. -1 X 100
36
Q

How do you compute a weighted average, say of Β?

A 
Make a chart like the one on p. 56-57.
Col. 1 name of each security.
Col. 2. Amt held in that security.
Col. 3. Amt of total portfolio
Col. 4. Β of that security.
Divide column 2 by column 3, multiply by column 4. Add everything in column 4 together.
37
Q

Describe IRR

How do you calculate it?

How does it compare to the discount rate?

A
  • A compounded rate of return for uneven cash flows.
  • The rate that sets NPV = to 0.
  • Calculate the same way as NPV, but hit OS IRR at the end instead of NPV.
  • When NPV is positive, IRR is higher than the discount rate.
  • When NPV is negative, it’s less.
  • When NPV is zero, IRR = discount rate.
38
Q

Explain dollar-weighted vs time-weighted return?

Who uses time-weighted return?

A

DW return calculates IRR using the investor’s cash flows.

TW return calculates IRR using the security’s cash flow.

Mutual funds use TW because it typically looks better.

39
Q

What is Arbitrage Pricing Theory?

A
  • APT is a multi-factor model that attempts to explain returns based on “factors”, such as inflation, risk premium, and expected returns, and the sensitivity of investments to those factors. When a factor has a value of 0 it has no impact on returns. It doesn’t concern itself with B or STD.
  • It attempts to exploit price imbalances.
40
Q

How do you do foreign currency translation problems?

A
  1. Convert the dollars to the foreign currency.
  2. Compute the return, typically holding period.
  3. Convert the currency back to dollars.
41
Q

Who insures municipal bonds?

2

A

American Municipal Bond Assurance Corp (MBIA)

Municipal Bond Insurance Association Corp (MBIA)

42
Q

What is annual yield?

What is annual appreciation?

A

Annual income ÷ purchase price

End of year value ÷ purchase price.

43
Q

4 things that are true about OID bonds?

A
  1. The bond basis increases at a set rate each year.
  2. The difference between the maturity value and the original issue discount price is known as the OID.
  3. The bond’s earnings are treated as exempt interest income.
  4. The bond was issued at a discount to its par value.
44
Q

How do you protect against a market downturn?

A

Buy a put.

If no other option, you can buy an index put, if you don’t want to sell your own shares.

45
Q

What is the relationship between the standard deviation of a portfolio’s returns and the weighted average of the standard deviation of the returns of the portfolio’s components?

A

The StD of a portfolio will = that of its components when the correlation is 1.

When the correlation is less than 1, the St D of portfolio returns will be less than the weighted average of the ST D of the returns of its components.

46
Q

According to fundamental analysis, what is the value of a share of common stock?

A

the discounted value of its future cash flows.

47
Q

Are unit investment trust shares traded?

A

I think not.

48
Q

If the market risk premium were to increase, what would happen to the value of common stock?

A

Value would decrease to compensate investors for the additional risk they are taking in buying the stock.

49
Q

When is selling a call better than buying a put to protect against market decline?

A

When the strike price is above what you’re currently holding. When that’s the case you’d essentially have to take an intrinsic value loss to buy the put.

50
Q

What is the potential trap for TEY questions?

A

Clients over a certain income amount are subject to the Medicare tax of 3.8% on investment income.

51
Q

What bonds have the greatest reinvestment risk? The greatest interest rate risk?

A

The greatest coupon rate = the greatest reinvestment risk.

The greatest duration = the greatest interest rate risk.

52
Q

Are open-end investment companies traded on the secondary market? Are they passively managed?

A

No and no. Shares are purchased and redeemed directly with the fund family.

Investments (9 decks)

Brainscape helps you reach your goals faster, through stronger study habits.
© 2024 Bold Learning Solutions. Terms and Conditions