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Comprehensive > Investments > Flashcards

Investments Flashcards

1
Q

systematic risk

what is it and what types are there

A
  • influences that cannot be diversified away (i.e., impacts all companies at the same time; not necessarily to the same degree)
  • measured by beta
  • Types: PRIME
    • purchasing power
    • reinvestment risk
    • interest rate
    • market risk
    • exchange rate
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2
Q

unsystematic risk

what is it and what types are there

A
  • may affect all businesses but not at the same time
  • Types: ABCDEFG
    • accounting risk (e.g., fraudulent activity in accounting)
    • business risk
    • country risk (e.g., firm has invested heavily in China)
    • default risk
    • executive (decisions)
    • financial risk (how they’re financed)
    • government regulations
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3
Q

what does standard deviation measure?

A
  • total risk
  • absolute measure
  • measures variation around an average

Formula:

  • r(t) = the return
  • r(absolute) = absolute value of the average
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4
Q

what the standard deviation probabilities?

A
  • 68% of the time, the return will fall within 1 standard deviation (+ or -)
  • 95% of the time, the return will fall within 2 standard deviations (+ or -)
  • 99% of the time, the return will fall within 3 standard deviations (+ or -)
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5
Q

what is the ideal beta and what does it mean if beat is more or less than that

A
  • Ideal = 1
  • E.g., If you have a beta of 1.5, that means your portfolio is 50% more volatile, so it will go up by 50% less and down by 50% more
    • market goes down 10%, portfolio goes down 15%
    • market goes up 10%, portfolio goes up 5%
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6
Q

what does beta measure?

A
  • systematic risk
  • how our asset returns relate to the market return
  • beta = the slope of the line if you were to plot market returns vs the portfolio return
    *
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7
Q

call option & what is long/short position

A
  • Holder has the right (but not the obligation) to buy
  • long position = buyer (the right to buy)
  • short position = seller (agrees to sell to the person with the long position and gets the premium either way)
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8
Q

put option & what is long/short position

A
  • Holder has the right (but not the obligation) to sell
  • long position = seller (right to sell)
  • short position = buyer (agrees to buy from the long position and gets the premium either way)
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9
Q

in the money / out of the money / at the money

how does premium factor in?

A
  • in the money - holder will make money if they exercise the option
  • out of the money - holder will not make money if they exercise the option
  • at the money - holder would break even if they exercised the option

disregards the premium because not everyone would have paid the same premium

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10
Q

how to value stock options

A

premium = fundamental (intrinsic value) + time value

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11
Q

fundamental (intrinsic value)

A
  • How much the option is in the money
    • for call = stock price - strike price
    • for put = strike price - stock price
  • Cannot be < 0 because if it wasn’t in the money, you wouldn’t exercise it
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12
Q

futures contracts

A
  • long position = buyer
  • short position = seller
  • legally binding obligation to make (seller) and take (buyer) delivery on specified date
  • highly leveraged (bought on margin)
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13
Q

futures hedgers vs speculators

A
  • hedgers = producers/processors; protecting their interests by locking in a price
  • speculators = investors trying to profit on expected price swings
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14
Q

Regulation T

A

initial margin requirement set by the federal reserve; must be at least 50%

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15
Q

formula to determine at what price an investor would receive a margin call

A

1 - (loan / maintenance margin)

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16
Q

what are the main rating agencies for mutual funds and stocks?

A
  • Value Line: ranks stocks only; 1-5 and 1 is the best
  • Morningstar: ranks mutual funds and stocks 1-5 and 5 is the best
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17
Q

Ex-dividend date

what is it and what happens if you buy on that date

A

business day prior to date of record; if you buy on or after you don’t get the dividend so the price typically falls this day

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18
Q

what is a qualified dividend and how is it treated for tax?

A
  • Cash
    • paid by US company or qualifying foreign company
    • held >60 days during 121 period beginning before ex-dividend date
    • Taxed as capital gains
  • Stock
    • not taxable to shareholder
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19
Q

Securities Act of 1933 vs 1934 vs Investment Company Act 1940 vs Securities Investors Protection Act of 1970

A
  • 1933 - regulates primary market
  • 1934 - regulates secondary market; created SEC
  • 1940 - authorized SEC to regulate investment companies
  • 1970 - protect from brokerage firm failures (up to $500K)
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20
Q

types of money market securities

A
  • CDs
  • T-Bills < 1 yr ($100 denominations)
  • commercial paper (maturity <270 days; denominations $100K)
  • Bankers acceptance (maturity < 9 mos; facilitates imports/exports)
  • eurodollars (deposits in foreign bank denominated in USD)
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21
Q

investment policy statement

A
  • establishes:
    • objectives: return, risk tolerance
    • constraints: time horizon, liquidity, taxes, laws (e.g., if in trust), unique circumstances (e.g., special needs child)
    • limits on investment manager
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22
Q

market indices (Dow vs S&P)

A
  • Dow - simple price weighted average of 30 stocks
    • doesn’t incorporate market cap
  • S&P - value weighted index
    • incorporates market cap of individual stocks
  • Russell 2000 - value weighted for small cap
  • Wilshire 5000 - value weighted on all stocks
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23
Q

coefficient of variation

symbol, formula, what it measures, when to use, what # you want

A
  • Symbol: CV
  • Formula: CV = standard deviation / mean expected average return
  • What it measures: risk relative to return
  • When to use: when comparing two assets with different average returns
  • Do you want lower or higher #?: lower = less risky
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24
Q

correlation coefficient

symbol, formula, ranges, what # you want

A
  • symbol: r
  • formula: r = COV / (standard deviation of stock 1 x standard deviation stock 2 etc)
  • ranges: from -1 to 1
  • what # you want: diversification benefits come whenever correlation is <1
    • Note: negative is better but NOT necessary
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25
Q

coefficient of determination

symbol, what it measures, when to use it

A
  • symbol: r2
  • what it measures: tells you how much of your return is systematic risk
  • when to use it: must be ≥70% to use beta as a benchmark
    • note: index that has the highest r2 is the best one to use as a benchmark
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26
Q

coefficient of variation vs correlation coefficient vs coefficient of determination

A
  • coefficient of variation (CV)
    • measures risk relative to return
  • correlation coefficient (r)
    • ranges from -1 to 1
    • diversification benefits come whenever correlation is <1
  • coefficient of determination (r2)
    • tells you how much of your return is systematic risk
    • must be ≥70% to use beta as a benchmark
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27
Q

modern portfolio theory

A
  • the acceptance by an investor of a given level of risk while maximizing their return objectives
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28
Q

efficient frontier

what is it and what does it mean to be above or below

A
  • curve that illustrates the best possible returns to expect from all possible portfolios
  • along the frontier are efficient
  • below frontier is inefficient
  • above frontier is unattainable
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29
Q

indifference curve

what is it and what does slope indicate

A
  • curve illustrating how much return is required for each level of risk
  • Indifferent because investor is indifferent toward where on that line we land)
  • steeper = more risk adverse
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30
Q

capital market line

A
  • the line that runs along the mid-ish point of the efficient frontier;
  • not commonly tested
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31
Q

capital asset pricing model

A
  • calculates relationship between risk and return of an individual security using beta as it’s risk measurement
  • ri = rf + (rm - rf)Bi (on formula sheet)
    • B = beta of the individual security
  • risk premium = (rm - rf)
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32
Q

security market line

A
  • relationship between risk and return as defined by the CAPM (ri) if you were to graph a line based on beta and return
  • on line, beta of 1 = rm
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33
Q

Treynor vs Sharpe vs Jenson’s vs Info Ratio

A
  • Treynor - measures return relative to systematic risk (i.e., beta)
    • doesn’t measure manager performance
    • only use if r2 ≥ 0.7
  • Sharpe - measures return relative to total risk
    • doesn’t measure manager’s performance
  • Jenson’s Alpha - absolute measure of risk
    • measures return of portfolio minus CAPM (fish symbol on formula sheet)
      • = good (i.e., out-performed the market)
      • = bad
    • only use if r2 ≥ 0.7
  • information ratio (IR on formula sheet) - relative measure of consistency of excess return
    • rb = return of benchmark
    • standard deviation A = tracking error of active return
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34
Q

arbitrage pricing theory

A

how does our return vary based on multiple factors across the market, not just risk (e.g., inflation)

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35
Q

holding period return

A
  • HPR = made / paid (on formula sheet to calculate HPR for returns)
  • no consideration for how long investment was held
  • simple rate of return, not compounded
  • e.g., bought share for $20 on initial margin of 60%, charged 10% margin interest then sold stock for $30
    • paid
      • margin = (20 x 0.6) = $12
      • loan interest = (20*0.4*0.1) = $0.80
    • made = 30 - 20 = $10
    • HPR = (10 - 0.80) / 12 = 76.67%
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36
Q

Net Present Value

A
  • PV of future cash flows minus upfront costs
  • Positive NPV = invest
  • Negative NPV = don’t invest
  • Calculate: Use CFj to enter cash flows, provided rate (required rate of return aka discount rate), and # periods to solve for NPV
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37
Q

Internal Rate of Return

A
  • what interest rate will make the NPV = 0 i.e. what % do i need to earn to break even
  • calculate: enter CFs just like NPV, N for the number of periods, solve for IRR/YR
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38
Q

time weighted vs dollar weighted return

A
  • time weighted: used for mutual funds; based on the cash flows from the security perspective
  • dollar weighted: used for investors; based on cash flows from the investor’s perspective
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39
Q

intrinsic value

what is it an when can you use it

A
  • V on the formula sheet
    • D1 is the dividend after 1 year (not today)
  • discount dividend model aka value of a stock after 1 year
  • Only works if dividends are growing at a constant rate
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40
Q

expected rate of return

A

r on formula sheet

if > than required rate of return, you would buy that stock

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41
Q

how to calculate intrinsic value when dividends aren’t growing at a constant rate

A
  • Step 1: Calculate intrinsic value for any time period where dividends are growing constantly
  • Step 2: Use CFj to calculate NPV up until the time that dividends start growing constantly, including NPV of the constant growth above
  • E.g.: Dividends paid
    • Yr 1 = 2; Yr 2 = 2.5; Yr 3 = 3
    • after Yr 3, start growing at 8%
    • required rate = 10%
    • Step 1: V = (3*1.08)/(10%-8%) = 3.24/0.02 = 162 (that is added to CF3)
    • Step 2: Calculate NPV
      • 0 → CFj → 2 → CFj → 2.5 → CFj → 165 → CFj → 10 → I/YR → orange → NPV = 127.85
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42
Q

PE Ratio

A

PE = stock price / earnings per share

43
Q

Dividend payout ratio vs retention ratio

A
  • dividend payout ratio = common stock dividends / earnings per share
  • retention = 1 - dividend payout ratio
44
Q

ROE

A

ROE = earnings (or net income) per share / stockholders equity per share

45
Q

dividend yield

A

dividend yield = dividend / stock price

46
Q

efficient market hypothesis and forms

A
  • random walk theory = the behavior of stock prices closely resembles a random walk
  • prices reflect the information available at that time
  • forms:
    • weak - prices reflect historical info/prices, so technical analysis wont help investors outperform market
    • semi-strong = price reflects historical info and public info, so technical and fundamental analysis won’t help
    • strong = price reflects historical info, public info, and private info (i.e., insider trading), so only option is to diversify
47
Q

technical vs fundamental analysis

A
  • technical: historical prices
  • fundamental: analyzing individual company reports (10-K)
48
Q

Series E and EE Bonds

A
  • sold at FV
  • non-marketable and nontransferable
  • accrue interest but don’t pay it periodically
49
Q

Series I Bonds

A
  • inflation protected based on a fixed rate + variable coupon rate
  • like E/EE bonds, do not pay interest periodically but accrue it
50
Q

Treasury bills vs notes vs bonds

A
  • bills = initial maturity < 1 year
  • notes = initial maturity 2-10 years
  • bonds = initial maturity > 10 years
51
Q

TIPS

A
  • Treasury Inflation Protected Securities
  • principal adjusts for inflation and coupon (fixed rate) applies to new principal
52
Q

STRIPS

A
  • US treasury security
  • separate trading of coupon payments and principal
    • e.g., 10 year bond will have 21 strips, 20 for the coupon payments and 1 for the principal
  • essentially creates many zero coupon bonds
53
Q

secured bonds

types

A
  • mortgage bonds: backed by a pool of mortgages
    • risk of default and prepayment
  • Collateral Trust Bonds: backed by an asset the company owns
  • CMOs (collateralized mortgage obligations):
    • investors divided into tranches (short term, long term)
    • intended to mitigate prepayment risk
54
Q

what securities are backed by the full faith and credit of US government?

A

GNMA (Ginnie Mae)

US Treasuries (bonds, notes, bills)

not backed: Fannie Mae, Freddie Mac, Sallie Mae, various federal banks

55
Q

unsecured bonds

types

A
  • debentures (bonds) - unsecured debt not backed by a specific asset
    • e.g., corporate bond
  • subordinated debentures (bonds) - have a lower claim on assets than unsecured debt so more risky
  • income bonds - stipulate that interest is only paid when specific level of income is obtained (rather than fixed coupon)
56
Q

Municipal Bonds Types

A
  • general obligation = backed by municipality; paid via taxes
  • revenue = baked by revenue of project (e.g., toll road)
  • private activity = partnership between gov. and private group (e.g., stadium); tax-preferred for AMT
  • insured municipal = companies that issue insured municipal bonds and pay if default (AMBAC and MBIA)
57
Q

Municipal bond taxation

A

NO tax (federal, state or local) if you live in the municipality

58
Q

how are treasury securities taxed

A
  • taxed at federal level but no state/local
  • to get tax-equivalent yield (TEY) of a treasury security, would only consider state tax since federal already applies to it
59
Q

current yield

A

current yield = annual payment / current price

annual payment = coupon interest

60
Q

Yield to Maturity

what is it and how to calculate

A
  • what is it: compounded rate of return if investor buys bond today and holds to maturity
  • how to calculate: using time value, solve for i based on all the payments to come (coupon rate /2) and the par value (FV)
    • Note: when you get the result, need to multiply i by 2 because coupon payments are semi-annual
61
Q

if a bond is selling at a premium, how does the coupon rate relate to:

current yield, YTM and YTC

A

Coupon > CY > YTM > YTC

62
Q

if a bond is selling at a discount, how does the coupon rate relate to:

current yield, YTM and YTC

A

YTC > YTM > CY > Coupon

63
Q

if a bond is selling at par, how does the coupon rate relate to:

current yield, YTM and YTC

A

Coupon Rate = CY = YTM = YTC

64
Q

what happens to accrued interest when a bond is sold?

A

buyer pays the seller the accrued interest

buyer gets 1099 for the interest but can claim deduction for interest paid to seller

65
Q

original issue discount (OID) bond

A
  • zero coupon bond
  • purchased at discount
  • interest is reported as phantom interest each year
    • tip: it’s good to keep these in a tax deferred account (IRA)
66
Q

yield curve theories

Liquidity Preference Theory vs Market Segmentation Theory vs Expectations Theory vs Unbiased Expectations Theory

A
  • theories that attempt to explain yield curve shape (Y-axis = yield; X-axis = time)
  • Liquidity Preference - investors are willing to accept a lower yield for shorter maturities b/c willing to pay for liquidity
    • doesn’t explain inverted curves
  • Market Segmentation - curve depends on supply and demand of given maturity
  • Expectations - curve reflects investor inflation expectations
    • if they think inflation will rise, lenders will increase rates so longer term yields will be higher than short term
  • unbiased expectations (UET) - rate for each year reflects both that year and years prior
67
Q

duration

what does it measure, what higher # means, and what duration value do you want

A
  • what it measures: bond’s price sensitivity to changes in interest rates
  • what higher # means: higher = more sensitive
  • what # you want: match duration to investment time horizon
68
Q

how does duration relate to other variables

A
  • Inversely related to interest rate variables (coupon rate, YTM)
    • e.g., lower coupon = higher duration = more volatile
  • directly related to time
    • e.g., longer maturity = higher duration = more volatile
69
Q

convexity

A

convexity is my friend so higher is better

70
Q

if interest rates increase, what happens to bond values and what kind of duration do we want?

A

bond values decrease

we want a shorter duration because it won’t be as price sensitive

71
Q

convertible bond value and conversion ratio

A

CV = (par value / conversion price) x stock price

conversion ratio = par value / conversion price

72
Q

property valuation formula

A

value = net operating income / required rate of return

when calculating NOI, operating expenses exclude depreciation and interest because the value of the asset does not vary based on how someone pays for it

73
Q

what is the lowest bond rating that can still be considered investment grade debt?

A

Moodys = Baa

S&P = BBB

74
Q

investment company/fund types

A
  • closed
    • fixed initial market cap
    • shares trade on organized exchange
    • may trade at premium or discount to NAV
  • open (mutual funds)
    • unlimited initial market cap
    • shares bought/redeemed directly from fund family
    • shares trade at NAV
  • unit investment trust
    • can be equity or fixed income
    • self-liquidating
    • passive investments
    • sold in units, NOT shares
75
Q

global vs international mutual funds

A
  • global: includes US
  • international: excludes US
76
Q

fund expenses (share types)

A
  • A Shares
    • front end load
    • small 12b-1 fee
    • no redemption fee
  • B Shares (rare)
    • redemption fee
    • max 12b-1 fee (1%)
    • no front end load
    • convert to A shares
  • C Shares
    • no front end load
    • usually small back end load
    • max 12b-1 fee (1%)
77
Q

Real Estate Investment Trusts (REITs)

A
  • tax-exempt because they pass income to investors
  • must distribute 90% of investment income to maintain tax-exempt status
  • types:
    • equity
    • mortgage
    • hybrid
78
Q

American Depository Receipts (ADRs)

what are they and are they subject to exchange rate risk

A
  • foreign stock held in domestic bank’s foreign branch
  • trade on US exchange, denominated in US dollars
  • DO NOT eliminate exchange rate risk because the US dollar denomination is still exchanged from a different currency
79
Q

portfolio insurance

A

using a put option on an index to “lock in” portfolio gains

80
Q

straddle

types and when to use them

A
  • Long
    • buy a put and a call
    • do when you expect volatility but you aren’t sure which direction
  • Short
    • sell a put and a call
    • do when you don’t expect volatility, you just want to keep the premiums
81
Q

option pricing models

A
  • Black/Scholes - used to value calls
  • Put/Call Parity - used to value puts; based on value of call option
  • Binomial pricing model - values options based on assumption that stock can only move two different directions
82
Q

Black/Scholes variables

A

InVEST)

  • INterest rate (specifically, risk-free rate)
  • Volatility
  • Exercise price (i.e.., strike price)
  • Stock price
  • Time
  • Note: all have a direct relationship EXcept the EXercise price
83
Q

Warrants

A
  • long-term call options (usually 5-10 years)
  • issued by corporations
  • terms are not standardized (can be any strike price)
84
Q

bond investment strategies

bond laddering, immunizing, bond-swap, bond-barbell

A
  • Bond laddering - includes short term, intermediate and long term bonds
  • Immunizing - uses duration rather than maturity as a measure of position for implementing the strategy
  • Bond-swap - trade different and varied maturities to meet the objective of the portfolio
  • Bond-barbell - involves both very long-term bonds and very short-term bonds for a portfolio, and very few intermediate-term bonds
85
Q

what kind of bonds are most sensitive to interest rate changes?

A

if the term is equal, bonds with the lowest coupon will have the longest duration and therefore be the most sensitive to interest rate changes

86
Q

Tactical asset allocation

A

active management portfolio strategy that re-balances the percentage of assets held in various categories to take advantage of market pricing anomalies or strong market sectors.

87
Q

12b-1 fees vs commissions vs management fees

A
  • 12b-1: used for marketing and distribution costs
  • Commissions are paid using either a front load or a back load.
  • management fees - pay for all other costs, such as legal, accounting and analysis
88
Q

calculate how much a bond’s price will change if interest rates change by X amount

A

Use “change in p / p” formula on sheet where D = duration

89
Q

what are treasure shares

A

shares a corporation as repurchased

90
Q

ETFs vs Index Fund

when they can trade, can they use margin, can they be shorted, which most closely matches underlying stock value

A
  • When can they trade?
    • ETFs - any time during day
    • Index - only at EOD
  • Can they be purchased on margin?
    • ETFs - yes
    • Index - no
  • Can they be shorted?
    • ETFs - yes
    • Index - no
  • which value will be closest to the value of the underlying stock?
    • ETFs because index funds will incur transaction costs, fund cash flows, and changes to the index
91
Q

best efforts vs firm commitment

A
  • forms of underwriting
  • Best efforts:
    • firm takes all the risk
    • underwriter agrees to sell as much as they can
    • unsold shares returned to company
  • firm commitment
    • underwriter takes all the risk
    • underwriter buys entire issuance and tries to sell to public for more
92
Q

red herring

A
  • preliminary prospectus issued before SEC approval
    • note: prospectus outlines risk, management team, fees, expenses, etc.
  • used to determine investor interest in the security
93
Q

market order

A
  • market order - timing and speed more valuable than price (thinly traded stocks)
  • limit order - price is most important (volatile stocks)
  • stop order - when price hits certain level, turns into market order; if market is moving quickly, can end up sold for significantly less
  • stop limit or stop-loss limit order - investor sets two prices: stop loss (turns it into limit order) and limit price (won’t sell below this price); risk that it won’t fill if market moves too quickly
94
Q

anchoring

A

anchor thoughts to a preference even if no logical relevance

aka conservatism or belief perseverence

95
Q

bounded rationality

A

seek satisfactory solution, not optimal one

96
Q

cognitive dissonance

A

tendency to misinterpret info that is contrary to existing opinion or only pay attention to info that supports existing opinion

97
Q

hindsight bias

A

assuming you can predict the future as readily as you can explain the past

98
Q

prospect theory

A

value gains and losses differently ; base decisions on perceived gains rather than perceived losses (loss averse)

99
Q

how to calculate standard deviation of portfolio

A

return1 → E+ → return2 → E+ → return3 → E+ → etc → ORANGE → Sx,Sy

100
Q

what measure of risk do capital market line and security market line use

A

capital: standard deviation
security: beta

101
Q

tools of technical analysis

A
  • charting - plot historical prices to determine pattern
  • market volume - how the market is trending indicates investor sentiment
  • short interest - # shares sold indicates future demand
  • odd lot trading - trading done by small investors (<100); do opposite of small investors
  • dow theory - signals when bull or bear market ends (not when it will begin)
  • breadth of the market - number of stocks that increase in value vs # stocks that decline
  • january effect - january has better gains because of tax selling in Nov/Dec
  • small firm effect - small caps tend to outperform large caps
  • value line effect - value line’s highest ranked stocks outperform lowest ranked
  • P/E effect - stocks with low P/E outperform those with high P/E
102
Q

bond rating agencies

A
  • Moody’s: Aaa-C
    • investment grade = Aaa-Baa
  • Standard & Poors: AAA-D
    • investment grade = AAA-BBB
103
Q

bond strategies

tax swap, barbell, laddered, bullets

A
  • tax swap - sell bond with a gain and a loss to offset each other or sell bond with loss and buy a new bond
  • barbell - own both ST and LT bonds
  • laddered - own varying maturities
  • bullets - little payments in interim then lump sum in future (e.g., zero-coupon, Treasuries)
104
Q

Closed end vs open end investment companies and calculating NAV

A
  • Closed
    • fixed # of shares and initial market cap
    • shares then traded on organized exchanged
    • may sell at premium or discount to NAV
  • Open
    • unlimited # of shares
    • shares bought and redeemed directly from fund family
    • shares trade at NAV
  • NAV = (assets - liabilities) / shares outstanding

Comprehensive (9 decks)

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