Investments Flashcards
With regards to investment questions on exam, default to more ________ answer.
Conservative
Junk bonds have a rating off…
Lower than a BBB rating
Factors that should influence investor’s capacity for risk.
Time horizon
Liquidity needs
Total investable assets
Outline the Market Structure.
(1)Financial markets - provide for the exchange of capital and credit in the economy
(1a) Money markets - concentrate on short-term debt
(1b) Capital markets - trade in long-term debt and equity instruments
(1.b.1) Primary markets - where new securities are issued and sold to the public for the first time; registered with SEC and sold via IPOs; issuing firm is the recipient of proceeds; primary markets and issues are regulated by Sec Act of 1933.
(1.b.2.) Second markets - where previously issued securities trade among investors; issuing company not involved; regulated by Sec Act of 1934; two forms of mkts - organized exchange (NYSE) and over the counter (Nasdaq)
Holding period return components
Capital appreciation: (Period End Value - Period Begin Value) / Period Begin Value
Income yield: Dividends / Period Begin Value
Dollar Weighted Return calc instructions
Use CHS, CFo, CFj…. Solve for IRR
What are the Systematic/non-diversifiable risks?
“PRIME”
Purchasing Power Risk
Reinvestment Risk
Interest Rate Risk
Market Risk
Exchange Rate Risk
Cannot be eliminated through diversification
Quantified by the beta (B) statistic
What are the unsystematic/diversifiable risks? Also known as firm-specific
“Red Sox Forgot to Buy Defense”
Regulation risk
Sovereignty risks
Financial risks
Business risks
Default or credit risks
Low risk investments
Cash
Money mkt securities
Treasury Securities
Investment grade bonds
High risk investments
Common and preferred stocks
Junk bonds
Options, futures and forwards
Small-cap and growth funds
Distribution curve and standard deviation
“Paul Pierce #34 on each side of the line”
1 SD = 34%
2 SD = 47.5%
3 SD = 49.5%
Standard deviation is a measure of the ______________ around the expected return.
Variance
Positively Skewed Distro
Skewed right
Negatively skewed distro
Skewed left
Mesokurtic distro
“….M, N, o, p….”
Normal curve
Leptokurtic distro
L = lean
More peaked curve
Platykurtic distro
“Plat - > Plateau”
Less peaked
3 Forms of EMH
Strong: Nothing helps (passive investment)
Semi-Strong: Inside information can help
Weak: Inside information and fundamental analysis can help
Bond ladder strategy
Investor purchases bonds with maturity dates evenly spaced across several months/years so that the bonds are maturing and the proceeds are being reinvested at regular intervals.
Yield spread strategy
Process of deducting the yield of one instrument from another. A hedge is a strategy used to offset potential losses/gains that may be incurred by a companion investment.
Operating profit margin
Measurement of determining a company’s revenue after paying for costs of production
=EBIT / Net Sales
Bonds are registered with what organization?
The organization that issues the bond.
Capital Asset Pricing Model (CAPM)
Describes relationship between risk and expected return. It is used in the pricing of risky securities, but it is NOT an indicator of investment risk.
Sharpe Ratio
Measure risk-adjusted performance of a portfolio in terms of SD. “Are we adequately being compensated for the risk undertaken?”
Use when r^2 < 0.70
A comparative value and is only useful when comparing against the Sharpe ratios of other investments
Theynor Ratio
Measures risk-adjusted performance of a portfolio manager
Use when r^2 > 0.70
Comparative (relative) value and is only useful when comparing similar investments
Capital Asset Pricing Model (CAPM)
Use only when r^2 > 0.70
Used to quantify expected return given a market return and a beta to the market.
Used to quantify the investor’s required rate of return.
Used to plot SML. (Y-axis is Er and X-axis is Beta).
Comprised of and contains Mkt Risk Premium/Equity Risk Premium and Stock Premium
CAPM value - Actual Return = Alpha
Jensen’s Performance Index (Alpha)
Use when r^2 > 0.70
Measure to evaluate the benefit of a portfolio manager.
Formula includes CAPM.
Value > 0 = Good
Value = 0 = Good
Value < 0 = Bad
Plotted; y-axis is Rf, x-axis is Beta
Bond valuation on fin calc
Intrinsic value = PV of bond
PMT = coupon (divided by 2)
i = Mkt interest
n = time remaining to maturity (x2)
FV = maturity value ($1K)
PV = solve for
FV and PMT are positive values; PV will be negative
Bond valuation and the seesaw
Bond $ ————— Coupon % ——————Market Yield %
Order of yield on right side…
-Nominal; Current, YTM, YTC
Bond duration
“Weighted average of the PV of future CFs of a bond/bond portfolio.”
Duration stated in years
Higher coupon will result in lower duration
How to decrease duration? Higher coupons rate; Short-term bonds
Bond immunization
Matching the duration of a fixed income portfolio to an investor’s time horizon
Notes about changes in bond prices 1
The longer the duration and the lower the coupon, the more sensitive to changes in rates.
Notes about changes in bond prices 2
The shorter the duration and the higher the coupon, the less sensitive to changes in rates
Notes about changes in bond prices 3
Duration is a linear estimate that tends to overestimate the impacts on prices
Notes about changes in bond prices 4
Convexity is more complex, however, is also a much more accurate indicator of changes in price
Multi-Stage Dividend Discount Model - fin calc steps
Step 1) Calculate the dividends for the given years at the stated dividend growth rate
Step 2) Calculate the stock valuation on next year based on the new, constant dividend rate
Step 3) Solve for the NPV
i = required rate
CFo = “0”
CF1 = D1
CF2 = D2
CF3 = D3
…..
CF4 = D4+V
SHIFT NPV =
Call option when in the money
“COME”
Call Option = Market Price - Exercise Price
Put option in the money
“POEM”
Put Option = Exercise Price - Market Price
What is a stock option premium?
Price the option BUYER pays to the option seller to establish the option contract.
Paid on a per-share price.
Options | Intrinsic Value
Can never be less than 0.
Remember COME and POEM.
Covered call writing
Long the underlying stock - short the call
-Only considered covered if you own enough shares to cover all contracts sold
-Used to generate income for the portfolio
*Exam
Naked call writing
Does not own the underlying stock - short the call
-Writer bears UNLIMITED risk
*Exam
Other option strategies - less testable
Protective put: Long the stock - long the put - portfolio insurance
Protective call: Short the stock - long the call - used to protect a short position
Covered put: Short the stock - short a put - writer uses stock put to cover short position
Collar / Zero Cost Collar
Long the stock - long the put - short the call
-The put is used to protect against a stock price decrease, the call premium is used to offset the cost of the put
Straddle
Long a put and a call on the same underlying stock with the same expiration date and strike price
-Used to capitalize in a VOLATILITY regardless of the direction
Spread
Involves purchasing and selling the same type of contract
-Benefit from STABILITY
Future Contract | Short Hedge
Anyone who is long needs a short hedge
-Selling a futures contract establishes a short hedge
Future Contract | Long Hedge
Anyone who is short needs a long hedge
-Buying a futures contract established a long hedge
Example of a long position
Farmer growing corn is long corn
“Anyone who owns something is said to be long”
Example of a short position
A construction company that needs to build is short lumber
“Anyone who has to buy something is said the be short”
When to use IRR-vs-NPV
NPV is considered a superior model to IRR when comparing investment projects of unequal lives.
With changes of more than two inflows or outflows in an investment project there will be only one NPV, however multiple IRRs.
NPV on fin calc
Use CF0, CFj, and Nj keys
IRR on fin calc
Use N, PV, FV, PMT, and i
Wash sale
Occurs when a taxpayer realizes a loss on the sale of a security and acquires a SUBSTANTIALLY IDENTICAL security within a 61-day period
Wash sale - day spread
30 days prior to trade to 30 days after
Thus, 61 day span
Wash sale calc
30Jan: Buy 100 shares of BRADY stock @ $1000
1Dec: Sell 100 shares of BRADY stock @ $750
15Dec: Buy 100 shares of BRADY stock @ $800
Thus, new basis is $1,050 (= $800 + ($1000 - $750)
Financial Ratios
“LAPD”
Liquidity ratios
Activity ratios
Profitability ratios
Debt ratios
Gross profit margin formula
Gross Profit / Sales =
Operating Profit Margin formula
Operating Income / Revenue =
Return on Assets formula
Earnings after Taxes / Total Assets =
Return on Equity formula
Earnings after Taxes / Equity =
Coupon payments are made to the person who holds which type of bond?
Bear bond
It is a debt security issued by a corp/gov. No records of ownership are kept. Coupon payments are attached to the bearer bond and are made to the person who holds the bearer bond.
Type of check for which the payment is guaranteed to be available by the issuing bank?
Bank draft
What is the simultaneous purchase of both a call option and a put option on the same stock at the same time?
Straddle
This is an extremely risky move as only a small move in either direction will result in a loss.
Protective put
Strategy to guard against the loss of UNREALIZED gains. It costs the investor money and therefore reduces the profit of the investor but also protects against losses if the stock loses value.
Collar
Purchasing an out-of-the-money put option while writing an out-of-the-money call option.
Modern Portfolio Theory
Aka Markowitz Model
Attempts to maximize the expected return of a portfolio for a given amount of risk
Odd Lot Theory
Based on assumption that the individual investor is always wrong, so if individual sales are up, then it is the right time to buy.
To shift the Markowitz efficient frontier upward and to the left, what should occur?
Investors should select investments with lower coefficients of correlation.
Leading indicators which rise and fall in advance of the economy
Average weekly hours of production workers
Unemployment claims - new
Manufacturers’ new orders
New private housing starts
% of companies reporting slower deliveries
Yield curve
S&P 500
Money supply growth ate
Index of consumer expectation
Which ratio assumes a non-diversified portfolio?
Sharpe Ratio
What occurs at the ex-dividend date?
The market price of the stock adjusts for dividends
Date of record
Day the company examines records to determines who are their shareholders
Declaration date
Day the investors are entitled to receive a dividend
Rationale for the federal regulation of initial securities offerings contained in the Sec Act of 1933 is based in:
The Interstate Commerce Clause of the US Constitution
Preferred stock
Preferred stock ratings are generally lower than bonds
Maximum gain as the premium and the maximum loss as unlimited?
A short call
Date of declaration
Statement issued on the date of declaration includes the size of the dividend, the ex-dividend date, and the payment date.
One benefit of ETFs over mutual funds?
Less expensive
Because of higher daily liquidity and lower fees
Type of stock that prospers in expanding economies and does poorly during market downturns?
Cyclical
Need based financial aid programs
Pell Grants
Federal Perkins Loans
Federal Work Study
Not a need-based financial aid program
National Merit Scholarship
Textbooks purchased via Amazon for a quailified expenses for what and what only?
Americans Oppty Tax Credit
Investment company puts loans into a pool and sells securities as shares of that pool. These securities sold are considered what?
Asset-Backed
Stocks bonus plans help prevent what?
Hospital takeovers
Because it spreads out ownership
R^2
Coefficient of determination and a measure of systematic risk
As bond interest rates decrease, duration _________.
Increases
Consumers will reduce their consumption more in the long run than in the short when the price of a product increases according the the Second Law of _________.
Demand
Arbitrage Pricing Theory
Used to calculate asset pricing by assuming that the expected financial return of an asset can be predicted according to a linear function based on multiple risk factors, each of which has a corresponding beta.
Arbitrage Pricing Theory
General theory used to calculate asset pricing by assuming that the expected financial return of an asset can be predicted according to a linear function based on multiple risk factors, each of which has a corresponding beta.
Black-Scholes valuation model
Used to calculate the premium of an option, specifically the value of a call option of a non-dividend paying stock.
It assumes the market consists of at least one risky asset and at least one risk less asset.
Longer the duration, lower the coupon, thus _______ sensitive to rate changes
More
Shorter the duration, higher the coupon, ________ sensitive to rate changes
Less
Duration is a linear estimate that tends to overestimate the impacts on __________
Price
Convexity is more _____________, however it’s also much more accurate indicator of changes in price
Complex
