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Investments Flashcards

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CFP® flashcards
1
Q

CDs carry interest rate risk

A
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2
Q

Treasury bills – one year or less
Commercial paper – short term, unsecured, promissory note issued by large financially, strong company (270 days or less)

A
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3
Q

Bankers acceptance

A

Before a foreign exporter will ship goods to US, they want assurance of payment. Bankers acceptances are bearer securities, and can be held to maturity. (nine months or less)

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4
Q

Euro dollar

A

Deposit in any foreign bank that is denominated in dollars

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5
Q

Yankee bond

A

Dollar denominated bonds issued in US by foreign banks and corporations. Must be registered with SEC.

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6
Q

Commission gets added to bonds basis

A
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7
Q

Original issue discount (OID)

A

Typically zero coupon bonds, but issued far below par value.

No interest until maturity

Each year portion of discount hat has been earned is included in taxable interest income and bonds basis is increased. Zero coupon bond holders must report interest income although bond pays no interest before maturity (phantom income)

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8
Q

Treasury notes and bonds have reinvestment, interest rate, and purchasing power risk (RIP)

A
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9
Q

Treasury bills, notes, and bonds all are subject to federal income tax, exempt from state and local income tax

A
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10
Q

Treasury issues it’s own zero-coupon bonds, called STRIPS

A

They are a direct obligation of the federal government

STRiPS do not distribute interest in form of coupon payment. Interest is accrued and phantom income.

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11
Q

TIPS

A

Min denominations of 1,000

Interest rate is fixed

Interest payments vary as the principal is adjusted for inflation

Obligations of federal government

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12
Q

EE bonds

A

Fixed rate based on 10 yr treasury

Guaranteed to reach face value in 20 yes but can earn interest for 30 yrs

Only subject to federal tax

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13
Q

GNMA

A

(Government national mortgage association) (Ginnie Mae)

Prepayment risk!

These are guarantee of US govt but not issued by the treasury

Fed state and locally taxed

Minimum sold is 25,000

Rates increase causes NAV of GNMA to decrease. Also principals being paid off can cause value to lower

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14
Q

Reports

A

10k- required to be filed with SEC. Annually
10q- required to be filed with SEC. Quarterly
Prospectus- for potential buyers of new stock issue
Red herring - preliminary prospectus

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15
Q

Preferred stock

A

Pays a fixed dividend rate.

Can be cumulative or non cumulative.
Cumulative- if dividend payments are missed, it will pay dividends in full before common shareholders.
Non cumulative- missed dividends do not have to be made up

No maturity date but can be callable

C corps will likely buy to get 50% of dividends excluded from taxation

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16
Q

ADR

A

A way for Americans to buy foreign shares in the US. An ADR is a receipt for the shares of a foreign based corp held in US vault.
Dividends are paid in US dollars, but declared in currency of country of origin

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17
Q

Hedge funds

A

Aggressively managed portfolio that uses long short, leveraging and derivative positions.

Open to a limited number of investors and require large minimum investment.

Often illiquid and require money in fund for at least one year.

Laws require a majority of investors to be accredited (must earn minimum amount of money annually, or have a net worth of more than 1 million. Primary residence does not count toward 1 million.)

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18
Q

GICS do not have interest rate risk

A

Guaranteed Investment Contract like a CD generally purchased by institutional companies

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19
Q

Net operating Income

A

Any income, less vacancy, less operating expenses = NOI

*do not do anything with any mortgage info they give you or depreciation info. It is not included in calculation
**if they ask for monthly income, that factors in mortgage payments

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20
Q

Put option

A

Gives owner right to sell a specific number of shares at a set price. Investors buy puts when they are bearish. Writers (sellers) of the put are bullish on price. They believe it won’t decrease and options won’t be exercised

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21
Q

In the money and out of the money for PUTS

A

When market price is less than the exercise price, a put is in the money.

When market price is greater than the exercise price, about is out of the money.

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22
Q

Call

A

Contract that gives holder the right to purchase a specific number of shares at a set price. Investors buy cars when they are bullish. Call writers (sellers) premium income. If an individual writes a covered call, a call is written on stock already owned by the call writer.

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23
Q

In the money and out of money for CALLS

A

When market price is greater than the exercise price, a call is in the money. When the market price is less than exercise price, a put is out of the money.

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24
Q

Intrinsic value of a put = exercise price - market price

Intrinsic value of a call = market price - exercise price

A
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25
Q

Warrants vs calls

A

Warrants are issued by corporations. Calls are created by individuals on exchanges.

Warrants generally have maturities of several years. Calls usually expire within 9 months

Warrants are issued with no intrinsic value

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26
Q

Collectibles long term capital gain rate is 28%

A

Real Property (1250) LT gains are taxed at capital gains rate. A special 25% depreciation recapture is applied when the property is sold. (This is just on the amount that was taken for depreciation.

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27
Q

Private placement (regulation D)

A

Is an issue offered privately that can be sold to a maximum of 35 nine accredited investors and an unlimited amount of accredited investors. This issue would be exempt from registration.

Accredited investor - individual with net worth $1 million, one individual with an annual income of 200,000, or a couple with joint income of 300,000
(remember 123 rule 100,000,000/200,000/300,000)

1 million excludes primary residence volume

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28
Q

Systematic risk

A

PRIME
Purchasing power risk, reinvestment, right risk, interest rate risk, market risk, exchange rate risk

  • S&P index would carry a systematic risk
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29
Q

Unsystematic risk is diversifiable risk, and can be largely eliminated

A

Business risk and financial risk

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30
Q

Future Contracts

A

Farmer may sell a contract on corn if he wants to hedge against lower crop prices in the future. He will make a short hedge if worries prices will be lower in the future.

Food processor may hedge to guard against increase in commodity’s price at the time of delivery. The processor wants to buy the crop at today’s price to hedge against higher price in the future. (This is the processors going long)

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31
Q

Total risk is expressed by standard deviation while systematic risk is expressed by Beta.

A
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32
Q

Revaluation

A

Generally means an increase in the currencies value

Devaluating is the lowering of the value of currency relative to currencies of other nations

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33
Q

Life insurance cash value is considered to be liquid. So is open ended money market mutual funds.

A
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34
Q

Savings, checking, money market accounts, and mutual funds are redeemed rather than marketable. Treasury bonds, and common stock are marketable.

A
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35
Q

Correlation coefficient, and covariance, both express the extent of which movements of stocks in the same portfolio are similar or not

A

+1 = perfectly positively correlated
-1 = perfectly negatively correlated

When correlation coefficient of an equally weighted portfolio is less than one, the risk must be lower than the average risk.

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36
Q

Coefficient of variation is the standard deviation, divided by the average return

A

The higher the coefficient of variation, the riskier the stock

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37
Q

Standard deviation and beta are used to express risk of security

A

Standard deviation measures variability of returns used in a non-diversified portfolio, and it’s a measure of total risk

Beta measures volatility of returns, used in a diversified portfolio and is a measure of systematic risk

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38
Q

Standard deviation

A

This is the bell curve chart. The mean is at the center.

1 standard deviation = 68%
2 standard deviations = 95%
3 standard deviations = 99%.

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39
Q

Correlation coefficient example

A

Correlation coefficient is .5
Fund A mean = 10% and risk = 20%
Fund B mean = 8% and risk = 12%
Portfolio is equally weighted. What is standard deviation?

Add the risks 20% +12%, then divide by two = 16%. Since the correlation coefficient is less than one, choose the next Lowest answer under 16%. if the correlation coefficient were exactly 1, the portfolio standard deviation would’ve been exactly 16.

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40
Q

Beta

A

Volatility of assets or portfolios rate of return compared to market. The market constant beta is 1.0.

1.5 beta is a stock with 50% more volatility than market

.75 beta is only 75% as volatile as market

Beta can be negative. Negative beta can lower volatility of portfolio

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41
Q

Risk adjusted return

A

Divide individual funds realized return by its beta coefficient.

42
Q

Reinvestment rate risk

A

GNMA have greatest reinvestment risk because payments include interest and return of principal.

Zeros and STRIPS have lowest since there are no coupon payments to reinvest

43
Q

Geometric return

A

Used to reflect compound returns over more than one time period.

  1. Add to returns (25% becomes 1.25, -12 become .88)
  2. Multiply returns 1.25x.88
  3. That result is your FV
  4. -1 is always your PV
  5. N is the the number of years of investment
  6. Solve for I
44
Q

Time weighted returns, such as geometric, allows investors to compare managers. This is not possible with dollar weighted returns

A

Time weighted return is normal

45
Q

Holding period return

A

Income plus price appreciation and dividends less margin interest.

If time period is over 1yr, then HPR overstates annualized returns. If under 1 yr, it understates.

46
Q

HPR

A

Sell price factoring in interest - cost basis factoring in any interest - any margin / initial investment

47
Q

When calculating yield to maturity, always use semi annual compounding, even with zero coupon bond

A
48
Q

Zero-coupon bonds

A

One advantage is the elimination of reinvestment rate risk, because there are no interest payments to be reinvested. Zeros still carry interest rate and inflation risk.

49
Q

Current yield

A

Current Yield = annual interest in dollars / bonds current price

50
Q

Taxable equivalent yield (TEY)

A

Taxable equivalent yield = tax exempt yield / 1 - tax rate

51
Q

Treasury securities are exempt from state and local tax

A
52
Q

Duration is inversely related to Yield to maturity and annual coupon. When market interest rates increase, duration decreases.

A

Duration and maturity are positively related.
(Remember time is on top, positively related)

53
Q

Duration

A

Enables investors to compare the price volatility of bonds with equal coupons, but different terms

Most important measure of how risky bones are because it measures are sensitivity to interest rate changes

54
Q

Interest rate risk is neutralized if duration is equal to the preselected investment horizon

A
55
Q

Zero-coupon bonds are most volatile if interest rates move quickly. The duration of the zero coupon bond is the same as its maturity.

A
56
Q

Remember UPS

A

If interest rates go UP, Shorten duration

57
Q

Remember fallen

A

If interest rates FALL, LENgthen duration

58
Q

Convexity

A

Expresses degree to which duration changes as a bonds yield to maturity changes.

Convexity is the largest for low coupon bonds, long maturity bonds, and low yield to maturity bonds.

59
Q

Constant Growth Model

A

Dividend (1+ Growth Rate of dividend)/Required rate of return - growth rate of dividends
*If constant growth model is higher than price, then the stock is undervalued.
*This model assumes dividends grow at a constant rate over time.

60
Q

When intrinsic value is lower than the MV of stock, the investor earns a lower rate of return than he requires.

A
61
Q

If dividend changes over time use TVM calculation.

A

Step #1 - Find PV. Input FV, Interest, and N. Do this for each year, then total the years PV.
Step #2 - Use constant growth model. D(1+G)/r-g
*D=the last dividend you figured from step 1.
Step #3 - discount this value back to PV. Then add that and step #1 value together

USE shortcut!!! not this..

62
Q

Dividend discount model shortcuts

A

shortcut #1 - If the FIRST growth rate is lower than the second growth rate, then do the discount model equation using the second growth rate (the highest). Once you have that figure, pick the answer that is the next lowest.

shortcut #2 - If the FIRST growth rate is higher than the second growth rate, then do the discount model equation using the second growth rate (the lowest). Once you have that figure, pick the answer that is the next highest.

***Always use the second growth rate. If it gets lower, pick the next lowest answer. If it gets higher, pick the next highest growth rate.

63
Q

Yield curve shows market rates of interest for bonds of different maturities with similar credit ratings.

A
64
Q

Current market price = Earnings x P/E ratio

A

if PE Ratio is more than price, it is undervalued.

65
Q

Return On Equity (ROE)

A

Earnings available for common (EPS) / Common Equity (net worth or book value)

*preferred dividends don’t factor in

66
Q

Dividend payout ratio

A

Common dividend paid/ EPS

67
Q

Short selling involves borrowing a security who’s price you think is going to fall and then selling it on the market. your plan is to then buy the same stock at a lower price and pocket the difference after repaying the loan

A

If stock goes up you have to buy stock on open market to close position. The stock could rise to infinity.

68
Q

Utility stocks typically have a high dividend payout ratio

A
69
Q

Change in interest rate formula

A

-Duration(change on interest/current interest rate)

70
Q

Capital Market Line

A

Specifies relationship between risk and return on a portfolio rather than on one investment

Individual securities or an efficient portfolios fall below the CML . Diversified portfolios should fall somewhere along the CML.

It can’t be used to evaluate a single security

71
Q

Modern asset allocation by Harry Markowitz

A

Risk, return, and covariance of assets are important input variables in creating portfolios

Risk adverse investor will have a steep indifference curve which demands a significant amount of return to take on more risk. Someone who is less risk adverse would have a relatively flat indifference curve

72
Q

Market risk premium

A

Return of market - risk free rate

73
Q

Stock risk premium

A

(Return of market - risk free rate)Beta

74
Q

Security market line (SML)

A

If security is above line, it’s undervalued. It offers more expected return than investor requires.

If under line, it’s overvalued

75
Q

Efficient market hypothesis

A

EMH justifies passive investing

Strong form -fully reflect all public and private info. Neither fundamental or technical analysis produces superior results over time.

Semi strong form - reflects, publicly known information. Neither technical analysis nor fundamental analysis produces superior results. Only an investor with the inside info could achieve superior results (illegal).

Week form - suggests historical price data is already reflected in current prices and is of no value in predicting future price changes. Technical analysis will not produce superior results. Fundamental analysis may produce superior results.

76
Q

Fundamental analysis

A

Factors such as interest rates, gross, domestic product, inflation, unemployment, and inventories are used to predict the direction of the economy

77
Q

Top-Down method

A

Investor first looks at trends in the general economy, then select industries, and then companies that shod benefit from those trends

78
Q

Bottom-up method

A

Client searches for individual stock with outstanding performance before considering the impact of economic trends. This approach assumes the individual company will do well, even if the industry doesn’t.

79
Q

Current ratio

A

Assets/liabilities
Assets - bonds count. IRA’s do not count

Liabilities - only use taxes payable when the material indicates the taxes are due or if it says the taxes are payable. Always use credit card debt even if the credit cards are paid off monthly.

80
Q

Technical Analysis

A

Most technical analysis looks at short or immediate term outlook. It is not concerned with any specific financial position of a company, unlike fundamental analysis.

Bar charts, resistance/support levels, ect

81
Q

Resistance

A

Price ceiling. If stock breaks through, it’s considered bullish.

82
Q

Support

A

Price floor, if stock breaks through, it’s considered Bearish

83
Q

Wilshire 5000

A

Broadest measure of the market but value-weighted.

84
Q

Date of record comes after ex dividend date.
You must purchase before the ex dividend date to get dividend

A
85
Q

Sharpe ratio

A

Ratio of the excess return of the portfolio to it standard deviation. This number is meaningless unless it’s compared to the market or other mutual funds.

86
Q

Treynor ratio

A

This measure is expressed as a ratio of the excess return of the portfolio to its beta.

Uses beta so portfolio must be diversified (using systematic risk only)

87
Q

Jensen ratio

A

AKA Alpha.

Uses beta so portfolio must be diversified (using systematic risk only)

Calculates the portfolio return actually attained and subtract it from what the return should’ve been based on the risk assumed. Positive number signifies that the return exceeded what was expected.

88
Q

R-squared (correlation coefficient squared)

A

Is the percentage of a funds movements that is explained by movements in the S&P 500.

If R-squared is higher than 60, look for highest alpha (Jensen). If alpha/Jensen isn’t option, look for highest Treynor.

If R-squared less than 60, look for highest sharpe number.

89
Q

Information ratio

A

Measures portfolio managers ability to generate returns higher than benchmark.

Rp-Rb/standard deviation

Rp=asset return Rb=return on benchmark asset

90
Q

Immunization

A

A portfolio is immunized if duration of portfolio is = to pre-selected time horizon of portfolio

91
Q

Barbell strategy

A

Buying half very short term and half very long term bonds

92
Q

Margin

A

Regulation T sets initial margin at 50%. Exchanges and FINRA set the next level, normally 25%.

Only actively traded securities are marginable not mutual funds or options.

Margins requirement= (1-margin %) / (1-maintenance margin %). x purchase price of stock

93
Q

Margins

A

If bought 200 shares at $150 on margin. Initial margin requirement is $15,000. Maintenance margin is 25%. What is maintenance call if stock drops to $90.

200 shares x $90. =$18,000
25% x $18,000 = $4,500 equity required
$18,000-15,000= -$3,000 actual equity

$1,500 maintenance call

94
Q

Long vs short position

A

Long position means you own it. Short position is generally a sale of a stock you do not own

95
Q

Risk capacity

A

Amount of risk an investor “must” take to reach their goals

96
Q

Arbitrage Pricing Theory (APT)

A

The security’s movement and return are not explained by a relationship between risk and return. They suggest four main reasons: unexpected inflation, unexpected changes in level of industrial production, unanticipated shifts in risk premium, and unanticipated changes in structure of yields.

When arbitrage pricing theory expect value is zero, the factor has no effect. It was expected.

97
Q

Black Scholes option value model

A

Valuation of options. An increase in exercise price of call decreases the calls value. Increase in exercise price of put increases the puts value. (Direct relationship)

98
Q

Interest rate risk

A

Danger that bond could lose value

99
Q

Naked call

A

Similar to short selling. In short selling you borrow the stock your selling in naked calls, you are selling the right to buy the security at a fixed price. You are aiming to make a profit from collected premium

100
Q

Out of the money

A

Stock price 39. Call price is 40. Intrinsic value is zero. There is no intrinsic value when you can buy the stock at a lower price than the call prize.

101
Q

Dividends reinvested get input as 0 in the IRR calculation. This then gets added to basis and is treated as phantom income. Dividends taken as cash are just a positive cash flow.

A
102
Q

Carryforward loss

A

Only $3,000 can be deducted on the 1041 estate tax return in the year of death. Any remaining losses are lost after year of death.

CFP (7 decks)

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