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CFP - Review Wrong answers > Investments > Flashcards

Investments Flashcards

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1
Q

Discount bond

A

A bond where its par value is in excess of the Bond’s purchase price.

Yield to maturity must exceed current yield because YTM factors the discount into the return.

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2
Q

Risk of Notes and Bonds

A

Reinvestment, Interest rate, Purchasing Power (RIP)

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3
Q

Treasury bonds

A

Interest paid is subject to federal income tax, sold in a YTM basis, can be callable

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4
Q

Treasury Inflation-Protection Securities (TIPS)

A

Issued in minimum denominations of $1,000, interest rate is fixed, interest payments vary as the principal is adjusted for inflation and deflation, obligations of the federal government, increase in principle must be reported (phantom income)

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5
Q

Mortgage-backed certificate

A

Security backed by mortgages, a pass- through security, represents pooled debt obligations repackaged as certificates.

Investors receive payments sources from the interest and principal on the mortgages

Ex. Includes GNMA, Fannie Mae, and Freddie Mac securities.

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6
Q

Bond quality

A

Based on rating agencies, not the indenture agreement.

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7
Q

Bond rating companies

A

Standard & Poors and Moodys

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8
Q

Banker’s acceptance

A

Used to finance import/export transactions.

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9
Q

I Bonds

A

Based on both a fixed rate of return and the semiannual inflation rate. Earn interest for up to 30 years.

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10
Q

How does preferred stock differ from common stock?

A

It pays a fixed dividend rate.

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11
Q

Property Intrinsic Value formula

A

Net Operating Income (NOI) / Capitalization Rate

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12
Q

What does Net Operating Income (NOI) not factor?

A

Debt service

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13
Q

Unit investment trust

A

It will self-liquidate and you can trade it on the secondary market.

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14
Q

ETF

A

May be an open-end or closed-end fund. Traded on a major exchange.

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15
Q

Shares for an open-end fund and a closed-end fund.

A

Closed - Issued with a limited number of shares.
Open - Increase or decrease based on customer deposits and redemptions.

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16
Q

No-load balanced mutual fund

A

Can always be purchased at NAV.

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17
Q

Unit investment trusts

A

Not actively managed. Once created, no new securities are purchased, and portfolio securities are rarely sold.

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18
Q

Similarities between an open-end fund and no-load balanced mutual fund

A

Shares are purchased and redeemed directly with the issuer.

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19
Q

10q & 10k vs. Corporate Annual Report

A

10q and 10k has to be filed with the SEC. Annual report is sent to stockholders.

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20
Q

American Depository Receipt (ADR)

A

A receipt for shares of a foreign-based corporation.

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21
Q

ETF advantages

A

Be bought on margin, be sold short, be bought or sold throughout the trading day, and trading orders can include stop-loss and limit orders.

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22
Q

Put options

A

Right to sell a specific number of shares at a set price. Investors buy puts when they are pessimistic (bearish).

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23
Q

Intrinsic value of a Put

A

Exercise price - Market price

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24
Q

Call options

A

The right to purchase a specific number of shares of common stock at a set price. Investors buy calls when they are optimistic (bullish).

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25
Q

Intrinsic value of a Call

A

Market price - Exercise price

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26
Q

Time Premium formula

A

Premium - intrinsic value

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27
Q

Riskiest option position

A

Selling a naked call because if the stock rises, the seller of the options has to buy the stock at the higher market price. Can rise without limit.

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28
Q

Difference between long position and short position

A

Long = buy the commodity/financial (bullish)
Short = sell the commodity/financial (bearish)

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29
Q

Difference between warrants and call options

A

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

Warrants have maturities last for several years; Calls expire within 9 months

Warrant terms are not standardized compared to call options

Warrants are issued with no intrinsic value

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30
Q

Futures contract

A

Formal agreement between buyer or seller that operates through a commodity exchange. Not securities and not regulated by the SEC.

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31
Q

Option with the highest potential for profit

A

Buying a call

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32
Q

Buying call/selling put vs. Buying put/selling naked call

A

Profitable strategies in a rising market vs. profitable strategies in a falling market.

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33
Q

Option with unlimited loss potential

A

Seller of a naked call

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34
Q

When is put in the money?

A

When the market price of a stock is lower than the exercise price of the option.

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35
Q

Total Risk vs. Systematic Risk

A

Total is expressed by standard deviation while systematic is expressed by beta.

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36
Q

Difference between correlation coefficient and covariance

A

While they both express which movements of stocks/securities in the same portfolio are similar or not, covariance considers an infinite possibility of outcomes while correlation coefficient falls within a specific range.

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37
Q

Standard deviation vs. Beta

A

Both are used to express the risk of a security. SD measures variability of returns used in a non-diversified portfolio and is 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

Applying standard deviation with bell-shaped curve

A

68% within 1 SD, 95% within 2 SD, and 99% within 3 SD

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39
Q

A portfolio with a beta of +1 has what?

A

Systematic risk

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40
Q

Why would a portfolio with a correlation coefficient of zero be good to own?

A

Standard deviation (risk) would be greatly reduced.

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41
Q

What does the risk level of beta express?

A

Volatility and systematic risk

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42
Q

Coefficient of variation formula

A

Standard deviation / Mean

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43
Q

What happens when a correlation coefficient is +1?

A

Investments are perfectly positively correlated.

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44
Q

Negative correlation in correlation coefficient

A

Reduce the portfolio risk and make the beta negative.

45
Q

Geometric mean

A

Compound returns over more than one time period (time-weighted return). Evaluates the performance of the portfolio manager.

46
Q

Dollar-weight vs. Time-weight returns

A

Dollar-weight enables investors to compare absolute dollar amounts with financial goals. Time-weight evaluates manager performance.

47
Q

Holding period return

A

Total return (income plus price appreciation and dividends less margin interest) over the period from purchase to end of period or sale divided by the price of the investment.

48
Q

What happens when you buy the stock on margin?

A

The downside risk is greater than the upside gain for the same rate of return.

49
Q

Treasuries and taxes

A

Only subject to federal tax, not state or city. Formula is % of treasury bonds (1-federal tax percent)

50
Q

Interest-bearing bonds

A

Pay interest at the end of the period, are issued at par value, and pay semiannual interest.

51
Q

What happens to a bond’s duration if it has a high coupon rate?

A

It is shorter than similar maturity debt with a smaller coupon. High coupon (interest) = low duration (inversely related). Smaller coupon (interest) = higher duration) inversely related)

52
Q

What happens to a bond’s duration if it has a long maturity?

A

Long maturity (time) = long duration (positively or directly related)

53
Q

What does it mean when zero coupon bonds have durations equal to their maturities?

A

Prices fluctuate more than those of coupon bonds with the same maturities, making it more volatile.

54
Q

UPS

A

Interest rates UP, Shorten duration.

55
Q

FALLEN

A

Interest rates FALL, LENgthen duration.

56
Q

not factored in calculating the intrinsic value using the dividend discount model?

A

Gross earnings of the company

57
Q

Relationship between duration and maturity

A

Positively correlated

58
Q

Intrinsic value of a stock

A

P/E ratio x earnings. If stock is more than intrinsic value, it is overvalued.

59
Q

Stock’s yield formula

A

Dividend / Closing price

60
Q

What does a curve look like for someone who is risk averse?

A

It would be a steep curve, compared to someone who is less risk averse, which would be more flat.

61
Q

Strong form

A

Insider information will not produce superior results over time. Neither fundamental nor technical analysis will produce superior results.

62
Q

Semi-strong form

A

Current prices reflect past prices and factor all publicly available information. Inside information can lead to superior results.

63
Q

Portfolio that is above the efficient frontier is what?

A

Unattainable

64
Q

Which form of EMH reflects all information including insider information?

A

Strong form

65
Q

Prices of securities in EMH

A

Fully reflect all available information.

66
Q

Modern portfolio theory expresses a risk-return relationship based on what?

A

Capital Market Line

67
Q

Random walk hypothesis

A

The next price change of a stock is unrelated to the last price.

68
Q

What are differences of a bond that wouldn’t cause a wash-sale?

A

Coupon rate or maturity

69
Q

Ex-Dividend Date

A

The day after the purchase date of a company and the day before the date of record. Does not count weekends or holidays.

70
Q

Sharpe Ratio

A

Ratio of the excess return of the portfolio to its standard deviation. Compared to the market or other mutual funds.

71
Q

Treynor Ratio

A

Ratio of the excess return of the portfolio to its beta.

72
Q

Jensen Ratio

A

Also known as alpha. Measures the contribution of the portfolio manager. Positive number means return exceeded expectations. Negative means poor management.

73
Q

Why must a portfolio be diversified when using Jensen or Treynor?

A

They both use beta to express risk.

74
Q

R2 (squared)

A

Correlation coefficient. If greater than 60, look for highest alpha. Next possibility is highest Treynor. If lower than 60, look for highest Sharpe.

75
Q

Why should you focus on standard deviation with a low R2 (squared)?

A

Because a low R2 means the fund isn’t diversified

76
Q

Information Ratio (IR)

A

Expresses portfolio returns above the returns of a benchmark to the volatility of those returns.

77
Q

Difference between excess return and active return

A

Excess (Sharpe) denotes return over the risk-free asset

Active (Information ratio) denotes the return over the benchmark

78
Q

Probability distribution examples

A

Normal
Triangular
Uniform
Lognormal

79
Q

What index is DJIA?

A

Price weighted

80
Q

Dow Theory

A

Contradicts Modern Portfolio Theory and EMH. Based on trends, not day to day.

81
Q

What does Alpha indicate?

A

How the portfolio manager performed relative to a benchmark.

82
Q

Difference between Sharpe and Jensen

A

Sharpe assumes the portfolio is not diversified, while Jensen does and compares the actual return to the expected return and uses Beta coefficient

83
Q

What is not included in a current ratio?

A

Retirement funds and mortgage

84
Q

How do you immunize a bond portfolio?

A

Match the average duration of the bond portfolio to the time horizon.

85
Q

How can volatility be controlled?

A

Buying stocks with low betas or diversifying the portfolio to reduce its weighted beta

86
Q

Under Black/Scholes, what will decrease the value of a call option?

A

Increase in strike price.

87
Q

Valuation model

A

Black/Scholes and Binomial. Prices are established through the action of buyers and sellers.

88
Q

Preferred stock and bonds similarities

A

Both are fixed income securities. Highly correlated since they are price sensitive to interest rate changes.

89
Q

SML vs. CML

A

SML quantifies the risk/return relationship of a single security. CML specifies the relationship between risk/return on a portfolio.

90
Q

What is Beta a measure of?

A

A stock’s systematic risk

91
Q

What should you do if the R2 is high?

A

Select the highest Alpha. If not available, then the highest Treynor number.

92
Q

The Markowitz Model

A

Uses standard deviation as a risk measurement (covariance, correlation coefficient, and return). It does not factor Beta.

93
Q

What do anomalies contradict?

A

Efficient Market Hypothesis, arguing that unexplained situations can occur.

94
Q

Semi-strong form

A

In EMH, suggests that investors with inside information can outperform the market.

95
Q

When is a publicly traded corporation most likely to issue new bonds?

A

When previously issued bonds are selling at a premium, interest rates are expected to rise, and interest rates have fallen.

96
Q

Duration and interest rates relationship

A

Inverse. If interest rates increased, then duration decreased.

97
Q

Bonds with lower coupons

A

Experience a greater relative price fluctuation

98
Q

What does it mean when the zero-coupon bond’s maturity equals its duration?

A

It is the most recommended bond to choose.

99
Q

STRIPS

A

Most often purchased by pension plans because the plan is tax-deferred.

100
Q

PUT feature

A

Able to redeem bonds back at par even when the market price of the bond has declined.

101
Q

T-Bills vs. Treasury Bonds

A

T-Bills have short-term maturities, are not callable, sold at a discount.
Bonds have longer maturities, are callable, and pay interest semiannually.

102
Q

Corporate long-term bond

A

Expected to generate the highest total return when interest rates decline.

103
Q

Benefit of buying a PUT

A

Whatever you paid for is the maximum you could lose.

104
Q

Naked short call

A

There is no limit to the potential loss.

105
Q

Writing

A

Selling the option

106
Q

Nonpublic REITs and Real Estate LPs

A

Not liquid and not marketable for many years.

107
Q

Equity REIT

A

Could provide leverage and a reasonable hedge against inflation.

108
Q

Stock price, Earnings, and Dividend Yield

A

When comparing stocks, you multiply stock price and earnings for each stock. Whichever amount is furthest below earnings will pay a dividend.

109
Q

Best way for a US investor to buy a foreign stock.

A

American Depositary Receipts (ADR)

CFP - Review Wrong answers (7 decks)

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