1
Q
10K vs 10Q
A
A 10K is an annual report of financial statements filed with the SEC. The 10K is audited.
A 10Q is a quarterly reported that is filed with the SEC. The 10Q is not audited.
2
Q
What is initial margin?
A
The initial margin reflects the amount of equity an investor must contribute to enter a margin transaction. * Regulation T set the initial margin at 50% and was established by the Federal Reserve. * The initial margin can be more restrictive based on the volatility of a stock.
3
Q
Initial Margin example
A
To purchase 100 shares of Starbucks trading at $50 per share with an initial margin requirement of 75%, Joe must contribute 100 x $50 x 0.75 = $3,750, and he will borrow $1,250 (100 x $50 x 0.25) from his broker
Assume 50% margin requirement on exam unless otherwise stated
4
Q
What is maintenance margin?
A
The maintenance margin is the minimum amount of equity required before a margin call
5
Q
What is Margin position/example
A
Represents the current equity position of the investor…
Joe bought Starbucks stock when it was at $50 per share, using 75% initial margin. Within two minutes of Joe’s purchase of Starbucks, the price fell to $40 per share. What is Joe’s new margin position?
Margin Position = Equity Fair Market Value Margin Position = ($40.00 - $12.50) $40.00 = 68.75%
Equity = Stock Price - Loan Equity = $40 - ($50 x 0.25)
6
Q
At what price does investor receive margin call?
A
7
Q
How Much Equity Must an Investor Contribute?
A
8
Q
Which research reports primarily rank stocks, bonds, etc.?
A
Value Line.
- Ranks stocks on a scale of 1 to 5 for timeliness and safety. - A ranking of 1 represents the highest rating for timeliness and safety (signal to buy). - A ranking of 5 represents their lowest ranking (signal to sell).
* Morningstar.
- Ranks mutual funds, stocks, and bonds using 1 to 5 stars. - 1 star represents the lowest ranking; 5 stars represents the highest ranking.
9
Q
Who declares dividend dates and how often are they paid?
A
Board of directors, typically quarterly
10
Q
Ex dividend date
A
- The date the stock trades without the dividend.
- If you sell the stock on the ex-dividend date, then you will receive the dividend.
- If you buy the stock on or after the ex-dividend date, then you will NOT receive the dividend.
- The ex-dividend date is one business day before the date of record
11
Q
Date of record
A
- Date of record is the date on which you must be a registered shareholder in order to receive the dividend.
- The date of record is one business day after the ex-dividend date. - An investor must purchase the stock two business days prior to the date of record in order to receive the dividend.
- Purchases made on ex-dividend date will not receive the dividend (ex-date = trades without dividend)
12
Q
When must an investor purchase a stock in order to receive a dividend?
A
Must purchase the stock prior to the ex-dividend date or 2 business days before the date of record.
13
Q
Securities Act of 1933
A
- Regulates the issuance of new securities (Primary Market).
- Requires new issues are accompanied with a prospectus before being purchased.
14
Q
Securities Act of 1934
A
- Regulates the secondary market and trading of securities.
- Created the SEC to enforce compliance with security regulations and laws.
15
Q
Investment Company Act of 1940
A
- Authorized the SEC to regulate investment companies.
- Three types of investment companies: Open, Closed, Unit Investment Trusts.
16
Q
Investment Advisers Act of 1940
A
- Required investment advisors to register with the SEC or state.
17
Q
Securities Investors Protection Act of 1970
A
- Established SIPC to protect investors for losses resulting from brokerage firm failures.
- Does not protect investors from incompetence or bad investment decisions.
- Protects accounts member firms open for clients, regardless of the client’s citizenship.
18
Q
Insider Trading and Securities Fraud Enforcement Act of 1988
A
-Defines an insider as anyone with information that is not available to the public.
- Insiders cannot trade on that information.
19
Q
Treasury Bills
A
- Issued in varying maturities up to 52 weeks.
- Denominations in $100 increments through Treasury Direct up to $5 million per auction. Larger amounts available through a competitive bid.
20
Q
Commercial Paper
A
- Short-term loans between corporations.
- Maturities of 270 days or less and it does not have to register with the SEC.
- Commercial paper has denominations of $100,000 and are sold at a discount.
21
Q
Bankers Acceptance
A
- Facilitates imports/exports.
- Maturities of 9 months or less.
- Can be held until maturity or traded.
22
Q
Eurodollars
A
- Deposits in foreign banks that are denominated in US dollars.
23
Q
Investment Policy Statement Established what?
(RR TTLLU)
A
Risk, Return, Taxes, Time-line, Liquidity, Legal, and Unique circumstances
24
Q
S&P 500
A
- A value-weighted index - incorporates market capitalization of individual stocks into the average.
25
Russell 2000
- A value-weighted index of the smallest market capitalization stocks in the Russell 3000
26
Wilshire 5000
- The broadest index that measures the performance of over 3,000 stocks. The last time the Wilshire 5000 actually contained 5,000 or more stocks was December 2005. The Wilshire 5000 is also a value-weighted index.
27
EAFE
A value-weighted index that tracks stocks in Europe, Australia, Asia (“Australasia”), and the Far East.
28
Affect Heuristic
Deals with judging something, whether it is good or bad. Do they like or dislike some company based on non-financial issues
29
Anchoring
Attaching or anchoring one’s thoughts to a reference point even though there may be no logical relevance or is not pertinent to the issue in question. Anchoring is also known as conservatism or belief perseverance.
30
Availability Heuristic
When a decision maker relies upon knowledge that is readily available in his or her memory, the cognitive heuristic known as “availability” is invoked. This may cause investors to overweight recent events or patterns while paying little attention to longer term trends.
31
Bounded rationality
When individuals make decisions, their rationality is limited by the available information, the tractability of the decision problem, the cognitive limitations of their minds, and the time available to make the decision. Decision-makers in this view act as “satisficers”, seeking a satisfactory solution rather than an optimal one. One consequence of this concept is that having additional information does not lead to an improvement in decision making due to the inability of investors to consider significant amounts of information
32
Confirmation Bias
A commonly used and popular phrase is that “you do not get a second chance at a first impression.”People tend to filter information and focus on information supporting their opinions
33
Cognitive Dissonance
The tendency to misinterpret information that is contrary to an existing opinion or only pay attention to information that supports an existing opinion.
34
Disposition Effect
Also known as Regret Avoidance or “faulty framing” where normal investors do not mark their stocks to market prices. Investors create mental accounts when they purchase stocks and continue to mark their value to purchase prices even after market prices have changed.
35
Familiarity bias
investors tend to over/underestimate risk of investments with which they are familiar/unfamiliar
36
Gambler’s Fallacy
Investors often have incorrect understanding of probabilities which can lead to faulty predictions. Investors may sell stock when it has been successful in consecutive trading sessions because they may not believe the stock is going to continue its upward trend
37
Herding
This cognitive bias is explained just by looking at the word. People tend to follow the masses or the “herd.”
38
Hindsight Bias
Another potential bias for an investor. Hindsight is looking back after the fact is known and assuming they can predict the future as readily as they can explain the past.
39
Illusion of Control Bias
The tendency for people to overestimate their ability to control events; for example, it occurs when someone feels a sense of control over outcomes that they demonstrably do not influence.
40
Overconfidence Bias
Usually concerns an investor that listens mostly to himself or herself, overconfident investors mostly rely on their skills and capabilities to do their own homework or make their own decisions. This effect causes many investors to overstate their risk tolerance.
41
Overreaction
A common emotion towards the receipt of news or information
42
Prospect Theory
Provides that people value gains and losses differently and will base their decisions on perceived gains rather than perceived losses. Investors are “loss averse” and have an asymmetric attitude to gains and losses, getting less utility from gaining, say, $100 than they would lose if they lost $100. This explains why investors may avoid higher risk investments even if they offer strong risk adjusted returns. It also explains why they over insure against risks through low deductibles.
43
Recency
Giving too much weight to recent observations or stimuli; for example, focusing on short-term past performance.
44
Similarity Heuristic
Used when a decision or judgment is made when an apparently similar situation occurs even though the situations may have very different outcomes.
45
Loss aversion
suggests investors prefer avoiding losses more than experiencing gains.
- An unwillingness to sell a losing investment, in the hopes it will turn around.
- In other words, investors feel more pain from losses, than enjoying gains.
46
You own 1,000 shares of ePlace stock. You purchased these shares for $25 per share on margin with a 50% initial margin requirement and a 25% maintenance margin requirement. ePlace has experienced some rever-sals in the pummeling that tech stocks have received recently. The price has dropped to $13 per share. Will there be a margin call? If so, how much?
1,000 shares purchased at $25 with a 50% initial margin, leaves debt of $12,500 (1,000 x $25 = 25,000 x 50% = 12,500[or 12.50 per share]) and the new portfolio value of 1,000 shares at $13 a share equals $13,000 in equity. There is a required 25% , maintenance margin requirement or $3,250 margin ([1,000 shares x $13] x 25%). With only $500 ([$13 - 12.50] x 1,000) remaining equity, there is a required call for $2,750 (3,250 - 500)
47
Standard deviation probability of returns
Memorize the 68, 95 & 99% depending if the return is +/-1, 2 or 3 standard deviations away from the average
48
Calculator steps for standard deviation
-On the HP 10BII or HP10BII+ the + key and the number eight (which has a orange Sx,Sy) will be used
-It’s possible that a CFP® Exam question regarding standard deviation could simply be “Which of the following assets is most risky?” They are
really asking you to calculate standard deviation and select the asset with the higher standard deviation.
49
COEFFICIENT OF VARIATION
50
What is monte carlo simulation
Monte Carlo simulation is a spreadsheet simulation that gives a probabilistic distribution of events occurring. For example, what is the probability of running out of money in retirement with a client who has a withdrawal rate of 3%, 4% or 5%. Monte Carlo simulation then adjusts assumptions and returns the probability of an event occurring depending upon the assumption.
51
What is covariance?
* Covariance is the measure of two securities combined and their interactive risk. In other words, how price movements between two securities are related to each other.
* Covariance is a measure of relative risk.
52
CORRELATION/CORRELATION COEFFICIENT
53
What is Beta?
* The beta coefficient is a measure of an individual security’s volatility relative to that of the market. * Beta is best used to measure the volatility of a diversified portfolio. * It measures systematic risk dependent on the volatility of the security relative to that of the market. - The beta of the market is 1. - A stock with a beta of 1 will be expected to mirror the market in terms of direction, return, and fluctuation.
- A stock beta higher than 1 means the stock fluctuates more than the market and greater risk is associated with that particular security.
- A stock beta of less than one indicates that the security fluctuates less relative to market movements.
* It should also be noted that the greater the beta coefficient of a given security, the greater the systematic risk associated with that particular security.
* Beta is also a measure of systematic risk or market risk, whereas standard deviation is a measure of total risk.
*Beta may also be calculated by dividing the security risk premium by the market risk premium.
54
COEFFICIENT OF DETERMINATION OR R-SQUARED (r2)
* R-squared is a measure of how much return is due to the market or what percentage of a security’s return is due to the market.
* Calculate r-squared (r2) by squaring the correlation coefficient.
R-squared (r2) also provides the investor insight into how well-diversified a portfolio is, because the higher the r-squared, the higher percentage of return from the market (systematic risk) and the less from unsystematic risk.
* R-squared also tells the investor if Beta is an appropriate measure of risk.
* If r-squared is greater than or equal to 0.70, then Beta is an appropriate measure of total risk. If r-squared is less than 0.70, then Beta is not an appropriate measure of total risk and standard deviation should be used to measure total risk.
55
Systematic vs Unsystematic risk
56
Systematic Risks (PRIME)
Purchasing power risk
Reinvestment rate risk
Interest rate risk
Market risk
Exchange rate risk
57
Unsystematic Risks (ABCDEFG)
Accounting risk
Business risk
Country risk
Default risk
Executive risk
Financial risk
Government/regulation risk
58
Capital Market Line
* The Capital Market Line (CML) is the macro aspect of the Capital Asset Pricing Model (CAPM). It specifies the relationship between risk and return in all possible portfolios.
* The CML becomes the new efficient frontier, mixing in the risk-free asset with a diversified portfolio.
* A portfolio’s returns should be on the CML.
* Inefficient portfolios are below the CML.
* The CML is not used to evaluate the performance of a single security.
**The CML formula is no longer on the formula sheet. You may be asked what measure of risk the CML uses, which is standard deviation.
59
Capital Asset Pricing Model CAPM
* The Capital Asset Pricing Model (CAPM) calculates the relationship of risk and return of an individual security using the Beta (b) as its measure for risk.
* The CAPM formula is often referred to as the Security Market Line (SML) equation because its inputs and results are used to construct the SML.
60
SHARPE, TREYNOR, AND ALPHA APPLICATION
* The question becomes “Which risk-adjusted performance measurement is appropriate to use and when?”
* Both Treynor and Alpha use Beta as the measure of risk; therefore, Treynor and Alpha are appropriate risk-adjusted performance indicators when considering a diversified portfolio.
* A portfolio is considered diversified when r-squared is greater than or equal to 0.70. If r-squared is greater than or equal to 0.70 then Beta is a reliable measure of total risk; therefore, Treynor and Alpha are appropriate risk-adjusted performance measures.
* A portfolio is considered not well-diversified when r-squared is less than 0.70. If r-squared is less than 0.70, then Beta is not an appropriate measure of total risk; therefore, standard deviation is an appropriate risk measurement. If standard deviation is an appropriate measure of risk, then using Sharpe as a risk-adjusted measurement is appropriate because Sharpe uses standard deviation as its measure of risk.
61
Summary of performance measures
62
Holding Period Return
63
Holding Period Return (Alternate calc)
64
Net Present Value
NPV = PV of Cash Flows – Initial Cost
**If NPV = 0, then YES make the investment**
65
Arbitrage Pricing Theory
* APT asserts that pricing imbalances cannot exist for any significant period of time; otherwise investors will exploit the price imbalance until the market prices are back to equilibrium.
* APT is a multi-factor model that attempts to explain return based on factors. Anytime a factor has a value of zero, then that factor is has no impact on return.
* APT attempts to take advantage of pricing imbalances. * Inputs are factors (F) such as inflation, risk premium, and expected returns and their sensitivity (b) to those factors.
*
Standard deviation and beta are not inputs variables to the APT. ri = a1 + b1F1 + b2F2 + b3F3 + e
Exam Tip
Don’t memorize the formula, but do make a flashcard of the bullet points above and memorize the keywords: multi factor model, sensitivity to those factors, and STD and Beta are not inputs.
66
RoR/Dividend changes to stock price effects
If the required rate of return decreases, the stock price will increase.
If the dividend is expected to increase, the stock price will increase.
If the required rate of return increases, the stock price will decrease.
If the dividend is expected to decrease, the stock price will decrease.
67
Price to Earnings Ratio
68
Price to Growth Ratio (PEG)
69
Dividend Payout Ratio
70
Dividend Yield
71
Exam tip technical analysis/etc.
t’s not likely that you will need to know the definition of each technical approach, but definitely make a flashcard of what technicians consider in their analysis (Dow Theory, Charting, Market Breadth, etc.) and what Fundamental Analysis considers (financial statement analysis and economic data).
72
Weak form
* Historical information will not help investors achieve above-average market returns. * The weak form rejects technical analysis and asserts that fundamental analysis will help an investor achieve above-average returns.
* Holds that security prices reflect all price and volume data. * Is in direct contradiction with technical analysis, which attempts to predict future pricing based on the study of past pricing and volume patterns.
73
Semi-Strong Form
* The semi-strong theory asserts that both historical and public information will not help investors achieve above-average market returns.
* The semi-strong theory rejects both technical and fundamental analysis but inside information will lead to above-average market returns.
74
Strong Form
* The strong theory asserts that historical, public and private information will not help investors achieve above-average market returns.
* The strong theory suggests that stock prices reflect all available information and react immediately to any new information.
* The strong theory holds that even with inside information the market cannot be out preformed on a consistent basis.
75
Efficient Market Hypothesis Summary
76
Nonmarketable US Treasury Issues
77
Treasury BILLS
- T-bills have maturities less than 1 year.
- T-bills are sold on a discounted yield basis, which simply means they do not pay interest; the bonds just mature at par value.
78
Treasury BONDS
- Bonds have maturities greater than 10 years.
- Interest is paid semi-annually
79
Treasury NOTES
- Notes have maturities between 2 and 10 years.
- Interest is paid semi-annually.
80
Original Issue Discount (OID)
81
Treasury Inflation Protected Securities (TIPS)
82
Separate Trading of Registered Interest and Principal Securities (STRIPS)
* The periodic coupon payments are separated from the bond and each coupon payment, including the par value, trade separately.
* Essentially treasury STRIPS create zero-coupon bonds.
* STRIPS are highly liquid and appropriate for investors looking for a low risk, highly liquid investment, and with a specific time horizon.
83
General Obligation Bonds
General obligation bonds are backed by the full faith, credit, and taxing authority of the municipality that issued the bond.
84
Revenue Bonds
* Revenue bonds are backed by the revenue of a specific project.
* Revenue bonds are NOT backed by the full faith, credit, and taxing authority of the entity that issued the bond.
85
Private Activity Bonds
Private activity bonds are used to finance construction of stadiums.
86
Insured Municipal Bonds
* The following companies insure municipal bonds: - American Municipal Bond Assurance Corp. (AMBAC) - Municipal Bond Insurance Association Corp. (MBIA)
* If an insured municipal bond is in default, the insurance company will pay the interest and principal amounts.
87
Fixed Income RISKS
88
CFPAndrewLee
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