Investments Flashcards
1
Q
Unsystematic risk
A
Also known as diversifiable risk or non-systematic risk
Ex: business risk or financial risk
2
Q
Business risk
A
- refers to the nature of the firm’s operations
-ex: possibility of loss due to new technology - a type of nonsystematic risk
3
Q
Financial risk
A
- refers to how the firm finances its assets
-ex: possibility of loss due to heavy debt financing - a type of nonsystematic risk
4
Q
Systematic risk
A
- also know as non-diversifiable risk
- the part of risk that is inescapable because no matter how well an investor diversifies, the risk of the overall market cannot be avodied
5
Q
Purchasing power risk
A
Type of systematic risk
Loss of purchasing power through inflation
6
Q
Reinvestment rate risk
A
Type of systematic risk
Risk that proceeds available for reinvestment must be reinvested at a lower interest rate than the instrument that generated the proceeds
7
Q
Interest rate risk
A
Type of systematic risk
Risk that a change in interest rate will cause the market value of the fixed income security to fall
8
Q
Market risk
A
Type of systematic risk
Risk of the overall market
9
Q
Exchange rate risk
A
Type of systematic risk
Risk associated with changes in the value of currency
10
Q
FDIC insured amounts (per bank/per type of account)
A
Individual- $250k
Joint- $250k
Trust (per beneficiary)- $250k
IRA/Keogh- $250k
11
Q
The yield ladder
A
Discounted bonds-yield higher than coupon
Y- yield to call
M- yield to maturity
C- current yield
A- nominal yield (annual coupon rate)
C- current yield
M- yield to maturity
Y- yield to call
Premium bonds- yields lower than coupon
12
Q
EE bonds
A
- non-marketable, nontransferable, cannot be used for collateral
- sold at face value
- interest rate based on the 10 year treasury note yields
- fixed interest rate that is in effect at time of purchase
- subject to federal taxation when redeemed (unless used as education bonds)
- not subject to state or local taxes
13
Q
I bonds
A
- non-marketable, nontransferable, cannot be used for collateral
- sold at face value
- interest rate is composed of 2 parts:
- Fixed base rate (remains same for
life of bond) - Inflation adjustment (adjusted
every 6 months)
- Fixed base rate (remains same for
- subject to federal taxation when redeemed (unless used as education bonds)
- not subject to state or local taxes
14
Q
General obligation bonds
A
- Type of municipal security
- Also known as GO bonds
- Backed by the full faith, credit, and taxing power of the issuer
- Generally considered the safest type of municipal credit
15
Q
Revenue bonds
A
- type of municipal security
- backed by a specific source of revenue to which the full faith and credit of the issuer is not pledged
- since they are backed by a single source of funds (like toll roads, hospitals, nuclear power plants), they have greater credit risk than GO bonds
- they trade at higher yields
16
Q
Insurer municipal bonds
A
- type of municipal security
- the insurers pay timely interest and principal when the issuer is in default
They are:
- AMBAC- American municipal bond assurance corp
- MBIA- municipal bond insurance association corp
17
Q
Indenture agreement covers
A
- form of bond
- amount of issue
- property pledged
- protective covenant, including any provisions for a sinking fund
- working capital and current ratio
- redemption rights, call, put or conversion provisions
18
Q
Default risk for corporate and municipal bonds
A
A creditor may seize the collateral and sell it to recoup the principal
19
Q
Reinvestment risk for corporate and municipal bonds
A
As payments are received from an investment, interest rates fall. When the funds are reinvested, the investor receives a lower yield
20
Q
Interest rate risk for corporate and municipal bonds
A
Rising interest rates may cause bond prices to fall
21
Q
Purchasing power risk for corporate and municipal bonds
A
Inflation may lower the value of the bond interest payments and principal repayments, thereby forcing prices to fall
22
Q
Government bonds have
A
RIP
- reinvestment risk
- interest rate risk
- purchasing power risk
No default or credit risk
23
Q
Capitalization market of company
A
- Large- market value exceeds $10 billion
- Mid- market value between $2-10 billion
- Small- market value less than $2 billion
- Micro- market value less than $300 million
24
Q
American Depository Receipt
A
- also known as ADR
- prices are quoted in US dollars
- dividend paid in US dollars
- dividend declared in foreign currency
Attain diversification and risk reduction due to lower correlation of foreign securities with US securities
25
Real estate (land-improved) (NOI)
- improved land is normally income producing
- this includes residential rental, commercial and industrial properties
- the intrinsic value of real estate property can be computed using net operating income (NOI) computation
26
Net operating income (NOI) calculation
Gross rental receipts
+ nonrental income (laundry, etc.)
= potential gross income (PGI)
- vacancy and collection losses
- operating expenses (excluded interest and depreciation)
= net operating income (NOI)
27
Intrinsic value
The minimum price the option will command as an option
It is the difference between the market price and exercise price of the stock
28
Exercise price
(Strike price)
The price at which the stock can be purchased or sold on exercise of the option
29
Premium
Market price of the option
As the option approaches its expiration date, the market price of the option (the premium) approaches its intrinsic value
IV + TV = Premium
30
Time premium
The amount the market price of an option exceeds its intrinsic value
31
Call options- taxability
At time of purchase: non-deductible capital expenditure
1. To the writer due to lapse: premium paid is ST gain
2. To the writer due to exercise: premium paid is added to sale price (can be LT gain if held more than 12 months otherwise it’s ST gain). Covered call
3. To the holder: if option is not exercised, the option is considered sold (expires) and is a ST loss. Option period is 9 months or less
32
Straddle
Buying a put and buying a call
The buyer does not own the stock
33
Collar
Sells a call (out of the money) at one strike price and buys a put at a lower strike price
Investor owns the stock
34
Protective Put
Buying a stock (or owning it already) and a put for the stock serving as insurance against the declining underlying stock
* usually a good answer for the exam
35
Warrants
- issued by corporations
- typically have maturities of several years
- not standardized
36
Calls
- created by individuals
- standardized
37
Long commodity positions
Future contracts
Owner needs a short hedge and will sell a futures contracts
38
Short commodity postion
Futures contract
Owner (like a company) needs a long hedge and will buy a futures contract
39
Reg D accredited investor
- unlimited
- net worth of $1,000,000, or
- individual with annual income of $200,000
- couple with joint income of $300,000
40
Reg D non-accredited investor
- sold to a maximum of 35 investors
- must use a purchaser representative if not “sophisticated”
41
Coefficient of determination R2
- the square of the correlation coefficient measuring the proportion of the variation in one variable explained by the movement of the other variable
- it describes the percentage of a fund’s movement that are explained by the movements in the S&P 500 index
- index funds/diversified will have R2 close to 100%
- sector funds will have low R2 typically 5-25%
42
Standard deviation
Measures variability of returns used in a non-diversified portfolio and is a measure of total risk
43
Beta
An index of volatility used in a diversified portfolio and is a measure of systematic risk
44
Geometric return or time weighted return
Evaluated the performance of the portfolio manager
45
IRR or dollar weighted return
Compare absolute dollar amounts
46
Real rate of return
The inflation adjusted interest rate
The nominal rate of return adjusted for inflation
47
Nominal rate return
Actual returns not adjusted for inflation
48
Holding period return
(HPR)
Total return is (income+ price appreciation and dividends- margin interest) over the entire period divided by the out of pocket cost of investment
Total return ➗ out of pocket cost of investment
49
Taxable Equivalents Yield (TEY)
To make the returns on municipal bonds comparable to those of taxable bonds we use this calculation:
TEY= tax exempt yield➗1-margin tax rate
Tax exempt yield= TEY ✖️(1-marginal tax rate)
50
Duration
- years to maturity: duration and maturity are positively related
- annual coupon: duration is inversely related to coupon rate
- YTM, the current yield on comparative bonds: duration is inversely related
coupon and yield are INterest rates (INversely related)
51
Zero coupon bonds
- duration = maturity
- no coupon interest, yet produces “phantom” income
- no reinvestment rate risk
- sold at a deep discount to par
- fluctuate more than coupon bonds with same maturities
52
Using duration to manage bond portfolios
If interest rates are expected to rise, shorten duration
- UPS- interest rates UP, Shorten duration
- buy high coupon bonds with short maturities
If interest rates are expected to fall, lengthen duration
- FALLEN- FAL for fall, LEN for lengthen
- buy low coupon bonds with long maturities
53
Conclusions to fluctuation in bond prices
- smaller the coupon, the greater the relative price fluctuation
- longer the term to maturity, the greater the relative price fluctuation
- lower the market interest rate, greater the relative price fluctuation
54
Convexity
- the degree to which duration changes as the yield to maturity changes
- largest for low coupon bonds, long maturity bonds, and low yield to maturity bonds
- allows investor to improve the duration approximation for bond prices
55
Return on Equity
(ROE)
EPS➗common equity
EPS- earnings available for common
Common equity- net worth or book value
56
Dividend payout ratio
Common dividend paid➗ EPS
EPS- earning available for common
57
Strong form- efficient market hypothesis (EMH)
- asserts that stock prices fully reflect all information public or private. Not even access to insider information can be expected to result in superior investment performance over time
- neither fundamental analysis nor technical analysis can produce superior results over time on a risk adjusted basis
58
Semi strong form- efficient market hypothesis (EMH)
- asserts that all publicly known information is reflected in stock prices
- neither technical analysis nor fundamental analysis can produce superior results over time on a risk adjusted basis
- only an investor with access to insider information may consistently achieve superior results (but this is illegal)
59
Weak form- efficient market hypothesis (EMH)
- suggest historical price data is already reflected in current stock prices and is of no value in predicting future price changes
- technical analysis will not produce superior results
- fundamental analysis may produce superior results
60
Dow Jones
- 30 industry stocks
- price weighted
61
S&P 500
- broader measure of NYSE
- float weighted
62
Russell 2000
- smallest 2000 stocks in the Russell 3000 index
- cap weighted
63
Wilshire 5000
- broadest measure of the activity and movement of the overall stock market
- value weighted
64
Value line
- +/- 1,700 stocks
- equally weighted
65
NASDAQ
- broadest measure of OTC trading
- cap weighted
66
Europe, Australia, and Far East
(EAFE)
-equity performance of the major foreign markets
-valued weighted
67
Barclay’s Aggregate Bond
Tracks performance of more than 5000 US government corporate, mortgage backed and asset backed bonds
68
First in, First out- tax basis of mutual fund
Shares acquired first as being sold firdt
69
Specific ID- tax basis of mutual fund
- requires the seller to identify the shares of the fund that are sold
- allows investor to create gain, neutralize gain or create a loss (most flexible)
70
Average cost method- tax basis of mutual funds
Allows investor to divide the total cost of all shares held by the number of shares held
71
Sharpe
- risk adjusted measures of performance
1. look for low R2 (less than 60) or non-diversified portfolio
2. look for highest sharpe number
72
Jensen (alpha)/treynor
risk adjusted measures of performance
1. Look for high R2 (60+) or diversified portfolio
2. Look for highest positive alpha, if no alpha given then look for the highest treynor number
73
Margin (maintenance) call
Formula for calculating when an investor will receive a margin call:
(1- initial margin percentage ➗1-maintenance margin percentage) ✖️purchase price of stock
Shortcut: 2/3 of purchase price if minimum maintenance is 25%. If minimum maintenance is 30% take 2/3 and choose next highest number
74
Passive investment strategies
- buy and hold (EMH)
- dollar cost averaging
- index investing
- strategic asset allocation (revise every few years)
75
Active investment strategies
- market timing
- tactical asset allocation
- technical analysis
76
Arbitrage Pricing Theory (APT)
- unexpected inflation
- unexpected change in industrial production
- unanticipated shifts in risk premium
- unanticipated changes in structure of yields
77
Bond rating companies
S&P
Moody’s
78
GNMAs
- if mortgage rates decrease, prepayment may increase
- the amount received each month can vary
- the certificates are guaranteed by the US government
- payments include interest and principal
- the realized yield on the bonds can be somewhat variable
79
UITs
- self liquidate
- can trade on the secondary market
- do not have continuous offering and redemption
- not actively managed- once created no new securities are purchased and portfolio securities are rarely sold
80
ETFs are most similar to
Mostly an open end fund but could be a closed end fund
81
“Shares are purchased and redeemed directly with the issuer”
Open end fund and no load balanced mutual fund
82
Put- in the money
Market price is less than exercise price
83
Seller of a naked call
Has unlimited loss potential
84
Beta risks
- volatility
- systematic risk
85
Standard deviation risk
- non systematic risk
- unsystematic risk
- total risk
86
Coefficient of variation (CV)
Standard deviation ➗ average return
- lower CV, less risky
- higher CV, more risky
87
Negative correlation coefficient
- will reduce portfolio risk
- will make beta negative
88
Covariance and correlation coefficient
- direct relationship
- negatively correlated = decrease in covariance
89
Treasury securities risk
- purchasing power risk
- do not have marketability risk
90
Examples of exchange rate risk
- revaluation
- devaluation
91
Treasuries after tax rate of return calculation
Treasury bond pay % ✖️ (1-federal tax in decimals)
Treasuries are not subject to state or city taxes
92
Geometric return calculation
1. Set percentages to 1+/- decimal form
2. Multiply all the numbers from step 1
3. PV= -1 always
FV = step 2 answer
N= number of years
I= solve
93
Pretax yield on corporate bonds compared to muni bond calculations
1. (Interest ✖️ 2 if semiannual)➗1,000
2. Answer from step 1 ➗ 1- marginal tax
94
Holding period return calculation- interest
If any indication that stock was sold under a year when margin interest give an annual number, interest must be recalculated (ex to quarterly)
95
Holding period return and how much a client makes in dollars
1. Find out how much interest client makes on margin (if quarterly set to 4 p/yr)
- PV = amount on margin account
- N = when they sell stock
- FV = solve
2. Selling price - (margin + FV answer) - margin
96
Duration and maturity
Are positively correlated
97
Price/Earnings calculation
P/E ratio x earnings per share
98
Constant growth dividend model
Dividend(1+growth rate of dividend) ➗ (required rate of return - growth rate of dividend)
99
Bond duration calculation
- duration (change in interest rate ➗ 1+ yield to maturity)
100
Dividend payout calculation
Common dividend paid➗EPS
or
Dividend➗ required rate of return = zero growth model
101
Stock yield calculation
Dividend ➗ closing price
102
Zero coupon bonds
- duration = maturity
- most volatile
103
Short duration bonds
- least affected by interest rate change
- = short maturity
- higher coupon
104
Long duration bonds
- more affected by interest rate change
- = long maturity
- lower coupon
105
Capital market line
(CML)
Specifies the relationship between risk and return on a variable weighted market portfolio consisting of all risky assets
106
Examples of probability distributions
- normal
- triangular
- uniform
- lognormal
107
Price weighted index
DJIA
108
Sharpe ratio assumption
Assumes the portfolio is not diversified
Standard deviation
109
Jensen ratio (alpha)
- assumes the portfolio is well diversified
- compares actual return to expected return
- standardizes performance by the portfolio’s beta
110
Financial ratio usefulness
Most useful- several ratios with the same industry over time
111
Portfolio correlation and risk
- more correlated investments in portfolio are, the greater the risk the portfolio carries
- diversifying helps reduce risk
Ex: S&P500 and Russell 2000 have a higher correlation (more risk) than S&P500 and EAFE- more diversified so less risk
112
Portfolio immunization
- passive investment strategy
- protects against interest rate volatility (reduced interest rate risk)
- neutralized (immunized) if the duration of the portfolio is made equal to the time horizon
113
Arbitrage pricing theory (APT)- factor is 0
When factor is 0 there is expected value
APT focuses on unexpected and unanticipated
114
Binomial option pricing and black-scholes option pricing
Valuation models
Use valuation models to estimate what prices should be
115
Investments with highest correlation
- preferred stocks and bonds
- fixed income
- both sensitive to interest rate risk
116
Beta measures
A stock’s systematic risk
117
Standard deduction measures
Total risk
118
Variables for the Markowitz model
- covariance
- correlation coefficient
- standard deviation
- return
Not beta
119
Public corporation would most likely issue new bonds when
- previously issued bonds are selling at a premium
- when interest rates are expected to rise
- when interest rates have fallen
120
Yield curve upward movement
When a yield curve moves up, that means interest rates increase. Interest rates and duration have an inverse relationship. So when interest rates increase, duration decreases
121
Term and duration for zero coupon bonds
Equal
122
Lower coupon =
Greater price fluctuation
123
Put feature
Allows the investor to redeem bonds back to the issuer at par even when the market price of the bond has declined
124
What bonds to own when interest rested decline
Long term bonds
125
Bond feature that is beneficial when interest rates rise
- put feature
- when inflation increases, bond price decreases
- this allows the investor to redeem the bond before maturity
126
Buying a put loss potential
Loss is limited to the amount it was purchase for (premium value)
127
Current yield calculation
Total income ➗ total market value
128
Gross profit percentage calculation
Income + (market value - basis) ➗basis
Market value - basis is the growth
129
Current tax equivalent yield
1. Coupon rate ➗ current worth of bond
2. Step 1 answer percentage ➗ 1-marginal tax rate
130
Outstanding bond prices
- have an inverse relationship with interest rates
-Interest rates fall, outstanding bond price will rise
-Interest rate rise, outstanding bond will fall
131
I bond and education expenses
Can be used for education expenses if certain requirements are met and will be redeemed tax free for those expenses
132
10k
Annual report from corporate management to the SEC
133
10Q
Quarterly reports from corporate management to the SEC
134
High beta
- more volatile
- irregular growth and fluctuating income
135
Yield curves reflect
- debt instruments with the same tax status and quality
- they do not illustrate coupon or nominal rates
136
FNMAs
- agency securities
- not treasury securities and therefore not guaranteed by the US government
137
UITs units
After the initial units are sold, no new units are issued. They are tradable
Mutual funds continuously issue new shares
138
Writer of a call- lapse
Due to lapse, the premium is a short term gain to the seller (writer) of the option
139
Lognormal distributions
Reflect possible ending portfolio values
140
Conversion value calculation
(Par ➗ convertible price) ✖️common stock price
141
Stock split
- does not change the value of the investor’s position
- when large number is first- share increases while stock price decreases
142
Change in bond price
Use -D (interest rate change ➗ 1+ YTM)
143
TEY- state and local tax
If you are a resident of the state of issuance then you do not pay state or local tax
144
Warrants and the underlying security
You do not need to surrender the underlying security
They may be separated from the underlying security and traded individually
145
Anticipated value calculation
Estimated earnings ✖️P/E
146
Breaking through resistance level
Bullish
Go on to new high prices
147
Geometric mean
AKA time weighted return
Measures change of wealth over multiple periods
148
Limit order
- transaction waits for acceptable price
- executed at limit price or “better”
- possibility of never executing
149
Stop loss
Activated a limit order when the market reaches the stop price
150
Book value per share
Book value ➗ shares outstanding
Can be part of ROE equation
151
Bullets
Investor chooses bonds that all mature at the same time
152
Earnings per share
After tax profits ➗number of shares outstanding
153
Par value
- face value of a share of stock as listed on a stock certificate and on issuer’s books
- for accounting purposes only
- does not reflect market value
154
Book value
- accounting term for company’s net worth
- assets - liabilities
- amount of stockholder’s equity in a firm
155
Growth company dividends
- generally reinvest their earnings
- dividends are usually small or non declared
156
Negotiable CD risks
- interest rate risk
- reinvestment rate risk
157
GICs risks
- purchasing power risk (inflation risk)
- reinvestment rate risk
158
Change in bond value
Use -D duration equation
159
Equation when there is no dividend
EPS ✖️PE current market price
160
Correlation coefficient and portfolio risk
1. Add up both risks and divide by 2
2. If correlation coefficient is less than +1, pick next lower number
3. If correlation coefficient is more than +1, pick next higher number
161
Coefficient of Variation
Standard deviation ➗ expected return
Lower CV, less risky
Higher CV, more risky
162
DDM
Dividend(1+growth rate)➗
required rate of return - growth rate
163
Market premium
Rm - Rf
If you see this, just input market premium
164
Price/Earnings Ratio
(P/E Ratio)
Current market price ➗ earnings
165
NPV
Its calculation discounts unequal cash flows at a required rate of return less the initial cost of an investment
Tells us whether the client achieved their required rate of return, not the amount of the profit.
Should factor both positive and negative entires. An investment can be profitable even if it’s NPV is negative
166
Market Premium
(Rm - Rf)
167
Stock premium
(Rm - Rf)Beta
