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Investments Flashcards

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1
Q

Unsystematic risk

A

Also known as diversifiable risk or non-systematic risk

Ex: business risk or financial risk

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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
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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
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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
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5
Q

Purchasing power risk

A

Type of systematic risk

Loss of purchasing power through inflation

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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

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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

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8
Q

Market risk

A

Type of systematic risk

Risk of the overall market

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9
Q

Exchange rate risk

A

Type of systematic risk

Risk associated with changes in the value of currency

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10
Q

FDIC insured amounts (per bank/per type of account)

A

Individual- $250k
Joint- $250k
Trust (per beneficiary)- $250k
IRA/Keogh- $250k

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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

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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
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13
Q

I bonds

A
  • non-marketable, nontransferable, cannot be used for collateral
  • sold at face value
  • interest rate is composed of 2 parts:
    1. Fixed base rate (remains same for
      life of bond)
    2. Inflation adjustment (adjusted
      every 6 months)
  • subject to federal taxation when redeemed (unless used as education bonds)
  • not subject to state or local taxes
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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
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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
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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

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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
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18
Q

Default risk for corporate and municipal bonds

A

A creditor may seize the collateral and sell it to recoup the principal

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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

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20
Q

Interest rate risk for corporate and municipal bonds

A

Rising interest rates may cause bond prices to fall

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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

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22
Q

Government bonds have

A

RIP
- reinvestment risk
- interest rate risk
- purchasing power risk

No default or credit risk

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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
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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

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25
Q

Real estate (land-improved) (NOI)

A
  • 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
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26
Q

Net operating income (NOI) calculation

A

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)

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27
Q

Intrinsic value

A

The minimum price the option will command as an option

It is the difference between the market price and exercise price of the stock

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28
Q

Exercise price
(Strike price)

A

The price at which the stock can be purchased or sold on exercise of the option

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29
Q

Premium

A

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

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30
Q

Time premium

A

The amount the market price of an option exceeds its intrinsic value

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31
Q

Call options- taxability

A

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
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32
Q

Straddle

A

Buying a put and buying a call

The buyer does not own the stock

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33
Q

Collar

A

Sells a call (out of the money) at one strike price and buys a put at a lower strike price

Investor owns the stock

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34
Q

Protective Put

A

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
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35
Q

Warrants

A
  • issued by corporations
  • typically have maturities of several years
  • not standardized
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36
Q

Calls

A
  • created by individuals
  • standardized
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37
Q

Long commodity positions

A

Future contracts

Owner needs a short hedge and will sell a futures contracts

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38
Q

Short commodity postion

A

Futures contract

Owner (like a company) needs a long hedge and will buy a futures contract

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39
Q

Reg D accredited investor

A
  • unlimited
  • net worth of $1,000,000, or
  • individual with annual income of $200,000
  • couple with joint income of $300,000
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40
Q

Reg D non-accredited investor

A
  • sold to a maximum of 35 investors
  • must use a purchaser representative if not “sophisticated”
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41
Q

Coefficient of determination R2

A
  • 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%
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42
Q

Standard deviation

A

Measures variability of returns used in a non-diversified portfolio and is a measure of total risk

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43
Q

Beta

A

An index of volatility used in a diversified portfolio and is a measure of systematic risk

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44
Q

Geometric return or time weighted return

A

Evaluated the performance of the portfolio manager

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45
Q

IRR or dollar weighted return

A

Compare absolute dollar amounts

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46
Q

Real rate of return

A

The inflation adjusted interest rate

The nominal rate of return adjusted for inflation

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47
Q

Nominal rate return

A

Actual returns not adjusted for inflation

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48
Q

Holding period return
(HPR)

A

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

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49
Q

Taxable Equivalents Yield (TEY)

A

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)

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50
Q

Duration

A
  • 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)

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51
Q

Zero coupon bonds

A
  • 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
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52
Q

Using duration to manage bond portfolios

A

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

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53
Q

Conclusions to fluctuation in bond prices

A
  • 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
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54
Q

Convexity

A
  • 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
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55
Q

Return on Equity
(ROE)

A

EPS➗common equity

EPS- earnings available for common
Common equity- net worth or book value

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56
Q

Dividend payout ratio

A

Common dividend paid➗ EPS

EPS- earning available for common

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57
Q

Strong form- efficient market hypothesis (EMH)

A
  • 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
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58
Q

Semi strong form- efficient market hypothesis (EMH)

A
  • 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)
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59
Q

Weak form- efficient market hypothesis (EMH)

A
  • 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
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60
Q

Dow Jones

A
  • 30 industry stocks
  • price weighted
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61
Q

S&P 500

A
  • broader measure of NYSE
  • float weighted
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62
Q

Russell 2000

A
  • smallest 2000 stocks in the Russell 3000 index
  • cap weighted
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63
Q

Wilshire 5000

A
  • broadest measure of the activity and movement of the overall stock market
  • value weighted
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64
Q

Value line

A
  • +/- 1,700 stocks
  • equally weighted
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65
Q

NASDAQ

A
  • broadest measure of OTC trading
  • cap weighted
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66
Q

Europe, Australia, and Far East
(EAFE)

A

-equity performance of the major foreign markets
-valued weighted

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67
Q

Barclay’s Aggregate Bond

A

Tracks performance of more than 5000 US government corporate, mortgage backed and asset backed bonds

68
Q

First in, First out- tax basis of mutual fund

A

Shares acquired first as being sold firdt

69
Q

Specific ID- tax basis of mutual fund

A
  • 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
Q

Average cost method- tax basis of mutual funds

A

Allows investor to divide the total cost of all shares held by the number of shares held

71
Q

Sharpe

A
  • risk adjusted measures of performance
  1. look for low R2 (less than 60) or non-diversified portfolio
  2. look for highest sharpe number
72
Q

Jensen (alpha)/treynor

A

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
Q

Margin (maintenance) call

A

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
Q

Passive investment strategies

A
  • buy and hold (EMH)
  • dollar cost averaging
  • index investing
  • strategic asset allocation (revise every few years)
75
Q

Active investment strategies

A
  • market timing
  • tactical asset allocation
  • technical analysis
76
Q

Arbitrage Pricing Theory (APT)

A
  • unexpected inflation
  • unexpected change in industrial production
  • unanticipated shifts in risk premium
  • unanticipated changes in structure of yields
77
Q

Bond rating companies

A

S&P
Moody’s

78
Q

GNMAs

A
  • 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
Q

UITs

A
  • 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
Q

ETFs are most similar to

A

Mostly an open end fund but could be a closed end fund

81
Q

“Shares are purchased and redeemed directly with the issuer”

A

Open end fund and no load balanced mutual fund

82
Q

Put- in the money

A

Market price is less than exercise price

83
Q

Seller of a naked call

A

Has unlimited loss potential

84
Q

Beta risks

A
  • volatility
  • systematic risk
85
Q

Standard deviation risk

A
  • non systematic risk
  • unsystematic risk
  • total risk
86
Q

Coefficient of variation (CV)

A

Standard deviation ➗ average return

  • lower CV, less risky
  • higher CV, more risky
87
Q

Negative correlation coefficient

A
  • will reduce portfolio risk
  • will make beta negative
88
Q

Covariance and correlation coefficient

A
  • direct relationship
  • negatively correlated = decrease in covariance
89
Q

Treasury securities risk

A
  • purchasing power risk
  • do not have marketability risk
90
Q

Examples of exchange rate risk

A
  • revaluation
  • devaluation
91
Q

Treasuries after tax rate of return calculation

A

Treasury bond pay % ✖️ (1-federal tax in decimals)

Treasuries are not subject to state or city taxes

92
Q

Geometric return calculation

A
  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
Q

Pretax yield on corporate bonds compared to muni bond calculations

A
  1. (Interest ✖️ 2 if semiannual)➗1,000
  2. Answer from step 1 ➗ 1- marginal tax
94
Q

Holding period return calculation- interest

A

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
Q

Holding period return and how much a client makes in dollars

A
  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
Q

Duration and maturity

A

Are positively correlated

97
Q

Price/Earnings calculation

A

P/E ratio x earnings per share

98
Q

Constant growth dividend model

A

Dividend(1+growth rate of dividend) ➗ (required rate of return - growth rate of dividend)

99
Q

Bond duration calculation

A
  • duration (change in interest rate ➗ 1+ yield to maturity)
100
Q

Dividend payout calculation

A

Common dividend paid➗EPS

or

Dividend➗ required rate of return = zero growth model

101
Q

Stock yield calculation

A

Dividend ➗ closing price

102
Q

Zero coupon bonds

A
  • duration = maturity
  • most volatile
103
Q

Short duration bonds

A
  • least affected by interest rate change
  • = short maturity
  • higher coupon
104
Q

Long duration bonds

A
  • more affected by interest rate change
  • = long maturity
  • lower coupon
105
Q

Capital market line
(CML)

A

Specifies the relationship between risk and return on a variable weighted market portfolio consisting of all risky assets

106
Q

Examples of probability distributions

A
  • normal
  • triangular
  • uniform
  • lognormal
107
Q

Price weighted index

A

DJIA

108
Q

Sharpe ratio assumption

A

Assumes the portfolio is not diversified

Standard deviation

109
Q

Jensen ratio (alpha)

A
  • assumes the portfolio is well diversified
  • compares actual return to expected return
  • standardizes performance by the portfolio’s beta
110
Q

Financial ratio usefulness

A

Most useful- several ratios with the same industry over time

111
Q

Portfolio correlation and risk

A
  • 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
Q

Portfolio immunization

A
  • 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
Q

Arbitrage pricing theory (APT)- factor is 0

A

When factor is 0 there is expected value

APT focuses on unexpected and unanticipated

114
Q

Binomial option pricing and black-scholes option pricing

A

Valuation models

Use valuation models to estimate what prices should be

115
Q

Investments with highest correlation

A
  • preferred stocks and bonds
  • fixed income
  • both sensitive to interest rate risk
116
Q

Beta measures

A

A stock’s systematic risk

117
Q

Standard deduction measures

A

Total risk

118
Q

Variables for the Markowitz model

A
  • covariance
  • correlation coefficient
  • standard deviation
  • return

Not beta

119
Q

Public corporation would most likely issue new bonds when

A
  • previously issued bonds are selling at a premium
  • when interest rates are expected to rise
  • when interest rates have fallen
120
Q

Yield curve upward movement

A

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
Q

Term and duration for zero coupon bonds

A

Equal

122
Q

Lower coupon =

A

Greater price fluctuation

123
Q

Put feature

A

Allows the investor to redeem bonds back to the issuer at par even when the market price of the bond has declined

124
Q

What bonds to own when interest rested decline

A

Long term bonds

125
Q

Bond feature that is beneficial when interest rates rise

A
  • put feature
  • when inflation increases, bond price decreases
  • this allows the investor to redeem the bond before maturity
126
Q

Buying a put loss potential

A

Loss is limited to the amount it was purchase for (premium value)

127
Q

Current yield calculation

A

Total income ➗ total market value

128
Q

Gross profit percentage calculation

A

Income + (market value - basis) ➗basis

Market value - basis is the growth

129
Q

Current tax equivalent yield

A
  1. Coupon rate ➗ current worth of bond
  2. Step 1 answer percentage ➗ 1-marginal tax rate
130
Q

Outstanding bond prices

A
  • have an inverse relationship with interest rates

-Interest rates fall, outstanding bond price will rise
-Interest rate rise, outstanding bond will fall

131
Q

I bond and education expenses

A

Can be used for education expenses if certain requirements are met and will be redeemed tax free for those expenses

132
Q

10k

A

Annual report from corporate management to the SEC

133
Q

10Q

A

Quarterly reports from corporate management to the SEC

134
Q

High beta

A
  • more volatile
  • irregular growth and fluctuating income
135
Q

Yield curves reflect

A
  • debt instruments with the same tax status and quality
  • they do not illustrate coupon or nominal rates
136
Q

FNMAs

A
  • agency securities
  • not treasury securities and therefore not guaranteed by the US government
137
Q

UITs units

A

After the initial units are sold, no new units are issued. They are tradable

Mutual funds continuously issue new shares

138
Q

Writer of a call- lapse

A

Due to lapse, the premium is a short term gain to the seller (writer) of the option

139
Q

Lognormal distributions

A

Reflect possible ending portfolio values

140
Q

Conversion value calculation

A

(Par ➗ convertible price) ✖️common stock price

141
Q

Stock split

A
  • does not change the value of the investor’s position
  • when large number is first- share increases while stock price decreases
142
Q

Change in bond price

A

Use -D (interest rate change ➗ 1+ YTM)

143
Q

TEY- state and local tax

A

If you are a resident of the state of issuance then you do not pay state or local tax

144
Q

Warrants and the underlying security

A

You do not need to surrender the underlying security

They may be separated from the underlying security and traded individually

145
Q

Anticipated value calculation

A

Estimated earnings ✖️P/E

146
Q

Breaking through resistance level

A

Bullish

Go on to new high prices

147
Q

Geometric mean

A

AKA time weighted return

Measures change of wealth over multiple periods

148
Q

Limit order

A
  • transaction waits for acceptable price
  • executed at limit price or “better”
  • possibility of never executing
149
Q

Stop loss

A

Activated a limit order when the market reaches the stop price

150
Q

Book value per share

A

Book value ➗ shares outstanding

Can be part of ROE equation

151
Q

Bullets

A

Investor chooses bonds that all mature at the same time

152
Q

Earnings per share

A

After tax profits ➗number of shares outstanding

153
Q

Par value

A
  • 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
Q

Book value

A
  • accounting term for company’s net worth
  • assets - liabilities
  • amount of stockholder’s equity in a firm
155
Q

Growth company dividends

A
  • generally reinvest their earnings
  • dividends are usually small or non declared
156
Q

Negotiable CD risks

A
  • interest rate risk
  • reinvestment rate risk
157
Q

GICs risks

A
  • purchasing power risk (inflation risk)
  • reinvestment rate risk
158
Q

Change in bond value

A

Use -D duration equation

159
Q

Equation when there is no dividend

A

EPS ✖️PE current market price

160
Q

Correlation coefficient and portfolio risk

A
  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
Q

Coefficient of Variation

A

Standard deviation ➗ expected return

Lower CV, less risky
Higher CV, more risky

162
Q

DDM

A

Dividend(1+growth rate)➗
required rate of return - growth rate

163
Q

Market premium

A

Rm - Rf

If you see this, just input market premium

164
Q

Price/Earnings Ratio
(P/E Ratio)

A

Current market price ➗ earnings

165
Q

NPV

A

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
Q

Market Premium

A

(Rm - Rf)

167
Q

Stock premium

A

(Rm - Rf)Beta

CFP (6 decks)

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